Bond Alternatives if Inflation is here to stay?

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-- Pardon what I just discovered became a very long post! --


Its a fair question, though I'm sure in 1975 no would have believed we would see 20% interest rates. Times change and policies must adapt.

Can it happen?
Like in the 80s, dramatically increasing rates would require the will of both the politicians and the electorate...but high inflation can create that sort of thing.

The fed has been able to keep interest rates low against a backdrop of near zero inflation and has at times been worried about deflation. Its helped that every major country has done the same which kept the dollar pretty strong by minimizing people chasing yields in other currencies.

There has been discussion about the "war on savers", but for the most part everyone has been relaxed because a pair of jeans cost pretty much the same as the year before, employment has been solid (punctuated by the black swan implosions) and the government turned on the printing presses when things hit the fan. Its been easy for the electorate to smile and move along.

If we start seeing 4-5% inflation that could change pretty quickly. It will be tempting for the government to "inflate away the debt", but the flip side of "smile and move along" may well surface. The average Joe doesn't think about using inflation to tame federal debt. They want to know why a pair of jeans suddenly costs $75.

Inflation hit 14% in 1980. We all know what followed.

So...what are the risks of high inflation?

I have no idea...but a few things I think about:

1) We are experiencing multiple global supply shocks simultaneously. In my industry, we're having to make consumer equipment procurement decisions 60 weeks out due to the shortage of chips. 60 weeks. It used to be 10 weeks.

2) Inflation has partially been held back over the last 30 years by the surge of globally cheap labor and accomodative trade policies. China is aging rapidly and lots of other countries lack the maturity to step into the demand.

3) Driven by geo & domestic political considerations and witnessing the global supply chain problems, western countries & big corporations are having serious conversations about "re-shoring" major industries into higher cost of labor/cost of operation countries. Aggressive climate policies may increase the costs of re-shored operations.

4) There is a shocking amount of cash sitting on the sidelines from the tale of two pandemics. For the white collar world, they stopped spending but kept earning. For the less fortunate, they got checks. Lots of people got both.

Its party time and many people have the cash to spend into the inflation. DD wants and iPad for university this fall. She'll get one even if its $50 more because I've loads of cash from not being able to travel last year. The guy after me might pay $50.01 more...$50.02...$50.03...lots of people want ipads.

If those forces combine?
Yes, we could see substantive inflation.

Will the Fed step in and use interest rates to curtail it?
Quite possibly.

So, yes, I think it could happen.

Interesting conversation. While I do not wish for high inflation, it is certainly possible. It is unclear how central bankers and national governments will be able react if it does happen. There is a wide variety of opinion in the financial world, for example Cathie Wood of ARK sees future deflation when many others are worrying about inflation. She believes that much of the near term shortages are driven by double/triple ordering that will ultimately lead to some commodity price collapse. Many computer chips are not commodities, but the same principle could be at work.

I tried to search and find a concise article that talked about the US debt and relationship to rising yields. I did not find any nice chart but this article had some numerical info, that indirectly notes how difficult it will be to service the debt if rates returned to 4-5%: https://www.crfb.org/papers/how-high-are-federal-interest-payments

This year, the federal government will spend $300 billion on interest payments on the national debt. This is the equivalent of nearly 9 percent of all federal revenue collection and over $2,400 per household. ... Each one percent rise in the interest rate would increase FY 2021 interest spending by roughly $225 billion at today’s debt levels.

This article was of the opinion that rates will stay low for a while
https://www.cbpp.org/blog/latest-cb...rest-payments-to-remain-low-for-several-years

CBO expects interest rates to stay below historical levels for at least a decade, projecting that the average interest rate on Treasury securities will drop from 2.0 percent in 2020 to 1.3 percent in 2023 through 2025 before rising to 2.4 percent by 2031.

 

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No idea if you are correct or not. But why not consider something "real" like PMs? They never go to zero. They don't get lost in the "ether." People instinctively understand them (not the subtleties perhaps) since they've been valued since antiquity. Even if gummints hate them, it's difficult to take them away except at the point of a gun. They have a track record - spotty though it is. You can hold them in your hand.

Given that they are a "bad" investment in most good times - which is why you don't keep a lot of them. 2-4% sounds about right. Very much a YMMV investment.

I agree PM should be more durable and keep up with inflation. I do not own PM as I mostly view them as a good inflation hedge but otherwise unproductive asset. An asset that the IRS will chip away at through taxes since their nominal value will increase, while the relative purchasing value will remain the same. Treating their price rise as income is unfounded IMO.

I was only speaking about crypto because of all the other market participants being so excited them. That another doubling+ in value is possible, so they would be better hedging the bond/money-market part of the portfolio. But I do worry about the greater fool behavior, and how "easy" it is to create alternative cryptocurrencies, and how if they became wildly successfully that national governments may effectively ban them.