I must confess, there are things out there that puzzle me. In the context of investing, the performance of gold consistent with my expectations, but the movement of bond yields contrary to, is one of them
My thesis, for those who don't know, has been that governments and central banks globally would print money relentlessly. The effect would be substantial currency debasement and rising bond yields, eventually resulting in a crisis scenario for lots of western countries. My main strategy to combat it has been the accumulation of gold and related ideas, assets that would benefit from such recklessness.
So far, the gold has worked. But the performance of bond yields has been unexpected (which is why I have stayed away). I know the Keynesian explanation: we're in a liquidity trap, people are hoarding cash, austerity in Europe is contractionary, the powers that be in the U.S. have not done enough printing and deficit spending, etc., etc. I just don't find that story convincing.
And that's where the Bob Murphy post is helpful. It triggered a thought and gave me a greater context to think about all the moving parts. My conclusion: we have not yet started the race to the bottom in earnest. And that's why certain assets are acting funny.
The interesting dichotomy right now is that countries with printing presses, who have shown a willingness to use them, are benefiting from incredibly low interest rates (think U.S. and Japan). By contrast, the countries of the European Union, who gave up their monetary sovereignty, are getting abused in the markets. The big problem is that they must defer to the ECB, and so far the guys in Frankfurt have not been willing to let the printing presses go in order to deal with the solvency issues of member countries. Thus, in a strange twist, because folks are scared, and more concerned about return of capital than return on capital, we see a difference in treatment that is counter-intuitive.
But, it will not last. There are two possible outcomes to the European situation, both of which will allow this interlude to proceed, finally, to the next and last act.
Scenario 1 - "Racers, start your engines!"
The most likely course of action is that the ECB will eventually relent and begin to print money with verve and vigor. It is the easiest call since it is right out of the Keynesian/Central Planner playbook. The immediate reaction is likely to be a relief rally. But, here's where it gets interesting, and where Murphy's observation is useful. At that point, everyone will be debasing. But, on a relative basis, no one is going to take a definitive lead. So, in effect, the export advantage that is expected won't manifest. But, you'll still have a lot more easy money floating around, which could end up anywhere. That will probably serve as the genesis for a more obvious inflation (versus the more sneaky one that we're experiencing now). And bond investors will start to demand more for their money because their purchasing power is being attacked. And, even if central banks start monetizing even more to keep rates low, they will end up crushing their currency. Not in a way that helps exports, but in a way that blows up their economy.
Scenario 2 - The Kyle Bass Story
The second outcome is that the ECB lets the sovereigns default. For simplicity's sake, I will call this scenario the Kyle Bass Story. He notes (as do Rogoff and Reinhart in their book) that there is a domino effect that comes into play once a single country goes down, increasing the probability that it will happen to others. The current belief system gets destroyed and the basis for the "safety trade" is questioned. And so it will start with Greece or Portugal. But then it moves to larger European states, and then eventually it move east to Japan, and finally it crosses the Pacific and lands at our doorstep. It is not an all-of-a-sudden thing, but the progression will speed up once the first sovereign goes.
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Okay, so the above is how I am rationalizing the current reality. Still, I feel pretty comfortable with what I've outlined. Whether you think its the first or second scenario, we're still simply in the build-up phase. The standard assumptions have not been put to the test yet because the critical decisions are still to be made. So, what does all of it mean? I think it means that those who are claiming victory because bond yields are still low are a bit premature. And, as an investor, you must be paying attention, because the situation is fluid and facts and circumstances will continue to evolve.
