Wednesday, December 7, 2011

Malkiel: Treasury Bond Investors are Sure Losers

In today's WSJ, Burton Malkiel, professor emeritus of economics at Princeton University, and the author of "A Random Walk Down Wall Street", warns about Treasury bonds. Malkiel, clearly sees the inflation that is coming:
For years, investors have been urged to diversify their investments by including asset classes in their portfolios that may be relatively uncorrelated with the stock market. Over the 2000s, bonds have been an excellent diversifier by performing particularly well when the stock market declined and providing stability to an investor's overall returns. But bond yields today are unusually low.

Are we in an era now when many bondholders are likely to experience very unsatisfactory investment results? I think the answer is "yes" for many types of bonds—and that this will remain true for some time to come.

Many of the developed economies of the world are burdened with excessive debt. Governments around the world are having great difficulty reining in spending. The seemingly less painful policy response to these problems is very likely to keep interest rates on government debt artificially low as the real burdens of government debt are reduced—meaning the debt is inflated away.

Artificially low interest rates are a subtle form of debt restructuring and represent a kind of invisible taxation. Today, the 10-year U.S. Treasury bond yields 2%, which is below the current 3.5% headline (Consumer Price Index) rate of inflation. Even if inflation over the next decade averages 2%, which is the Federal Reserve's informal target, investors will find that they will have earned a zero real rate of return. If inflation accelerates, the rate of return will be negative.
Malkiel also gives us a little history on what the last time interest rates were as low as they currently are in the U.S.:
After World War II, the debt-to-GDP ratio in the United States peaked at 122% in 1946, even higher than today's ratio of about 100%. The policy response then was to keep interest rates pegged at the low wartime levels for several years and then to allow them to rise only gradually beginning in the 1950s. Moderate-to-high inflation did reduce the debt/GDP ratio to 33% in 1980, but this was achieved at the expense of the bondholder.

Ten-year Treasurys yielded 2.5% during the late 1940s. Bond investors suffered a double whammy during the 1950s and later. Not only were interest rates artificially low at the start of the period, but bondholders suffered capital losses when interest rates were allowed to rise. As a result, bondholders received nominal rates of return that were barely positive over the period and real returns (after inflation) that were significantly negative. We are likely to be entering a similar period today...long-term U.S. Treasury bonds are likely to be sure losers for investors today.
Malkiel is a lot more optimistic about municipal and corporate bonds, than I am. It's all a matter of how strong the price inflation will be. If inflation stays under 5%, there might be some buys in the corporate and muni world, but if price inflation climbs to double digit levels, which I expect, all bonds will prove to be very poor investments.


  1. Poor investments, especially when compared to physical gold; negative real returns are just brutal to pensioners, retirees, anyone directly/indirectly tied to bond income...

  2. Just more disinformation from the mainstream economics profession. "Investment" is defined as choosing from a basket of various paper-based financial products.

  3. just to be clear, Bob, you are speaking about US dollar denominated bonds, when you says all bonds will prove to be poor investments? Correct?

  4. The yuan is likely going up from here, especially if the PBoC backs the RMB with gold. They've opened the Pan Asian Gold Exchange, and the Hong Kong Mercantile. Check out the Wikileaks cable about gold price suppression. Thanks JP Morgan for suppressing (naked shorting) precious metal prices, more time for us to cash out of this fiat.