Hoisington Quarterly Report Predicts Lower Long Term Treasury Yields

[Reub]

http://www.hoisingtonmgt.com/pdf/HIM2012Q3NP.pdf

The quarterly Hoisington report is out and their analysis is the following:

"Until the excessive debt issues are addressed, the multiyear
trend in inflation, and thus the long Treasury
bond yields will remain downward."

[MediumTex]

http://www.hoisingtonmgt.com/pdf/HIM2012Q3NP.pdf

The quarterly Hoisington report is out and their analysis is the following:

"Until the excessive debt issues are addressed, the multiyear
trend in inflation, and thus the long Treasury
bond yields will remain downward."

My belief since 2008 has been that treasury yields were going to stay low for a LLLLLLLOOOOOONNNNNNGGGGGGGGG time.

So far, that belief has been validated by experience.

[Reub]

And you have been right!

[Ad Orientem]

In the near to intermediate term I tend to agree. The only way to deal with an asset bubble depression that is based on bad debt is to bleed out the bad debt and let the chips fall where they will. That will be incredibly painful in the short run, but long term it is essential to rebuilding an economy on a sound footing.

[melveyr]

The private sector has too much debt relative to its income.

There are two ways out: You can give the private sector more income, or you can let the debtors default (destroying the debt). My main problem with the latter solution is that debtors defaulting destroys income further.

The low Treasury yields indicate to me that the market thinks we are pursuing the latter solution.

[Ad Orientem]

The private sector has too much debt relative to its income.

There are two ways out: You can give the private sector more income, or you can let the debtors default (destroying the debt). My main problem with the latter solution is that debtors defaulting destroys income further.

The low Treasury yields indicate to me that the market thinks we are pursuing the latter solution.

I agree with you in part. But I suspect that low Treasury yields are at least partly being influenced by the massive QE. Remember that in 2011 60+% of all US Gov't debt that was issued was bought... by the US Government. I will be interested to see the numbers for 2012 when the eventually come out.

[melveyr]

The private sector has too much debt relative to its income.

There are two ways out: You can give the private sector more income, or you can let the debtors default (destroying the debt). My main problem with the latter solution is that debtors defaulting destroys income further.

The low Treasury yields indicate to me that the market thinks we are pursuing the latter solution.

I agree with you in part. But I suspect that low Treasury yields are at least partly being influenced by the massive QE. Remember that in 2011 60+% of all US Gov't debt that was issued was bought... by the US Government. I will be interested to see the numbers for 2012 when the eventually come out.

That is true. It is hard to know where yields would be on the long end of the curve without the Fed's actions. However, I still think they would be low on a historical basis.

[systemskeptic]

The low Treasury yields indicate to me that the market thinks we are pursuing the latter solution.

The market doesn't think anything because the market isn't the largest purchaser of treasuries -- the U.S. Government is. 

That is true. It is hard to know where yields would be on the long end of the curve without the Fed's actions. However, I still think they would be low on a historical basis.

Yields are based on demand.  Currently the US government is providing the demand (buying up a large share of treasuries at auction) required to match the enormous supply [of our exploding debt].    If that demand vanishes, yields will rise or the dollar will go into default.  Possible, but quite unlikely.  More likely is the U.S. government will be forced into buying a larger and larger percentage of treasuries at auction [as they already are], and the inflation that was previously exported to other countries [the previous buyers of treasuries] will finally hit home. 

The result of this is very high inflation / hyperinflation in $USD.

[MediumTex]

The low Treasury yields indicate to me that the market thinks we are pursuing the latter solution.

The market doesn't think anything because the market isn't the largest purchaser of treasuries -- the U.S. Government is. 

That is true. It is hard to know where yields would be on the long end of the curve without the Fed's actions. However, I still think they would be low on a historical basis.

Yields are based on demand.  Currently the US government is providing the demand (buying up a large share of treasuries at auction) required to match the enormous supply [of our exploding debt].    If that demand vanishes, yields will rise or the dollar will go into default.  Possible, but quite unlikely.  More likely is the U.S. government will be forced into buying a larger and larger percentage of treasuries at auction [as they already are], and the inflation that was previously exported to other countries [the previous buyers of treasuries] will finally hit home. 

The result of this is very high inflation / hyperinflation in $USD.

If you look at things more broadly you see that we are in a post-bubble economic environment, which is typically deflationary, especially if the speculative bubble was fueled by cheap credit.  It is unusual to see inflationary conditions in such an environment because the structural deflationary forces are so powerful. 

When you overlay the historic demographic shift we are also living through (which is also deflationary when you are on the back end of it), it would be hard for inflation to get any traction unless the government literally mailed a $50,000 check to every household in America.

Remember that interest rates are very low in many countries right now (Japan, Germany, U.K., and the U.S. to name a few).  These low rates cannot be explained simply by central bank action, since all of the central banks have adopted bond buying programs of different sizes, but the rates have fallen more or less in tandem, at least in the U.K., U.S. and Germany. 

There is something more fundamental going on here, and it is just the typical low interest rate environment you typically see after a credit-fueled asset bubble pops.  Risk-free bonds simply don't have much to compete with and thus there is nothing to push interest rates higher, whether or not you have central bank action. 

The Fed's actions might explain 100-150 basis point in treasury pricing across the whole yield curve (if that much), but if you take this element away you still have VERY low interest rates.

[systemskeptic]

MediumTex,

While it is true that we recently experienced credit deflation, what happens in the private/banking sector is only one part of the puzzle.  The U.S. has been running a trade deficit for decades.  Previously this deficit was settled by selling treasuries to other countries (exporting our inflation).  We were only able to do this because of the Bretton Woods system, signed on 22 July 1944 by 44 countries, which was a direct result of the outcome of WWII.

China, and many other countries have been slowly withdrawing their support of the dollar.  This can be seen in the recent statistics at treasury auctions -- foreign countries are no longer buying in size.  The percentage of treasuries purchased by the U.S. government has been increasing every quarter in recent years.  In 2011, the US ran a trade deficit of $558 billion.  What will happen when the U.S. government is forced to purchase the entire lot at auction, because no one else will?

If the dollars no longer go overseas, and instead stay at home, how can you expect deflation with an extra $558 billion a year accumulating in the U.S. -- year in and year out?

[systemskeptic]

You can't compare Japan to the US because Japan has been running a trade surplus since the 80s.  The yields were low because they experienced a legitimate deflation.  It's misleading to look at low Japanese yields because their currency was appreciating. In the US, rates are low because our own Government is currently inflating away our currency to settle our $500 billion/year bar tab.  

Yields could be low for the next 20 years (if everyone plays along) and anyone holding US dollars will see their savings inflate away as yields are 1-3% and inflation is much higher.  If the facade is dropped, everyone plays hot potato as all the foreign reserves pour back to the US, and you are left with a hyper-inflationary scenario.

[systemskeptic]

In short, the narrow view is looking at this as a credit bubble.  The broad view is realizing this is the result of 68 years of having the privilege of owning the world's reserve currency and being able to run decades of massive trade deficits by exporting our inflation all over the world.

[MediumTex]

Who would you say is in a better position in a fiat money world, the nation with a trade surplus or the nation with a trade deficit?

Whichever one you choose, can you explain why?

[stone]

Who would you say is in a better position in a fiat money world, the nation with a trade surplus or the nation with a trade deficit?

Whichever one you choose, can you explain why?

I'd say a nation with balanced trade. A country needs to maintain expertise and be able to do stuff. If a nation just prints money to buy what it needs, it becomes incapable. If a country works itself to the bone and accumulates immense FOREX reserves, then it is creating instabilities for itself down the line. Both those situations tend to distort society and the economy in unfortunate ways. IMO balanced trade leads to stable long term prosperity.

[melveyr]

One way I look at imports (if we pay for them in dollars) is that we are receiving things that are scarce to our nation (real goods and services) and sending them something that we have an infinite amount of (our own fiat money). It's not a terrible deal for us. Now, this only happens because NET the foreign sector wants to accumulate dollars. You can only do this up until the foreign sector is satiated with dollars. After this level of dollar satiation, you might have to pay for imports in a foreign currency (acquired by providing a real good or service to a foreigner and getting paid in their currency).

In many ways, the trade deficit denominated in dollars is pretty awesome benefit to our nation. We are lucky that the foreign sector likes to hoard dollars. It's one of the subtle ways that America's power is like an empire. The end result is that real goods and services flow towards us.

[systemskeptic]

Who would you say is in a better position in a fiat money world, the nation with a trade surplus or the nation with a trade deficit?

Whichever one you choose, can you explain why?

Right, of course the U.S. benefits from this agreement.  However, that isn't the question -- the question is how long can this free ride last, and what will happen if it ends?  What you are seeing today (in a broad view) is again, not a credit bubble but the ending of this free ride.

[MediumTex]

Who would you say is in a better position in a fiat money world, the nation with a trade surplus or the nation with a trade deficit?

Whichever one you choose, can you explain why?

Right, of course the U.S. benefits from this agreement.  However, that isn't the question -- the question is how long can this free ride last, and what will happen if it ends?  What you are seeing today (in a broad view) is again, not a credit bubble but the ending of this free ride.

Part of the "free" ride the U.S. has enjoyed has required massive military spending to keep this arrangement going around the world (sort of like the British Empire needed a massive navy to protect its commercial interests around the world), so I don't know if the ride the U.S. has been on was actually that free.

What do you think the catalyst will be for the U.S.'s structural trade deficit arrangement with the rest of the world to come unwound?

What would China do with all of its productive capacity if the U.S. was no longer willing to buy its products?

I completely agree that the U.S. will sooner or later enter a period of decline, but I don't think it's going to be any time soon.  The U.S. simply enjoys too many structural advantages over virtually any other country on earth at this point in time.

The U.S. is the:

#1 economy (only slightly smaller than the whole EU)
#2 manufacturing economy (China is #1)
#2 total natural resources (Russia is #1)
#3 world oil producer (behind Russia and Saudi Arabia)
#1 currency
#1 gold reserves (more than double Germany's, the next country on the list)
#1 bond market ($37 trillion+)
#1 stock market ($21 trillion+)
#1 military (U.S. military spending is more than the next 15 nations on the list combined)

Advantages like that take decades to erode.  It's not something that happens quickly when you've got leadership and dominance in so many categories.

Are you thinking that all of that is just going to collapse over a period of a few years in one giant hyperinflationary bonfire?

In these hyperinflationary scenarios, one of the questions that is never answered is whether the #1 economy in the world wouldn't actually get much stronger in an inflationary scenario because it would suddenly have an enormous export advantage over every other country in the world that wasn't seeing the value of its currency decline.  Would the rest of the world sit by and watch this happen without making their own attempts at devaluation?  The world economy since 2008 basically answers this question.  No nation that depends on exports is going to allow its exporters to be ruined by another productive economy's efforts at devaluation.  No nation wants a strong currency any more.  See what Switzerland did to its currency last year for an excellent example of how a modern industrial nation responds to a strengthening currency.

The whole world is in a devaluation derby right now.  What's happening in the U.S. is happening in most of the industrialized world.

If China stopped trading with the U.S. completely, who would be hurt more, China or the U.S.?  Well, if you look back a few decades when China wasn't trading with the U.S. like it is today, China was a communist thugocracy whose most notable accomplishment was presiding over the greatest orchestrated human starvation event in history.  What was the U.S. doing back then?  It was having some political and economic struggles, but it was still #1 in most of the categories above.

The media sells this narrative of U.S. decline, but I just don't see it (though there are obviously a lot of ways in which the U.S. could be improved).

A nation with the world's reserve currency must run a trade deficit.

[systemskeptic]

MediumTex,

"so I don't know if the ride the U.S. has been on was actually that free."

It is free from the perspective that the debt that was taken out to fund these projects cannot/will not be paid back.

"What do you think the catalyst will be for the U.S.'s structural trade deficit arrangement with the rest of the world to come unwound?"

I would turn the question to you and ask: is a perpetual trade deficit sustainable, particularly if that country is not the holder of the world's reserve currency?  The rest of the world is already moving to revoke this privilege, that is undeniable.  The support for the $USD has already been removed.  The final straw will simply be the realization/acceptance of this fact.  One reason it hasn't occurred yet is nobody knows exactly what will replace the dollar as a reserve currency.  What is certain is the dollar cannot maintain it's reserve status indefinitely.  Do you agree?

"Advantages like that take decades to erode.  It's not something that happens quickly when you've got leadership and dominance in so many categories."

100% agreed.   Unfortunately it's times like this that often lead to war.

"The media sells this narrative of U.S. decline, but I just don't see it (though there are obviously a lot of ways in which the U.S. could be improved)."

I agree with you that we have the strongest military, the strongest economy, etc. but again how much of that is due to our innate abilities and how much of that is due to our ability to export $500 billion dollars in inflation to the rest of the world?  What I am saying is once you take that away, we have to balance our trade... period.   The only way to do that is austerity, and that means a drop in the standard of living and a devaluation/hyperinflation of our debt.

How do you see deflation, considering this picture?

[MediumTex]

MediumTex,

"so I don't know if the ride the U.S. has been on was actually that free."

It is free from the perspective that the debt that was taken out to fund these projects cannot/will not be paid back.

"What do you think the catalyst will be for the U.S.'s structural trade deficit arrangement with the rest of the world to come unwound?"

I would turn the question to you and ask: is a perpetual trade deficit sustainable, particularly if that country is not the holder of the world's reserve currency?  The rest of the world is already moving to revoke this privilege, that is undeniable.  The support for the $USD has already been removed.  The final straw will simply be the realization/acceptance of this fact.  One reason it hasn't occurred yet as nobody knows exactly what will replace the dollar as a reserve currency.  What is certain is the dollar cannot maintain it's reserve status indefinitely.  Do you agree?

Nothing in our world is perpetual.  There are just different time scales for change.

I don't think the world is moving away from the dollar as the world's reserve currency right now.  I hear noise, but I see no actual steps in that direction.  The dollar is stronger than people probably realize.  It just takes a good disaster or emergency to remind everyone of this fact.  Someday that will all change, but I don't believe it will be any time soon.

"Advantages like that take decades to erode.  It's not something that happens quickly when you've got leadership and dominance in so many categories."

100% agreed.   Unfortunately it's times like this that often lead to war.

Sure, but should war be bothering the U.S. with the largest military in the history of the world and orders of magnitude larger than any other current military?  This kind of military dominance is almost unheard of in all of history.

"The media sells this narrative of U.S. decline, but I just don't see it (though there are obviously a lot of ways in which the U.S. could be improved)."

I agree with you that we have the strongest military, the strongest economy, etc. but again how much of that is do to our innate abilities and how much of that is due to our ability to export $500 billion dollars in inflation to the rest of the world?

We have immense natural resource deposits, an immense manufacturing infrastructure, a hardworking and docile labor force, and a good legal system that allows the enforcement of property rights.  Those are the ingredients for a VERY powerful economy.

What I am saying is once you take that away, we have to balance our trade... period.   The only way to do that is austerity, and that means a drop in the standard of living and a devaluation/hyperinflation of our debt.

Where has austerity worked?  It hasn't, not in a fiat money world.

How do you see deflation, considering this picture?

In an economy that is not experiencing capital flight, has unused capacity (including a lot of unemployed people), is experiencing private sector deleveraging, and is experiencing a demographic shift, deflation is all I would expect to see, and that is what the Fed has been fighting since 2008.  Inflation will come along at some point, I just don't think it will be any time soon.

[systemskeptic]

MediumTex,

I think it boils down to this:

"The U.S. simply enjoys too many structural advantages over virtually any other country on earth at this point in time."

While true, where our position differs is I believe the structural advantage can be removed at any time [as is currently in progress].  It's confusing because there are many concurrent variables.  The dollar is temporarily strong because we are the best apple in a bundle of bad apples.  However, this will not be the case if we lose our privileged status as world currency. 

To some degree, we are already enforcing this status with war.  Iran, Iraq, what do these countries have in common aside from what you hear in the news?  The answer is both officially declared they would no longer sell oil for dollars -- they openly removed their support for the $USD.  Look how that turned out. 

Remember in 1944 the privilege of reserve currency was unanimously given by 44 countries, not taken by 1.  There is only so much the U.S. can do with it's fleet of battle carriers.

[systemskeptic]

that is what the Fed has been fighting since 2008.  Inflation will come along at some point, I just don't think it will be any time soon.

Again, are they fighting a credit bubble or trying to prolong the reserve status of the $USD as long as possible?  As we've already seen, it's a huge advantage to export your inflation and run perpetual trade deficits without penalty.  So far we've been able to prolong it for 41 years (ever since Nixon terminated gold convertibility) at great benefit to our economy.

[MediumTex]

that is what the Fed has been fighting since 2008.  Inflation will come along at some point, I just don't think it will be any time soon.

Again, are they fighting a credit bubble or trying to prolong the reserve status of the $USD as long as possible?  As we've already seen, it's a huge advantage to export your inflation and run perpetual trade deficits without penalty.  So far we've been able to prolong it for 41 years (ever since Nixon terminated gold convertibility) at great benefit to our economy.

I think that since this interesting exchange has erupted more or less off topic in a pretty boring sounding thread title, no one else may even be reading our posts. 

It's sort of funny when that happens.

I see your perspective, and it might happen sooner than I'm thinking.  The good news is that the PP should provide plenty of protection if such a rapid currency devaluation were to occur.  There would probably also suddenly be tons of U.S. manufacturing jobs as U.S. exports got a lot cheaper in foreign markets.

[clacy]

I am reading, if it makes you feel better 

[Pointedstick]

Me too! I just feel l would detract from the level of wisdom and intelligence on your side of the discussion were I to chime in. 

[MachineGhost]

#3 world oil producer (behind Russia and Saudi Arabia)

The WSJ recently reported that the US will be the #1 oil producer in the world, tied with Saudi Arabia, at the end of 2013.