Two veteran rate watchers offer dramatically different takes on a dangerous security: the 30-year Treasury.
With William BaldwinSenior Contributor
Tbull market bonds which lasted four decades stopped in 2020. The yield on long-term government bonds has quadrupled. And now what?
Faced with this question are two extremists, both longtime yield curve analysts, both stubbornly clinging to their long-held views. One, a bond bull, was spectacularly right for 38 years and then just as spectacularly wrong. The other has a history that is almost a mirror image.
The bull is Gary Shilling, Ph.D. economist whose A. Gary Shilling’s Insight The newsletter is aimed at corporate treasurers and money managers. In 1982 he made the very opposite argument that inflation was destined to decline, meaning that you would do well to hold long-term Treasuries whose coupons were fat in anticipation of high inflation. He makes the same argument today. In the portfolios he manages are the long bond and the long the US dollar.
James Grant, editor of Subsidy Rate Monitor, it is the bear, sour on both government bonds and the dollars they will be redeemed with. A long time ago, his letter gave strong comments about the “Ph.D. model of monetary management,” by which Grant means the Federal Reserve’s theories about why it’s a good idea to print money with abandon. He believes that gold is a better store of value than a dollar.
When, Forbes asks Grant, did you first become a fiat currency skeptic—in grade school? Deflecting the question, he notes that he recently admitted to his readers that his recommendation to get out of bonds was a bit premature. It came in 2004, 16 years before their prices peaked.
These polar opposites have a few things in common. They were both, in the 20th century, its columnists Forbes magazine. Both believe a recession is likely, though for very different reasons: Shilling, because an inverted yield curve and other statistics indicate that; Grant, why a decade of artificially suppressed interest rates has created so much financial disarray. Both have farming instincts. Schilling collects honey from 60 hives near his office in Springfield, New Jersey. Grant presides over 250 acres of farmland, timber and pasture a few hours north of his Manhattan office.
The shilling makes many arguments for the proposition that inflation will ease. First is that inflation is not so much a monetary phenomenon as a consequence of excess demand. The US experiences this in times of war or pandemic, but not now.
Next is that technology lowers costs, albeit after a delay: “The American industrial revolution began in New England in the 1700s and only after the Civil War became important. Railroads took 50 years to become important.” He expects something good to come from AI, even if people expecting an immediate productivity boost are disappointed.
Finally, there is Shilling’s belief that the price-squeezing effect of globalization is far from over. Western technology married to Chinese labor made goods cheap. now india will make services cheap. Software can be offshored. Perhaps medicine, accounting and money management will follow.
How would an investor fare by persistently holding long-dated bonds? Surprisingly good, at least on paper. Shilling says that a hypothetical portfolio of zero-coupon government bonds, created in October 1981 and issued annually to maintain maturity at 25 years, would have beaten an investment in the S&P 500. That’s despite the wild fall in bond prices over the past three years.
Grant’s talking points start with this: Politicians are ungrateful. The October 27 issue of Interest rate monitor Economist Charles Kalomiris, who posits a bleak scenario in which Congress, unwilling to raise taxes or cut spending, counts on the Fed and financial regulation to get by by essentially imposing an 8% inflation tax on currencies and bank deposits.
Grant, author of books chronicling economic events of a century or more ago, has good reason to be pessimistic about paper money. The dollar that bought 1,500 milligrams of gold in 1923 buys only 16 milligrams today. This decline suggests that the 30-year Treasury bond now yielding 4.6% will leave you with a 0% return on metal.
One more thing that should be given to bond buyers comes from the charts. Grant notes that fluctuations in interest rates have historically spanned long periods. Perhaps every new generation needs to relearn history. The half of the country that didn’t live through Paul Volcker’s heyday was pretty unprepared for what happened to interest rates recently.
The previous bond market bear market lasted from 1946 to 1981, when, Schilling recalls, “everyone thought inflation would stay in double digits forever.” It was a great time to buy bonds. If the pattern repeats, the next buying opportunity will appear in 2055.
Grant isn’t prepared to predict that the current bear market will last another 32 years, but he wants investors to be careful: “I’m a ‘yeah but’ guy in a ‘gee whiz’ world.” If interest rates continue their upward trajectory, he says, bondholders can at least recoup some lost ground by reinvesting coupons at better rates. He advises fixed income investors to fill their positions with gold.
The shilling is not a fan of hard assets. “Human ingenuity has always beaten scarcity,” he says, adding that he has taken a short position in copper futures.
A two-point drop in interest rates would take a 25-year zero now trading at 31 cents on the dollar at 50. Equally plausible, gold could soar to $3,000.
Cellini, at 86, still works full-time. Grant, 77, has no plans to retire. There’s time for one of these Wall Street veterans to get one last tail.
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