My favorite economist, A. Gary Shilling, has been recommending the long Treasury bond for so long that some gurus have dismissed him as a Johnny One-Note. But the results, had you followed his advice, would have been spectacular. If you had invested $100 in a 25-year zero-coupon Treasury bond in October 1981 and kept rolling it over each year to maintain the 25-year maturity, your $100 would have grown to $16,695 in June 2010. Meanwhile, had you invested $100 in the S&P500 at its low in July 1982, you would now have $1997 (including dividend reinvestment). So much for financial advisers who tell you that stocks always outperform bonds.
Okay, the doubters say, so Shilling has been right for the last three decades, but now interest rates are so low that they can’t go any lower. Not so. The long bond is still yielding about 4%, and if it drops to 3% it will generate a healthy capital gain – even healthier if you buy a zero coupon bond, as he suggests, and roll it over. Gary has been forecasting deflation for years, even writing a book or two on the subject, and he is not changing his tune a whit.
What does all this mean for the U.S. economy? Here’s the problem: Our economy was, as everyone now sees, a house of sand, built on too-easy credit. People bought houses they could not afford, ran up credit-card debt they could not service, and lived a life style impossible to sustain. Meanwhile, a huge retail infrastructure was built to service that easy-credit lifestyle (see my blog post “Overmalled,” dated October 29, 2007). Everyone now realizes that, but what does it mean for the future?
The only way to resuscitate the U.S. economy quickly and painlessly is to restore the very easy-credit environment that brought us down. Some members of Congress are in fact advocating that approach (they would not admit that, of course), and the President and his economic team have come perilously close to the line, maintaining that a “cold turkey” approach would trigger catastrophe. But once you start pushing banks and others to relax loan standards, it’s a very slippery slope – greased, moreover, with the politics of mid-term elections.
Levering was great fun; delevering is no fun, but it must be done. So people will not rush to the malls but will build their savings, because they are, understandably, worried about their futures. Investors will increasingly avoid most stocks and look for dividend-paying securities, the safer the better.
And underlying these realities is another, more serious problem: We have a President who has made clear his distaste for the business of business, especially big business. Bankers are fat cats, the drug companies are dishonest, insurance companies are crooks. Notwithstanding all the Presidential rhetoric glorifying the small machine shop or the corner hamburger joint, it is companies who hire people by the thousands that make the difference. And this President doesn’t inspire their confidence.
Shilling was right; deflation is here.