The last time the yield on the 10-Year US Treasury dipped below 2% was in 1941; just before (not just after), the Japanese attack on Pearl Harbor.
Perhaps then the recent 1.8% low was not just because of Euro-refugees, perhaps we are on the cusp of another Black Swan tail-risk potentially as devastating as World War II? Or perhaps there is another explanation?
This article is a continuation of a series started two years ago which correctly predicted the 10-Year was headed to below 3%. Back then that notion was a minority; some analysts were predicting more than 6% by 2012 and in those days 3% or less was considered pretty odd-ball.
What are the odds that theory can do it again?
Now everyone is saying less than 3% or thereabout will be around for a while, although it’s not abundantly clear whether the theory behind that idea is a new theory or if it’s the same one that incorrectly predicted more than 6%? I have no doubt that the idea of more than 6%, based on the same theory that predicted less than 3%, will be considered odd-ball.
Not that many people are making specific predictions these days…prediction seems to have a bad name, I wonder why? But it wasn’t always like that, in 1953 Milton Friedman wrote: “The question whether a theory is realistic “enough” can be settled only by seeing whether it yields predictions that are good enough for the purpose in hand or that are better than predictions from alternative theories.”
So, according to Friedman, did “below 3%”…settle it?
The tail-risk of making a prediction, of course, is that you can end up looking silly, and no one likes that. For example, in 2010 I had a theory that gold was a bubble. That brilliant insight (not all mine) was based the historical correlation between the price of gold and the price of oil. Today I am pretty sure that theory most probably…err…missed something important; even though it was a very pretty theory that explained the past almost perfectly. That proves it is much safer to couch predictions with caveats, that way you can say your theory was right, whatever happens.
That said, in common with some of the fringe religious sects who predict things like “The World will end on 12th August 2011”, some theorists when confronted with the evidence that the world did not in fact end, say things like, “Oh but that was a Black Swan Tail Risk so it doesn’t count”. Which goes to show those Black Swans can come in real handy for anyone in the guru business….house prices didn’t go up forever, Black Swan…no WMD in Iraq, Black Swan…NYSE didn’t drop back to the lows of March 2009, Black Swan.
Of course one correct prediction does not prove a theory is any good. To do that you have to work out the probability that the correct prediction could equally have been a lucky fluke; if so, even if the prediction was right, that didn’t mean the theory was.
Tail-risk or heads or tails risk:
If the probability that a prediction based on a theory could have been made by a fluke is low then you can start to believe that perhaps it has some merit, or in other words it might be useful…err…to make predictions…rather than simply being something you can roll out to impress everyone at the next conference to debate how many angels can fit on the end of a pin. Although you can never be 100% sure a theory that correctly predicts the future many times, will deliver next time.
A small practical problem is that it’s not completely obvious how you work out the probability of a fluke on economic or financial prediction. Even though there has been much debate about the art, science, or psychic wonders of prediction, there is no consensus on how you work out by how much one prediction about something financial or economic is better (or worse) than another.
How about this for an idea; [IF] say for example in February 2010 the credible options for the future yield on the 10-Year ranged from “below 3%” to “above 6%”, and those extremes each represented two standard deviations from the mean at the time. [THEN] assuming those “credible options” were normally distributed, the probability a prediction “below 3%” was a fluke, is about 2.5% (one in 40). That logic at least gives an order of magnitude.
Another way to work that out might be to say that all the possible options were from 1.75% to 15% (some analysts were talking about hyper-inflation at the time and that’s pretty-much the complete range over 100-Years), so “less than 3%” had a chance of being a lucky guess of 1.25/13.25 = 9% (one in eleven).
Sadly, although according to the hurdle used by many financial and economic experts, both those “probabilities” are “statistically significant”, even if we take the most flattering estimate of one in 40, that’s not anywhere near the one in 3.4 million 5-Sigma probability set to decide if the theory about the Higgs Boson is correct. Which might explain why sometimes economists and financial gurus are accused of suffering from physics-envy?
Some consolation can be garnered from the knowledge one in 40 is about the same probability that when Paul the Octopus predicted five winners in the 2010 FIFA World Cup, it was a fluke…rather than thanks to some genius theory Paul had, or perhaps because he was psychic.
Given that Paul went on to predict the right answer another three times in a row, what that proves, beyond all reasonable doubt, is whoever had that genius-theory about “below 3%” (half of which, I hasten to add, was not mine), might just be as smart as a common octopus from Weymouth, but only if he does the same trick twice.
The Calamari Conundrum:
The last time prior to Q1-2009, the year-on-year quarter to quarter growth of nominal GDP in USA dipped below minus 3% was Q3-1938, in both cases, two and a half years later the 10-Year went below 2%.
Doth that prove history doth repeat or doth it rhyme?
Or in other words (a) perhaps the prospect of imminent disaster such as the threat of something akin to the most destructive war mankind has ever engineered, might affect the yield on the 10-Year, and/or (b) perhaps also there is a causative link between changes in nominal GDP in the past and the yield on the 10-Year in the future?
That’s two theories, there are other theories although not many of those (if any) have stood the test of trial and error in the brutal “real” world, which eats predictions based on silly theories, for breakfast.
Is something as bad as World War II on the cards?
If the theory about rhyming history is right then just like you can predict how many fairies will be standing on the end of a pin, next Wednesday, once the 10-Year recovers her composure we might have to wait another seventy years for that to happen again. That’s a bit like waiting for a total eclipse of the sun, although those are easier to predict.
But perhaps something worse is brewing; perhaps the pesky Black Swan is still out there lurking with a bag-full of pent-up tail-risks which will be as destructive to the New World Order as World War II was to the way things used to be? Certainly the seeds of belligerence then are reminiscent of now, plus, like then, there is an abundance of massive and multiple deficits…of intelligence.
For example, who knows what the Federal Reserve paid for the $1.2 trillion or so of toxic asserts they have on their books, who knows how to value those things, who knows how much of the $1 trillion or so the ECB threw into the fire will get paid back, who even knows what is the GDP of Greece? And who could possibly have known there were no WMD, given all the “intelligence”?
So many theories and who can tell which one to pick for salvation? Scottish philosopher David Hume (1711-1776) had some ideas on that, he once said…“a statement or question is only legitimate if there is some way to determine whether the statement is true or false.”
Well at least we found out that the statement, “House prices will go up forever” and that other one, “There are hundreds of WMD in Iraq”, were both false. Sadly, unless you are a banker or a defense contractor, added together it cost “someone” (else) more than quite a few couple of trillion dollars to find out those two theories were, in the words of Alan Greenspan…“flawed”.
But that’s OK. Just like the Roman emperors and since then, legions of Rambo-inspired, princes, kings and dictators, all say, “So what? Money is easy to make, all you need to do is debase your currency, or thanks to modern technology, you can just print it”. See…that proves history doth repeat and it doth rhyme.
Perhaps, there is indeed worse to come? John McCain’s little ditty, Bomb-Bomb-Bomb-Bomb-Bomb-Iran is now being chanted like a mantra by the latest Republican hopefuls and the good news is that the focus groups all show that idea is immensely popular. Almost as popular as the idea in Roman times of having Christians eaten-alive by lions, complete with live updates and slow-motion close-ups on CNN.
The brutal reality is that regardless of the up-tick in employment numbers the only way Obama will get re-elected will be if he does the Rambo thing before the Republicans claim all the glory delivering Mission Accomplished, one more time.
Some say that’s the Achilles Heel of popular democracies; you have to choose between what’s popular but not smart, and what’s smart but not popular. Like once upon a time when 70% of Americans “owned” their own homes and you asked the focus groups, “Would you like higher house prices?” The answer was infinitely predictable, and you have to remember, those in the 70% represented 90% of the electorate who vote.
Pondering the darker side of the unforeseen consequences of history rhyming plus the risk that there is a Black Swan lurking, insofar as the experts who debate the meaning of life, plus or minus the Geneva Convention which is of course optional if the goal is the “greater good”, there remains a stubborn confusion over the difference between a “tail risk” and a “heads or tails” risk.
A tail risk is the sort of risk that the seven meter high barrier in Fukushima might have been breached some time during its design life. A heads-or-tails risk is the 50% chance that the theory “US-house prices will go up forever” would turn out to have been catastrophically wrong. Which was sadly a detail not appreciated at the time by the rating agencies provided with a three-way monopoly concession by central banks to assign AAA ratings on securities, whose value relied on that premise. The brutal reality is that “statistically speaking” a tank full of octopuses could have done a better job, much cheaper.
Just because house prices went up for 99 years out of 100 and that means if “history rhymes” the probability they will go up next year is 99%, doesn’t mean that THEORY for why they will go up next year or forever, (as in “history rhymes”), is right.
Even if a theory correctly predicts “up next year” ten years in a row, the chances that theory was WRONG based on that evidence of ten years correct predictions, is 99% raised to the power of 10 which is equal to 90.4%.
You would have to test the theory that history rhymes and get the correct answer for 70-years in a row to achieve the same degree of certainty in your theory, as the theory Paul the Octopus used to pick the winner of a FIFA World Cup game…once, i.e. 50%, one flip of the coin.
By that logic, the probability of default of a toxic RMBS rated AAA by Moody’s, Fitch, or S&P, was 50% x 70% (thanks to the waterfall) = 35%. That’s about how it worked out; although if you search high and low on the Internet you won’t find those statistics…I wonder why?
There are others who get confused about probability, for example the theory behind the GE design of Fukushima which put the generators which were needed to power the pumps to lift the cooling water to cool the reactor core in the event of a “tail-risk” and then a shutdown…IN THE BASEMENT; was beyond stupid.
Anyone who knows anything about engineering knows that according to The General Theory of Murphy, anything electrical of a critical nature installed in a basement has a 99.42% chance of being flooded just when you need it most.
That’s not a tail risk, that’s a “heads I lose tails you win type of risk” with the 0.58% residual being the chance that once in a while the coin will end up standing on its side.
By the same token, like Basel II, the newly reinforced pillars of Basel III stand on the shaky foundations of the theory that someone, some-day, will be able to figure out how to do a proper valuation. Basel II mentioned the word “value” 246 times, but they never explained, once, how you work that out. As in…err…Duh!
Remember when Hank Paulson said he could value toxic assets for TARP, and then he changed his mind, remember when Tim-Boy said he could do the same thing for PPIP, and then he changed his mind? The brutal reality is that “value” is not the price you can sell rubbish to the Federal Reserve for, it’s the price you can sell it to your worst enemy for, on the day you have to sell it. Valuation is like a generator, you can choose to put it in the basement, out of sight, or on the roof.
Could the risk of a World War II scenario simply be that those who are paid to stay awake but are pretending to be asleep; might soon be rudely jerked into consciousness by the tail-risk discovery that the ghostly zombies from the shadow’s who have found a way into their beds, are sucking their blood?
Personally I don’t believe in Ghosts, but I do believe in Stupidity.
Perhaps there is another explanation for why the 10-Year is hovering around 2% at the moment, other than a collective dread that there will be the economic equivalent of another World War II?
That’s another theory. By way of background, the previous correct prediction of the direction to below 3% was based on two theories:
1: You can use International Valuation Standards to value anything (Treasuries have a value). That’s not exactly a radical theory, given that those standards are agreed by every valuation society in the world to represent the best way to do valuation, not that anyone uses them, particularly not FASB, IASB or BIS.
2: The General Theory of the Pebble in the Pond which says in times of bubble & bust, E2 = MC. Where in times of market disequilibrium [E] is the equilibrium (or other than market value if you use International Valuation Standards), [M] is the minimum after the bubble pops, and [C] is the crest of the bubble; assuming of course that the equilibrium is constant, if it’s not it gets (a little bit) more complicated.
So far since September 2008 those theories combined have made a total of seventeen correct predictions on the direction of (a) the US Stock Market (b) Oil (c) US House Prices (d) US Treasuries.
The probability those predictions, made in a row without one wrong, could have been made by lucky guess; worked out using the least flattering methodology outlined above, is one in 4.3 million; which less (i.e. better) than the one in 3.4 million 5-Sigma hurdle set for the discovery of the Higgs Boson.
Paul the Octopus would have had to make a correct prediction on the results of those football games twenty-three times in a row to have achieved the same degree of certainty that his theory was right.
So, in the words of Milton Friedman, does that “settle it”? Or perhaps there are other theories that can do predictions better than that?
Can the Pebble in the Pond foretell the future…Again?
Maybe not, “below 3%” was the first time that idea was used for US Treasuries, and there is a one in eleven to one in 40 chance that in the case of Treasuries the theory could be wrong.
Perhaps therefore it would be a good idea for the Guru-with-a-Theory and the ear of the pebble in the pond, to rest on his laurels and tell everyone, “See I can prove beyond a shadow of a doubt that I am a lot smarter than a common octopus from Weymouth”, and from here on in, “I don’t make predictions”. That’s the tail-risk-free option…but what would be the fun in that?
The valuation side of the prediction (Step-1); is to figure the “equilibrium” or what International Valuation Standards calls other than market value. That loosely translates as the price the market ought to be if it was not going through a period of disequilibrium, which is a word sometimes used to politely describe outbreaks of collective mass-stupidity.
In this case the valuation was based on the theory that there is a causal relationship between past nominal GDP growth and the yield on the 10-Year; here’s a chart:
The first thing that smacked me in the mouth when I looked at that chart, which I never seen before, was that I finally understood why Ludwig von Mises used to go on and on about the “business cycle”.
Up until the Great Awakening, which appears to have started in the early 1960’s, what appears to have been happening was a succession of booms and busts in nominal GDP with economists scurrying around saying that wasn’t “real” and that the booms were caused by inflation, and the busts were caused by deflation, as if that’s any more helpful than knowing how many angels can stand on the end of a pin.
Perhaps after World War II the policy-makers secretly started listening to Mises…just a little bit? Although that said; one wonders how relevant all that is to the main problem today which is that the world is full of Zombies and Black Swans, and the truth is that a couple of years of 20% growth of nominal GDP in USA, whether it was real or not, and whether or not it might lead to an equally sized bust, would be welcomed by almost everyone. Sadly like for an addict with a terminal habit, even massive doses of the new-fangled Q-Drugs can’t seem to create a return to boom-and-bust.
Anyway, that’s all by-the-by, the idea that somehow past nominal GDP growth drives the yield on the 10-Year is just a theory. All the same, International Valuation Standards does say that you must collect “sufficient” market derived data, and analyze it…”sufficiently”, before you offer up your opinion on what other than market value is; particularly if someone is paying you for your opinion.
What is “sufficient” is of course how long is a piece of string, but nearly one hundred years sounds…”sufficient”, although there again, whatever might constitute “sufficient” analysis to make a prediction, one year, five year, fifteen years into the future is, looking at that chart, less than completely obvious.
Oh well, when all else fails, do a regression analysis and build a model and see where that goes, here’s how that works out…sort of:
Actually that’s a regression analysis with bells on, truth be-told all I did was plot a third-order polynomial and then fit a cumulative normal distribution (S-Curve) from the up and down lines and the inflections at the top and the bottom…pretty scientific eh!!.
At least that’s a starting point, and there is good evidence the lines going up and down are about in the right place, although there is not good evidence as to precisely where they flatten out (top and bottom), also I’ve chosen to call some of the points outliers, which is always suspect
That said I’m pretty sure that the fundamental is an S-Curve but I can’t prove it from that data, so that’s another theory. Although what we are talking about here is nature and logically the arithmetic ought not to be any different from the mating habits of toads, which incidentally is a particular speciality of mine.
I know, I know…I probably could have got a better correlation if I could have been bothered to do a multivariate analysis with perhaps CPI (whatever that means) or even something esoteric like total debt to GDP or outstanding Treasuries to GDP as secondary variables. But that curve is just a first peek, and the problem with loading up on the variables is you can get spurious auto-correlation, me I’m simple minded, I like to keep it simple.
I plotted two lines; the lower one (blue) is based on all the data from 1900, although I know that the business cycle sort of smoothed out after the War, so we could be talking two unrelated data-sets, or the theory could equally be that far from reality.
The logic for why there might be a (sort of) correlation, and that might be a valid explanation for what happened, not that it matters because this article is explicitly about prediction not the rhyming of history, could be that when nominal GDP is growing (whether that’s inflation or “real” is completely irrelevant); companies, people want to do things, they see opportunity, so they want to borrow so they can gear a 12% project IRR to a 20% investment IRR.
The way it works is that when a load of people roll up at the bank wanting to borrow money, what do the bankers do? They peek out the window, notice there is a queue, and put the interest rates up so that you have to pay more to borrow. By the same token, like now, when there are hardly any people who can qualify to borrow who aren’t rolling in cash so they don’t need to, and even then not many of the business plans are better than dubious, so the bankers make borrowing cheaper for the shrinking minority who can qualify for a loan, and want one.
The fact that the US Government got downgraded is also irrelevant, they can print money whenever they feel like it; it’s the market for risky debt that determines the correct risk-free-long rate, not the other way around. Of course that doesn’t stop governments trying to drip-feed
Viagra liquidity into to the equation as election candy.
That’s all another way of expressing the Daisy Principle which says that you can only milk a cow so much before she drops down dead, also called the Theory of Parasite Economics. Those two theories say that insofar as lending money is concerned, as a business model, it’s pretty much like selling crack-cocaine.
Demand is effectively infinite and profits are huge so long as you don’t get busted and you can’t run fast, you just need to consider the possibility that once your customers are hooked if you cut the margin to increase the volume (supply) so you can maximize your ROI, a proportion of those customers might just drop down dead, which can be bad for business.
That’s what happened in the housing bubble and bust, supply of debt went up thanks to the genius of Fannie and Freddie and securitization (nothing to do with interest rates, they just followed the Daisy Chain), and sure enough, there was a collective overdose. The moral of that story is next time you self-medicate, be sure you get dose right, because what might happen next, if you don’t, is not a tail-risk, it’s a heads-or-tails risk.
Step 2: The Theory of the Pebble in the Pond
OK so we got an estimate for the equilibrium-line, not that it’s particularly good, but you got to work with what you got.
For example, when I was a lot younger, but much less foolish, I was sailing across the North Sea from Norway to Scotland with some mates in their dad’s boat, who after a session of serious self-medication and we were 100 miles (nautical) from land, broke the good news to me of my promotion.
They thought because I used to tell girls I was smart…well chubby boys got to have some sort of hook to get girls to talk to them…therefore I knew something about navigation, so I was promoted to Navigation Officer, which is the closest I ever got to an STWC A-II/2 ticket.
OK navigation isn’t that important when you are sailing blissful broad reach long tacks on compass bearings through the open sea, but it does come in handy when you are approaching your destination, at night, in fog.
Long-story short, that was years before GPS was invented, we gave up on that little mechanical fish thing you are supposed to trail behind and keep a log of, that gets tangled up in seaweed; and the sextant, well I couldn’t even work out which bit to look through…instead we used the radio beacons from the oil rigs to triangulate where we were…to within plus or minus 200 square miles.
Then when we got close to land we used the radar to give us an image of the shoreline and we poured over the maps (real sailors call them things “charts”) to fit the puzzle together. Sometimes you need more than one reference point to figure out where you are.
That’s where the Theory of The Pebble in the Pond comes in, think of it like the radar.
The idea there is that when there is a bubble, the structure of the bust that follows is predicated by what happened before. Call it history rhyming if you like; other ideas are what Mises called the “tedious process of recovery”, then there was Bob Farrell’s idea on excesses from the equilibrium one way being followed by excesses the other way and the idea of “markets overshoot”, and of course that one about “what goes around comes around”.
I call it the pebble in the pond, because every bubble needs someone to throw the first stone, and like a pebble thrown in a pond, the net result is zero-sum. Because for everyone who sold something at a price more than the equilibrium, there has to be someone else who paid too much. Just like a pebble thrown in the pond does not raise the equilibrium level, a bubble and bust creates no net economic value added, because for “real” economic value added, both sides of a transaction must gain.
So to get a second opinion on where the lines end up, top and bottom, you look for the ratio of mispricing, if the bubble mispriced by a factor of two at its peak (i.e. the equilibrium was 100 but the price went up to 200), then you expect the bust to be 50% of the equilibrium.
Plotting 100-Years and adjusting the variables on the first algorithm to fit the theory of the pebble in the pond, you get this:
When I first saw that chart I thought, “Nah that can’t be right”. Could it be possible that US Treasuries can bubble and bust, AND that the “cycle” is 70-Years, that’s really hard to believe.
OK so think about it, what that says is from 1935 to 1958 money was much too cheap…which could perhaps explain the boom/bust that Mises was talking about…cheap credit, caused over borrowing, causes mal-investment, causes boom and bust.
So what happened from 1968 to 1970 that caused a change in direction? Well there was the Vietnam War, the US Government was bust and defaulted on its gold obligations, and oil prices went through the roof. I don’t know, I can’t sort of see any of those as a massive trigger for a total change in direction?
But if that’s right…like it was sort of pre-ordained by the previous thirty-years, that would explain:
1: The regression of the full data (i.e. since 1900) is probably the right one, because the regression from 1980 was only part of a cycle, that’s why International Valuation Standards says you have to have “sufficient” data, what the chart shows is the “sufficient” is enough to cover a whole business cycle.
2: Re-working that data says the bottom of the S-Curve is 2.7% which sounds about right, and the top is 5.9% which is also hard to believe, that says when the 10-Year was 12% that was a massive bust…caused probably by the preceding bubble.
3: Looks like Mises might have been right about all that boom-bust stuff and that suggests a strategy of extend and pretend aided by keeping interest rates lower than the fundamental, extended the damage of The Great Depression…and could extend the damage this time, like it did in Japan?
5: By the same token, after the Volker Peak, interest rates on the long-end, were artificially high, perhaps caused by the Pebble in The Pond Theory, although truth be told, even I have problem completely believing that; but it might explain why over the past thirty years you could make as much, sometimes more, just sitting in US bonds rather than by investing in US stocks. That could also explain the driver of creative ways of manufacturing new-fangled forms of debt, because that was easy money…until it wasn’t.
6: That might also go some way to explaining why the performance of the US economy (the “real” part not the bubble/bust part), was so lackluster over the past twenty years, money was expensive and it made more sense to invest, and create jobs, outside USA.
7: That said, the notion that keeping the 10-Year high immediately after a bubble bursts, like in 1929, looks like it was a bad idea, and Ben Bernanke did the right thing by reacting quickly and decisively, (and the Euro-crowd did the wrong thing by vacillating). But the danger now is the over-cheap money will cause a bubble, somewhere; although equally, controlling mal-investment caused by outbreaks of collective mass stupidity, by austerity, is not necessarily the way to go either; it’s hard to balance those two extremes when you don’t have good navigation tools…bit like trying to make landfall in a fog.
The test of Black-Swan Pudding…is in the eating:
So that’s a theory, even I’m not sure if it makes any sense, and it’s MY theory!! Well if it’s right, and it’s useful, then it can be used to make a prediction:
Let’s assume…yes I know, “Assumption is the Mother of all Frappuccinos”… but let’s assume Ben Bernanke has learned a few tricks and we can forget about the theory he had about house prices going up forever and the silly things he said in the past about inflation targeting, that’s history and we all make mistakes, I know all about that.
Although one thing you can say about Ben is that he has got the courage to do what’s smart but not necessarily popular.
Forget about if it was right or not, I really admire how he just went out and quietly printed $1.2 trillion to buy up toxic debt, without clearly telling anyone he was going to do it, and certainly not asking anyone’s permission. There are not a lot of people who would have had the courage to do that, particularly when they knew that a lot of their theories were wrong, as in the navigation systems had totally broken down.
What went wrong just after the 1929 crash was they vacillated, the 10-Year yield stayed (relatively) high for five years, he got that part right; the second mistake was after that, they went overboard the other way creating twenty years of boom-bust; so lets assume, having got one thing right, Ben doesn’t blow it in the second round.
If so then the current round of policies that are depressing the yield on the 10-Year below what’s “natural”, will get softly scaled back over the next two years as the (nominal) growth of the US economy starts to tick up, albeit on four cylinders, and jobs start coming back and securitization (done properly) re-starts; and let’s assume no one does anything REALLY stupid, like bomb Iran.
If so…Big IF…the bubble in Treasuries will pop.
This analysis says Treasuries were 180% over-valued at a little under 2% (value is the reciprocal of yield), so expect, that when there is a pop; then they will be under-valued for a while and yields will be 1.8 x the equilibrium.
But the equilibrium will go up too; perhaps the 2-year moving average of nominal GDP will go up to 5% in which case the “equilibrium” yield will go up to 3.8% so the yield at the top of the bust will go up to 6.27%, before dropping back to about 4% (by then the equilibrium will probably have gone up a tad more).
This is how that looks on the yield (the other chart is upside down so you have to stand on your head to understand it):
That’s a prediction:
The 10-Year Treasury will go up above 6% within three years.
There is a caveat. No I’m not trying to wriggle out of my prediction, even though my gut is telling me to keep my big mouth shut, and I am reminded of Bill Gross eating crow, although there again, this prediction says he was right, just early. But there are some major headwinds that might interfere with the “natural” process.
First if the policy is to go for the easy-win of boom and bubble to wipe away all the mistakes of the housing bubble in one go, the day of reckoning will be delayed, which will mean that when the bubble pops, it will be a bigger pop. If yields stay at 2% even when nominal GDP is growing, that would indicate a 250% over-valuation, which could mean that unless nominal collapses again the bust could take yields up to 10%, when that happens, in perhaps five years time.
There are also a lot of folks who might be disturbed by a spike in yields up to 6%, notably the US Government, which would have to pay a lot more interest to issue new debt and to roll over the stuff they have.
So they will face a conundrum, either cut off the green shoots at their knees and constrain the sort of economic activity that can pull America out of the hole she has dug for herself, or just bite on the bullet, and let nature take its course.
Or equally, perhaps a theory that, based on the evidence so far, has a one-in-40 chance of being wrong…is…err… wrong?
Only time will tell.
By Andrew Butter
Twenty years doing market analysis and valuations for investors in the Middle East, USA, and Europe. Ex-Toxic-Asset assembly-line worker; lives in Dubai.
© 2012 Copyright Andrew Butter- All Rights Reserved
Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.
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