The Great Reflation: How Investors Can Profit from the New World of Money

Chapter 9. Interest Rates and the Bond Market

Bonds are certificates of Guaranteed Confiscation.

—Franz Pick^[66]

When it comes to bonds, investors will want to know whether the Great Reflation will eventually become the Great Inflation. If that were to happen, bond values would evaporate as they did in the 1960s and 1970s. A 30-year bond lost over 70 percent of its value during those two decades. However, if the Great Reflation fails to resuscitate the economy and Japanese-style deflation were to take hold on a sustained basis in the United States, then Treasury and other very high-quality bonds would be valuable assets.

As pointed out in Part I of the book, the Great Reflation poses very serious risks for bonds in the long run. However, in the time frame of most investors, say one to three years, deflationary pressure as measured by the consumer price index (CPI) will be strong enough to dampen potential upward pressure on interest rates.

The mathematical relationship between bond yields and bond prices is inverse. When one goes up, the other must go down.^[67] Should the outlook for general prices change from deflation to rising inflation, bond prices would fall. There are techniques (discussed later) that will provide investors with ways to protect them from inflationary losses in the fixed income markets. However, as Figure 9.1 indicates, this is not likely to be a risk anytime soon. Some measures of price inflation in late 2009 were even negative and others were close to it.

Figure 9.1. U.S. ...