There has been a lot of publicity today for recent remarks by Nassim Nicholas Taleb, the hedge fund manager who wrote The Black Swan and Fooled by Randomness, who says he is “betting on the collapse of government bonds'”. Government deficits, he says, are now “the main danger to the global economic system”. His view is that “every single human being” ought to bet against US Treasuries. This is, in his view, a “no brainer”.
This is a short extract from his interview: “When I wrote The Black Swan, I realised there was a huge bias in the way people estimate deficits and make forecasts. Typically things cost more, which is chronic. Governments that try to shoot for a surplus hardly ever reach it. 'The problem is getting runaway. It's becoming a pure Ponzi scheme. It's very nonlinear: You need more and more debt just to stay where you are. And what broke Madoff is going to break governments. They need to find new suckers all the time. And unfortunately the world has run out of suckers”.
The real risk ahead for bondholders lies rising interest rates. “Because governments can print more of their own currency, the risk comes from a rise in interest rates rather than a government default. When you have hyperinflation, deficits, or debt problems, with short-term bills you can catch higher interest rates to compensate you for the inflation or whatever return you've missed. By staying in cash or hedging against inflation, you won’t regret it in two years”.
The only comment worth making is that Mr Taleb is fundamentally right. Those with short term trading horizons continue to opportunities to make money from further declines in bond yields, and for a while by their own criteria they too may be right. Deflation fears encourage that behaviour. According to the Financial Times, hedge funds have recently become much bigger players in the US bond market, chasing arbitrage opportunities along the yield curve arising from the effects of the Federal Reserve’s QE programme.
This is not an encouraging sign. The way money is flowing into bonds and bond funds is a perfect example of the Greater Fool theory at work. For most investors, by far the most important priority today is to prepare for the fallout that will inevitably happen when the deflationary cycle eventually turns. The loss of wealth that will ensue from the bond market breaking will make the losses from the stock market fall of 2000-2003 and the housing market collapse seem mild by comparison.
