Bear Traps in the Bond Market

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Fat guys can surprise you. They don’t move very fast. But they can be very agile intellectually.

That was how G.K. Chesterton was. Laurence Lindsay, former assistant to George W. Bush for economic policy, seems to be the same way. Slow on his feet, perhaps. But quick in his mind.

Writing in The Wall Street Journal, Lindsey delivers thoughts that might have come from The Daily Reckoning. First, he notes that the budget problems faced by Washington are larger than generally reported. Growth rates have been overestimated, he says, while interest costs and deficits have been grossly underestimated. When more realistic assumptions are plugged in to the numbers it adds more than $4 trillion in ‘budget costs’ over the next four years. He concludes:

Underestimating the long-term budget situation is an old game in Washington. But never have the numbers been this large.

There is no way to raise taxes enough to cover these problems. The tax- the-rich proposals of the Obama administration raise about $700 billion, less than a fifth of the budgetary consequences of the excess economic growth projected in their forecast. The whole $700 billion collected over 10 years would not even cover the difference in interest costs in any one year at the end of the decade between current rates and the average cost of Treasury borrowing over the last 20 years.

Only serious long-term spending reduction in the entitlement area can begin to address the nation’s deficit and debt problems. It should no longer be credible for our elected officials to hide the need for entitlement reforms behind rosy economic and budgetary assumptions. And while we should all hope for a deal that cuts spending and raises the debt ceiling to avoid a possible default, bondholders should be under no illusions.

Under current government policies and economic projections, they should be far more concerned about a return of their principal in 10 years than about any short-term delay in a coupon payment in August.

Yesterday, stocks rose. The Dow was up 145 points. Oil increased a little too. Gold stayed at $1,500.

Still no clear direction.

But the direction of the bond market for the last few months has been up. This appears to contradict Mr. Lindsey. QE2 is ending. Everybody knows it. The Fed was the world’s biggest customer for US debt – in some months buying two times as much debt as the US government issued. Now that the Fed’s buying program is coming to an end, shouldn’t bonds go down?

If the economy sinks the way we expect, Lindsey will appear to be a fool – for a while. That is, the Great Correction will intensify rather than go away. Bond yields will fall, not rise. Lenders will make money as bond prices go up, while stocks, employment, commodities, houses and almost all other assets go down.

People will say:

“See, everybody wants the US dollar. Everybody wants to buy US Treasury debt. It’s the only thing you can trust. Debt is not the problem. The problem is growth. That’s why we need QE3.”

This is probably the trap Mr. Market is setting. The Great Correction will prove to be more bad news for investors – except for those who have put their money in ‘safe’ US dollars…and US treasury debt. Gradually, investors will move more and more of their money out of ‘risky’ assets and into bonds. Then, Mr. Market can spring his trap. As Lindsey warns, that is when they will stop worrying about debt ceilings and Congressional budget talks. That is when they will realize that it is too late. That is when bond yields shoot up and bond prices fall. That is when investors regret having lent money to Washington.

How far ahead will that be? We wish we knew. But Bill Gross, who famously sold US bonds, could turn out to be years early.

Then, Mr. Market – the joker – will have such a laugh. All those people who tried to get away from risk…by moving to the dollar and US Treasury bonds…will get whacked.

And more thoughts…

Most of the Bonner clan is shy. Has been for generations. When visitors would drive up to the family farm in the ’20s or ’30s, for example, they would find an empty front porch…but a rocking chair still in motion.

Whoever was on the porch had beaten a retreat…trying to avoid company.

“The rocking chair syndrome,” the family called it.

An uncle, a local farmer, went to church regularly. But he snuck into the assembly by a side door at the last minute…so as to avoid the usual pleasantries. Then, he left the same way…

Shy people are usually considered to have a problem. They are ‘socially dysfunctional,’ widely believed to lead lonely, barren lives, trapped in their own prisons.

Various remedies have been proposed. Alcohol is an ancient elixir, prized by shy people. More recently, they are given drugs to loosen them up.

But maybe shyness isn’t such a bad thing, after all. Maybe we’re not sick. Maybe we’re ‘normal’ after all. Here’s The New York Times on the subject:

BEAUTIFUL woman lowers her eyes demurely beneath a hat. In an earlier era, her gaze might have signaled a mysterious allure. But this is a 2003 advertisement for Zoloft, a selective serotonin reuptake inhibitor (S.S.R.I.) approved by the F.D.A. to treat social anxiety disorder. “Is she just shy? Or is it Social Anxiety Disorder?”

It is possible that the lovely young woman has a life-wrecking form of social anxiety. There are people too afraid of disapproval to venture out for a job interview, a date or even a meal in public. Despite the risk of serious side effects – nausea, loss of sex drive, seizures – drugs like Zoloft can be a godsend for this group.

But the ad’s insinuation aside, it’s also possible the young woman is “just shy,” or introverted – traits our society disfavors. One way we manifest this bias is by encouraging perfectly healthy shy people to see themselves as ill.

This does us all a grave disservice, because shyness and introversion – or more precisely, the careful, sensitive temperament from which both often spring – are not just normal. They are valuable. And they may be essential to the survival of our species.

Theoretically, shyness and social anxiety disorder are easily distinguishable. But a blurry line divides the two. Imagine that the woman in the ad enjoys a steady paycheck, a strong marriage and a small circle of close friends – a good life by most measures – except that she avoids a needed promotion because she’s nervous about leading meetings. She often criticizes herself for feeling too shy to speak up.

Before 1980, this would have seemed a strange question. Social anxiety disorder did not officially exist until it appeared in that year’s Diagnostic and Statistical Manual, the DSM-III, the psychiatrist’s bible of mental disorders, under the name “social phobia.” It was not widely known until the 1990s, when pharmaceutical companies received F.D.A. approval to treat social anxiety with S.S.R.I.’s and poured tens of millions of dollars into advertising its existence. The current version of the Diagnostic and Statistical Manual, the DSM-IV, acknowledges that stage fright (and shyness in social situations) is common and not necessarily a sign of illness. But it also says that diagnosis is warranted when anxiety “interferes significantly” with work performance or if the sufferer shows “marked distress” about it. According to this definition, the answer to our question is clear: the young woman in the ad is indeed sick.

But shyness and introversion share an undervalued status in a world that prizes extroversion. Children’s classroom desks are now often arranged in pods, because group participation supposedly leads to better learning; in one school I visited, a sign announcing “Rules for Group Work” included, “You can’t ask a teacher for help unless everyone in your group has the same question.” Many adults work for organizations that now assign work in teams, in offices without walls, for supervisors who value “people skills” above all. As a society, we prefer action to contemplation, risk-taking to heed-taking, certainty to doubt. Studies show that we rank fast and frequent talkers as more competent, likable and even smarter than slow ones. As the psychologists William Hart and Dolores Albarracin point out, phrases like “get active,” “get moving,” “do something” and similar calls to action surface repeatedly in recent books.

Yet shy and introverted people have been part of our species for a very long time, often in leadership positions. We find them in the Bible (“Who am I, that I should go unto Pharaoh?” asked Moses, whom the Book of Numbers describes as “very meek, above all the men which were upon the face of the earth.”) We find them in recent history, in figures like Charles Darwin, Marcel Proust and Albert Einstein, and, in contemporary times: think of Google’s Larry Page, or Harry Potter’s creator, J. K. Rowling.

In the science journalist Winifred Gallagher’s words: “The glory of the disposition that stops to consider stimuli rather than rushing to engage with them is its long association with intellectual and artistic achievement. Neither E=mc2 nor ‘Paradise Lost’ was dashed off by a party animal.”

Regards,

Bill Bonner
For Daily Reckoning Australia

Bill Bonner

Bill Bonner

Best-selling investment author Bill Bonner is the founder and president of Agora Publishing, one of the world's most successful consumer newsletter companies. Owner of both Fleet Street Publications and MoneyWeek magazine in the UK, he is also author of the free daily e-mail The Daily Reckoning.
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