"Believers in perpetual inflation think that the government can keep assuming others’ bad debts infinitely. But it can’t. The only reason that Congress has gotten away with issuing this latest blizzard of new IOUs is that society is still near the top of a Grand Supercycle, so optimism and confidence still have the upper hand. But as pessimism and skepticism continue to wax and the economy contracts, the bond market will figure out that the Treasury will be unable to fund all these obligations with tax collections. Then Treasury bond prices will begin falling as if they were sub-prime mortgages. A collapsing bond market is deflation; it is a contraction of the outstanding credit supply. Recent bailout schemes will not reverse the deflationary freight train. They will serve only to confuse the marketplace and hinder the efficient retirement of bad debts, thus exacerbating the crisis and aggravating investors’ uncertainties and thereby falling right in line with the declining trend of social mood."
I think it is an important perspective and certainly viable. There is one investment move that seems to be a winner in both an inflation and deflation scenario. That scenario is short long US Treasuries. As Bob states above and we have stated in previous posts, the question hinges truly on whether or not the US government can overwhelm the massive credit deflation in the market. If yes, then you will get inflation which will cause Treasury yields to rise. If no, then as Bob states above, Treasury yields will blow out because of perceptions of US credit and the ability of the government to pay these debts.
For retail investors, an interesting way to play this would be buy TBT, the ultrashort 20+ year Treasury index. They charge a 1% fee but if the direction is correct the returns should overwhelm those fees. Just look at what happens to bond prices if Treasury yields move from 4% to 8%. It gets sliced in half. That is a significant move.
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