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July 9, 2008

Whichflation?

A lot of people are worried about inflation and have said that the government's reports are unrealistically low. Others worry about stagflation. In the last two issues of John Mauldin's Outside the Box E-Letter three knowledgeable financial experts are saying that the fears of inflation are unfounded because we are headed toward deflation: Quarterly Review and Outlook, Second Quarter 2008 by Van Hoisington and Dr. Lacy Hunt of Hoisington Investment Management and The End of the Inflation Scare? by Louis-Vincent Gave of GaveKal Research.

Whichfaltion is it then? Hoisington, Hunt and Gave all mention that long term government bond yields indicate no future inflation. If inflation were in store, yields would be higher and bond prices lower. Then they set out in various ways with some rather convoluted reasoning to prove that the bond rates are telling the truth.

Some smart fellow, whose name I do not recall,¹ said that if there is a simple explanation then you should discard the complicated ones. I believe there is a very simple explanation for the low yield of long term government bonds. Simply that investors no longer trust private borrowers after the recent financial scandals involving sub-prime, toxic waste, miscalculated ratings, failing banks and failing bond insurers. Since investors have nowhere else to turn they buy government bonds forcing up the price and forcing down the yield.

Game. Set. Match.

Denny Schlesinger

Quarterly Review and Outlook, Second Quarter 2008 by Van Hoisington and Dr. Lacy Hunt of Hoisington Investment Management
The End of the Inflation Scare? by Louis-Vincent Gave of GaveKal Research

1. Franciscan friar William of Ockham - Occam's razor.


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