John Mauldin: Any Bonds Today?

John Mauldin |


By a continuing process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens. By this method, they not only confiscate, but they confiscate arbitrarily; and, while the process impoverishes many, it actually enriches some. The sight of this arbitrary rearrangement of riches strikes not only at security, but at confidence in the equity of the existing distribution of wealth. Those to whom the system brings windfalls . . . become 'profiteers', who are the object of the hatred of the bourgeoisie, whom the inflationism has impoverished not less than the proletariat. As the inflation proceeds . . . all permanent relations between debtors and creditors, which form the ultimate foundation of capitalism, become so utterly disordered as to be almost meaningless….

– John Maynard Keynes

One of the more frequent and important questions I get asked when I travel is whether I think we will see inflation or deflation. My usual flippant answer is "Yes," and then I go on to explain that there is no simple answer. Over what time period? In what country? And by what means do you want me to measure inflation or deflation? Today we take a look at part of a white paper I am working on with Jonathan Tepper, the co-author of Endgame, on this topic. I think you will find it interesting reading on a summer's day. And I have to quickly mention the absolute disaster that is happening before our eyes in the labor market. Our kids are getting skewered (the polite word) by unintended consequences of the Affordable Care Act. We need a bipartisan fix quick, before we damage an entire generation.

But first, let me call your attention to a dynamite conference at which I'll be speaking in October. It's "3 Days with Casey," the Casey Research Summit for 2013, to be held October 4-7 in Tuscon, Arizona. In addition to the indomitable, incredible Doug Casey, my friends Ron Paul, Lacy Hunt, Rick Rule, and Don Coxe will all stand and deliver, along with a bunch of other outstanding speakers, including Jim Rickards (author of Currency Wars), Paul Brodsky (I love this guy's stuff!), and Chris Martenson (author of The Crash Course). And of course you get the whole Casey research team. Thoughts from the Frontline readers can get a special early bird discount here. Come help me celebrate my 64th birthday!

A Temporary Problem

Back in 2010, a number of analysts (including me) noted an unintended consequence buried in the Affordable Healthcare Act (aka ObamaCare). Employers are not required to provide insurance for temporary workers, and a temporary worker is defined as someone who works under 29 hours per week. Many of us noted that this would result in businesses shifting workers from full-time to part-time. The answer from AHA supporters was that "No, it wouldn't" or that the effect would be small. There was no real way to know, of course. I and others could only point to our experience of how the real world works. If you defined the cut-off for part-time work at 35 or 39 hours a week instead of 29, the economics of ObamaCare simply got blown out of the water. But the bill passed, and now it's law.

And now the argument is over. It is clear that businesses have indeed responded to the rather perverse incentives in the law. A year ago, growth in full-time employment far outpaced increases in temporary employment. That trend has reversed this year. Mort Zuckerman wrote in an op-ed piece in the Wall Street Journal this week:

The jobless nature of the recovery is particularly unsettling. In June, the government's Household Survey reported that since the start of the year, the number of people with jobs increased by 753,000 – but there are jobs and then there are "'jobs."' No fewer than 557,000 of these positions were only part-time. The June survey reported that in June full time jobs declined by 240,000, while part-time jobs soared 360,000 and have now reached an all-time high of 28,059,000 – three million more part-time positions than when the recession began at the end of 2007.

That's just for starters. The survey includes part-time workers who want full-time work but can't get it, as well as those who want to work but have stopped looking. That puts the real unemployment rate for June at 14.3%, up from 13.8% in May.

The US Chamber of Commerce summarizes the situation:

"Small businesses expect the AHA requirement to negatively impact their employees. Twenty-seven percent say they will cut hours to reduce full-time employees, 24 percent will reduce hiring, and 23 percent plan to replace full-time employees with part-time workers to avoid triggering the mandate."

Younger people and those whose jobs could readily be farmed out to plenty of potential replacements are in danger. There are many jobs that can almost as easily be done by two people working 20-25 hours as by person working 40-50 hours. And that is what is happening. As Zuckerman notes, if you count those who have only temporary employment though they want full-time work, the unemployment rate rose last month from 13.8% to 14.3%. This is recovery?

I have seen this happen in my own family (and to a union member, no less!). How can you support yourself on a part-time job? Juggling two part-time jobs takes a lot more than 40 hours a week and increases the costs of getting to and from work. And under the AHA, the government, not the employer(s), is going to have to pick up that bill if a part-time worker is going to have health insurance.

Republicans want to repeal ObamaCare. Many are not interested in anything short of that outcome. Democrats don't want to change anything and won't touch legislative fixes, afraid to be seen as opening up the whole issue before the next mid-term elections. But we are seriously damaging the ability of people to get work and be able to support themselves and especially the opportunity for younger people to get work that can result in acquiring skills and moving upward on the income scale. The definition of part-time should revert to the traditional standard: if you work less than 40 hours a week, you are part-time.

I get that that destroys the economics of ObamaCare. But do we want to see our children as unintended casualties in a political war over healthcare? A bill has been introduced to fix this problem in the Senate. The US Chamber of Commerce survey is telling us the direction we are currently headed in. Do we really want to wait until things get even worse?

And now, let's think about inflation, together with my co-author, Jonathan Tepper.

Any Bonds Today?

Can you imagine Julia Roberts and Gwyneth Paltrow helping the US government sell bonds or Jay Z and Justin Timberlake composing songs about Treasury bills? It would not be the first time Hollywood stars or famous musicians tried to help the government sell its debt.

The last time the US government had an enormous load of debt, it used Hollywood stars to help sell government debt. The Treasury Department conducted a massive public relations campaign through radio, newspapers, and film. During World War II, war bond rallies were held throughout the country, and Hollywood stars such as Bette Davis and Rita Hayworth traveled around the country to promote war bonds. The great Irving Berlin even wrote a song titled "Any Bonds Today?" and Berlin's tune became the theme song of the Treasury Department's National Defense Savings Program.

The government also enlisted cartoon characters, actors, comedians, and musicians to encourage people to pay income taxes. Donald Duck told viewers it was their "duty and privilege" to pay income tax. Abbott and Costello appeared in advertisements to get people to pay taxes, and Irving Berlin wrote songs not only about bonds but songs about taxes like "I Paid My Income Tax Today."

While the war bond and income tax drives garnered all the press, the real reason the US was able to borrow so much and with so little burden had nothing to do with the glitz and glamor of movie stars. The US government borrowed easily because the Federal Reserve printed money to keep interest rates low. Borrowing is very easy when a central bank has your back.

How did it work in practice? As is the case today, the Treasury wanted to borrow cheaply then, and the central bank was happy to accommodate. In 1942, after the United States entered World War II, the Federal Reserve officially agreed to fix interest rates on government bonds at a low level. To maintain the pegged rate, the Fed was forced to give up control of the size of its balance sheet. Unsurprisingly, the Fed bought and held all available short-term US treasuries and almost all long-term government bonds.

The costs of paying for World War II pushed the national debt up sharply, from around 40% of GDP before the war to a peak of nearly 110% as the war ended. But a combination of strong economic growth, tight fiscal policies, and financial repression brought the debt back below 50% of GDP by the late 1950s. (Currently our government debt has reached about 90% of GDP and continues climbing very sharply.)

During the war years, the Federal Reserve pegged long-term interest rates at extremely low levels so the government wouldn't have to pay much to fund itself. To make sure that inflation didn't spike, the government instituted wage and price controls. After the war, the price controls disappeared and inflation rose very quickly, averaging about 6.5 percent annually from 1946-51. By the postwar price peak nine years later, wholesale prices had more than doubled, and the stock of money had nearly tripled.

Normally, such high inflation would have made it much more expensive for the government to borrow money. But after being pressured by the Treasury, the Federal Reserve agreed to keep on pegging long-term government bond yields at 2.5% until the spring of 1951, when the Federal Reserve finally refused to print money to keep bond yields low. Because of the coordination between Federal Reserve and the US Treasury, real yields on government bonds were very negative during the years following World War II. With negative real yields, borrowers win and lenders lose. The clear winner was the US government, and the loser was anyone who bought and held US bonds. The combination of very low government bond borrowing costs and high inflation ate away a sizable chunk of the government's debt burden.

The same thing is happening today in almost all government bond markets around the world. Governments are winning, and investors are losing. The Federal Reserve is helping the Treasury to borrow cheaply while the government expands its deficit spending and debt accumulation. Using inflation and low bond yields this way to reduce government debt is called financial repression.

The government and central banks also contribute to higher inflation by pretending inflation is always under control. For example, throughout the Greenspan and Bernanke years, the Fed consistently chose to focus on lower inflation measures whenever doing so suited the central bank. You can see this in the semiannual monetary policy reports to Congress, specifically in the inflation forecasts made by the members of the Federal Open Market Committee. Until July 1988, inflation forecasts used the implicit deflator of the gross national product, but then the Fed switched to the Consumer Price Index. In February 2000, the Fed replaced CPI with the personal consumption expenditures (PCE) deflator. Thus from July 2004 onward, inflation forecasts have employed the core PCE deflator that excludes food and energy prices. Using lower and lower, less comprehensive estimates for inflation has allowed the Fed to pretend that it is meeting its mandate – but by ignoring high inflation readings. In the meantime, interest rates have been kept too low, and the inflation rate has consistently remained above the Federal Funds rate.

But measuring inflation is not so easy. The vast majority of readers have no idea about the rather contentious nature of the debates that go on in academic conferences about arcane topics such as the minutiae of how to measure some minor aspect of inflation. Passions run deep. Careers are made. Once you delve into how things are actually done, you realize that what we think of as an inflation number is actually an approximation of an idea the very definition of which can change over time.

Your perception of inflation (and everyone else's) has a very close relationship to how stock markets perform over time. Indeed, one of the questions we are both regularly asked wherever we speak is something along the lines of "What do you think inflation or deflation will be?" And the answer is not easy: it depends on a number of factors that vary from country to country.

In general, the trend for the last 75 years has been one of inflation. Sometimes, in some countries, inflation has spun out of control. At other times you see outright deflation. Neither one promises good times for investors. Ever-falling inflation or low inflation is the best environment for investing. But given the paramount importance of the inflation/deflation debate, we need to briefly investigate what inflation is and is not.

To continue reading this article from Thoughts from the Frontline – a free weekly publication by John Mauldin, renowned financial expert, best-selling author, and Chairman of Mauldin Economics – please click here.

DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not represent the views of Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions. To read our full disclosure, please go to:


Symbol Name Price Change % Volume
JPMSZ JPMorgan Chase Bank London Branch Taiwanese Low Ex n/a n/a n/a 0


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