Many libertarians have been predicting much higher interest rates and a popping of the bond bubble for quite some time. However, these predictions have yet to come true. It is hard to believe after QE1, QE2, and QE3, along with a national debt exceeding $20 trillion, that interest rates have remained low.
Even more incredibly, the bond market is not being directly propped up by the Federal Reserve at this time. The Fed ended its QE3 in October 2014. Therefore, all of the new debt (not counting rolled over maturing debt) has been bought by private investors or foreign central banks for the last three plus years.
As a side note, the Fed is still propping up the bond market by its past actions and its implicit guarantees. Although the Fed is not currently buying new government debt, the market fully expects the Fed to step in, if needed.
While the current path is unsustainable, it doesn’t mean it can’t last for a while longer. As Keynes once said, the market can remain irrational longer than you can remain solvent. In other words, you shouldn’t be shorting the bond market right now.
Japan has proven that you can have massive monetary inflation and massive government debt without having imminent price inflation and higher interest rates. In fact, Japan has seen negative interest rates in recent years, almost defying gravity. The economy there has certainly suffered from the massive malinvestment, but it hasn’t yet proliferated in the form of significantly higher consumer price inflation and higher interest rates.
There are likely a lot of bubbles, both in the U.S. and throughout the world. In the U.S., stocks seem to be in a bubble. Real estate, while not to the same extent as a decade ago, is probably in a bubble in at least some regions. Bitcoin and other crypto currencies that aren’t actually backed up by anything other than some fancy new technology are probably in a major bubble.
We don’t know for certain that anything is in a bubble because value is subjective. If a large segment of the population has determined that owning a house is a higher priority than almost everything else in their lives, then maybe housing will stay permanently high for a long while. Still, we can be sure that there are unsustainable bubbles because there is malinvestment from the previous rounds of monetary inflation and the artificial lowering of interest rates. While we can’t be certain of any particular bubble, we can look at past history and make a decent judgement.
Is there technical justification for stock market indexes going up around 20% in 2017? Does this reflect earnings and economic growth?
As for bonds, there should be little question that there is a bubble, especially since there is an implicit guarantee from the central bank to prop up the bond market (keep interest rates down) when needed. One could argue that this is always the Fed’s policy, but that still doesn’t avoid the likely outcome of bubbles and busts.
However, I would argue that the bond bubble will be the last major bubble to go. In fact, if stocks tumble and we have a new recession, interest rates would probably go down. The Fed might start buying government debt again, and investors would be seeking safety. Although many libertarians do not view U.S. government debt as a safe haven, the fact is that many investors do view it this way. It is a safe haven in the sense that outright default is highly unlikely.
We need a popping of the bubble that is government. We need drastic reductions in federal spending. This overall government bubble goes hand-in-hand with the bond bubble.
As long as consumer price inflation is low, or viewed as low by the public, then interest rates will likely remain relatively low. It gives the Fed the ability to step in at any time and create more monetary inflation.
We would have to see a scenario similar to the 1970s with higher price inflation before the Fed really feels the pressure to stop all monetary inflation and for the public to take it seriously. This is when we would see higher interest rates and a crashing of the bond bubble. It would also finally force the federal government to rein in some spending.
In conclusion, now is not the time to short the bond market. This will be one of the last things to fall. There will be a major fall in stocks before we see a major fall in bonds.