“The current crisis is the culmination of a super boom that has lasted for more than 60 years,”
writes George Soros in the Financial Times .
Soros is more right than wrong, in our opinion. He goes on to describe how “market
fundamentalism…became the dominant ideology in the 1980s,” leading to a U.S. current account
deficit equal to 6.2% of GDP in 2006. Globalism, he says, permitted the United States to “suck up
the savings of the rest of the world and consume more than it produced.”
The important point Soros makes is one we keep making: we are now on the downhill side of the
credit cycle. For many years to come, real rates of interest will generally be going up.
We say ‘many years’ because we don’t know how many…and because trends in the credit cycle
tend to be long. Currently, the real yield on a 10-year Treasury note is negative. Subtract the
inflation rate from the nominal yield and you get a number with a minus sign in front of it. The last
time that happened was in the run up to Ronald Reagan’s first term – when real rates fell below
negative 4%, thanks to inflation over 10%. Then, the credit cycle turned. Real yields on 10-year
Treasuries rose to nearly 10% within a couple years. They have been coming down ever since –
that is to say, for more than 20 years. Our guess is that they will now go up, after perhaps a further
spike to the downside.
An investment involves hope for the future. A man buys a T-note. He gives up sure money now in
favor of the hope of more money in the future. All investments work the same way. The more
hopeful people become, the more risk they are willing to take. If they think the wind is to their
backs, they will invest more…at longer odds. Yields will go down.
But when they lose hope, they keep their money in their pockets and clutch onto it harder. The 4%
yield they accepted last year is no longer enough; they want more…to compensate for what they
see as the greater likelihood that they will never see their money again.
When Ronald Reagan took hold of the White House in 1980, it was a triumph of hope over despair.
It was “morning in America,” he said. He was right. Yields fell for the next 25 years and hope
Now the sun is setting.
Markets and Money