Run, Don't Walk From Treasuries

If the U.S. is the strongest and most powerful country in the world, why wouldn't investors always want to buy our bonds? Unfortunately, America's dominant position in the world, both politically and economically, is increasingly being questioned.

This is not the first time we have been through a rough patch like this in the post-World War II period. A similar period of declining American influence and credibility occurred in the late 1970s following the end of the Vietnam War, Watergate, the OPEC oil shock, rampant domestic inflation, and culminating in the Iran hostage crisis.

How did Treasuries perform during that period? The yield on the 10-year Treasury went from under 7% in 1977 to nearly 16% in 1981. During that period, Treasuries performed so badly compared with other investments, including stocks, real estate, commodities, municipals and corporate bonds, that they were sarcastically termed "certificates of confiscation."

Obviously, the actions of Paul Volcker, who was Fed Chairman at the time and substantially increased the fed funds rate, contributed to the selloff in Treasuries.

However, Volcker was taking those actions in an attempt to restore credibility in the U.S. financial system. His policies were more of a painful remedy, rather than a cause, of the problem. In fact, Treasuries were already performing badly before Volcker even started running the Fed. The underlying problem was a crisis of confidence in the U.S., not Volcker's policies.

What about the asset deflation that everyone keeps talking about? Shouldn't that keep inflation down and support Treasuries? There is, unfortunately, not a consistent and direct link between asset deflation and deflation in consumer prices.