Surviving a debt crisis
In a new article in Citywire, Stuart Fowler argues that the global debt crisis transforms, in a perfectly intuitive way, the suitability of each of bonds and equities for protecting long-term real wealth. Backing intuition, individuals should minimise exposure to other people’s debts, whether governments or companies.
“In the particular circumstances the world economy finds itself in, we clearly cannot exclude the possibility of either deflation or high inflation. One of the greatest bond bull markets ever has left conventional bonds extremely vulnerable to both risks.
Governments may not be able to prevent the forced liquidation of excessive levels of debt, causing a vicious cycle of falling prices and incomes that mean debts cannot be serviced or repaid in full. Ten-year gilt yields of around 2% have almost never been this low. They imply a high probability of this ‘debt deflation’ but the additional 2-3% yield on the small population of high-grade, sterling-denominated corporate bonds is not enough to guard against its consequences. To the extent that monetary policies aimed at averting debt deflation eventually lead to high inflation and currency collapse, we might even experience both, in sequence.’
Bonds without guaranteed inflation protection cannot hold out these possibilities of high nominal and real loss and at the same time act as ‘risk reducers’ in a portfolio. Yet this is how bonds and bond funds are being used across the industry and by self-directed investors.