Debt deflation and Investing?

Christopherjart · Post by **Christopherjart** » Sun Jul 08, 2012 4:55 am

according to some, we are starting a period of "Debt deflation" like in the 1930s.
If that is true what should we invest in? Cash in a bank here earns no interest unless you have the equivalent of normally more than 5,000 dollars and inflation is probably above 4% in real expenses so I don't see keeping money in cash in the bank as a good option.
So far I've been depositing my non-emergency savings in my retirement account's voluntary savings which is a managed fund that invests mostly in CETES which are Mexican government short term bonds and some corporate and bank bonds earning around 5% a year after subtracting the 1% management fee.
Thoughts on investment strategy for the next few years?

Post by **jacob** » Sun Jul 08, 2012 5:02 am

viewtopic.php?t=2566#post-34946
5% nominal interest with 4% inflation for a 1% real return doesn't sound bad at all compared to what's available in EUR or USD which is more like 0.25% nominal and 3%+ inflation for a negative 3% "return".

dragoncar · Post by **dragoncar** » Sun Jul 08, 2012 6:17 am

I'm confused -- how can there be 4% inflation during debt deflation?

Christopherjart · Post by **Christopherjart** » Sun Jul 08, 2012 6:48 am

Inflation here might be a little higher. It depends on how you calculate it.

44deagle · Post by **44deagle** » Sun Jul 08, 2012 8:15 am

In a debt deflationary environment you want to be in cash.

Christopherjart · Post by **Christopherjart** » Tue Jul 10, 2012 1:12 pm

ok, I was right. The inflation here is above 4%. I read about 4.8% this year with June prices up about 1%.

Dragline · Post by **Dragline** » Wed Jul 11, 2012 2:25 am

I think there is some confusion here as to definitions. "Debt deflation" refers to a situation where the overall level of debt in an economy (public and private) is contracting. While this usually results in deflation in the price of goods, it is still possible to have inflation in the price of goods in such an environment. The debt deflation theory says essentially that the bad debts must be cleared via repayment or default before the economy can recover and new lending can take place on a large scale.
The theory of debt deflation was pioneered by economist Irving Fisher, who famously lost his fortune in 1929 and spent the remainder of his career trying to figure out why. His work was expanded upon by Hyman Minsky, Charles Kindleberger and more recently by Australian economist Steve Keen, who has done some absolutely brilliant stuff with it. Here's an interview of him from last week that explains some of this: http://www.youtube.com/watch?v=dsCzqqvI ... re=g-all-u

Christopherjart · Post by **Christopherjart** » Wed Jul 11, 2012 3:43 am

who was that for?

Dragline · Post by **Dragline** » Wed Jul 11, 2012 12:14 pm

Everyone -- there was an implicit assumption in the discussion above that a "debt deflationary" macro environment means that there must be asset price deflation all the time in that environment. That assumption is false.
Which means that investment decisions are just as complicated and unpredictable as ever, if not more so. But in a strictly asset price deflationary situation, cash and long govt. bonds typically do better than other choices. Look up TLT's performance at the end of 2008 for a striking example.
Historically, these periods have been much more volatile than periods of expanding debt (e.g., the so-called "great moderation" we had pre-2008). The issue often becomes one of liquidity, which is explored at great length in that "Tail Risk Killers" book that Jacob recently recommended.

secretwealth · Post by **secretwealth** » Wed Jul 11, 2012 1:31 pm

Thanks for that, Dragline--very enlightening stuff. TLT's total return price is up 138% for the past 10 years--that's a pretty impressive performance for any asset.
I still don't understand exactly why long-term bonds is growing so much, though. Is it that there is greater demand for these bonds because all other assets are seen with suspicion?

jennypenny · Post by **jennypenny** » Wed Jul 11, 2012 1:47 pm

I guess it's time to read "Tail Risk Killers." (I just finished "Fourth Turning")
Thanks for the video dragline. I have more youtube bookmarks from you than anyone else. You need your own channel

Christopherjart · Post by **Christopherjart** » Wed Jul 11, 2012 2:36 pm

What are TLTs?

jennypenny · Post by **jennypenny** » Wed Jul 11, 2012 2:46 pm

@Christopher, it's how people refer to US long term treasury bonds. You might find this site helpful http://www.bogleheads.org/wiki/Main_Page
Longer interview with Steve Keen...

http://www.youtube.com/watch?v=sxebomn2 ... re=related

Dragline · Post by **Dragline** » Thu Jul 12, 2012 1:49 am

Yes, TLT is an exchange-traded fund that invests in long-term US bonds.
@secretwealth -- yes, long US bonds are seen as shelter in a deflationary storm and as liquid because the U.S. government will print money if it has to in order to pay them. As long as the dollar remains as the world reserve currency, there is almost no risk of default. Their value has also increased due to the relative instability of alternatives such as the Euro. But they are very volatile due to interest rate sensitivity.
@jennypenny -- Tail Risk Killers has some very insightful ideas, particularly as to liquidity, but unfortunately is poorly written and even more poorly edited, sometimes veering off into tangents that don't really lead anywhere. It reminds me of Taleb's first effort, "Dynamic Hedging", which had some similar problems and even more math. Both are really more directed at the quant world than for general consumption.

jennypenny · Post by **jennypenny** » Thu Jul 12, 2012 2:17 am

@dragline--I'm not sure if I mentioned this, but my part-time ERE job is copy editing and proofreading. I edit everything as I read it. I can't help it. My Nook is so frustrating because I can't mark up the pages as I go

Not surprisingly, I have a lot of trouble getting through Taleb. I didn't buy Tail Risk Killers today because it was $19.25 (seemed high for an ebook.) I guess I'll search for a used printed copy so I can mark it up to my heart's content as I read it.