Where Are the Bond Vigilantes When You Need Them?

We just passed the 40-year anniversary of America's highest interest rate environment in history. The Wall Street Journal ran this headline in its weekend edition. They highlighted the very valid point that nobody knew then, that the top was in and rates were about to fall, precipitously at first, and then continue in that downward trend for four full decades. I am old enough to have lived through that entire period. Double-digit inflation had been raging since OPEC -- the International Organization of Petroleum-Exporting Countries -- jacked up oil prices via an oil embargo to the United States in 1973-1974 as our punishment for helping the Israelis during the 1973 Arab-Israeli war. The embargo pushed oil prices up painfully and was meant to gain leverage in the post-war settlement negotiations. OPEC's actions back then were the reason that every U.S. president since, with the exception of Joe Biden, vowed to develop domestic sources of petroleum to make America energy independent. The images below tell the story of what interest rates looked like exactly 40-years ago. Nuveen advertised federally tax-free, muni-bond fun interest of 12.69% to 12.97%. T. Rowe Price was offering close to 16% on its taxable money-market fund. The Treasury had trouble finding buyers at its 20-year bond auction. They eventually had to pay 15.78% to lure people and institutions to lock in for two decades. Why did rates get so high? So-called bond vigilantes insisted on getting paid enough to offset the ravages of inflation. They let Washington politicians know they weren't going to take rates, which lowered the true buying power of the money they were lending. That was, and remains, the proper way to set coupon rates. Auction pricing reflected the true balance of supply and demand based on all known information at the time. The most recent PCE reports show officially reflected inflation north of 4%. If the Federal Reserve Bank was not distorting bond demand, by buying up a majority of all new bond issuance, coupon rates would likely be at least 5% - 7% depending on the maturity. Instead, these were the pitifully inadequate current yields on treasury paper from 30-days out to 30-years. Anyone purchasing fixed income at those rates is virtually assured they will lose significant buying power over time -- just look at the current rates. Why is the Fed setting rates artificially low? With the nation's national debt above $28 trillion, and about to shoot much higher, normalized interest rates would cripple America by pushing debt service expenses to an unsustainable percentage of the entire budget. Fed Chief Jerome Powell's refusal to address already fast rising, and non-temporary inflation, merely reflects this reality. From a practical standpoint the Fed can never revert back to what had previously been normal interest rates. What does all this mean to you, and what you should be investing in right now? Keeping any long-term money in fixed income is probably the worst decision you could possibly make. Think twice before paying down a super low-interest rate mortgage early. You may never be able to borrow huge sums at negative true interest rates (adjusted for inflation) ever again. Only hold things that can be marked up as inflation marks down the buying power of each dollar. What works best in relation to No. 3? Shares of companies with pricing power that can offset ever higher costs of labor, raw materials, healthcare and the proposed increase in corporate taxes. Retailers like grocery store chains, Costco , Walmart and Target etc. will simply raise prices, adding a profit margin based on their new realities. Credit card issuers will automatically see higher revenue as prices inflate and total amounts charge follow suit. Real estate may go up nominally in price, but cash-starved politicians in local power are likely to keep adding to property tax burdens as their needs become greater. Utility prices, insurance and maintenance costs on real estate will likely also rise sharply. Plus, real estate is illiquid and has large frictional transaction costs on both purchase and sales. Precious metals are a possible play to fight escalating money printing and hard-to-swallow interest rates. That said, physical gold produces no income and often carries insurance and storage fees. Paper gold such as commodity options, futures and notional products like the SPDR Gold Trust ETF involve risk of their sponsors' ability to make good on their promises. We certainly are living in interesting times. Government agencies have been politicized and the Federal Reserve Bank is painted in a corner. We voluntarily, and unnecessarily, threw away energy independence and were recently forced to beg Saudi Arabia to increase production to make up for our own reduced domestic supply of oil and gas. Individuals like us are powerless to fix these problems. All we can do is make the best of these crazy situations. In my world, the best way to survive and prosper is to keep most of your long-term assets in shares of healthy, price-protected companies. Where are the bond vigilantes when you need them?

Where Are the Bond Vigilantes When You Need Them?

We've got rising inflation, a Fed that can't turn back to 'normal' interest rates, and an energy problem. Here's what you can do to protect yourself.

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