Custom Search

JIM: Let’s talk about an investment that is being bandied about as a good place to be right now, which is the bond market, because of lower interest rates or lower economic growth. Explain to our listeners why bonds can get hurt in a deflationary environment.

BOB: There are two types of bonds. Bonds that have been issued by such strong issuers that there’s no question that both interest and principal will be paid, that’s one group. The other group of bonds are those issued by entities that are questionable as to whether they will pay all of the interest due and all of the principal. The questionable end of the market is by far the largest. I would say that probably encompasses 95% of the debt outstanding today. That’s corporate, individual, governmental, including municipal, around the world. We’ve already seen major countries in trouble trying just to pay the interest. Forget the principal on the debt. So, if you observe the interest rate of bonds from these pristine debtors who are in terrific shape, you’ll see that the interest rates are low. There’s no really serious price erosion. As for all the other bonds, at some point during the depression, their holders begin to wonder, worry and eventually panic over whether what is owed will eventually be paid off. If you’re privy to any junk bond chart, you can see that the prices of junk bonds have been falling pretty relentlessly for the past 12 years. Now it’s beginning to spill over into the medium-tier bonds issued by corporations. I think this is a smart market. I think this is the bond market beginning to realize what my book is all about, that we’re heading into a depression. People need to get out of them before everyone else realizes it.

JIM: Speaking of quality bonds, there are very few corporations today that carry a AAA rating. As I recall, there are only about 7 or 8 of them.

BOB: Yes, and the worst of it is, how do you know that those ratings will remain AAA? They’re rated that way under the current economy, and if this economy gets weaker, which I’m positive it will, those ratings are likely to slip below AAA. But that’s an amazing statistic. I need to add that to my book.

JIM: Let’s talk about one of the last pillars, in my mind, that is still holding up this market. To me, the bubble in the stock market simply found another place to land — which is real estate. We had this boom. In fact I just read an article today where somebody was disputing whether this is a bubble, saying it’s just a huge demand. The individual that wrote this article said that real estate prices would remain high because government entities are making it hard for new development due to urban sprawl. They’re trying to contain it, and that’s going to maintain the price of real estate. I see this as the next bubble to pop. And once that does, that’s it.

BOB: I agree with you, and I think bubble is the correct term. Demand is one thing. There can be a tremendous demand for bread and milk out of the grocery store when a hurricane’s coming. But people don’t go out and systematically, decade after decade, borrow more money to buy bread and milk, as they do to purchase real estate. The reason they do this is for two reasons. Number one, they want to consume something today that they haven’t saved for. And the second reason is, they believe that the price always goes up, so they’re willing to take a tremendous risk of debt in order to own something that they believe will continue to rise. The problem is that every so often — and it isn’t that often, but it does happen, and when it does happen, it’s very devastating — real estate prices go down, and they go down severely. The last time that we had anything like what I’m looking for here was in the early 1930s, and prior to that was the early 1840s. We’ve had 8 episodes of severe real estate drops in the past 200 years, and I think we’re heading into our 9th one right now.