Crowding Out In The Bond Market

1. Reader Question

A common refrain in the press, almost daily: gov't borrowing is crowding out private investment.  Referencing I am sure the Fed buying debt, I still am unsure how this effects a decrease in private investment.  Corporate debt still available?  Private equity as well.

Perhaps I am missing credit worthiness in the mix and borrowers propensity to seek out govt issuance's over all else.

Can you clarify given the focus these days on macroeconomic trends and the national debate... and how these changes impact the individual investor.

My Reply

Two possible scenarios of "crowding out" would be:

1. The government finances its (excessive) spending by higher taxes, leaving less money for individuals and/or business to spend or invest.
2. The government finances its (excessive) spending by borrowing so much that it leads to rising interest rates which hurt all borrowers -- government, individual, and business alike.

Scenario 1 is not in the picture today. Even with the partial expiration of Bush tax cuts for higher earners and the extra taxes (again on high earners) that were part of The Affordable Care Act the overall tax levels in the US are still at or below historical post-WW2 levels as percentage of GDP  -- see Table 2.3 at http://www.whitehouse.gov/omb/budget/Historicals/ .

Scenario 2 is also not happening. Although the US federal government is enjoying its lowest borrowing rates (combined with highest deficits) in about 60 years, other types of borrowers are also able to borrow at very low rates:

Even when looking at the junkiest of the junky corporate issues, their spread relative to treasuries is at or below historical average (which combined with record-low treasuries yields means that junk bonds are still enjoying low rates):

There simply is no crowding out taking place. What could arguably be taking place is that government  is spending capital that could have been more efficiently spent/invested by the private sector and/or that government spending will not generate enough future growth to pay for itself even at today's low rates. But that is a different topic from crowding out (and not one I'm interested in discussing here as it goes straight into politics).

The implications for investors are pretty clear, but they are not really related to crowding out or lack of it. The simple fact is that interest rates are very low across the board which will necessarily mean that future fixed income returns will be meager. Nobody should be looking at returns from bonds over the past 30-40 years and use those as a guide to the future. The only way we can begin to hope to repeat those returns is if we first go through an agonizing period of high inflation and/or high interest rates, similar to 1960s-1970s.

This doesn't mean we should abandon bonds because when (not if) the next economic crisis strikes bonds will be relatively spared while stocks plunge. But equally we should not expect from today's bonds anything more than about keeping up with inflation -- and there is a very real chance of not even getting that much for a while.



2. Reader Question

Hi LTR, Your investing blog is extremely useful and concise. Great job! There are a few other information sources that I think are excellent (Bogleheads, Morningstar, etc). What are the investment information sources (blogs, newspapers, websites, quarterly reports, media, etc.) that you periodically read (or view) and find most useful and insightful and that you would recommend? Thanks.

My Reply

Thank you, very glad you like my blog. Unfortunately I don't have much free time to spend on the many worthwhile publications and sites out there. You've mentioned Bogleheads.org which is easily the best internet resource available for an individual investor. Good passive-investing-oriented blogs include TheFinanceBuff.com and ObliviousInvestor.com.

I subscribe to the Economist (use your frequent flyer miles to get the subscription!) and think highly of it, though I wouldn't say I get much out of it investing-wise. It's just a quality publication with great coverage of very wide range of topics (and countries).

As far as personal investing research/tinkering, Morningstar.com is a very nice resource, as are St. Louis Fed FRED, Yahoo Finance (for downloadable data). I also like reading old investing/finance books -- the older the better. They provide a very neat perspective on how once-sure things (e.g. dividend yield should be higher than bond yield) start to seem ridiculous over time or how supposed cutting-edge strategies (e.g. moving averages trading) are just rehashes of what was sold to investors many decades ago. Old economics books can also be interesting sometimes. From a late 1990s economics book I learned that the national debt is expected to disappear just about now. Surprise!



3. Reader Question

What do you think about Timber? 1. Any different than other commodities? (I know how you feel about commodities in general via your other posts:) 2. Any way to efficiently invest in it without getting fleeced on fees? Other than physically owning land-n-trees? Thanks!

My Reply

Good question, but unfortunately I have zero experience with timber. About the only thing I know about it is that Jeremy Grantham and GMO have been recommending it since last millennium.

Timber REITs such as PCL and PCH do not look appealing at all on valuations with P/Es north of 30 and dividend yield (which is 90+% of their profits) of less than 4%. I would be very hesitant to make new allocations to them -- or REITs in general -- today because of valuations.