The Case for Shorting Bonds

Bill Cara has claimed that The Trade of the Generation is to sell bonds and to buy gold.  I think he’s right.  Here’s why:

1. The inflation rate is currently being reported at 3.8%.  Most people think that the books are at least a bit cooked, and some well respected economists even think that we’ve averaged closer to 8% pa since the 80s.  The 20 year rate is currrently 3.487%.  Even going by inarguably understated government statistics, you’re losing money.
2. The target rate which governments lends money is 1%.  The real lending rates have been dramatically lower — near 0% for close to a year now.  Friday’s weighted average was 0.441%.  Wednesday’s was 0.33%.  This is actually an improvement over earlier in the month where we see the Fed lending at 0.253% on the 4th, 0.195% on the 5th, 0.18% on the 6th….  this is going to serve to increase inflation.

With effective rates at less than 1% and the current backdrop of financial crisis, do you think 3.487% pa reflects the inflation or default risk over 20 years?  I surely do not, and I think the current principle in domestic government bonds is a bubble caused by flight-to-quality and flight-to-liquidity from the bust of commercial bonds.