I thought this was an interesting quote to keep in mind in light of the Fed's open-ended QE announcement today. If we ever start to reach “that phase”, someone please remind me
of this excerpt. From a Bridgewater piece with the title “Asset Class Returns in Deleveragings” (April 19, 2012):
“It takes an awful lot of printing to convert the naturally
deflationary forces of a deleveraging into a highly inflationary deleveraging.
It rarely happens, but when it does, it happens in a classic manner that is
worth noting. In all deleveragings (both deflationary and inflationary) the
average maturity of debt is shortened as the risks of either default or
inflation rise. As buyers of bonds have less demand for them, central banks
lengthen the maturities of their purchases, increasing debt monetization. At first
that is beneficial, though it is a modest negative for the currency. If taken
too far so that it is out of balance with the deflationary forces of austerity
and debt restructuring, it will drive lenders out of the currency and out of
longer-duration bonds, which will require the central bank to tighten to stem
that flow. This is when bond vigilantes are in control and the central bank has
little or no maneuverability. You can tell when that phase occurs because the
yield curve steepens with long rates rising. The collapse of the currency pushes
inflation, nominal growth and interest rates up, and the currency down, in a
self-reinforcing spiral. Bonds and stocks perform terribly in this ugly
inflationary environment, particularly in real terms, because the currency in
which their cash flows are denominated collapses and inflation rises more than
discounted. The collapse in the currency produces high returns in
storeholds of wealth like gold, which rise is value in local currency terms,
reflecting the decline of the value of the currency in gold terms.”