Will Our Global Inflation Cause Bonds to Again be "Certificates of Confiscation?"

Min Zeng and Liz Rappaport noted in yesterday's Wall Street Journal that "Treasurys are in their worst selloff in months as investors return to riskier assets and have second thoughts about government debt in the face of inflation concerns." More fundamentally, investors now realize the credit crunch has been dealt with by a vast overextension of short term credit by the U.S. Federal Reserve. This has set off inflation in the U.S. and a global commodity boom that dangerously resembles the beginning of the Great Inflation of the 1970s.

Historically investors have had to protect themselves against rising inflation by demanding higher yields. There is a nasty lesson every bond market neophyte learns quickly and painfully: higher yields mean lower prices. In the 1970s, bonds were called "Certificates of Confiscation," because their losses were so great. The bonds' principal kept losing value in real terms as inflation eroded their purchasing power. Then prices fell each time inflation accelerated. Investors marked them down to keep yields up with inflation.