The perception of government bonds as 'safe' is challenged by history. In the 35 years following WWII (1945-1980), a period of inflation and financial repression, investors in most global government bond markets saw the real value of their capital decimated.
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The Federal Reserve encouraged banks to buy long-term treasuries while signaling low rates, only to then hike rates at a historic pace. This action decimated the value of those bonds, making the world's 'safest asset' the riskiest and directly triggering bank collapses like Silicon Valley Bank.
Holding cash is a losing strategy because governments consistently respond to economic crises by printing money. This devalues savings, effectively forcing individuals to invest in assets like stocks simply to protect their purchasing power against inflation.
Since leaving the gold standard in 1971, the default government response to any financial crisis has been to expand the money supply. This creates a persistent, long-term inflationary pressure that investors must factor into their strategies, particularly for fixed-income assets.
Bear markets are not all the same. Deflationary shocks (like 2008) cause rapid collapses as earnings evaporate. Inflationary periods (like 1966-1982) cause a slow, grinding decline in real returns as valuations compress, even while nominal earnings may grow.
Historically, surges in U.S. public debt have consistently led to periods of negative real interest rates. This suggests that the sheer weight of government debt creates a structural constraint, forcing markets to keep real rates capped, irrespective of short-term inflation or central bank policy.
Despite recent concerns about private credit quality, the most rapid and substantial growth in debt since the GFC has occurred in the government sector. This makes the government bond market, not private credit, the most likely source of a future systemic crisis, especially in a rising rate environment.
While low rates and high nominal growth typically favor equities, financial repression introduces a counterintuitive risk. If institutions are forced to buy government bonds, they must sell liquid assets—primarily equities. This could lead to a slow, multi-year decline in the S&P 500, mirroring the 1966-1982 period, instead of a sudden crash.
For 40 years, falling rates pushed 'safe' bond funds into increasingly risky assets to chase yield. With rates now rising, these mis-categorized portfolios are the most vulnerable part of the financial system. A crisis in credit or sovereign debt is more probable than a stock-market-led crash.
Investors often prefer interest-bearing cash or bonds over non-yielding gold. Dalio calls this a "trap." This works until the government's promise to redeem the currency is broken (like the US leaving the gold standard), revealing the hidden credit risk of fiat money.
In an environment dominated by government debt and money printing, holding cash is not a neutral act of saving; it's direct exposure to inflation. As the government devalues the currency to manage its interest payments, the purchasing power of cash diminishes. The priority must shift from simply saving to owning productive or scarce assets as a defense.
