Chart: Inflation, Not The Flu

Today we had the amazing Nassim Taleb in for what I'm hoping will be the bulk of the Wednesday podcast. What can I tell you now? He takes milk with his tea, but he puts the milk in after the water. And he says inflation is coming, maybe even hyperinflation.

Hyperinflation is scary, but so is the specter of no inflation (or even deflation, where wages and prices go into a sustained fall). In the graph above, Alan Cordova tracked the difference in yields for Treasury bills of varying lengths. That "spread" shows how much higher a return investors demanded — and Treasury provided — on loans lasting longer than a month. For an investor, the risk of Treasuries has mainly to do with inflation. That is, you're generally not worried that the government won't pay you back, but rather that inflation will spike and the $100 you put in for won't buy as much as you expected when you finally get it.

The picture you're seeing here shows that investors expected inflation to fall back around 2006 and 2007, but now they're expecting inflation to rise, and not by a frightening amount. By demanding a somewhat higher yield on a one-year Treasury bond, for instance, they're just trying to build in a meaningful profit.

After the jump, two trading days — one weird, one normal.

 

The chart above looks at two trading days, one from 2007 and one from 2009.

The red line, for April 16, 2009, shows investors demading higher returns on longer-term loans — meaning they expect healthy inflation in the next three to 360 months.

The blue line, from July 31, 2007, shows what is known as an "inverted yield curve," where investors expect the value of the dollar to fall over a certain period of time. Since they're not worried about inflation, they demand a lower rate for longer-term notes than for shorter one. "This corresponds to expected deflation, which is (in my opinion) the worst possible thing that could happen," Cordova writes.

If you consider the 2007 snapshot in the context of the first chart, you'll see that the spreads are actually in the negative, with investors willing to take a lower rate of return for Treasury notes longer than a month.