| Money illusion is somewhat understandable for stocks. Prior to the 1970s, common stocks were considered to be inflation hedges; the thinking went that corporate profits would rise along with the general price level. No such illusion ever applied to bonds, though, which makes the next bit of history even more mystifying. After the October 2002 bear-market low, inflation expectations started to rise steadily. Nominal 10-year note yields have remained in a low and tight trading range. Implicit in all this is a steady decline in the real interest rate during a time of strong economic growth. This would be true only if the supply of funds available to buy bonds was increasing faster than the demand for credit, certainly a possibility given the massive Asian central bank bond purchases seen since that time. |
