Treasury Bills are not the safe investment people think. With the 10-year yield below the rate of inflation, T-Bills are now a bet that recent price increases won’t last.

They are basically a leveraged bet against inflation, says Bill. And as oil and food prices drop, this may be a good bet. Then again, it may not be

Either way, professional and amateur investors seem to agree on one thing: Stocks are a bad bet right now…

The yield on a 10-year Treasury note is barely above 4%. This puzzles us.

People are buying Treasuries for safety. Money markets, which hold short-term Treasury bills, are at record levels. We understand why you might want to have money in a money market fund…but where’s the margin of safety in a 10-year note paying less than the rate of consumer price inflation? Even in the money market funds, you’ll lose money when the dollar goes down - whether it goes down against other currencies or against consumer items. And what do you get in exchange for the risk? Not much. The 91-day T-bill rate is only 1.66%.

Currently the inflation rate - according to official statistics - is near 5%. Buying a 10-year note at a full percentage point lower is not a safe investment - it is a speculation, a bet on the direction of rates in the future. If they go …the value of the T-notes goes down.

Lately, that’s begun to look like a reasonable bet.

“Falling prices ease worries about stagflation,” says a headline in the International Herald Tribune. Oil is down about 15% from its peak. Food has fallen a similar amount. Could it be that inflation has topped out? Could it be that the “civil war” between inflation and deflation is finally reaching a conclusion…with deflation the clear winner?

Could be. Then again, it could not be.

“The question for investors is whether the slump in oil and commodity prices will last or is simply a temporary retreat brought on by overstretched increases,” continues the IHT. If the increase in prices won’t last, we can all forget about girding our loins for the fight against inflation. We can simply buy Treasury notes and wait for the current downturn to pass, right?

Maybe. Maybe not.

Meanwhile, investors are selling stocks short at record levels. The pros think stocks are a bad bet. This puts the stock market under a lot of tension. A rally to the upside can be explosive, as the shorts need to buy in order to cover their positions. On the other hand, the pros may be right; deflation is a big threat to stocks. The amateurs may be right too - they’re moving to cash and bonds.

Cash is probably a good move. You’re protected against defaults and write-downs. And you can take cover if inflation gets worse. Moving to bonds is another matter. They are a leveraged bet against inflation. And yes, for all we know inflation is dead forever. But we wouldn’t want to bet on it.

Source: The Daily Reckoning