A Few TIPS on Inflation Protection

by Bill Bonner.

What a whacky, whacky world…

“Debt sales highlight abnormal conditions,” says the headline in yesterday’s Financial Times.

Abnormal? Freaky. Bizarre. Strange.

The latest auction of TIPS – US Treasury debt with inflation protection – produced a curiosity. Investors were willing to pay $105 for every $100 worth of inflation-protected notes.

Go figure.

What does it mean? What are investors worried about? On the surface of it, they are setting themselves up for a built-in loss. TIPS always offer less interest than regular bonds. You give up some yield to pay for the inflation protection. But TIPS buyers are now buying them with negative yields. Which is to say, they pay for the privilege of owning the bonds. Inflation has to beat expectations…and then some…before they are even at breakeven.

All very weird. If they are so afraid of inflation, why not buy gold? No negative yield. You pay $100…you get $100 worth of gold.

And you won’t have to worry about the people who are making the calculations. In the case of TIPS, the people who sell the notes are the same people who determine how much they’re worth – because they’re the people who figure out the CPI. Besides, we haven’t studied the matter, but when we last looked into it, we found that there was a delay in making the adjustments. So, in a period of hyperinflation the adjustment process would be overrun by events. When Hungary had its hyperinflation of 1947, for example, the pengo lost half its value every 13 hours. No adjustment in the world can keep up with that rate of loss… A TIPS holder would be wiped out. A gold buyer, on the other hand, would be, well, golden….

The other strange thing about protecting oneself from inflation via TIPS is that there isn’t any inflation to speak of. According to the people who keep the statistics, the rate of consumer price inflation is barely 1%. And according to the people who buy regular non-adjusted Treasury debt, there is no inflation on the horizon either.

All of which makes the TIPS auction curiouser and curiouser…

Stock market investors didn’t seem to know what to make of it either. The Dow ended yesterday essentially unchanged.

Gold didn’t know what to think. It didn’t move yesterday.

And that’s not all…how’s this for weird?

From Bloomberg:

“Dollar Gains Against Euro on Speculation Fed Easing Will Spark Inflation”

Huh? Investors worried about inflation in the dollar. They buy dollars? Yep.

The dollar strengthened against the euro for the first time in three days on speculation an increase in debt purchases by the Federal Reserve will cause inflation to accelerate.

Sterling rallied against all of its major counterparts as a report showed the UK’s economy grew in the third quarter at double the pace forecast by economists and Standard & Poor’s raised the nation’s credit outlook. The yen dropped versus the dollar on the prospects of Japan renewing intervention to weaken the currency and protect exporters.

“Inflation expectations have been lifted because people think the Federal Reserve will be successful,” said Marc Chandler, global head of currency strategy at Brown Brothers Harriman & Co. in New York.

The US currency appreciated 0.8 percent to $1.3859 per euro at 5 p.m. in New York, from $1.3965 yesterday. The dollar gained 0.8 percent to 81.43 yen, from 80.81 yesterday, when it reached 80.41 yen, the lowest level since April 1995. The euro was little changed at 112.86 yen, compared with 112.85.

The Dollar Index, which IntercontinentalExchange Inc. uses to track the greenback against the currencies of six major US trading partners including the euro, yen and pound, increased 0.7 percent to 77.6533. The gauge has fallen 1.4 percent in October on speculation a boost in debt purchases, also known as quantitative easing, will erode the value of the greenback. The Fed is next due to decide on policy at its Nov. 2-3 meeting.

The markets are seriously confused. Inflation? Deflation?

Well, what are we going to do?

We’ll hold our gold. We’ll sit. We’ll laugh. And we’ll wait for this whole shebang to go ka-plouey.

How’s that?

Bill Bonner
for The Daily Reckoning

Since founding Agora Inc. in 1979, Bill Bonner has found success and garnered camaraderie in numerous communities and industries. A man of many talents, his entrepreneurial savvy, unique writings, philanthropic undertakings, and preservationist activities have all been recognized and awarded by some of America's most respected authorities. Along with Addison Wiggin, his friend and colleague, Bill has written two New York Times best-selling books, Financial Reckoning Day and Empire of Debt. Both works have been critically acclaimed internationally. With political journalist Lila Rajiva, he wrote his third New York Times best-selling book, Mobs, Messiahs and Markets, which offers concrete advice on how to avoid the public spectacle of modern finance. Since 1999, Bill has been a daily contributor and the driving force behind The Daily Reckoning. Dice Have No Memory: Big Bets & Bad Economics from Paris to the Pampas, the newest book from Bill Bonner, is the definitive compendium of Bill's daily reckonings from more than a decade: 1999-2010. 

  • http://www.investorsfriend.com The InvestorsFriend

    Strange indeed…

    Some investors are bidding up the price of regular long-term treasuries, accepting tiny yields which suggests they expect very low inflation.

    Other investors are bidding TIPS price up and yields down to negative real yields suggesting they expect high inflation.

    The two contradict each other

    But, both have one thing in common. Someone or something (country, institution?) has gobs of money and is eager to invest it.

    Interest rates of all kind are ultimately driven by supply versus demand. (Even central banks I believe manipulate interest rates by changing their demands or supply of money).

    It’s hard to argue, extremely low interest rates suggest a surplus of lenders / savers and a scarcity of qualified borrowers. (No one is forced to buy treasuries at extremely low yields and yet they are buying…)

    But that (surplus of lenders) is very strange indeed in a world of huge deficits and debts…

    Many may owe money but it seems others own money and are faced with investing at very low interest rates.

    Strange Days Indeed…

  • Krakondack

    It is very deep pockets that need to park their moneys in treasuries to begin with. These pockets have that need. Your gold argument is, well, golden. So the reason they’re not going into that must have to do with the small size of the physical bullion market. There aren’t many entities that this could be.

  • Glantz

    Maybe the explanation is simpler – the FT was wrong in it’s reporting.

    The reporting from other sources is that investors don’t believe the QE will be as robust as the FED is making it out to be. Therefore deflation vs inflation.

  • Luis de Agustin

    According to official consumer-price statistics, the outlook for US inflation still looks benign; but this impression is mostly a function of the shallow way in which the government measures the cost of living. Monetary inflation pressures are dramatically visible in commodity prices and are already a major restraint on the US economy and the stock and bond markets. The scope for further loss in the dollar’s purchasing power is more threatening than ever according to recent trends in precious-metals prices. The force behind inflation shows gold prices have accelerated this year, and the current price above $1360 has overshot the previous ten-year trend rising at 17 percent a year.

    The idea that “quantitative easing,” or holding interest rates close to zero, has stimulative effects on the economy is a matter of doctrine rather than evidence. The third-quarter real GDP estimate of 2.0 percent is new evidence that the US is not recovering as it should from the 2008-09 recession, and hope of any major improvement now looks forlorn; yet, on a global scale, the outlook for economic recovery continues to look excellent according to the credit spreads data. That’s the outlook on the topic from macro analytics shop Wainwright Economics.

    And yup, as the article concludes, continuing to hold onto your gold makes much sense.

    Luis de Agustin

  • kevin

    GOLD went “ka-bloeee” Friday.
    .
    A bubble made of gold is still… a bubble.
    .
    It’s irresponsible to tell people to buy into any bubble, and my writings/ research show the gold bubble will wipe you out far faster and worse than TIPS, which have built-in floors at least.

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