Use These “TIPS” to Protect Yourself Against Inflation
by Alexander Green, Chief Investment Strategist
Monday, April 19, 2010: Issue #1241
A recent column of mine, in which I recommended Treasury Inflation-Protected Securities (TIPS), outraged a number of readers.
Why was it so upsetting? Because – and don’t ask me what they’re smoking – 17% of Americans actually approve of the job Congress is doing.
Taking both parties to task, however, I wrote:
#1: When George W. Bush and his fellow Republicans came to power a little more than nine years ago, they promised to cut wasteful spending, limit the size of government and move closer to a balanced budget.
Instead, they…
- Created a Medicare drug entitlement that will cost nearly $1 trillion in its first decade…
- Started a string of expensive financial bailouts that continues today…
- Passed a record number of earmarks…
- Increased federal spending 58% faster than inflation…
- Presided over a $2.5 trillion increase in the public debt.
#2: Then, last November – anxious for change – voters threw the bums out and put the Democrats in charge. The Democrats promised to change this reckless course and restore fiscal sanity to the country.
Instead, they tripled the budget deficit in their first year. The White House and the Congressional Budget Office now estimate that this year’s deficit will explode to $1.56 trillion – a post-World War II record at 11% of the overall economy – and add $9.7 trillion in debt over the next decade.
Facts vs. Opinions
Here are the other points I made…
#3: The Obama Administration’s own projections see the federal debt hitting $18.5 trillion by 2020. However, that was before the passage of the healthcare reform bill – the biggest new entitlement since the creation of Medicare in 1965.
#4: Unfunded liabilities for Social Security, Medicare, Medicaid, the prescription drug benefit and the new federal healthcare program have now jumped to $108 trillion, nearly eight times our annual GDP.
#5: Moody’s has threatened to downgrade the Triple-A rating of U.S. sovereign debt, perhaps within three years. A drop in our credit rating would both decrease the perceived safety of Treasury securities and increase the interest that Uncle Sam – excuse me, you, your children and your grandchildren – will pay on the deficit.
#6: Credit Suisse recently produced a report pointing out that the country whose debt profile most resembles that of Greece is – hold your breath – the United States. (If you believe a picture is worth a thousand words, try this: http://www.usdebtclock.org/)
#7: Down the road, Washington – with the reluctant consent of the Federal Reserve – could opt to solve this problem the way so many governments throughout history have – by inflating our way out of it.
Inflation: The Bane of Debt-Holders & A Godsend to Debtors
Inflation is the bane of debt-holders, of course. But it is a godsend to debtors – and Uncle Sam is the biggest of them all – as they can repay fixed obligations with increasingly worthless currency.
What surprised me was not that some readers had a difference of opinion. I always welcome that. It was that respondents uniformly barked that they didn’t want to hear my “political opinions.”
Opinions? Go back through these seven points and tell me which one contains an opinion. Even the last one modestly states that Uncle Sam “could opt” to inflate our way out of this problem.
As Jack Nicholson reminded us in A Few Good Men, some people can’t handle the truth. Especially when it’s something they don’t want to hear.
For example…
- When we warned 11 years ago about the massive bubble in Internet stocks, the majority of respondents gushed about the New Era and insisted we “just didn’t get it.”
- When we warned six years ago about the ominous housing bubble, many scoffed and insisted that home prices “always go up.”
- When we talk today about the threat to your financial security that Washington is creating with its Ponzi-style entitlement schemes, a lot of investors don’t want to hear that, either.
Believe me, I hope I’m wrong. I don’t want high inflation any more than you do.
Fortunately, inflation today is as tame as a kitten.
The Benefits of Treasury Inflation-Protected Securities & Three Ways to Buy Them
I only suggest that you buy Treasury Inflation-Protected Securities ( TIPS) as an important insurance policy. (Because when inflation – the thief that robs us all – rears its ugly head, neither stocks nor bonds do well.)
You can purchase inflation-protected Treasuries (TIPS) in three ways…
- Directly ( http://www.treasurydirect.gov/indiv/research/indepth/tips/res_tips_buy.htm).
- Through the Vanguard Inflation-Protected Securities Fund (VIPSX).
- Through the ETF equivalent – the iShares Barclays TIPS Bond Fund (NYSE: TIP).
There are several advantages to buying TIPS…
- TIPS pay interest every six months, just like a regular Treasury bond. But unlike traditional bonds, your principal increases each year by the amount of inflation, as measured by the consumer price index (CPI). Semi-annual interest payments also increase by the amount of inflation.
- The interest you receive is exempt from state and local (but not federal) income taxes.
- TIPS are less volatile than traditional bonds.
- They’re also excellent diversifiers.
Some investors complain that these securities haven’t done anything exciting lately. Of course not. We’ve been in the grip of disinflationary forces, not inflationary ones – and that won’t change next week or next month.
Protection Against The Government “Doing Something”
But as the deficit keeps expanding and the electorate grows increasingly unhappy, pressure will mount on the government to “do something.”
That “something” could be a decision to inflate our way out of this mess, rather than risk the kind of deflationary spiral that Japan has endured over the past two decades.
Bear in mind…
- The Fed has already taken interest rates close to zero…
- Congress has already tried a massive fiscal stimulus…
- The Federal Reserve has already created trillions out of thin air to mop up worthless securities.
If the economy stumbles again and further government action is taken, it could be even more reckless, resulting in inflation.
In the interest of full disclosure, however, that’s just my opinion.
Good investing,
Alexander Green
Any investment contains risk. Please see our disclaimer.
14 Responses to “Use These “TIPS” to Protect Yourself Against Inflation”
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Alexander Green is the Chief Investment Strategist of Investment U. A Wall Street veteran, he has more than 20 years of experience as a research analyst, investment advisor, financial writer and portfolio manager.
I agree with your facts completely. Leaving the country is rapidly becoming the most prudent option. Just as the Feds will no doubt require that all retirement plans contain a substantial percentage of gov debt, I am sure that the TIPS will also be recalled with a fixed interest substituted. TIPS are far more risky than foreign investments or metals. I will stay in the US stock market a while longer but long term looks very grim.
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TIPS are only good if we assume the inflation numbers used to make the periodic adjustments are good. But they’re probably not. Any number of sources claim the government understates the true inflation number with the various games they play–such as “core inflation, ex food and energy”,
changing the way inflation is calculated every so often, hedonic pricing (computer power, not price)
etc etc TIPS in my opinion a bad bet and I wouldn’t touch them.
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I am sorry that some of the readers don’t understand how government affects their life, and even their children and future generations’s life. Thanks for the warming to get people prepared. We were not prepared when the last housing bubble burst (we were one of those buy-and-hold firm believers for stocks, did not interested in bond, did not have any idea about any other investment vehicles like currencies and precious metals), but we learned from this lesson and are better prepared now (probably too early, but rather early than late). We allocated good part of our portfolio into PMs and still continue doing so when there’s any dip in prices. We still have descent investment in stocks, but are considering moving our gradually. However, we did not plan to get TIPS. It’s almost a consensus (among people who’s aware of what government is doing) that government underestimated inflation to suit its own need, and therefore TIPS will never compensate for the real inflation.
Hope everyone will be well-prepared. No matter you’re belong to the 47% people who don’t need to pay the tax or not, everyone will be affected.
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In caps I AGREE WITH YOU AALEX!!!!!! I gave a copy of the investment U on tips you are refering to today to my US Rep Mr Tom Cole from Oklahoma. He is conseritive and after reading, red faced had to agree they blew it 9 years ago. I told him he might get only one more chance to make it right in 2010. Mickey Pettit
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Alex’s article on TIPS is very well written and summarizes how they work. However, as in other financial areas, the Government CHEATS and LIES when it comes to statistics. Since TIPS depend on the CPI, there is the opportunity to understate the real CPI.
I would appreciate Alex or someone writing an article on the changing of statistical methods by the Government over the years to manipulate Financial Statistics. The data exists to do so. This would be a “real service” to the investing public!
Thank you. Lou
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Alex,
I think your subscribers represent a wide range of views, with a growing number of them bearish on the future of gov. actions.
you know the gov. manipulates the CPI to about 50%
of shadowstats inflation numbers, so why would anyone want to loan this gov. money in the first place, and accept that they will continue to manipulate the rate of return in the second place?
You acknowledge the scale of gov. indebtedness, and the potential for inflation, yet offer their debt as safe. To be sure they will pay out paper dollars, but is the value of these future dollars staying ahead of real inflation-I don’t think so.
Markets worldwide generally sport lofty evaluations with exceptions, and I believe the dumb money will soon be taken off the table. I don’t envy your need to make rccommendations, but you can do better than TIPS, I’m sure.
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Alex,
Thanks for your insight. Your opinions are always welcome, as I feel they are fair and balanced. Nothing substitutes for the truth, no matter which way it cuts.
Greg
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I have stopped speaking with people based on the idea they do not understand what you are speaking about. They also don’t understand that the government told the banks they had to give loans to people with bad credit ratings in 1996. This was one of the most stupid things I had ever heard. Also there were complaints that insurance was higher in different neighborhoods, could it have been the crime rate was higher. We are living in stupid times, people also think John Paulson is Hank Paulson. I have to get out of this place.
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Hi Alex, what if confidence in the TIPS disappears and there are no buyers at the other end? Wouldn’t we be better off in physical gold?
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Another great report
I have owned both Vanguard inflation protected fund and the Ishare TIP for over a year – actually 2 for the TIP – not going up a lot but better than a simple no interest money market fund – besides they are INSURANCE – one usually has to pay for insurance. But the inflation the government acknowledges that will be reflected in TIP is much less than the real inflation. Governments – ‘welfare states’ rely on inflation to pay for their promises – they are debtors – but once so many government hand outs were indexed to inflation the government scam was exposed. Government will find a way to keep TIP from paying off as much as inflation would warrant.
best
john
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Thanks for the article. I agree with your assesments. If anything, your comments are a bit restrained. The fact is, our government has been robbing us blind, lying to us, and taking away our freedoms for decades. And we have been watching it happen while doing nothing. Government is one massive wealth redistribution machine. I own gold, silver, and a variety of commodities and will continue to add to my portfilio.
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Alex, I value your opinion and would appreciate a follow up article on other inflation hedges like gold and silver. Thanks.
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hi – i would be interested in more info on dividends more monthly paying than quarterly – quarterly are easy to locate…
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Fact 1: Inflation is a Tax.
Fact 2: Dollar is the World Reserve Currency.
Result: USA is taxing every country that hold Dollars as the Reserve Currency.
Fact 3: Dollar is own and printed by the Federal Reserve (Every dollar says “Federal Reserve Note”). The Federal Reserve is not Federal, it is a private institution form by Private Banks.
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