Inflation Bonds: Why the I-Bond Is a Better Bet than the New 30-Year Treasury Bond
By Dr. Mark Skousen, Chairman, Investment U
Monday, February 13, 2006: Issue #511
At the turn of the new millennium, I had a private meeting with then-Speaker of the House Newt Gingrich at a friend’s home in Florida. At the time, the Federal government was running a surplus, and the Republicans were taking full credit for this fiscal victory.
Newt was giddy about a rosy financial future. “The entire national debt could be eliminated in 10 years!” he exclaimed. “What shall we do with the surpluses?” He talked with great enthusiasm about paying down the deficit, tax cuts, or maybe even a new spending program.
I was less sanguine. Surpluses have never lasted long in Washington, I said. Either the government comes up with new ways to spend the money, or a recession is not far around the corner. To quote Ben Franklin in The Compleated Autobiography, “Revenue without economy is never sufficient.”
For a year or so, Newt was right, and in 2001, the U.S. Treasury was so flush with money that it stopped selling 30-year bonds. We’ll briefly cover what’s happened since belowthen take a look at how inflation bonds (known as I-bonds, or inflation-linked savings bonds) stack up as investments against the Fed’s new 30-year Treasury bond.
Deficit Back In the Red For Good!
The Bush recession came next, followed by the terrorist attacks in 2001, and the surpluses evaporated overnight. Last week, the Bush administration announced a record deficit of $423 billion for this year – during a time of full employment. (Even the Keynesian economists are scratching their heads in disbelief.) The chart below, showing the deficit/surplus from 1996-2006, says it all.
Now we’re back in the deep red, and so it came as no surprise last Thursday when the U.S. Treasury did something it has not done in five years: It sold $14 billion in 30-year Treasuries. “The Bond,” as it is known by traders, was quickly bought up at a 4.53% yield.
I have no problem with corporate long-term debt. Disney issued 50-year bonds, which also sold quickly. In the late 19th century, railroads sold 100-year bonds and paid only 2% interest because they were gold-backed railroad bonds. That was an earlier version of inflation-indexed bonds.
Investors who bought up the 4.5% long bond are likely to be disappointed. They are a bad deal in a period of accelerating inflation. Inflation is making a major comeback, as we have demonstrated in recent Investment U columns. They have no protection on the downside if inflation worsens.
The Antidote: Invest in Inflation Bonds
Wise investors would do better buying inflation bonds, or I-bonds. Inflation bonds/I bonds are a type of inflation indexed security issued by the Treasury, sold at face value in $50 to $10,000 increments. Inflation bonds consist of two parts:
- A fixed rate (currently at only 1%) that lasts for 30 years, and
- An inflation rate that changes every six months (May 1 and November 1)
On the tax front, inflation bonds enjoy exemptions from state and local taxes. Additionally, specific federal tax exemptions exist if investors’ earnings are used for tuition and fees at colleges, universities or trade schools that qualify.
Here are the current rates of return on inflation bonds: (Note: The rates can move up and down, depending on the Consumer Price Index set every six months.)
|
Issue Dates |
Earnings Rates* |
| NOV 2005 – APR 2006 | 6.73% |
| MAY 2005 – OCT 2005 | 6.93% |
| NOV 2004 – APR 2005 | 6.73% |
| MAY 2004 – OCT 2004 | 6.73% |
| NOV 2003 – APR 2004 | 6.83% |
| MAY 2003 – OCT 2003 | 6.83% |
| NOV 2002 – APR 2003 | 7.35% |
| MAY 2002 – OCT 2002 | 7.76% |
| NOV 2001 – APR 2002 | 7.76% |
| MAY 2001 – OCT 2001 | 8.79% |
| NOV 2000 – APR 2001 | 9.20% |
| MAY 2000 – OCT 2000 | 9.40% |
| NOV 1999 – APR 2000 | 9.20% |
| MAY 1999 – OCT 1999 | 9.09% |
| NOV 1998 – APR 1999 | 9.09% |
| SEP 1998 – OCT 1998 | 9.20% |
| *Annual rates compounded semiannually |
Where To Buy Inflation Bonds
Series I bonds are available through the following ways:
- Directly from the Treasury
- Through commercial banking institutions
- From employers with eligible employee savings plans
Investors are issued registered certificates of ownership after purchase. Please note that while other Treasury securities can be resold or passed down, inflation bonds must be kept.
Visit Treasury Direct for current rates or to learn how to set up a Treasury Direct account.Good investing,
Mark
Today’s Investment U Cribsheet
- Ben Franklin’s “Revenue without economy is never sufficient” certainly rang true as we witnessed our last surplus vaporize. Find out how Franklin built his own wealth in Investment U #502, The Way to Wealth: Three Rules That Made Ben Franklin One Of the Top 100 Richest Americans. Also, stop by Amazon.com for more information about The Compleated Autobiography by Benjamin Franklin.
- I mentioned that inflation is making a major comeback these days – a topic we’ve been following here at Investment U Be sure to take a look at Investment U #493, The Federal Reserve Discontinues the M3 Chart: How To Profit from the Fed Ban, and Investment U #494, Gold as an Inflation and Market Indicator: Where to Put Your Money When Prices Edge Higher.
- Citigroup Gets Treasury “Seal of Approval”
- Treasury TIPS Coming Back into Fashion
- 406 Days Until This Market Crashes…
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