The Permanent Portfolio, Investing, Finance and Random Thoughts.
Posts tagged TIPS
Governments Like Inflation
51 week ago
Let’s talk about Treasury Inflation Protected Securities (TIPS) again. It’s no secret that I dislike them vs. gold in the Permanent Portfolio. But will they ever “default” as some say? No, they won’t. But this doesn’t mean they don’t have other serious problems.
I don’t believe the US will ever default on its debt because they control the money it is denominated in. They can simply print money to pay it all off. Not a good thing, but technically not a default. If you own $10,000 in TIPS and the Treasury hands you a $10,000 bill in the future they technically paid off the obligation. Of course the money may be worthless, but you did get paid back as stated in the agreement.
Now, what causes inflation? Inflation across an entire economy is caused by politics, not economics. It’s different than a shortage of a crop like corn that cause prices to spike in that one area. Inflation as a policy makes all prices go up together. This is a unilateral truth if you look at financial history.
Therefore, the idea of relying on the government causing the inflation to protect you from the inflation is a really bad idea. If the government really cared about protecting you from inflation they would implement monetary policies that balanced the demand for new money each year with the supply so inflation was 0% +-. But that’s not what they do. They target 3-4% inflation and often get it wrong and all sorts of things happen as a result.
Governments like inflation. They have no desire to protect their citizens from inflation or they wouldn’t use it as a monetary policy at all.
What does this mean? Simple:
Governments like inflation. They have no desire to protect their citizens from inflation or they wouldn’t use it as a monetary policy at all.
Why buy a product like TIPS from an entity that is actively working against your interests behind the scenes?
Even the much vaunted “independence” of the Fed is an illusion. Enormous pressure can be put on the Chair of the Fed to react in certain ways. I really enjoyed this paper for instance that discussed the Nixon tapes and the pressure put on Fed Chair Arthur Burns. Nixon wanted an easy money supply for political reasons at the risk of sending inflation even higher and it appears Burns complied. The taped quotes are interesting:
How Richard Nixon Pressured Arthur Burns: Evidence from the Nixon Tapes
What’s the lesson from this (and likely other manipulations by later administrations)? Well it’s that true inflation protection is not going to be gained by trusting the people with their hands on the printing press.
TIPS may be wonderful if inflation is low and steady. But I have a very difficult time believing they are going to do any better than a simple short-term Treasury fund in terms of offering inflation protection under higher rates. In other words, they are very likely to just tread water or probably lose a little each year in the game of catch up if bad inflation comes to the US.
Don’t buy TIPS for the Permanent Portfolio. Gold is immune from a lot of political shenanigans that can affect the actual reporting of inflation and subsequent inflation adjusted payments. There’s nothing wrong with keeping 25% of your wealth in a form of money (gold bullion) that is not subject to the whims of those in power.
TIPS Are a Bad Idea: Argentina’s CPI
As a follow up to another post, I am blogging to mention this article I read today about Argentina. Yes, we’re not Argentina. But it is very constructive to look at other countries handling high inflation to see what lessons can be gleaned. This article exposes one of the issues with relying on the Consumer Price Index (CPI) to protect investors against high inflation. Namely, political risk. Specifically, political risk of having the CPI manipulated to make those in power look less culpable than they really are.
The point I’m driving at about TIPS for inflation protection is that when the CPI is very high, and you really need the inflation protection, is the point when CPI is the most likely to be gamed against you.
No One Cries for Argentina Embracing 25% Inflation
Index Underreported
And when inflation remained stuck at about 10 percent in 2006, Kirchner replaced the officials in charge of the CPI report. Since then, Lavagna says, the government has underreported the consumer price index. The bureau says prices rose just 10.9 percent last year, while research firm Ecolatina, which Lavagna founded 30 years ago, says the gain was 26.6 percent.
(emphasis added)
Again, just a possible risk what could happen with relying on TIPS or other inflation indexed products to protect you under high inflation. For all its faults, at least gold doesn’t need to worry about getting fired for going up too much in value against a collapsing currency.
This is one of many reasons why gold is held in the Permanent Portfolio for inflation protection, and not TIPS.
TIPS are a Bad Idea
People sometimes want to know my view on Treasury Inflation Protected Securities (TIPS) vs. Gold for inflation protection. Well, I have boiled my research on this topic down into two simple rules:
Rule #1 – Don’t let the people causing the inflation tell you what the inflation adjustment rate on the investment will be.
Rule #2 – Don’t let the people causing the inflation pay you in the same currency that is being inflated away.
Explanation:
Rule #1 – Governments lie. Yes, that even means your government. When inflation is raging it is the government that will lie about the problem to protect itself. I have studied the financial history on this and it is just what happens in every country. And is it really surprising when you have your population angry that they can’t afford life necessities due to poor management of the paper money supply? Of course the pols are going to lie to protect their necks. Gold though is independent of government spokesmen, incompetent economists and political speeches. The price of gold is going to react to market forces and is not going to be weighed down in govt. policy decisions about true inflation figures, etc. Gold doesn’t care. TIPS however have this huge conflict of interest involved.
Rule #2 – If there is high inflation, then why in the world would you want more of the currency being debased and losing value? You don’t. You wan’t much less of it. In fact, you probably want to hold only the bare minimum to pay for current living expenses and that’s it. Yet, TIPS are paying your inflation adjustments in dollars. If the dollar is falling rapidly under high inflation why would you want more dollars? This only benefits the currency issuer, not you.
Gold has its own quirks and I acknowledge that. However it doesn’t have these very serious drawbacks that TIPS possess. But when it comes to serious inflation protection I believe that TIPS are not the solution. I just don’t know how to say it any clearer. Don’t buy arson insurance from arsonists and don’t buy inflation insurance from inflationists. It’s just a really bad idea.
Permanent Portfolio 25% Gold Allocation FAQ
2 years ago
This FAQ will be updated from time to time. I didn’t think it would be as involved to write as the other FAQs on Stocks, Bonds and Cash. What I found though is that there is just so much misconception about gold (both pro and con) that it needs a lot more detail. This FAQ is huge. It probably needs to be broken out. But I figured I’d post it all now because it’s been months since I promised it and if I wait until it is “done” then it could be many more months.
So this is a work in progress and will be updated as I get around to it.
Last Updated: November 19th, 2009
The Permanent Portfolio allocation is 25% stocks, 25% bonds, 25% gold and 25% cash. In this series of posts we’re going to talk about how to implement each one of these components to take advantage of the economic cycles of Prosperity, Inflation, Recession and Deflation. This FAQ is divided into two sections: Short Answers and Long Expanded Answers. If you don’t want to know the details then just read the Short section and skip the Long Expanded section. This page will be updated from time to time as more common questions and answers are needed. In this series we talk about the 25% gold allocation and how it protects you from inflation and other currency problems.
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