The Permanent Portfolio, Investing, Finance and Random Thoughts.
Posts tagged TIPS
Gold Not an Inflation Hedge? Hardly!
2 months ago
by Craig Rowland
in Investing
Larry Swedroe posted an article arguing that gold is not an asset that can be used to protect against inflation:
How to hedge against inflation (hint:forget gold)
Of course I disagree and the Permanent Portfolio holds gold precisely to protect against inflation.
First let’s be clear that inflation is a deliberate policy decision on the part of the government. To think that the same entity is going to provide “inflation protection” with something like Treasury Inflation Protected Securities (TIPS) is a risk (governments do lie about these things). If they wanted people to be protected from inflation they wouldn’t use it as monetary policy! But they do which means they don’t care what happens to you and others that hold dollars in terms of the effects of inflation. The conflict of interest is simply too much to ignore. You don’t want to hedge your inflation risk with the same currency that is being inflated away. Nor do you want inflation protection from the same group that is causing the problem.
I don’t consider paying protection money to the mob for not burning down my store as a favor. And that’s exactly what what TIPS are: Paying for protection from the same people threatening me with inflation.
Ideally you want your primary inflation protection to be from stocks and bonds which have a way to generate real returns in excess of the debasement of the currency long term. However when you don’t get that (e.g. the 2000s and 1970s) then gold can be a useful asset. Comparing the peak gold price from 1980 as Mr. Swedroe did in his article is cherry picking. It assumes an investor did nothing but a) buy gold and b) did it at the exact top peak of the market. It would be like picking 2000 as the date to suggest that someone shouldn’t own stocks because the past decade they have not kept up with inflation.
In hindsight, the gold price in 1980 looks like it was obvious. But fact is prime rates were over 20% and inflation could have continued to get worse. Likewise, telling someone not to buy stocks because they have had a bad time since 2000 is also hindsight analysis. Stocks could have recovered and continued to go up. We don’t know these things ahead of time.
All assets have risks. Gold, stocks, bonds, t-bills, etc.. All of them have their own risks but their own rewards. So you own a little of each to protect yourself against a catastrophic loss but also capture profits when presented. This is because the future is just not knowable and any one of them can work out to be a savior of a portfolio at any time and for any reason.
So I humbly disagree with Mr. Swedroe on this point. Gold is a great inflation hedge when the chips are down. When currencies are going into the toilet people want gold and not TIPS or other similar products. The facts of history are overwhelmingly in support of gold as a currency protection asset. In a diversified Permanent Portfolio gold works perfectly fine and does a great job to balance the risks of stocks, cash and bonds.
Governments Like Inflation
3 months 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
1 year ago
by Craig Rowland
in Economics
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.
