TIPS as Seen Through Governmental Eyes

The following two documents are a MUST read for those considering the purchase of TIPS.

Minutes of the Meeting of the Treasury Borrowing Advisory Committee (pdf)



Click to enlarge.

First, I want to sum up the ex-ante vs. ex-post thing. When looking ahead, inflation expectations imply that TIPS save the government money. That's the ex-ante part. However, when looking backward, inflation ran hotter than expected. That's the ex-post part. As an investor in TIPS, this condition serves me VERY well. In other words, the government did not expect me to make as much money off of TIPS as I have. I don't see this changing much as I look into the future.

Second, I want to point out the stagflation sentence. I don't want anyone to miss it.

The member noted that the "pro-cyclical benefits" argument for issuing TIPS also breaks down in stagflation environments.

Should stagflation appear, the good deal that TIPS have been becomes even better relative to the debt the government could have offered me. The government gets a VERY rotten deal on inflating away the debt away if I'm sitting in inflation protected treasuries. Let's just put it that way.

GAO: Treasury Inflation Protected Securities Should Play a Heightened Role in Addressing Debt Management Challenges

Economists conducting ex-post analyses have concluded that the TIPS program has been less cost-effective for Treasury than nominal securities.

In contrast, other economists who have studied the issue argue that from an ex-ante (before the fact) basis, TIPS are not more costly to issue than nominal securities and that the relative cost of the TIPS program to date in part reflects start-up costs that will not be incurred again.

Gotta love those "other economists" who love using predictions of future inflation instead of tried and tested actual inflation. What do you suppose the thinking is? Well, no need to wonder. They'll tell you.

The time horizon of the analysis affects the results since, over the long run, the average amount by which actual inflation exceeds expected inflation will roughly equal the average amount when the opposite is true.

Tell that to Zimbabwe, the Weimar Republic of Germany, or the Roman Empire. Surely there must be something in the document to support my wild accusations of future financial instability. Let's see. Maybe a chart would do it.



I should die of old age right on schedule. Those expecting immediate short-term financial apocalypse will no doubt be sorely disappointed. This can drag on for decades. Rome did not fall in a day.

My burden will not be placed on my grandchildren though. Like many forward-looking Japanese peering into the never ending pile of government debt, I have chosen not to have any children. Should other people become as financially defensive as I am, then demographics will be a future source of financial instability.

Are Western Governments Going Broke?

The underlying problem which deficit spending does not solve is compounded by demographics. Japan’s government is hoping that continued borrowing can be financed at low rates by pensioners who will be cashing out of their pensions but seeking safety. However, we suspect that Japanese pensioners will begin to consume their savings as they downsize their lives into their twilight years (which tend to last much longer in Japan, as the number of Japanese centenarians shows).

That means interest on Japanese bonds-which already one fifth of the Japanese budget-will consume even more of the nation’s resources, if the older population clams up with its money. And like in the U.S., you’ll see the government borrowing more and more of every new yen spent, with more of that borrowed yen going to pay a previous creditor. That’s bordering on Ponzidom.

So why would I pick stagflation over Japan's deflation long-term? Japan exports physical goods to us. We export paper dollars to them. We will always want Japanese goods in exchange for our freshly printed dollars. I think that pretty much goes without saying. However, what would happen if Japan started losing their interest in our paper dollars? Then what?