Peter Crabb: Here's a tip about TIPS: Buyers don't really expect negative interest
The price paid for these bonds at auction is such that the real interest rate will turn out to be negative if inflation doesn’t occur.
Real interest rates are GUARANTEED to be negative if inflation DOES occur. He's got this exactly backwards.
In fact, the only way these bonds could earn a positive real interest rate is if deflation strikes and the deflation protection that TIPS offers therefore kicks in.
Picture paying $1050 for $1000 bonds but then prices in general fall 50%. You'd be pretty darned pleased even though you overpaid for those bonds. You may not get the $1050 back, but $1000 is nothing to sneeze at. You'd definitely have a positive real return on your investment. You only lost about 5% as prices in general dropped 50%? Sign me up! I'd take that deal any day of the week.
Can this really be true? Would people really lend at a negative interest rate?
The answer is no. U.S. Treasury bond investors don’t expect to lose money. They expect inflation to rise, and with it, the value of TIPS.
I've got news for Peter Crabb (who has a doctorate in international and financial economics). The answer is yes. Investors expect to lose money in negative real interest rate TIPS when adjusted for inflation. They just don't expect to lose as much as some. If the investors are really smart then they are hoping for serious deflation.
If investors are actually hoping for more inflation as Peter Crabb implies, then investors really are stupid. As I have said here time and time again, inflation never helps investors in TIPS. It only hurts them. The higher the inflation, the higher the taxes on the inflationary gains and the worse the real interest rate after taxes becomes. In any event, higher inflation cannot turn negative real interest rate TIPS into something that can actually protect purchasing power.
If inflation moves back to its long-run average, these investors stand to earn much more.
Yes, and if inflation moves to 100% per year and stays there, these investors stand to earn even more than that. Much more. The taxes on all those inflationary gains will nearly financially ruin them each and every year but as Peter Crabb says, "Investors want to be compensated for it."
I own TIPS. I hope inflation remains tame. I am most certainly not rooting for higher inflation on the hopes that I can say, "I told you so." My bragging rights would pale in comparison to the lost real purchasing power due to the taxation. In fact, serious hyperinflation would transform my bragging rights into idiot's rights, as I would be forced to admit what a lousy investment TIPS had become.
And now back to the first paragraph of the article.
Is it real or not? Can investors make a real return today?
If investors are buying negative interest rate TIPS thinking that they will make a real return if inflation picks up, then investors are stupid. There's just no other way to put it.
Good frickin' grief.
You might think I'm being harsh here but this topic hits a nerve with me. I've seen it first hand more than a few times.
ReplyDeleteMy post on TIP
If (big if) the CPI rises 0% per year going forward then we'll still be earning roughly 1.5% after expenses. Our purchasing power will hold up nicely. Further, the taxes will be modest.
I'd much rather have that than 10% CPI increases while earning 11.5%. The taxes would make it difficult to maintain purchasing power.
A Reply
Not me. If you have money on the sidelines waiting to invest, 11% return sure beats the slopply returns today.
Some people just like big numbers and big taxes I guess. That's one one reason the government gets away with its inflationary policies.
Less inflationary success these days of course thanks to the previous success of excess!
Stag,
ReplyDeleteHe's got this exactly backwards.
It's not an accident. These eCONomics professors are indoctrinated with tripe during their educations so that they can then brainwash the masses. It all starts with the bogus assumptions that markets are free and rational.
If investors are buying negative interest rate TIPS thinking that they will make a real return if inflation picks up, then investors are stupid.
Stupid indeed. And they expect to be "compensated" for their stupidity. And they WILL get what they deserve.
Dumbing down the masses was the point all along. The stupidity and fraud go hand in hand. Mission accomplished!
Propaganda and fraud for the win!
There's an interesting post out at Econbrowser (linke below) regarding TIPS yields and the 1970s episode of negative real rates. The second chart in the post is something I haven't seen before -- I will be putting it in my archive for future reference.
ReplyDeletehttp://www.econbrowser.com/archives/2010/10/negative_real_i.html
mab,
ReplyDeleteI suspect that at least a few of the dumbing down the masses preachers are falling for their own propaganda.
Wisdom Seeker,
ReplyDeleteReal interests rates and the 1970s are common themes on this blog.
1970s Real Treasury Bill Yields
Here's a bonus chart from 2007.
ReplyDeleteFed Funds Rate vs. Commodities
I bought gold and silver for the first time in my life back in 2004. I know exactly why I did it. It is still fresh in my mind. My gut said that earning 1% in three month treasury bills when inflation was clearly higher than that was not a good thing. I didn't know how long it would go on. The Fed pretty much forced me to own something of substance. Since I'm a saver by nature, I chose rocks. I already had a house. I can understand why renters might choose to buy. It surprised me that the rocks did so well. It surprised homeowners that real estate did so well. I just wanted a hedge against inflation but I got so much more than that. If you can believe in that chart above, you'll see that I actually bought a piece of heavily leveraged inflation. It seems a very small change in the Fed Funds rate can (not always) have a dramatic effect on commodity prices. Why? We live in an overleveraged society. Everything is overleveraged. Just look at how many hedge funds we have. That's my opinion and I'm sticking to it.
More...
ReplyDeleteIn 2006, when interest rates were somewhat back to normal I sold my hard assets. I had a nice profit. I removed my leverage. It is one year later and I still don't know if it was a good plan or not. I'm still worried about inflation, but I'm also worried about deflation. In order to know what to do I have to know what the Fed is going to do. Anyone know? It looks to me like the Fed is willing to fight this a bit, perhaps even long enough to get a bit of disinflation (or dare I say it, worse).
Jim Jubak didn't fall for the propaganda.
ReplyDeleteInflation-spooked investors run for cover
Investors paid $105 for each $100 in face value. That reduced the yield on these bonds to a negative 0.55%.
These investors weren't insane. Just very, very afraid of inflation.
I completely agree. The fear is real and it is justified. These are uncertain times and those who don't believe that are the insane ones.
Nothing is safe right now.
It's like waking up in the morning and finding empty gasoline cans all around your property. What are they doing there!
Does it mean your house is about to burn? Who knows! It might mean that. It might not.
Uncertainty!
Now what if you woke up and there were rolls of toilet paper all around your house? Is it a Halloween prank or a coming chit storm?
ReplyDeleteCould not help it!
GYSC,
ReplyDeleteThat's a great analogy!
I would think it was just a Halloween prank.
A foreigner who just moved to this country might think something entirely different though.
Heck, the first reaction might even be....
Wow! America sure is great. It literally rains basic necessities!
Hahaha!