Tuesday, March 29, 2011

The Slow Grind of Inflation

Click to enlarge.

The annual inflation rate as seen in the CPI is shown in black. The average annual inflation rate over the previous 20 years is shown in red. The expected inflation rate over the next 20 years is shown in blue (as seen by comparing the yields in inflation protected treasuries to the yields in treasuries without inflation protection).

I turned bearish in the fall of 2004. I could not predict what inflation would do then and I cannot predict what inflation will do now. I have seen above average inflation and I have seen below average inflation since I turned bearish. It has been a roller coaster ride. Here's the interesting part to me. Inflation has averaged 2.4% per year since then. That's roughly 1/3rd of this chart.

I don't have many reasons to suspect that the bond market's prediction of 2.7% inflation per year over the next 20 years is necessarily wrong. It is simply predicting more of the same.

Just something to think about if you are content earning 0.10% in three month treasury bills awaiting the next deflationary crash. It is also something to think about if you have loaded up on risky assets by assuming far greater inflation in the future.

There are alternatives. 20-year TIPS still pay 1.61% over inflation. I can't say they are 100% safe, but they do protect against the slow grind of inflation if held until maturity. In fact, they are ideal for protecting against the slow grind of inflation. Unlike what most financial experts preach, higher inflation does not help those who own inflation protected treasuries. It only hurts (due to the taxation on the gains).

This is not investment advice.

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