The TIPS of the iceberg

One of the funnest things about writing this blog is I get to come up with AWESOME! blog titles.  Now I have never been a great fan of TIPS (Treasury Inflation-Protected Securities) because of the nature of the way the "inflation" component is calculated.  Unfortunately the inflation number the government uses can be manipulated and cajoled into showing what Washington wants to see and not actually whats going on.  In the past this has usually taken the form of showing a lower inflation number than is actual.  This has helped get politicians re-elected by a public inferring low inflation rates with good fiscal stewardship of the country.  Because of the lower than actual inflation figures, the treasury pays a lower interest rate on TIPS and buyers of TIPS receive a lower real yield.  But now the tables are turned.

For the past couple of years the USA, and to some extent the world, has been slightly deflationary.  Now, I want to be clear, deflation is bad.  People stop spending money because next week the price will be lower than today.  While its good for our individual pocketbooks, it can devastate a consumer economy based upon inflated asset values (houses).  At the moment the Fed is contemplating a strategy to pump more money into the economy and thus drive up inflation.  Increasing the inflation rate drives up asset prices and thus will keep the housing market buoyed, keeping bank balance sheets healthier, increasing money velocity, and finally getting you to spend what little savings you may have today to avoid paying more next week.  This strategy may now also encourage the government to report higher than "normal" inflation numbers to show that its policies are working and hopefully for them (not so much for us) get them re-elected.  This will be good for TIPS and the buyers of TIPS.

This is just a working theory and does NOT constitute investment advice.  As I stated earlier, I have never been a fan of TIPS because of the potential for manipulation of the inflation number and thus the interest rate the number setter pays.  TIPS can be a relatively cheap way to buy inflation protection that doesn't include a lot of market risk if held to maturity.


PS Sorry for the clunky writing.  The brain and finger connection is kind of weak today.