The Treasury sells you a bond that promises to track inflation. That’s the pitch behind Treasury Inflation-Protected Securities. Buy a TIPS bond, and the principal adjusts upward with the Consumer Price Index. Prices rise, your principal rises, your coupon rises with it. Inflation can’t touch you.
So they say.
Protection against what?
But it’s a lie at two levels.
First, the bond doesn’t track inflation. It tracks CPI. Those are not the same thing. And we know that particular foundational error leads to a panoply of subsequent errors.
Second, the CPI is a manipulated measure of price levels.
So TIPS keep up with a manipulated CPI, and that’s it.
Rigging the game.
In 1995, the Senate Finance Committee asked Stanford economist Michael Boskin to find out whether CPI overstated inflation. His commission said it did, by more than a point a year, and recommended that the Bureau of Labor Statistics change how it counts. The BLS made changes. Substitution effects. Quality adjustments. New math on housing costs. Each change sounded reasonable on its own. Stacked together, they shaved the number down for good.
Substitution bias assumes that when steak gets expensive, you buy chicken, so the index prices the chicken even though you wanted steak. Hedonic adjustment assumes a laptop with a faster chip is “cheaper” than last year’s model, even though you paid more for it at the register. And owners’ equivalent rent, the single biggest piece of CPI, doesn’t measure what a home costs to buy. It measures what a government survey imagines you’d charge yourself to live in it.
Call it what it is: layers of subjective arithmetic performed by bureaucrats under political incentives to produce a smaller CPI number. Social Security checks, federal pensions, and your TIPS coupon all ratchet off that arithmetic and the subjective decisions behind it.
The US CPI is also kept lower because of globalization bringing us the productivity gains achieved overseas. (Our government regulations and our own compliance staffs reduce our own productivity.) When a domestic manufacturer gets undercut by a cheaper import, the index doesn’t record a quality problem. It records a price drop. A $10 engine part that used to cost $90 counts as deflation, whether the part is built to the old standard or not. Nobody at the BLS notices that the carburetor made out of Chinesium fails after only two months of exposure to ethanol forced into our gasoline.
Inflation isn’t a price. It’s a supply.
Even a perfect, unrigged CPI would still be measuring the wrong thing.
Ludwig von Mises defined inflation as an increase in the supply of money and credit. Rising prices are a symptom of that. The BLS, the Fed, and every financial reporter on television have spent decades trying to prevent us from understanding that.
Under Jerome Powell, the Fed expanded the currency supply at a pace not seen since World War II. That currency didn’t sit in a vault waiting to show up in a grocery bill. It went looking for yield. It bid up equities. It bid up real estate. It bid up gold and silver.
None of that appears in the CPI. Stocks aren’t in the basket. Gold isn’t in the basket. A dollar that buys fewer shares of a gold miner and fewer ounces of silver is a dollar that has been debased, but the CPI report will tell you nothing happened.
The bond adjusts to a number built from cereal boxes and haircuts, while the primary and initial effects of monetary expansion can show up in assets that the CPI mostly ignores. Relative to stocks and gold, TIPS will decline as the currency inflation inflates these other assets. The dollars you’d spend on a TIPS bond would buy you more gold now than they would buy you in the future. How is that protection against inflation?
The IRS wants its cut now.
The annual bump in TIPS principal counts as income the year it accrues, not the year you collect it. Hold TIPS in a taxable account and you’ll write the IRS a check on money you haven’t touched yet. The government will tax you on the inflation that they cause.
TIPS principal adjusts downward if the CPI declines, although that rarely happens. Keynesians call this deflation. Austrian economists call it... a decline in the CPI. Nothing more. We think that true deflation is a decline in the supply of money and credit. TIPS provide a floor against a sustained decline in the CPI, if such were ever to occur, by promising your initial principal back if you hold them to maturity, even though the principal can move lower before maturity. But if you need liquidity before they mature, you won’t benefit from that protection.
And who’s kidding? CPI won’t stay negative for long. The Fed will pump currency into the economy (inflation) to raise the CPI back up. After all, they’ve spent years teaching us how dangerous “deflation” is. Of course, they are lying. But politicians will demand that the Fed print currency units to prevent the evil “deflation.” And when they inflate, the rich will get richer and the poor will be thrown some bits of stale bread and circuses.
The monetary system is a giant mess. And We the People have been educated about it not just poorly, but wrongly. As Doug Casey says, this can’t end well.
I don’t own TIPS. Although, to be clear, I don’t own any Treasuries because I think it is wrong to loan money to a government. If I had to buy a Treasury, I suppose it would be a TIPS bond. But I much prefer the assets the new currency units flow into.
We build the Crisis Investing portfolio to prepare for and profit from the crises, as well as the numerous stupidities that fall short of crises. Paid subscribers get the rationale behind every position. Every new stock I present as a good idea to acquire, I own myself and will be acquiring more of.
TIPS I don’t intend to buy. Not because the government lies about the price levels, though it does. But because a bond built on the wrong definition of inflation can’t protect you from the actual inflation.
If the government wanted to protect us from currency inflation, they wouldn’t inflate the currency.
John Hunt, MD
Editor, Doug Casey’s Crisis Investing
Excellent article, John! You touched this in the article, but let me emphasize it:
Even if the government were honest about measuring price increases, no price index or aggregation could achieve that result. Consumer tastes, products, and their relative importance change all the time; no statistical aggregation can reliably measure changes in purchasing power over long periods. In short term it may provide "rough image", but that is it.
Your conclusion: "If the government wanted to protect us from currency inflation, they wouldn’t inflate the currency." I sure agree that TIPs are not the best protection from inflations.