The Fate of Treasuries in the Upcoming Ka-Poomification

[raja]

Several people have discussed some of their investment strategies on the iTulip forums, but I’ve only seen TIPS (Treasury Inflation Protected Securities) mentioned once. Members seem to be investing primarily in gold and non-dollar denominated assets to protect against future inflation from a falling dollar.

My question is:
Would TIPS or continually reinvested short-term T-bills also protect against inflation?
Would the interest payments on Treasuries rise in step with the dollars fall, because the Treasury would have to raise rates to keep global and domestic investors loaning them money?

I realize there are some negatives with Treasuries securities:

1) They don’t provide a high return.
2) The government manipulates the CPI so that TIPS aren’t really indexed to true inflation.
3) In really bad times, the government might default on payback, or in other ways lower value.

My response to these concerns is that, despite being low profit, Treasuries also are low risk. Things would have to get pretty bad for the government to default. (I wrote privately to one of the luminaries recently interviewed by iTulip, asking him the likely fate of Treasuries in the event that financial disaster struck. He said that, in his opinion, the government would pay back domestic securities in full.)

I’m primarily interested in preserving my wealth, which is why I’m looking at TIPS as a large part of my portfolio. Treasuries may not make a lot of money, but I’m hoping they won’t lose much during the coming downturn (hence my question above).
I also want to grow my wealth, so I’ve allocated a small portion of my portfolio to riskier investments. And, I’ve got a portion devoted to what my wife calls a “black day.” (She’s Ukrainian, and vividly remembers in the early 90’s when all Ukrainian banks shut their doors, then later the money became near worthless -- people’s savings were wiped out.)

By the way . . . I wondered whether it would be better to invest in TIPS or buy and continually reinvest short-term Treasuries, so I did a 16-year historical analysis comparing TIPS and short-term Treasuries – how each stand up to inflation (CPI). If anyone is interested in that, I can post it.

I look forward to hearing others’ opinions, and responses to my questions, as I am definitely a novice in these matters.


Thanks . . . .

[grapejelly]

Re: The Fate of Treasuries in the Upcoming Ka-Poomification

I’m primarily interested in preserving my wealth, which is why I’m looking at TIPS as a large part of my portfolio. Treasuries may not make a lot of money, but I’m hoping they won’t lose much during the coming downturn (hence my question above).

We can guarantee cash benefits as far out and at whatever size you like, but we cannot guarantee their purchasing power. --Alan Greenspan

If you just want to park cash for awhile, short term treasurys are great. If you want to preserve your wealth, then I would go with gold and silver, mostly the metal variety with some of the paper kind.

[WDCRob]

Re: The Fate of Treasuries in the Upcoming Ka-Poomification

Unfortunately my 401(k) offers only treasuries or equities. If there's a surprising bout of rapidly increasing inflation, TIPS would be a better option than a money market, right?

Also...could someone speak to the effect of having money in TIPS that are not held to maturity? If they are bought and sold by the fund does the answer to the previous question change?

[raja]

Re: The Fate of Treasuries in the Upcoming Ka-Poomification

Grapejelly,

By indexing TIPS to inflation, the Treasury is guaranteeing the purchasing power . . . .

Yes, they can fudge the CPI to a certain extent, but not so outrageously that it is too far off the mark . . . otherwise it would become meaningless.

[jk]

Re: The Fate of Treasuries in the Upcoming Ka-Poomification

the problem with tips is that they are indexed to cpi-u [consumer price index-urban], which is a highly manipulated index. see, e.g., john williams' website, shadowstats.com. my wife's 401k is in these things because she has no better option. during a disinflationary ka period they will at least hold value, like cash. during inflation they do not serve their stated purpose, because the inflation is not fully reflected in the official numbers.

[grapejelly]

Re: The Fate of Treasuries in the Upcoming Ka-Poomification

The CPI is meaningless. Buying power of the US$ is declining 8% - 10% per year right now...in terms of things we have to buy day-to-day like rents, housing, energy and food.

In terms of other assets, such as gold, the dollar depreciation is even worse.

Why not buy gold? I'm puzzled...

[raja]

Re: The Fate of Treasuries in the Upcoming Ka-Poomification

I went to the Shadowstats.com site, and it looks like the pre-Clinton CPI is running 2 1/2 - 3% above the Official CPI.

Right now, the TIPS fixed interest coupon for 10-year bonds is 2.28. With TIPS, the coupon is added to the CPI rate to get the yield. So, if true inflation is 3% higher than the CPI, then I am losing 0.72% to inflation each year by investing in TIPS (3% - 2.28% = 0.72%).

Looking at it from another perspective, TIPS are preserving my wealth with 99.28% effectiveness per year.
Of course, this assumes that the government doesn't degrade the CPI even further, which could happen.
But I don't think it can get too far out of wack without causing some reprecussions that would reverse the trend. . . .
And then there's income tax on the profits . . . but no state tax with TIPS.

Since the TIPS rate is fixed over the life of the bond, if the value of the dollar fell the CPI would have to rise to compensate, so TIPS would continue to be 99.28% effective in preserving wealth. (Again, this assumes that the government would not continue to degrade the CPI.)

My knowledge of the CPI is meager, but I understand from the Bureau of Labor Statistics website that it is based on common purchases including many currently imported items, such as clothing, cars, televisions, computers, etc. If these imported items went up in price due to the dollars decline, then the CPI would have to go up in step.

I also think straight Treasury bond interest rates would go up as well, because the government would have to raise rates to keep global and domestic investors loaning them money. But I'm not so sure about this point . . . .

Grapejelly, I do think gold is a good investment, and should be part of one's portfolio at this time.
But it feels more risky to me than government bonds.

Gold's value is so dependent on psychology. Aside from it's relatively low commodity value, it's really only worth what people are willing to pay for it.
Gold fell from over $800 in 1980 to $256 in 2001, and has recently risen to over $700. You don't see such wild fluctuations in the history of Treasury bills.

I've read EJ's prognostications on gold, and I find it all believable and most probably accurate. That's why I think gold's a good investment. But sometimes the future doesn't always turn out the way we expect . . . .

As I said in my original post, I'm interested primarily in preserving wealth, especially through the rough financial times that may lie ahead, and I don't see anything better and safer at doing that right now than TIPS. Everybody has their particular level of risk tolerance, and, certainly, risk levels are debatable . . . . I'd like to hear other people's perspectives.

[grapejelly]

Re: The Fate of Treasuries in the Upcoming Ka-Poomification

Grapejelly, I do think gold is a good investment, and should be part of one's portfolio at this time.
But it feels more risky to me than government bonds.

Gold's value is so dependent on psychology. Aside from it's relatively low commodity value, it's really only worth what people are willing to pay for it.
Gold fell from over $800 in 1980 to $256 in 2001, and has recently risen to over $700. You don't see such wild fluctuations in the history of Treasury bills.

I've read EJ's prognostications on gold, and I find it all believable and most probably accurate. That's why I think gold's a good investment. But sometimes the future doesn't always turn out the way we expect . . . .

As I said in my original post, I'm interested primarily in preserving wealth, especially through the rough financial times that may lie ahead, and I don't see anything better and safer at doing that right now than TIPS. Everybody has their particular level of risk tolerance, and, certainly, risk levels are debatable . . . . I'd like to hear other people's perspectives.

Gold riskier than bonds?

Precious metals are the only asset you can own conveniently that are not a liability of someone else. And you can own PMs "outside the grid", stored somewhere where they are completely free from anything that may befall paper and digital "assets".

I too used to think like you. Then I realized that gold is not *always* a good store of value. Neither are bonds or stocks.

Asset classes have their bull and bear markets.

Bond have been in a bull market lasting about from 1982 to about 2003. That market is arguably over. Certainly bonds are yielding a negative real interest rate as are TIPS I believe.

When you come right down to it, the US$ and its bonds are a short term way to park money, not a way to preserve wealth. Just look at the dollar depreciation over the past years.

Right now we are in, I think, a financial asset bubble. A credit bubble. At some point, it will pop. The money that is invested there will flee to precious metals.

What keeps it from popping is continuous high inflation, i.e. dollar depreciation. You are talking about CPI as if it was a measure of inflation, but it's not. CPI is a bogus number. It's a lie. You can measure inflation many different ways, but in my world dollar depreciation is close to 10% per year as that is the depreciation of my dollars against things I have to buy and commodities and so forth.

Gold is the safest asset there is for conserving wealth for the foreseeable future. There will come a time when stocks are selling for 7X PEs ratio, dividends average 5% and everyone hates the stock market. Everyone will be raving about precious metals. That will be the time to dump all your gold and buy stocks.

[raja]

Re: The Fate of Treasuries in the Upcoming Ka-Poomification

Are government bonds riskier than holding physical gold?
I'm not so sure. It depends on many factors.

1. If the government defaulted on its bonds, and anarchy riegned throughout the land, I'd rather have a rifle and gold coins buried in a hole in my yard.
2. If the price of gold went down to $70, and I had bought into gold at $670, I'd rather have the bonds.
3. If the Ka-Poom theory unfolds as it's been laid out, I'd rather have gold.

The question is, what is the probability that any one of these scenarios will play out?
My personal preference would be for #3 to be our future. But I want to be hedged against all three, and am willing to settle for less potential profit in order to do so.

I am not experienced or well-read in economics, and I would be very happy for someone to shoot holes in what I'm going to say, but let me give you a possible scenario for future #2 . . . .

Let's say the stock market plunges for whatever reason, and a deep global recession rapidly ensues.
It scares the s__t out of everbody, and suddenly everyone wants to buy gold to save their assets.

But . . . I read somewhere that the amount of gold available to buy is microscopic compared to the world's investment money, and herein lies a possible problem.

In the above scenario, when people realize a black day is upon them, the price of gold shoots up astronomically . . . and very quickly.
It goes up so high and so fast that people soon begin to realize that everyone cannot put their money into gold . . . there's just not enough gold to go around. As a result, gold begins to plummet in a reverse bubble, and in a few weeks it falls to $70 an ounce. People understand it can no longer serve as a safe haven for the world's wealth, and it loses that status forever, returning to it's commodity value.

With the efficiency of modern worldwide communications and electronic investing, maybe the entire life of the gold bubble -- its rise and fall -- lasts two weeks or a month.

Of course, the people who are invested in gold now hope that this dramatic downturn is temporary . . . but it isn't, and they lose 90% of their money.

You'll have to ask people that are smarter than me if this type of scenario is plausible . . . I don't know. I hope it isn't.
But it's this kind of scenario that makes me want to be diversified into TIPS.

[jk]

Re: The Fate of Treasuries in the Upcoming Ka-Poomification

your gold scenario reminds me of yogi berra's remark about a nightspot: "it's too crowded, so nobody goes there anymore."

[raja]

Re: The Fate of Treasuries in the Upcoming Ka-Poomification

your gold scenario reminds me of yogi berra's remark about a nightspot: "it's too crowded, so nobody goes there anymore."

Isn't that exactly why a bubble bursts?
People begin to realize that something is increasing in value solely because so many people believe it has value. When that happens people fall all over each other to jump ship.

But the other factor I brought up is that there may not be enough gold to function as a safe haven for the world's investment money, causing a very rapid rise and decline of the bubble.

Can someone comment on that?

By the way, Yogi's right about the nightspot . . . .
A hot nightclub can lose its cachet when everybody starts showing up -- suddenly it's no longer a cool in-place to be.

Another amusing Yogi Berra quote, "It's tough to make predictions, especially about the future."

[grapejelly]

Re: The Fate of Treasuries in the Upcoming Ka-Poomification

Isn't that exactly why a bubble bursts?
People begin to realize that something is increasing in value solely because so many people believe it has value. When that happens people fall all over each other to jump ship.

But the other factor I brought up is that there may not be enough gold to function as a safe haven for the world's investment money, causing a very rapid rise and decline of the bubble.

Can someone comment on that?

It doesn't seem overly plausible. To say the least.

To me it makes no sense. Are there enough zeros in the world?

There is enough gold because you can simply add one zero or several to the "price" of gold (in US$) and without cost you have enough gold.

I don't anticipate a gold standard anytime soon. But gold has done very, very well compared to paper in these sorts of times. Bonds have done very, very poorly. As they said in the 1970s, Certificates of Confiscation. Why lend money to the government, and how would you expect to conserve your wealth by being a lender anyway? Inflation is the greatest enemy of wealth, and the government is its instigator.

[raja]

Re: The Fate of Treasuries in the Upcoming Ka-Poomification

There is enough gold because you can simply add one zero or several to the "price" of gold (in US$) and without cost you have enough gold.

Would you pay $1000 for an ounce of gold?
Would you pay$10,000?
Would you pay $100,000?
Would you pay $1,000,000?

The more zeros you add, the less likely it is that people are going to buy, and the closer you are to the top of the bubble.

My point is that because there is a small amount of gold compared to the vast amount of investment money in the world (or so I have read), the number of zeros would rise very rapidily, and so would the bursting of the bubble. I worry that I might not react fast enough.

How would you expect to conserve your wealth by being a lender anyway?

The banks seem to do well . . . .

But, seriously, I agree with you on the point that bonds are not great profit-making vehicles.
However . . . I read one pudit who, when writing on the upcoming times of trouble, said, "Success won't be measured by who makes the most, but who loses the least." I sure hope he's wrong, but I'm hedging my bets with some TIPS in my portfolio.

[grapejelly]

Re: The Fate of Treasuries in the Upcoming Ka-Poomification

Would you pay $1000 for an ounce of gold?
Would you pay$10,000?
Would you pay $100,000?
Would you pay $1,000,000?

The more zeros you add, the less likely it is that people are going to buy, and the closer you are to the top of the bubble.

My point is that because there is a small amount of gold compared to the vast amount of investment money in the world (or so I have read), the number of zeros would rise very rapidily, and so would the bursting of the bubble. I worry that I might not react fast enough.

You need to get your gold now, accumulate before mass public participation.

The banks seem to do well . . . .

But, seriously, I agree with you on the point that bonds are not great profit-making vehicles.
However . . . I read one pudit who, when writing on the upcoming times of trouble, said, "Success won't be measured by who makes the most, but who loses the least." I sure hope he's wrong, but I'm hedging my bets with some TIPS in my portfolio.

Bonds are terrible in the type of inflationary times we are in. They are a guaranteed wealth destruction vehicle UNLESS there is the classic currency appreciation / classic deflation that happened in 1929-1932.

Rick Ackerman and Mish believe in this. I don't. I believe we are already experiencing real currency depreciation rates of 10% or so per year. The government misleads the public into scrutinizing the gamed and deceptive "CPI" or better yet "core CPI" numbers, which give the impression that the currency depreciation is very slow.

That will change soon. I agree with Steve Saville who has pointed out that the government's corn-to-ethanol mania is causing corn to crowd out other grains and is raising food prices, which will show up quite dramatically soon.

So if the currency depreciation is really 8% - 10%, how is your wealth being conserved? At 5% loss per year...

When will bonds be a good investment again? When real interest rates turn decidedly positive. When will that be ... ?

[spunky]

Re: The Fate of Treasuries in the Upcoming Ka-Poomification

Inflation is used to patch the hole in the bubble balloon so all the air doesnt rush out at once. Poo Poo on geo political events , a pandemic is what would toss the world into a downspin. Wars are contrived, watered, fertilized and made for certain peoples to profit from, like Dick Cheney.


Let us see the BOJ , nut up and hike rates again. Cant wait for $3.30 gas here in the midwest in May. Sweet


I'd be in euros and holding my own gold/silver, mabye some Kanadian mining stocks.