inflation

Something unheard of happened this week in the world of finance. The government sold ten billion dollars in bonds with a negative interest rate. Who would buy such things can be best understood by first explaining what are called “Treasury inflation protected securities” or TIPS. These bonds first started in 1997 have interest rates pegged to the consumer price index (CPI). If the CPI goes up, the interest these bonds goes up correspondingly. People who believe that high inflation is on the way will purchase these bonds as a hedge against inflation. Experts say that if these bonds were not available the price of gold would be over $3,000 per ounce instead of the current price of $1,300. People who purchased TIPS would otherwise buy gold.

The sale this week was for 10 B in ten year TIPS with a negative rate if .55% percent. In other word you had to put up $1,000 to guarantee that in ten years you would get back $995. Why do this? Assume that inflation goes up 5% per year each year over the next ten years and you will collect $50 per year and at the end of ten years get $995 back. The higher inflation the greater the return. Anyone who bought these bonds expects inflation. Who is the biggest buyer? China. They know that the US plans to pay off it’s debt using inflated dollars so they are covering by buying TIPS.

I see this as an early warning signal that inflation is coming back in a big way. This will bring back the value of fallen real estate, people will be getting a big raise each year and the government will be reducing its debt. Most like inflation when it starts but as time passes all the gains are wiped out with high prices.