Why Treasury Inflation-Protected Securities do not adequately protect you from inflation
Posted by John Reed on
This is my article on TIPS Treasury Inflation-Protected Securities. They are U.S. treasury bonds of 5, 10, or 30 years.
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They suck in many ways. Do not buy them. If we get hyperinflation, the government will renege on the promise to make you whole in terms of purchasing power. The original “TIPS” were gold certificates. That is, they were US government bonds that had a clause saying you could demand to be repaid in gold coins. Americans then had gold coins in their pocket and could get them at any bank in return for paper currency or US government bonds that contained the gold certificate wording until 1933. That is the year FDR issued Executive Order 6102 reneging. SCOTUS upheld the reneging which was wrong of them to do.
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Why will the renege? Same reason as in 1933. The U.S. government does not have enough gold to keep the promise. In the TIPS case, they will have to replace the hyperinflated US dollar with a new trusted currency. TIPS promises to pay you in the old inflated USD. They do not have any gold or any other thing of value to enable them to keep the TIPS promise.
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As of May 31, 2024, the U.S. Treasury had $2,025,752,000 in TIPS outstanding.
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All the little details about TIPS are at the government web site https://www.treasurydirect.gov/marketable-securities/tips/#id-tips-at-a-glance-280398
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“At a glance” is a bit much, the page links to 26 other pages.
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A man named David Enna has a web site with data and his opinions on TIPS. https://tipswatch.com/
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One bad thing about TIPS is that you owe the income tax on the adjustment of the principal for inflation at the time of the adjustment even though you do not get the money until maturity.
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Enna suggests avoiding that by putting the TIPS into an IRA or other tax deferred pension account.
.
Well, okay, but my perspective on inflation protection is hyperinflation. That is, an emergency situation if and when it hits. IRAs, etc, have many limits. There are relatively low limits on how much you can put into an IRA or a Roth IRA pension account each year based on your age or income.
.
Also, there are restrictions on withdrawals. To buy food, you may need money now. You cannot withdraw before age 59 1/2 without penalty. A hyperinflation emergency may get the penalty waived.
.
Withdrawals also are taxed at ordinary income rates even if all or part of the gain in the account stems from long-term capital gains which are taxed typically at a lower rate than ordinary income.
.
At age 73, you are required to make minimum withdrawals.
.
This makes TIPS during hyperinflation like a fire extinguisher that you cannot use in a house fire unless several criteria are met, including possibly penalties and taxes. In hyperinflation, residents of the country in question are frantic to get rid of the inflating currency TODAY.
.
Enna also notes that the value of the TIPS can rise and fall during its term but he does not worry about that because he plans to hold his TIPS tp maturity. When your house is on fire, a fire extinguisher that cannot be used until the end of a ten-year period is worthless.
.
Enna also seems to expect only mild single-digit inflation. In 4% per month inflation, as now in Argentina, the leisurely way that TIPS inflation adjustments are calculated would be maddening.
.
They use the consumer price index for all urban consumers. https://www.bls.gov/news.release/cpi.t01.htm
.
Here is what the Treasury web site says about how to calculate how much the principal amount of your TIPS bond is adjusted for inflation twice a year. And when they do the adjustment, they use the seasonally adjust CPI from TWO MONTHS to the semi-annual adjustment month. Again, you do not get the adjustment in cash at that time. They only give you the cash when the TIPS bond matures.
.
Calculating your inflation-adjusted interest payment
To calculate your inflation-adjusted interest, follow these steps:
1. Use the CUSIP number (each edition of TIPS bond has a CUSIP) to find your TIPS in the table.
2. Click on the CUSIP number.
3. The TIPS/CPI query results page for that CUSIP number appears.
In the table on the query results page, find the Index Ratio that corresponds to the interest payment date for your security.
4. Multiply your original principal amount by the Index Ratio.
This is your inflation-adjusted principal.
Next, multiply your inflation-adjusted principal by half the stated interest (coupon) rate on your security.
The resulting number is your semi-annual interest payment.
.
If you have to bail out of the TIPS, you get a principal amount during the six-month period which is two months out of date the first month and eight months our of date. 4% per month is 24% per half year. So something that cost $100 six months ago—like a bag of groceries—will cost as much as $124 by the time the Treasury adjusts your principal amount up 24%. But they will not pay that amount until maturity. If you are forced to bail out of the TIPS before maturity to get money to buy food, all you can sell to the bond buyer who lets you bail out is the promise of the bond increasing by that 24% in however many years remain until maturity.
.
Roughly speaking, Treasury Inflation-Protection Securities provide NO INFLATION PROTECTION WHATSOEVER UNTIL MATURITY! So if you are going to buy these, I guess you’d better only buy the shortest ones which are still five years.
.
Furthermore, you only get an after-tax, after-inflation amount at maturity. Even on that maturity date, the inflation adjustment will only bring you up to two months before the Treasury finally pays you the increased principal amount.
.
They suck in many ways. Do not buy them. If we get hyperinflation, the government will renege on the promise to make you whole in terms of purchasing power. The original “TIPS” were gold certificates. That is, they were US government bonds that had a clause saying you could demand to be repaid in gold coins. Americans then had gold coins in their pocket and could get them at any bank in return for paper currency or US government bonds that contained the gold certificate wording until 1933. That is the year FDR issued Executive Order 6102 reneging. SCOTUS upheld the reneging which was wrong of them to do.
.
Why will the renege? Same reason as in 1933. The U.S. government does not have enough gold to keep the promise. In the TIPS case, they will have to replace the hyperinflated US dollar with a new trusted currency. TIPS promises to pay you in the old inflated USD. They do not have any gold or any other thing of value to enable them to keep the TIPS promise.
.
As of May 31, 2024, the U.S. Treasury had $2,025,752,000 in TIPS outstanding.
.
All the little details about TIPS are at the government web site https://www.treasurydirect.gov/marketable-securities/tips/#id-tips-at-a-glance-280398
.
“At a glance” is a bit much, the page links to 26 other pages.
.
A man named David Enna has a web site with data and his opinions on TIPS. https://tipswatch.com/
.
One bad thing about TIPS is that you owe the income tax on the adjustment of the principal for inflation at the time of the adjustment even though you do not get the money until maturity.
.
Enna suggests avoiding that by putting the TIPS into an IRA or other tax deferred pension account.
.
Well, okay, but my perspective on inflation protection is hyperinflation. That is, an emergency situation if and when it hits. IRAs, etc, have many limits. There are relatively low limits on how much you can put into an IRA or a Roth IRA pension account each year based on your age or income.
.
Also, there are restrictions on withdrawals. To buy food, you may need money now. You cannot withdraw before age 59 1/2 without penalty. A hyperinflation emergency may get the penalty waived.
.
Withdrawals also are taxed at ordinary income rates even if all or part of the gain in the account stems from long-term capital gains which are taxed typically at a lower rate than ordinary income.
.
At age 73, you are required to make minimum withdrawals.
.
This makes TIPS during hyperinflation like a fire extinguisher that you cannot use in a house fire unless several criteria are met, including possibly penalties and taxes. In hyperinflation, residents of the country in question are frantic to get rid of the inflating currency TODAY.
.
Enna also notes that the value of the TIPS can rise and fall during its term but he does not worry about that because he plans to hold his TIPS tp maturity. When your house is on fire, a fire extinguisher that cannot be used until the end of a ten-year period is worthless.
.
Enna also seems to expect only mild single-digit inflation. In 4% per month inflation, as now in Argentina, the leisurely way that TIPS inflation adjustments are calculated would be maddening.
.
They use the consumer price index for all urban consumers. https://www.bls.gov/news.release/cpi.t01.htm
.
Here is what the Treasury web site says about how to calculate how much the principal amount of your TIPS bond is adjusted for inflation twice a year. And when they do the adjustment, they use the seasonally adjust CPI from TWO MONTHS to the semi-annual adjustment month. Again, you do not get the adjustment in cash at that time. They only give you the cash when the TIPS bond matures.
.
Calculating your inflation-adjusted interest payment
To calculate your inflation-adjusted interest, follow these steps:
1. Use the CUSIP number (each edition of TIPS bond has a CUSIP) to find your TIPS in the table.
2. Click on the CUSIP number.
3. The TIPS/CPI query results page for that CUSIP number appears.
In the table on the query results page, find the Index Ratio that corresponds to the interest payment date for your security.
4. Multiply your original principal amount by the Index Ratio.
This is your inflation-adjusted principal.
Next, multiply your inflation-adjusted principal by half the stated interest (coupon) rate on your security.
The resulting number is your semi-annual interest payment.
.
If you have to bail out of the TIPS, you get a principal amount during the six-month period which is two months out of date the first month and eight months our of date. 4% per month is 24% per half year. So something that cost $100 six months ago—like a bag of groceries—will cost as much as $124 by the time the Treasury adjusts your principal amount up 24%. But they will not pay that amount until maturity. If you are forced to bail out of the TIPS before maturity to get money to buy food, all you can sell to the bond buyer who lets you bail out is the promise of the bond increasing by that 24% in however many years remain until maturity.
.
Roughly speaking, Treasury Inflation-Protection Securities provide NO INFLATION PROTECTION WHATSOEVER UNTIL MATURITY! So if you are going to buy these, I guess you’d better only buy the shortest ones which are still five years.
.
Furthermore, you only get an after-tax, after-inflation amount at maturity. Even on that maturity date, the inflation adjustment will only bring you up to two months before the Treasury finally pays you the increased principal amount.
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