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I’ve pointed to the troubles in Europe as being like a time-machine glimpse into our own future here in America.
If you see something happen in Europe today, it’s likely something similar to will happen here within 18 months. That’s because though Europe’s problems appear to be worse, in actuality the Euro-member states are just more publicly dysfunctional. The problems Europe faces are no worse than our own here in the U.S.
So I think we can look to Europe for what might be coming down our own pike…
And today, there’s a proposal in Great Britain to change the way inflation is calculated with regard to bond payouts (bonds are called gilts over there).
According to the Financial Times, “Proposed changes to the calculation of UK inflation data could ‘ruin’ the £338bn index-linked gilt market… Holders of some UK index-linked gilts could see more than 40 percent wiped off the value of their bonds.”
I’ve long warned investors away from similar securities sold here in the United States: Treasury Inflation Protected Securities. The U.S. Treasury sells these securities with the promise that they will keep pace with inflation – and that you’ll at least get your principal back in the event of deflation.
From the Treasury’s website: “TIPS provide protection against inflation. The principal of a TIPS increases with inflation and decreases with deflation, as measured by the Consumer Price Index. When a TIPS matures, you are paid the adjusted principal or original principal, whichever is greater.”
Sounds nice – right? It seems like a safe strategy for the bulk of your safe cash.
But TIPS share a problem with regular old dollars, or with any government denominated bond, bill, note or security for that matter.
That problem is that all U.S. government securities (dollars included) are liabilities of the U.S. government. That’s fine when the government is solvent – when its tax receipts are on the rise, when America’s GDP grows at a healthy clip. It can always kick these liabilities down the road to “tomorrow” and everything will work out fine if tomorrow is a better day.
But tax receipts are not growing to keep pace with liabilities – nor is American GDP. And most alarmingly, the U.S. government is decidedly not solvent by any accounting metric known to man.
So putting your faith (and money) into the idea that the government will play fair when it comes to its liabilities seems riskier every day.
As the Treasury website notes, inflation and deflation are calculated using the Consumer Price Index (CPI), an index calculated and controlled by – you guessed it – the federal government.
The Feds can (and do) re-jigger CPI to suit their needs with the flick of a pen. They constantly discover new ways to calculate inflation – and usually their new calculations leave their creditors holding the short end of the stick.
If you own TIPS you’re making a bet that the U.S. government will play fair with CPI – and not re-jigger it to their advantage, and your disadvantage.
Knowing what we know about situation over in the UK – and how some UK bondholders could lose 40% of their current bond value… that’s reason enough for me to avoid this type of security.