Jeffreyalan wrote:While we are on the topic of I Bonds, I have a general question. It seems most posters here are of the opinion that the Treasury will never outright default on their bonds, but will instead opt to pseudo-default by inflation. If one believes that then part of that scheme would have to be the under reporting of the inflation numbers. It seems to me that there would be no use to inflate the debt away if you reported the exact correct inflation numbers and therefore govt salaries, social security, TIPS, Ibonds etc all grew at the rate of inflation. I sure would feel like a sucker holding a bond with a zero fixed rate that was earning the "official" rate of inflation while "real" inflation was twice that amount. Thoughts?
Dear Jeffreyalan,
1. I am one of those who is of the opinion that the Treasury will not “outright default on their bonds.” Why? Because I am a historian. I can’t know it for certain—no one can—but I do have two centuries of consistent data that includes the dislocations of two world wars, the biggest depression in world history, bouts of high inflation, decades on and off the gold standard, a number of real estate bubbles, frequent stock market crashes, and a civil war that almost tore the nation in two and killed upwards of one million of its citizens. The U.S. Treasury is not perfect by any means, but Alexander Hamilton’s creation remains, to paraphrase Winston Churchill, the worst financial system in the world—except for all others.
2. I am also of the opinion that the Federal Reserve Open Market Committee (FOMC), which sets short term interest rates, has an inflationary bias. Why? Take Janet Yellen’s word for it, not mine. She regularly proclaims it from the mountain tops for all to hear. It is an article of faith for those of her academic stripe and her actions as Fed chair consistently match her words.
3. I do not believe that there is a “scheme” to underreport inflation. Why? See 2. above. The “inflationistas”—from Paul Krugman to Janet Yellen don’t hide their views because they believe inflation is good for the economy. Why should they mis-report inflation? Besides that, millions of Americans with Social Security, military, and federal pensions get annual inflation adjustments based on the Consumer Price Index (CPI). They also have powerful lobby groups in Washington who you can bet your bottom dollar would raise a ruckus from here to kingdom come if somebody tried to cook the books on the compilation of CPI.
4. On the subject of I bonds, I was a sceptic too until I began reading and thinking about Medium Tex’s posts about I bonds on this forum. MT pointed out that THE ONLY THING that I bonds have to do to make them attractive for PP Cash is to beat the yield of a 1 year Treasury. A 1 year Treasury is a simple gauge of no-risk, guaranteed minimum return for PP Cash (Tyler, for instance, uses 1 year Treasurys for STT numbers in his wonderful graphics). One year is also, coincidentally the minimum time you must hold an I bond before you can redeem it. At that point, you can either keep your I bond (if you like the new rate) or sell your I bond (if you think the new rate stinks).
So how have I bonds done in practice, you may ask? Consider a concrete example:
If I bought an I bond purchased in November 2016, from Nov. 16 to April 17 the 6 month yield was 2.76%. From May 2017 to October 2017 the re-set 6 month yield was 1.96%, for an annualized yield of 2.36%, redeemable on 1 November 2017. That was the variable yield only; the additional fixed yield set at the time of purchase was a disappointing 0%. (The I bond yield is composed of both a fixed rate and a variable rate that automatically reset each 6 months based on the CPI-U inflation figures).
In comparison, a 1 year Treasury, sold on 11/02/2016 with a maturity of 11/02/17, has a yield when held to maturity of 1.08%. The best 1 year CD available (from Fidelity brokerage) in November 2016 had a coupon of 1.50%. That means my I bond handily outperformed my PP standard STT by 1.28 % and the “best deal” FDIC-insured brokerage CD by 0.86%!
THIS IS FREE LUNCH FOR THE MIDDLE CLASS, PEOPLE! GET YOURS NOW!!
So, Jeffreyalan, the first error in your post was your assumption that if there is an inflationary bias among economic officials, then there must be some kind of “scheme” to under report inflation. The Department of Labor bureaucrats who compile CPI-U figures would have a good laugh at that one. There is a lot of argument among professional and academic economists over tweaks in the formula used to compute the real rate of inflation (just as there is in the unemployment figures), but it is pretty much all out there in the open.
The second error in your post was misunderstanding how the I bond rate is computed. The I bond yield is composed of BOTH a fixed component and a variable component. It’s nice to have a fixed component that is higher than 0%, but the variable rate alone can still make I bonds attractive compared with a 1 year Treasury bill or a 1 year CD. I bonds have other attractive features for savers and investors, but those are just the icing on the cake.
You do eat cake, don’t you?