Monday, November 23, 2009

A useful inflation framework re: TIPS and gold

TIPS are a reasonably new creation (last decade or decade and a half) by the US government to sell bonds that are protected against inflation.
TIPS are basically yielding 0 right now, which has made the spread between TIPS and normal bonds actually seem to be pretty small.
In isolation, TIPS don't really face the 0 lower bound that normal bonds do, because I may be willing to pay a small fee in real terms to avoid getting smashed by inflation.
The problem is that gold is nominally a vehicle which allows you to earn 0 but not get smashed by inflation, so the existence of gold provides a 0 lower bound on TIPS.
Now, this is imperfect, because gold is currently in a bubble, but people don't necessarily realize that.
I will say that I'd rather have TIPS at 0 interest rates than gold at 1100. Inflation's almost inevitable (that or another recession) but 1100 gold is really, really expensive.
Btw, the fact that so many people are willing to buy gold at the price it's at makes parts of Krugman's "phantom menace" article ( seem silly.

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