Has the invention of TIPS made hyperinflation less of a threat?

The WSJ reports that the Treasury Department is making its biggest offering of inflation linked bonds in five years today:

In a bid to meet the demands of big creditors such as China and Japan and keep its funding costs low, the Treasury will kickstart this year’s offerings of Treasury Inflation-Protected Securities by selling $10 billion in 10-year notes.

With this auction, the total market value of TIPS will top $600 billion for the first time since the government started selling the debt in 1997 …

With the total U.S. government debt held by the public at $7.8 trillion as of last week, $600 billion is still small beans. But if the TIPS share grows, it will get harder and harder for our U.S. government to inflate its way out of its burgeoning debt burden. That is, if all a country debt is in fixed rate bonds (as was the case for the U.S. before 1997), inflation shrinks the size of that debt relative to the overall economy and, more to the point, tax revenue. If all the debt were in inflation-linked bonds, inflation wouldn’t reduce the debt load at all.

So that’s partly bad news—inflation played a big role in the relatively painless whittling away of the U.S. government’s debt load from 108.6% of GDP in 1946 to a low of 23.9% in 1974. But it also imposes a form of discipline on Washington’s taxers and spenders and money creators that will presumably make them less likely to follow policies that could lead to hyperinflation.

It isn’t just TIPs. Before the Great Inflation of the 1970s, inflation provided an easy way of bringing the federal budget into balance (or at least closer to it): the real value of fixed outlays for Social Security and other programs fell as the overall price level rose, while tax revenues rose as inflation kicked people into higher tax brackets. That changed with the introduction of automatic cost-of-living adjustments in the 1970s, and the indexing of tax brackets to inflation in the 1980s. The Alternative Minimum Tax remains as an ever-growing exception to this inflation-indexing, which is why it keeps hitting more people and generating more money. But on the whole, inflation is no longer the budgetary boon in Washington that it once was. Meaning that maybe it’s less of a threat than it once was.

There is one interesting side issue here—that inflation-indexing of government bonds, entitlement payouts and tax brackets makes the measurement of inflation far more politically important than it used to be. As Peter Schiff pointed out to me a couple years ago, undercounting inflation is now very much in the interest of most people in official Washington. That’s not to say we do undercount it. I think the Bureau of Labor Statistics (which calculates the consumer price index) has up to now remained pretty well insulated from political pressure. But not everybody agrees with me on that, and if the government debt keeps growing (the debt held by the public is currently at 55% of GDP), the pressure on the BLS will only grow.

Stocks Rally Further in Run-up to EU Summit

MOSCOW — Global stocks enjoyed one of their best days in weeks on Tuesday ahead of a summit of European leaders that’s expected to be dominated by calls to boost economic growth.

Europe remains the focus of attention across all financial markets in the run-up to the June 17 Greek election that could go a long way to determining the country’s membership of the euro as well as the future of the single currency zone.

http://www.abnormalreturns.com/2010/01/monday-links-equity-demand/ Monday links: equity demand Abnormal Returns

[...] Bond investors want TIPS. The Treasury will accommodate them. (WSJ also Curious Capitalist) [...]
ps56penn62pr64

The United States is a sovereign nation with fully recognized authority to issue all the money needed to fund the government and to provide sufficient money for the nation’s commerce.

What is logic for our borrowing any money?

The US government can easily eliminate the national debt by simply issuing debt free US notes and substituting them for interest-bearing bonds.

Inflation will not be created because the money created by the bonds is already in play in the economy. Furthermore, the value of an investor’s assets will not change, but simply change form from bonds to cash. If an investor has a portfolio with $10,000 in stock and $10,000 in bonds and the government substitutes $10,000 in cash for the bonds, the value of the portfolio has not changed: it remains $20,000.

America must restore the power to issue the nation’s money to the people and their representatives in government.
pneogy

“But it also imposes a form of discipline on Washington’s taxers and spenders and money creators that will presumably make them less likely to follow policies that could lead to hyperinflation.”

I hope you’re not implying that taxes produce hyperinflation.
http://www.riskey.cn/2010/01/monday-links-equity-demand/ Monday links: equity demand | Financial engineering resource center

[...] Bond investors want TIPS. The Treasury will accommodate them. (WSJ also Curious Capitalist) [...]
http://www.rodgermitchell.com Rodger Malcolm Mitchell

“. . . it will get harder and harder for our U.S. government to inflate its way out of its burgeoning debt burden”

How does the government inflate its way out of its debt burden? Yes, today’s dollar has less value than tomorrow’s dollar, but so what? The government does not pay its debts with value. It pays with dollars.

Imagine the government owes $12 trillion, payable in 10 years, and inflation for the next 10 years is 100% per year. How much will the government pay in 10 years? Answer: $12 trillion.

Now, same scenario, except inflation is 0% for ten years. How much will the government pay? Answer: The same $12 trillion. The “burden” neither is more nor less.

Sure, in the first case the $12 trillion will have less buying power than in the second case. But how does that benefit the government? It goes merrily along, creating just enough dollars ad hoc, to pay its bills, whatever the buying power of the dollar.

The notion that the government can “inflate its way out of its debt burden” is indicative of the massive misunderstanding about federal finances.

By the way, debt hawks, does this “inflate away the debt burden” mean our current debt isn’t as bad as you say, and all we need is more inflation?

Rodger Malcolm Mitchell
strawmn

@Rodgermm,

In your scenario, you seem to have seriously confusioned notional amounts with purchasing power. Breaking your argument down, you say, “the debt burden is $12 trillion, therefore the debt burden is $12 trillion.”

Yet that’s the point of inflating away debt. Debt is a fixed cost, but inflation increases the total pool of money available in the economy. You’re right that it erodes purchasing power of an individual dollar, but it also makes debt much cheaper.

So let’s take a slightly more coherent scenario. Let’s say that, in a very cheap world, I earn $10 a year. $4 goes to pay my debt, while I spend $3 on food and $3 on luxury goods. That’s 40% debt servicing, 60% goods.

Now it’s next year, and we’ve had a sudden surge of 100% inflation. I now earn $20. It’s not a good thing for my good purchasing. Thanks to inflation, I’m spending $6 on food, and $6 on luxury goods. The same 60%. But my debt is fixed, so I’m still paying $4 to pay my debt. My costs are cut in half – 20% my income.

I mean, come on. At a basic level, it’s not even complex.
http://rodgermmitchell.wordpress.com Rodger Malcolm Mitchell

You missed the point. The government has the unlimited power to create money. Why does it need to “inflate away the debt”?

Your example, “I earn [...] I now earn” indicates you are confusing personal experience with federal government experience. The government is unique. It alone can pay any bills of any size.

The whole notion of the government having to “inflate away debt is obsolete” — disappeared in 1971 with the end of the gold standard.

Rodger Malcolm Mitchell