For Inflation Protection, Half Measures Won't Work by Malcolm Berko on Creators.com

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For Inflation Protection, Half Measures Won't Work

Dear Mr. Berko: I want to buy $20,000 worth of Treasury Inflation Protected Securities. But when I called my broker, he wanted to sell me a mutual fund that owns TIPS. I want to avoid paying a 5 percent commission and annual management costs of 0.75 percent, both of which would reduce my yield. I just want the plain TIPS and not shares of a fund that manages them. I asked why I need to have a managed TIPS fund if all I want to do is hold them in my account for 10 years or so. But this broker just doesn't get it. He tried to talk me out of TIPS because he insists we are not going to have an inflation problem. He said we are going to have deflation, and that prices are going to start falling. He made a good case for lower prices and deflation, so now I'm confused. He says "deflation" and you say "inflation." Please tell me who's right. — P.D., San Antonio

Dear P.D.: So far, your broker is 50 percent correct. The Consumer Price Index has actually fallen 0.4 percent in the past 12 months. Aiding and abetting that decline was a large drop in the price of oil, a continuing collapse in the housing market, and a decline in the cost of clothing and transportation. A strong drop in personal income further supports the deflationary trend.

Many newspapers are reducing salaries between 5 percent and 15 percent, such as the, New York Times, the Chicago Tribune and the Dallas Morning News. Winnebago Industries, manufacturer of motor homes, reduced salaries, the Big Three automakers — soon to be the "Smaller Two" — are reducing payroll costs, Hewlett Packard's employees will forfeit between 3 percent and 15 percent of their incomes, and a recent survey by the outplacement firm Challenger Gray & Christmas found 27 percent of the employers they contacted reported wage cuts or salary freezes.

Deflation, or falling prices, concerns the government more than inflation because consumers delay their purchases in the belief that prices will continue to fall. And that can drive companies out of business.

A true inflationary spiral involves unemployment between 3 percent and 4 percent and rising salaries, neither of which is happening in today's economy.

That is why your broker is 50 percent right. But it's dangerous to ascribe short-term events to long-term consequences.

While inflation is not currently a problem, our massive Federal and state debts scare the bejabbers out of me. Today, the U.S. government has $11.7 trillion in outstanding debt, up from $5.2 trillion in 2000. We also must include the government's efforts to jump-start the banking system, which is likely to add another $1.5 trillion to that $11.7 trillion number. The Obama administration is literally and figuratively flooding the economy with cash.

Basically, inflation is defined as too much money chasing too few goods and services. The big concern among most analysts is that Congress, rather than pay off the debt and reduce the deficit with incoming taxes and receipts, will authorize the Treasury Department to print even more money. In this scenario, the value of the dollar crashes like a coconut from a tall island palm tree.

Because printing money is the convenient solution used in the past, there's little doubt Congress will again deluge the economy with caskets of cash. This is politically preferable to cutting hundreds of billions of dollars of government pork programs, and it keeps voters as happy as pigs in slop. It's a quick-fix Band-Aid that borrows the economy out of trouble. But the payback will be double-digit inflation.

Today, inflation isn't a big problem. But you and I both know that in 2010 or 2011, inflation will soar. Oil prices won't remain at $50 a barrel, food and clothing costs are going to rise again, falling home prices will begin to stabilize, and employment will increase. Because government continues to borrow trillions to shore up Medicaid, education, health care, etc., intemperate inflation is inevitable. So I'd rather own TIPS when they're not in hot demand or potentially trading at a premium. A year or two from now when this recession is over and you hear consumers complain about double-digit inflation, your TIPS will make you proud.

Meanwhile, you can purchase TIPS directly from the U.S. government. Go to www.treasurydirect.gov and follow the bouncing ball.

Please address your financial questions to Malcolm Berko, P.O. Box 1416, Boca Raton, FL 33429 or e-mail him at malber@comcast.net. To find out more about Malcolm Berko and read features by other Creators Syndicate writers and cartoonists, visit the Creators Syndicate website at www.creators.com.