The Flinchum File
Thoughtful Economic Analysis and Existential Opinions

Please Take My Money?

10/26/2010

Yesterday, the Treasury Department issued $10 billion in five-year bonds. In other words, they borrowed another $10 billion. But, something was different . . . very different. Instead of repaying $10 billion at the end of five years PLUS interest earned by the bond-holder, the government will repay $10 billion LESS interest paid to the government for holding the money. This has never happened before! The lender or bondholder doesn’t get paid regular interest.

What made this possible was that the bonds were TIPS or Treasury Inflation Protected Securities, which means the principal amount ($10 billion in this case) will be increased to offset inflation. It is a good way to protect investors with minimal income needs from inflation. Yesterday’s investors were willing to take a negative interest rate in order to get protection from inflation.

What makes this significant is that it clearly shows the market is expecting inflation. The Fed is widely expected to begin another round of quantitative easing on November 3rd, which the market expects will create inflation. Actually, this is a good thing, as deflation is much worse than inflation. Now that an inflationary psychology has developed, the fear of deflation is reduced . . . hallelujah! That’s a good thing!!

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