Wednesday, March 6, 2013

Unsustainably High TIPS Prices: What's Next?

As was anticipated in this blog last October: TIPS funds have paid an annualized return rate of around 2.5% during the last six months, and more recently the return rate has been closer to zero and even negative. It now underperforms nominally-guaranteed fixed income funds such as Minnesota Life (3% in fixed dollars) and nominally-guaranteed long-term savings accounts in Europe, which pay 2.5% or above in euros or Swiss francs. To put it short, real interest rates are so low that they cannot fall further even under a future scenario of financial repression and high inflation. Much on the contrary: if inflation rises, real interest rates will have to rise, no mattering how accommodative is the central bank policy.

To make things worse, this situation is financially and fiscally unsustainable, causing nominally-guaranteed funds to become insolvent or to need massive government subsidies to private savings, the latest leading to all kinds of obvious financial and fiscal distortions. This phenomenon took place from time to time in Brazil during the years of financial repression that preceded hyperinflation and fiscal chaos.

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