As I was getting coffee in the faculty lounge, I started talking to a senior colleague who is nearing retirement. He said that he avoided a lot of the market pain of the last year because he had only about 25 percent of his savings in stock. (Now with the market drop, he has an even smaller percentage!) But his current concern is inflation.
As this killer graph from Paul Krugman shows, Ben Bernanke has been incredibly aggressive in expanding the money supply.
It is quite reasonable to be worried that the Fed will not be nimble enough to suck up this cash as the economy recovers. The banks and others are currently hoarding cash. But when they start to spend or invest it, the Fed will need to remove it by buying back assets (such as Treasury bonds), or we will have substantial inflation.
So here’s a puzzle: What should you do if you are retired or close to retirement and you are scared about the risk of inflation?
Holding stocks is often a way to hedge inflation — because dividends and stock prices rise with inflation. But at this stage in your life, you don’t want the risk of holding stock. Where should you invest at least some of your money to hedge the inflation risk?
This is not a hard puzzler; but if you’re having trouble, here’s a hint: Larry Summers.
A less obscure hint is the title of this post.
I’d love to hear your suggestions (let me say in advance that speculating on gold is not a great answer).
But the most simple response is to buy TIPS. TIPS stands for Treasury Inflation Protected Securities:
TIPS are treasury notes which offer guaranteed payments — interests in every six months and principal on security maturing. In every six months, the value of TIPS is automatically recalculated with respect to the inflation rate (measured based on Consumer Price Index, CPI). That is, when the inflation rate is up, the value of TIPS is also increased automatically.
I mentioned Larry Summers because Summers championed their creation when he was Deputy Treasury Secretary in the 1990′s. I think of TIPS as Summers’s gift to the world, giving us a low-risk way to hedge inflation risk.
The brilliant Andy Tobias also points out that TIPS hedge not only against inflation, they also provide a hedge against deflation — because in comparison to stocks they will keep their value, even if there is a decline in the Consumer Price Index.