Overpaying for bonds? Not as crazy as you'd think

U.S. bonds.


Kai Ryssdal: So here's an interesting investment idea: Pay the government to hold your money.

For the first time yesterday, the Treasury Department sold inflation-protected bonds at what's called a "negative yield." Buyers lined up to lend the government money, and then pay for the privilege. The bond market matters because it can help figure out the future direction of all kinds of things -- economic growth, interest rates, consumer prices, the whole shebang. The success of this week's Treasury auction is a bet that the Federal Reserve's latest plan to juice the economy and drive up inflation just might work.

Marketplace's Mitchell Hartman reports.

Mitchell Hartman: Let's say I invest in a government bond, which is really the same as lending the government money. The bond is worth $100. But instead of getting paid interest by the government, I'm actually going to pay a little extra, 55 cents. Meaning, I start out at a loss.

Rich Gritta: It's rational, but it appears to be nuts.

University of Portland finance professor Rich Gritta says it's rational, because this particular bond offers a guaranteed protection against inflation.

Dan Greenhaus at institutional trading firm Miller Tabak explains, if inflation goes up, the value of the bond goes up too.

Dan Greenhaus: Even if you overpaid in the immediate, a sufficient enough rise in prices will compensate you for whatever overpayment you had in the short term.

And Greenhaus says the fact that investors snapped up these inflation-protected bonds means they're betting prices will rise, eventually. Which in turn means they believe the Federal Reserve will succeed in reversing the stagnation in consumer prices we've seen in the recession.

And why would the Fed want higher prices? Well, because low prices are keeping the economy down, says Rich Gritta.

Gritta: Deflation sounds cool, because hey, wide-screen TV sets are real cheap. But the bad news is that producers can't make money, so they quit producing. And then what you get is a continuing recession.

To make sure that doesn't happen, the Fed is expected to pump hundreds of billions of dollars into the economy. And bet that prices will rise. Which in turn will give businesses a chance to make more money on what they make and sell, and what they export abroad.

I'm Mitchell Hartman for Marketplace.

About the author

Mitchell Hartman is the senior reporter for Marketplace’s Entrepreneurship Desk and also covers employment.
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Deflation isn't great for business or consumers either (assuming consumers work for businesses producing something). Why would anyone buy anything not an absolute necessity if they had reasonable confidence that the price would be lower next week, and even lower the next week, and even lower the next? That sounds like a recipe for nobody buying anything and nobody getting hired to produce things no one is buying.

to mike amendola: As a former student of Dr Gritta's I feel the need to point out that he didn't actually say "the Fed is expected to pump hundreds of billions of dollars into the economy. And bet that prices will rise. Which in turn will give businesses a chance to make more money ..." That was the author's explaination.

And no worries about the job offers, all of the former students I know are gainfully employed.

"the Fed is expected to pump hundreds of billions of dollars into the economy. And bet that prices will rise. Which in turn will give businesses a chance to make more money ..." No one in business wants "more money" that is worth less. Pumping hundreds of billions of dollars into the economy destroys the value of existing assets, savings and investment. It sends distorted economic information to the real marketplace and causes malinvestment further destroying wealth. This is exactly how we got here in the first place. Gritta should be charged with malpractice. I would like a list of his students, so I know not to hire them.

Government/corporatist propaganda. Deflation is good for consumers and inflation is good for producers. Which one will the Fed try to bring about? Hmmm. And Marketplace falls in line right behind them.

Is it possible that the fact that prices are rising faster than wages and easy credit (all brought about by the Fed, by the way) are to blame for the very predicament we're in now? And we're supposed to believe that more of the same will get us out?

By all means, please continue to devalue the money in my pocket and penalize saving by devaluing the dollar. All hail the Fed.

The problem with TIPS is that the Government defines how CPI is computed. The Government uses hedonic models in which THEY decide which things go in the basket of goods from which they calculate inflation. For example, in the 1970's homes were included in the CPI. But rising home prices made the CPI too large and those Social Security COLA's too expensive ... so the Government threw homes out of the basket. The Government will probably try similar dirty tricks with the TIPS because they are rapidly running out of deficit spending options.

So ... rather than deal that that kind of uncertainty, why not just buy physical gold?

When prices go up, who has the money to buy? The unemployed? What if gas goes up too? What is the formula that lets the Fed know, how much quantitative easy is enough for say 4% inflation? I think you get better odds in a casino.

This sounds like a recipe for stagflation. Where nobody gets hired, companies stop producing and we have a continuing recession.

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