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To: Thomas M. who wrote (16811)	10/20/1998 10:46:00 PM
From: Thomas M.	Respond to of 18056

forbes.com A Hot Tip By Steve H. Hanke EASY MONEY AND CREDIT all across the globe have created the greatest speculative boom the world has ever seen, with well-connected hedge fund operators employing insane 250-to-1 leverage ratios. As I anticipated in my Sept. 21 column, the bond defaults in faraway Russia have forced investors and policymakers to come to grips with the magnitude of this global speculative bubble. The world's biggest banks and hedge funds are now hemorrhaging severely as a result of their overexposure to emerging markets. In a quiet panic, the Fed rapidly switched gears on Sept. 29 and lowered the federal funds rate from 5.5% to 5.25%. So what should an investor do in these troubled times? Put protection of capital ahead of enhancement of capital. For this I especially recommend a little-noticed but useful security, Treasury Inflation Protection Securities (TIPS). The Dec. 20, 1993 issue of FORBES carried a column in which Sir Alan Walters and I urged the U.S. Treasury to start issuing TIPS. The Treasury started offering those bonds in January 1997. TIPS protect investors against inflation by paying a real rate of interest that is topped off with an inflation adjustment based on changes in the Consumer Price Index. Consequently, a TIPS principal grows at the same rate as inflation and maintains its real value in terms of the market basket of goods that makes up the CPI. The fixed-rate coupon, which is paid semiannually, is also adjusted for inflation: It rises in proportion to the increase in a TIPS' principal. Here then is a bond of the very highest quality and security that carries no inflation risk at all. The simplest way to evaluate TIPS is to compare them on a break-even basis with a standard (nominal) Treasury bond of the same maturity. On Oct. 9 the 30-year standard Treasury bond traded to yield a nominal 5.11% to maturity, while the 30-year TIPS traded to yield a real 3.7% to maturity. The difference of 1.41% represents the market's assessment of what annual inflation measured by the CPI is likely to be for the next 30 years. Should annual inflation turn out to be higher than 1.41%, the 30-year TIPS will provide a better return than the standard 30-year Treasury bond. And who with any sense of history would believe that we have seen the last of inflation? Over the past 30 years the average inflation rate has been 5.2%, and during the last decade, it has averaged 3.55%. Even now, in the great deflation, annual CPI inflation is 1.7% and core inflation (the CPI minus the volatile energy and food components) has accelerated to 2.5%, from 2.3% a year ago. If history is any guide at all, 30-year TIPS will clearly outperform standard 30-year Treasury bonds. Inflation has been subdued over the past three years because the U.S. dollar has been strong. In anticipation of the Fed's easing of Sept. 29, the dollar has come under pressure, however. Indeed, on a trade-weighted basis, the greenback shed 6% of its value in the month prior to the Fed's rate cut. Absent a super-strong dollar, the U.S. is vulnerable to the importation of inflation. And if that's not bad enough, the Fed has been expanding the money supply beyond its own targets and prudential levels for some time. Indeed, broad money measured by M2 is growing at 7.3% annually, over 2% above its upper target of 5%. Assuming that real growth would average 3% over the next two years (a generous assumption), M2 money growth of 7.3% implies an annual inflation rate of about 4%, a substantial acceleration from the present rate. And if real growth should be lower than 3% over the next two years, implied inflation rates would even be higher than 4%. Inflation is not today's problem, but it will be tomorrow's. On that you can bet with considerable certainty. Investors should start worrying about it and protect their capital with TIPS.