Monday Morning: Investor alert! I-Bonds may get jerked

A few months ago, I suggested that advisers consider investing at least part of their clients’ portfolios in I-Bonds.

I-Bonds offer investors the possibility of protecting part of their portfolios from the effects of inflation while locking in a reasonable rate of return. In effect, an individual can lock in an inflation-adjusted annual stream of income – important in retirement.

Unfortunately, that might not be an option for much longer. A committee of bond dealers has advised the Department of the Treasury to stop issuing inflation-protected bonds, saying they cost the government too much.

Disappearing act

Goldman Sachs & Co. also issued a report this month saying the inflation-indexed bonds have so far cost the government $1.7 billion more in interest payments than ordinary bonds.

If the experts succeed in persuading the government to stop issuing the bonds, Treasury Inflation Protected Securities aimed at institutional investors and I-Bonds for individual investors would disappear.

That would be unfortunate for individuals and corporations trying to protect themselves from inflation. Both deserve to have the option available.

There is another reason why the bonds should be preserved. Inflation is a monetary phenomenon, and since the money supply is controlled by the Federal Reserve, it is a governmental phenomenon.

Governments inflate the currency to surreptitiously shift to investors the costs that they don’t dare raise taxes to pay.

Inflation-indexed bonds take this option away from the government, and thus reduce the temptation to inflate. If the government inflates, it, not I-Bond holders, bears the cost. It can’t gain by inflating.

The advisory committee cited high costs in suggesting the inflation-indexed bonds be abolished. But how much is too much to protect investors from the possible misbehavior of the government? And why should investors not have that protection?

The federal government guarantees or subsidizes programs for many other groups. It guarantees price supports for farmers. It provides subsidized flood insurance for homeowners who insist on building in flood plains or on Atlantic Ocean sandbars. It guarantees Government National Mortgage Association (Ginnie Mae) mortgages.

All those guarantees and subsidies cost billions of dollars. Compared to them, the cost of the inflation insurance offered to investors through the bonds is minuscule.

One reason the inflation-indexed bonds have been more expensive than regular bonds is that the demand for regular Treasury bonds, especially 30-year issues, has been very strong.

The high demand for regular Treasuries is a result of the uncertain world economic outlook, which sent foreign investors scurrying to U.S. Treasuries for safety at a time when the supply was declining along with the federal deficit.

The demand for indexed Treasuries hasn’t been as strong as some expected. That is a result of the low inflation of the past few years and the lack of marketing effort behind them.

The Treasuries are, after all, something new that competes with a well-established and very popular product.

Financial advisers and institutional investors should rally behind TIPS and I-Bonds and let the Treasury Department know they are valued and must be preserved.

Mike Clowes is the editorial director of InvestmentNews.