Inflation and Bonds

Inflation and Bonds

Why the government likes inflation

Are bonds really safer than stocks?

The worst time to buy bonds

The German hyperinflation of 1922 - 1923

The Hungarian hyperinflation of 1945 - 1946

Inflation in the US

Why the government likes inflation

The government is the largest debtor

Debtors love inflation because it means that they can repay the debt with less valuable dollars

The government also likes inflation because inflation creates hidden taxes

Bracket creep

Inflation pushes you into a higher tax bracket

Taxes on phantom capital gains

You buy $100,000 in stocks

Over ten years prices double

You sell your stocks for $200,000

You have a real gain of $0, but the government says you have a capital gain of $100,000

Are bonds really safer than stocks?

In general, short-term bonds (maturity of five years or less) provide greater safety of principal than stocks

But long-term bonds, like 30 year US Treasury bonds, are very volatile in price

But, over the long run, stocks can be said to be safer than bonds

• The biggest risk of investing solely in bonds is inflation risk
• Over the long run, bonds have a negative return after taxes and inflation
• Stocks have short-term risks, but long-term safety because of ability to resist inflation

The worst time to buy bonds

Don't buy bonds during or after a war

For some reason wars scare investors out of stocks

But stocks have the best chance of surviving the inflation that always accompanies wars

The US had it's highest recorded inflation of 18 percent in 1946 - immediately after World War II

The US also had high inflation after World War I and the Vietnam War

Wars always bring inflation, but the losers in a war face hyperinflation

High Russian inflation after end of Cold War

The German hyperinflation of 1922 - 1923

Most famous modern case of hyperinflation

Monthly inflation averaged over 300 percent

Prices increase about 10 billion times over one year

Marks in circulation increased about 7 billion times

The link between inflation and printing of money is obvious

Hyperinflation ended when

A new currency gained a link to gold

An independent central bank was formed that refused to monetize the government's budget deficiets

The Hungarian hyperinflation of 1945 - 1946

More vicious than Germany's hyperinflation

Monthly inflation averaged over 19,000 percent