TIPS Owners -- Chained CPI and TIPS!

[Browser]

Just reading about the chained CPI, which calculates the CPI based on "substituting" items in the current CPI calculation based on presumed changes in consumer spending patterns if prices rise (e.g., shifting toward lower-priced pork vs. beef). This method has resulted in a 0.3% lower annual CPI calculation over the last decade. It's being proposed for calculating Social Security Cola adjustments and looks like it might have a good chance of being part of the "cliff" deal. If it starts being used for SS, then I reckon it will be used for adjusting TIPS principal also, right? I figure this will cause an immediate sell-off in TIPS, and since I hold a bunch in a retirement income ladder I'm considering dumping the lot right now. What are your thoughts???

[Taylor Larimore]

Just reading about the chained CPI, which calculates the CPI based on "substituting" items in the current CPI calculation based on presumed changes in consumer spending patterns if prices rise (e.g., shifting toward lower-priced pork vs. beef). This method has resulted in a 0.3% lower annual CPI calculation over the last decade. It's being proposed for calculating Social Security Cola adjustments and looks like it might have a good chance of being part of the "cliff" deal. If it starts being used for SS, then I reckon it will be used for adjusting TIPS principal also, right? I figure this will cause an immediate sell-off in TIPS, and since I hold a bunch in a retirement income ladder I'm considering dumping the lot right now. What are your thoughts?

Your "reading" is already in the price of TIPS. Stay-the-course.

Best wishes and Happy Holiday!
Taylor

[sscritic]

If it starts being used for SS, then I reckon it will be used for adjusting TIPS principal also, right?

I reckon it might not. I have read about the possibility of it being used for tax brackets. I know the current law for I bonds specifically mentions the CPI-U as long as it is being calculated. They can calculate both the CPI-U and the chained CPI; they do today. Now you are correct that they might change the law in many places, but I have read that there are places where the suggestion is that CPI-U continue to be used. Note also, SS uses CPI-W, so the substitution of Chained CPI for CPI-W in one law is separate from the substitution of Chained CPI for CPI-U in others.

Isn't this speculation about laws that don't exist?

[Oicuryy]

[nisiprius]

Here's part of the law that does exist, quoted from TreasuryDirect:

If, while an inflation-protected security is outstanding, the CPI is (1) discontinued, (2) in the judgment of the Secretary, fundamentally altered in a manner materially adverse to the interests of an investor in the security, or (3) in the judgment of the Secretary, altered by legislation or Executive Order in a manner materially adverse to the interests of an investor in the security, Treasury, after consulting with the BLS, will substitute an appropriate alternative index."

I won't speak to whether the Treasurer can be trusted to act in good faith on this, but those are the stated terms and conditions.

What is the Minister of Gold obligated to do if the price of gold changes in a manner materially adverse to the interest of an investor of gold? How about the Minister of Real Estate Prices?

[Browser]

I'm guessing that if the government has a choice between (a) paying more for borrowing, and (b) paying less for borrowing, it will be happy to select (b) and hope that you and I don't notice. They've done it before, as when "hedonic" adjustments were incorporated to lower the calculated CPI-U. But I don't guess they'd ever do that again, would they?? Nah. We begin to wonder just how much stock to put in those promises to offer "inflation protected" securities when the guys making the promises are the same guys who are calculating what "inflation" is.

[sscritic]

Here's part of the law that does exist, quoted from TreasuryDirect:

If, while an inflation-protected security is outstanding, the CPI is (1) discontinued, (2) in the judgment of the Secretary, fundamentally altered in a manner materially adverse to the interests of an investor in the security, or (3) in the judgment of the Secretary, altered by legislation or Executive Order in a manner materially adverse to the interests of an investor in the security, Treasury, after consulting with the BLS, will substitute an appropriate alternative index."

I won't speak to whether the Treasurer can be trusted to act in good faith on this, but those are the stated terms and conditions.

This speaks to what happens if the CPI-U is changed in how it is calculated or discontinued (not calculated at all). That has not been proposed as far as I know. The proposals all speak of using another CPI rather than CPI-U, none of which is addressed in this language.

Note that the CPI being discussed in this passage is specified earlier on the same page; it's the CPI-U.

The index for measuring the inflation rate is the non-seasonally adjusted U.S. City Average All Items Consumer Price Index for All Urban Consumers (CPI-U), published monthly by the Bureau of Labor Statistics (BLS).

[neurosphere]

Interesting observation. I re-plotted the data from the FRED site comparing the CPI-U to the CPI-W back to the early 1900s. I don't have time to post the plot here, but the two indexes were exactly the same. By exactly, I mean that within the resolution of a line-width, they completely overlapped. Why bother to have the two different metrics if they are going to track so closely. It's just one more index to create, update, etc. Anyway, I just expected there would be more of a difference between the two.

NS

[nisiprius]

I'm guessing that if the government has a choice between (a) paying more for borrowing, and (b) paying less for borrowing, it will be happy to select (b) and hope that you and I don't notice. They've done it before, as when "hedonic" adjustments were incorporated to lower the calculated CPI-U. But I don't guess they'd ever do that again, would they?? Nah. We begin to wonder just how much stock to put in those promises to offer "inflation protected" securities when the guys making the promises are the same guys who are calculating what "inflation" is.

Could we have something more than 100% pure ideology? I trust you're watching the MIT Billion Prices Project, which uses such a different methodology (online prices) that an exact match shouldn't be expected. The results suggest that the the CPI is certainly in the right ballpark--it's not a crazy low number.

The Billion Prices Project is the only convenient source of independent data that I know of. Are you aware of any other place that is a) calculating inflation based on actual prices, and b) discloses its methodology? If so, please let us know what they are finding.

[staythecourse]

I don't want to debate a "potential" change, but would like to hear from others what the effect of even thinking about a change in the calculation of inflation means to your faith in TIPS itself.

This whole idea of changing the calculation started to make me think if there isn't a BIG counterparty risk with TIPS that folks have not discussed in the past. If the government who is in charge of calculating inflation can change the formula (likely for their financial benefits and not to the purchasers) and they are the same folks selling the product is there an issue of counterparty risk??

BTW, thinking about it are TIPS actually a form of derivitives at heart?? Part of the return of the product is based on something else, i.e. inflation.

Good luck.

[grayfox]

Here's part of the law that does exist, quoted from TreasuryDirect:

If, while an inflation-protected security is outstanding, the CPI is (1) discontinued, (2) in the judgment of the Secretary, fundamentally altered in a manner materially adverse to the interests of an investor in the security, or (3) in the judgment of the Secretary, altered by legislation or Executive Order in a manner materially adverse to the interests of an investor in the security, Treasury, after consulting with the BLS, will substitute an appropriate alternative index."

I won't speak to whether the Treasurer can be trusted to act in good faith on this, but those are the stated terms and conditions.

What is the Minister of Gold obligated to do if the price of gold changes in a manner materially adverse to the interest of an investor of gold? How about the Minister of Real Estate Prices?

Suppose the BLS continues to produce the series called CPI-U, but changes the method to chained CPU. BLS will claim they are making the measurement of consumer inflation more accurate. Then the Treasury Secretary judges that the change does not materially alter the interests of investors, because investors signed up for protection of actual inflation, measured as accurately as possible. Investors are not entitled to inflation + some bias due to measurement error.

Who knows, maybe Treasury will say investors have been overpaid for years and adjust down all the inflation factors on existing bonds.

This sounds like an area for the lawyers to argue about.