Friday, June 12, 2009

Clipping coupons, eating feline pate', buying diapers

Every so often you run across the phrase "clipping coupons" as in "His widow lived out her remaining years clipping coupons." I've known what the phrase meant; but until today I've never seen a picture of an actual bond with coupons to be clipped.

Here's a picture of a ten year One Million dollar U.S. Treasury bearer bond with some of the coupons still on it. As each interest coupon comes due it becomes just like cash since anyone can take it to a Federal Reserve Bank to redeem it for cash. Then at the end of the term the owner (or anyone who has the bond) can return it to the treasury for the million bucks that the bond itself is worth.

It's called a "bearer bond" because the treasury will pay out the interest and the principal to whoever comes in bearing the coupons and the bond when they're mature.

On a related note, yesterday I had reason to check out the rate of inflation over the past thirty years and also over a variety of prior thirty years periods. Inflation ran at a 4.4% rate from 1975 to 2005. There is a useful mental tool called the Rule of 72. If you divide the interest rate into 72 the answer tells you how fast money doubles if invested at a certain percentage interest rate or how fast its value is cut in half at a certain inflation rate. The Rule of 72 says a dollar lost approximately half of its value every 16 years from 1975 to 2005. A 1975 dollar is worth a bit less than 25 cents in real purchasing power today since it's been 34 years since then. Put another way, if your house was worth $50,000 in 1975 and it's worth $200,000 today its real value hasn't changed.

The worst thirty year period in the recent past for inflation was the period from 1965 to 1995 when inflation ran at an average rate of 5.4%. During that period a dollar lost half of its value every 13.3 years. It's purchasing power was reduced by 75% in about 27 years during that time period.

I think what's been happening down in Washington is setting the country up for an inflation rate even higher than the 5.4% average rate that prevailed from 1965 to 1995.

If I'm right that means a lunchtime can of catfood that costs an old lady $2 today will cost her daughter more than $8 twenty six years years from now in 2035, perhaps much more, and it will cost her granddaughter $32 in 2051. The same thing goes for Depends, Fixodent, Prunes and all the other necessities of old age.

Just so you know, I found the inflation rates I used at the site link below. Other sites give different and somewhat lower inflati0on rates. I was looking for a worst case estimate, so I purposely looked for the inflation calculator that showed the worst picture of what's happened on the inflation front over the last 100 years.


Your son said...

On the plus side... the real cost of your mortgage will go down.

Something else interesting that i was thinking about... half of all the loans made by the banks (give or take 20%) are "subprime" variable rate loans that were given to people with bad credit... the other half are "prime" loans that are mostly fixed rate loans given to people with good credit. How much money will the banks lose if inflation gets to 5-7%, which is the fixed rate on all of those "prime" loans? Second wave of banking crises comming soon? I'm considering buying puts on Bank of America

Sully said...

A long time ago I got into a pretty spirited discussion with Ken M, who was then chief economist of a big bank, when I described mortgages as a sucker bet for banks because people have the right to refinance their mortgages at lower rates when the inflation rate falls, but the banks don't have the right to raise the rate when the inflation rate rises.

However, the problem with buying puts is that they have only limited life spans and nobody knows how fast inflation will rise in reaction to rapid growth of the money supply, and there are high transaction costs associated with puts. Don't just count the brokerage fee when you consider the cost of a put, also check the bid versus asked spread.

Also, the government may well support and push money into the banks for an indefinite period to avoid recognizing reality. Japan has done that for something like 20 years