Sorry, but I couldn’t pass this one up.

The introductory letter to the recent 2007 Investor Guide issue of Forbes magazine (12/11/2006) has a really neat little tongue-in-cheek reference to a new way to beat inflation. First, check out this graph from the article:

Yes, that’s depressing. Most people learn that typical “money market” returns for cash match inflation over time. That means that the interest you earn on cash accounts historically lines up with the amount prices go up every year. It’s why many people use money market funds and other similar cash equivalents, like certificates of deposit, to “protect” their savings.

Unfortunately, what this chart shows is that your cash equivalents only keep up with inflation when they aren’t taxed. T-Bills, which are the basic proxy for the cash equivalent market, actually lose money against inflation because the US government taxes their gains.

The chart plots what would have happened to a hypothetical dollar invested in T bills by a top-bracket taxpayer. The government that issues these bills gets you two ways. First is via inflation, what Ronald Reagan called the “thief in the night.” The other is to send around the Internal Revenue Service to rob you in broad daylight. Your real aftertax return over the past 75 years is a cumulative –72%.

Interestingly enough, there are real investment options today, in both Europe and the United States to protect your money from inflation. Several options, in fact:

• Treasury Inflation-Protected Securities. This is the official, US, 10-year bond that is guaranteed to pay out both a real return and the inflation-adjustment based on the consumer price index. There are similar bonds in Europe as well. The only problem – you have to pay taxes on the inflation “gain” every year, even though it isn’t paid out until the end of the 10-year term. This also ignores the obvious fact that keeping up with inflation isn’t really a gain, so like the T-Bill, you are getting kicked in the stomach by the same government that inflated your currency.
• Series I Savings Bonds. I love these. In business school, I independently did an analysis for my finance professor on the expected return of these incredible instruments. Conclusion: The government is heavily subsidizing them. Translation: the government is over-paying for these bonds, likely to help small savers and to encourage college savings. Let’s count the benefits:
  • Taxes. None, until you cash in the bond. Up to 30 years of tax deferral!
  • No State Taxes. None, ever. It’s excluded, a real perk for high tax states like good old California.
  • No Taxes, education benefit. If you use the proceeds to pay for education, the gains are tax free.
  • Inflation protected. You get paid a real rate of return plus inflation, every six months. Better yet, they use the CPI-U (consumer price index – urban), which tends to run hotter than the CPI overall, but better reflects costs when you live in the city.

  In fact, the only limitation are the 1-year waiting period to cash out, the 3-month interest penalty you pay if you cash them in before 5 years, and the $30,000 per-person, per-year maximum (which I doubt many people hit).

• Municipal Bonds. My understanding is that there are now inflation-protected municipal bonds in some areas… all the tax-free benefits of municipal bonds and inflation protection sounds good to me. (unfortunately, the real rate of return on these is negligible)
• Gold. No, it’s not backed by any government, but the gold bugs out there will flame me to a crisp if I didn’t mention the oldest, and dearest inflation hedge in the world. The theory is that gold always stays the same price, and all other currencies just effectively float around based on how well they manage their money supply. You could make this argument about any precious metal, or even for commodities and real assets in general. Personally, I still think that one day we’re going to be able to find unlimited supplies of any metal, so not putting my 50-year money here…

But I am here today to mention a humble, fourth opportunity for inflation protection:

The new “Forever Stamp” proposed by the US Post Office.

The basic idea is that the post office will issue a new 42¢ stamp in 2007 (yes, another price increase), but one that will hold it’s value forever. No more price increases. The stamp will always be good for one first-class mail item, up to 4 ounces.

Let’s think about that.

First, we know that the US Postal rates have approximately kept pace with inflation over the past 25 years… maybe a bit more than inflation.

Second, there is no proposed “time limit” on the stamp. I guess the stamp will be valid as long as there is a US Post Office?

Third, there is no limit on resale. So, I am assuming that if postal rates increase, you could resell your stamps to someone else who needs them, for approximately full value.

Fourth, there is no accumulation limit. You could theoretically by $1M worth of these stamps, if you wanted to.

Fifth, no taxes. At least, right now, the IRS has not said that it will tax you on the appreciation of your first-class stamps. At minimum, there are no taxes until you “cash them in” by selling them.

The blog Marginal Revolution asserts this just gave the Post Office the ability to print money. Since the Post Office is effectively backed by the US Government, they can just print stamps to effectively increase the money supply. (I do love it when the stable money fanatics get worked up.)

The blog Economist’s View has another interesting take on the proposal.

There you go… tidbit for the day. If you are looking for a safe place to park your money, you may now have a new friend in the US Post Office. I will say that this looks like a very hot item for the Stamps category on eBay…