Satisfying America's Creditors: Issuing More TIPS to Soothe China's Concerns   By Ralph Smith Friday, August 7, 2009 Click here for more articles by Ralph Smith

Many Americans, including federal employees, are worried about the growing federal debt. We should be worried about it since the large numbers surrounding the debt mean more interest will have to be paid and that the money won't be paid back for a long time.

But Americans are not the only ones worried. China, too, is concerned.

The Wall Street Journal reports that from October 1, 2008 through June 30, 2009, the United States issued $6.66 trillion in government bonds.

Those who invest in these bonds are wondering if they will get their money back. In addition, those who have purchased the bonds are wondering if American will go into a period of high inflation in the next several years as a result of the staggering debt load and the federal government printing more paper money that will be injected into our economy.

No one knows the future inflation rate for the United States but China, as America's largest debt holder, is concerned. It wants more protection for its money before making more large investments in American Treasury bonds.

When you borrow money from the bank, you have to make sure the bank is comfortable with your financial status. That is particularly true if you want more money and puts the debtor in the role of a supplicant to the organization with the money.

To satisfy our largest credit holder, American officials are responding positively to Chinese concerns. They have to be responsive because, for the quarter ending September 30, the Treasury Department will have to borrow another $406 billion dollars--following the $343 billion from the previous quarter.

China wants inflation protected bonds instead of the more traditional Treasury bonds. Treasury Inflation-Protected Securities (known as TIPS) hold their value during inflation as the interest rates increase if inflation goes up. As a result, the Treasury Department will start selling for TIPS to ensure that China and others will continue to loan America more money.

One result of the new policy of issuing more TIPS is that the value of the TIPS currently held by investors will likely decline. The other disadvantage is that, if inflation does increase as some think is likely to happen in the next several years, America's debt load will increase even faster because of rising interest rates.

Federal Employee Investment Alternative

Federal employees may be wondering if they should buy TIPS as an inflationary hedge as well. While that may not be a bad idea, the G fund in the Thrift Savings Plan may be a good alternative and is readily available to anyone with a Thrift Savings Plan (TSP) account.

The rate paid by the G fund varies each month.

For example, in July 2009, the G fund paid a yearly rate of 3.25% according to the Thrift Savings Plan. The 10-year Treasury note paid 3.54%. Back in January 2009, the G fund paid an annual rate of 2.13%. The 10 year Treasury note paid 2.21%. G Fund securities earn interest at a rate equal to the average market yield on outstanding marketable U.S. Treasury securities with 4 or more years to maturity. In effect, these are securities issued only to the G fund and the rate varies each month. According to the TSP, from January 1988 through December 2008, the G Fund rate was, on average, 1.68 percentage points higher per year than the 3-month T-bill rate.

Here are the annual rates paid by the G fund (and other TSP funds) since 1988.

Most TSP investors already use the G fund. It is, by far, the most popular fund with 57% of CSRS TSP investments being placed in the G fund and 50% of FERS employee TSP investments being invested in this fund.

The G fund is not the same as the TIPS that China and others want to borrow but it may serve the purposes of many readers who want an investment that is relatively safe and easily available to those who participate in the TSP.

Of course, how America will pay back the huge debt load in the future, instead of continuing to borrow large sums of money, is a question with an unknown answer. Those loaning us the money are understandably nervous about the safety of their investment. While no one knows the ultimate impact of this large debt on our daily lives in the form of higher inflation, higher taxes or a lower standard of living, chances are the debt will not be paid back anytime soon.

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