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The Message of China's Buying "TIPS"

The United States is going the way of Mexico (of 1994, when we lived in that country and experienced a horrendous crash at the end of the year. That's the signal that we're getting from China's shift out of U.S. Treasuries, and into TIPS.

In Mexico that year,  there was "bad" paper, and there was "good" paper. The "bad" paper were CETES, Spanish for "Tresury Certificates," which were denominated in pesos. The "good" paper was the Tesobonos, Treasury bonds, denominated in U.S. dollars, then a "hard" currency, which is say that they implicitly offered inflation protection.

Rates on CETES at the time were 14%. Rates on Tesobonoss, a high-yield "Eurodollar" bond, if you will, were 9%. Implicitly, the two bonds were saying that the inflation differential between Mexico and the U.S. wouold be no more than 5%, or conversely, the Mexican peso should fall no more than 5% in the coming year against the U.S. dollar. Theoretically, the two statements are equivalent.

It turned out that "5%" became more like 50%. The CETES were paid in worthless pesos. After a Rubin-led bailout, the Tesobonos were paid in full, by the skin of Mexico's teeth, to preserve its international credit.

By opting for inflation protected securities,  China is signalling that there will be raging inflation in the United States. It won't be 50%, but it might be more than 5%, perhaps as high as 15%.