Let’s Honor Kemp with Inflation-Indexed Bonds

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One single legislative act will stop government overspending in its tracks.

In 1978, Representative Jack Kemp (R-NY) proposed legislation (which had no chance of passage in Tip O’Neill’s Democrat Congress) designed to stop the government from defrauding investors with inflation: bond indexing.  The measure would have the additional value of discouraging government spending.

Ronald Reagan and Milton Friedman endorsed Kemp’s proposal.  Let’s dust off this bill and push it through Congress as a memorial to Jack Kemp.

What Is It?

Bond indexing requires that all government issued bonds must be retired at their current value.  In other words, the maturity payment of Treasury bond is face value plus inflation over the period of the bond’s life.  This keeps interest rates down, since the bond is guaranteed to match inflation, and prevents taxpayers from paying taxes on a loss, should inflation exceed the cumulative interest the bond paid.

Why Do We Need It?

Borrowing is great for governments.  As the US government continues to break every borrowing record in the books, it realizes — just as it did in the late 70s — that the easiest way to retire these debts is inflation.   A trillion dollars owed 10 years from now isn’t that much money if the annual inflation rate is, say, 25 percent during those 10 years.

If inflation threatens to wipe out the interest earned on the bond, lender will require much higher interest rates.  That Treasury buyers now settle for yields of about 3 percent on 10-year notes tells us the borrows do not expect much inflation–or they they plan to dump the bonds before inflation picks up.

Once inflation enters the scene, everything changes.  If I expect today’s dollar to buy $.50 worth of goods and services three years from now, I’ll want each dollar of that bond to be worth at least $2.00.  I get that return through higher interest rates–inflation plus something for the use of my money.

But the government taxes the lender on the return, so higher interest rates to cover inflation must go higher still to cover additional taxes.  So if I want to realize a gain of 3 percent over 10 years after taxes and inflation, I’ll need a very high interest rate should inflation kick up.

That yield-inflation-tax spiral destroyed the American ecnonomy in the 1970s, and threatens to repeat itself in the next 10 years.   The government is simply borrowing too much, too fast, to sustain long-term, predictable growth.

What Can I Do?

Ask your Congressmen and Senators to introduce legislation requiring that all Treasury bonds be indexed to inflation. And treasure having shared the Earth with such as Jack Kemp.

More on Kemp:

Kemp’s Playbook