Table 5.1 shows that when the original $1,000 is returned, the inflation-protected bond is always at least as good as the standard bond and usually much better. Even in extreme conditions, the inflation-protected bond ensures that the investor is protected.

This inflation protection, however, comes at a price. That price is the lower interest rate paid on the inflation-protected bond. Currently that difference is about 3% a year. Therefore the most that inflation insurance could cost you is about $30 a year for each $1,000 investment. This maximum price will be paid only if there is no inflation at all. If there is even modest inflation, however, the price of insurance is even less than $30 a year for each $1,000 investment.

Because inflation protection has been unnecessary over the last 20 years, the behavioral economic research suggests that our lizard brains, and consequently the market, may be undervaluing the inflation-protected bond. Furthermore, U.S. government bonds are fantastic investments in deflationary times. Therefore the inflation-protected bonds are almost unique in being great investments under both inflation and deflation. Thus, I believe that the inflation-protected bonds represent good value.

There are two types of U.S. government, inflation-protected bonds. They are the I-series of U.S. savings bonds, and the Treasury Inflation Protected Securities or TIPS. There are some legal differences between the two types of bonds. For example, the savings bonds are restricted both in the amount of purchase and the type of investor (mainly U.S. citizens). Both bond types, however, are essentially identical when it comes to inflation protection.

What about stocks as a protection against inflation or deflation? At first glance, this seems like a crazy suggestion. Consider three of the most famous periods of inflation and deflation. They are the current Japanese deflation, the U.S. deflation during the Great Depression, and the U.S. inflation of the 1970s. In all three periods, stocks were terrible investments. So stocks would appear to be a very bad way to protect wealth against an end-of-the-Goldilocks era of price stability.

While stocks were bad investments in past periods of price instability, they may be good investments now. Company profits have a built-in

inflation protection, just like the U.S. government bonds. Inflation, without other economic change, simply inflates a companys revenue and costs. Thus company profit-the difference between revenue and cost- ought to rise in lockstep with inflation.

If corporate profits are inflation protected, why have stocks done poorly in previous periods of price instability? The answer may be that in those previous periods the inflation and deflation were symptoms of deeper problems. For example, the poor stock performance in the United States during the 1970s may not have been caused by inflation. Perhaps the oil shocks of the time caused both inflation and poor stock performance. Thus, in future periods of price instability, stocks may provide protection.

Magic Paper

As Professor Friedman suggests, money is a fascinating topic. The magical little pieces of paper and electronic entries in bank computers allow us to leave behind the inefficiencies of barter and to amass wealth that we will use over many years.

The form of money has changed over time from commodities to precious metals to the current standard of fiat currencies. These modern forms of money are perfect with the exception of one enormous risk. That risk is that monetary authorities will misuse their power to determine the rate of inflation. In the past, such monetary mischief has bankrupted many families.

The United States has lived through 20 Goldilocks years during which inflation has hovered near optimal levels. The science of irrationality suggests that these halcyon years will have left most of us unprepared for any future price instability. Therefore, when most peoples lizard brains feel that the risks of price instability are negligible, we may have an opportunity to buy low-cost protection for our wealth. Fortunately, there are both traditional and innovative investments that allow us to protect our wealth.