Would you believe that we will actually have significant deflation in the US next year? And the year after that? And flat consumer prices for the year following? That's happened only once in a developed country since the 1930s, when Japan recorded a negative 1.6 per cent consumer price index for 2002.

Yet, if you believe the yields on US Treasury inflation protected bonds, or Tips, we will have a 2.2 per cent fall in prices in 2009, a 2.5 per cent decline in 2010, and only flat prices in 2011. If that turns out to be true, the real interest rate burden on even the highest rated borrowers will be extremely hard to bear.

As a practical matter, long before we had significant "negative prints" of consumer prices, the Federal Reserve would just flat out buy Treasury bonds and monetise away with "quantitative easing". Gold dealers would replace hedge fund managers at the art auctions, model agency parties, and Congressional hearings.

What's really going on is another effect of the disappearance of dealer and arbitrageur capital. The dealers can't afford to make efficient markets, given their decapitalisation, downsizing, and outright disappearance. That means anomalies sit there for weeks and months, where they would have disappeared in minutes or seconds. The arbs, well, they thought they had risk-free books with perfectly offsetting positions. These turned out to be long-term, illiquid investments that first bled out negative carry, and then were sold off by merciless prime brokers. So if you still have cash, there's a lot of credit-risk-free value on offer in the US Treasury Tips market. If you could leverage these positions, you'd make a fortune, but that would only be possible in an alternative universe.

For example, there is the Treasury Inflation Indexed bond with a January 2009 maturity. They are trading at a real annualised yield of 11.85 per cent, and an implied break-even inflation rate of -11.7 per cent. That's right. I re-read and checked the numbers, which are based on a price midway between the bid and offer.

The problem is that it is so difficult for dealers to finance these issues that the bid/ask spread is about 190 basis points. So while the underpricing you get when you punch the numbers into your bond calculator comes to 140 basis points, that is overwhelmed by the market's illiquidity.

Fine, let's forget the arbitrages, because this is just too illiquid and weird a world. How about just buying the bonds outright?

US inflation-linked bonds are the cheapest in the developed world; we'll leave emerging market risk to others for the moment.

This is in part due to the indexation of pensions in most other advanced countries, which leads to an enormous built-in demand for longer dated paper, and consequent overpricing.

Along the US Tips curve, the best values would be at the seven-year part of the curve, where there was the most forced unwinding of leveraged positions. By one measure, (comparative yields on asset swaps), seven-year Tips bonds are asset swapping at 130 basis points over Libor, agency bonds from housing entities are asset swapping at 50 basis points over.

You actually pick up quality selling the agencies and buying Tips, since Tips bonds are full faith and credit obligations of the US government, while the agencies have either an "effective" guarantee or an "implicit" guarantee, depending on which official is speaking on which day.

Mike Pond, an inflation-linked bond strategist at Barclays Capital, says: "A lot of people call the move in nominal Treasuries [without the inflation indexing] a flight to quality. But it is really a flight to liquidity. Tips have the same credit as nominals, but the nominals are indeed much more liquid. If you believe the most dire scenarios, then we would have low inflation in the near-term, but the combined stimulus from fiscal and monetary policy should lead to a steeper curve in the longer term," as inflation picks up.

The relative scarcity of Tips should increase. Mr Pond says Barclays estimates that issuance of nominal Treasury bonds next year should be about $1,400bn (£958bn, €1,116bn), while Tips will account for just $56bn of gross issuance. That 25-to-1 ratio compares with a 2008 ratio of 15-to-1.

So if you are a "real money" person who doesn't finance your bond positions, the relative values are pretty striking.

If you listened to Treasury secretary Hank Paulson speak on November 12, you heard him admit that by the time the rescue/bail-out bill was signed into law on October 3, he had realised that the supposed purpose of the Tarp (troubled asset relief programme) fund, buying distress-price mortgage backed paper, was not the best way to spend the money.

The honest thing to do would have been to share that observation with the taxpayers who were putting up the cash. He did not.

This column was alone in pointing out, the following business day, that Tarp, as laid out at the time, would simply not happen, and that the money would go to buy preferred stock. While I enjoy saying "I told you so", it will be even more pleasurable to see the back of this official.

johndizard@hotmail.com