Felix Salmon

The return of GDP bonds

By Felix Salmon
December 28, 2009

GDP bonds are the instrument that refuses to die: Robert Shiller has resuscitated them in the NYT this weekend, this time with equity-like characteristics.

Each trill would represent one-trillionth of the country’s G.D.P. And each would pay in perpetuity, and in domestic currency, a quarterly dividend equal to a trillionth of the nation’s quarterly nominal G.D.P.

There are lots and lots of reasons why this is a bad idea, not least the fact that measuring the rate of increase of GDP is vastly easier than measuring GDP itself. Bonds like the ones pushed by Jonathan Ford are at least linked to the GDP growth rate; Shiller’s bonds, by contrast, are linked to actual nominal GDP, and that’s a much harder number to pin down.

But much more seriously, Shiller’s “trills” would be incredibly — and unhelpfully — volatile, as David Merkel explains. That fact becomes immediately obvious the minute you realize that if expected long-term nominal GDP growth ever rose above the yield on a sovereign perpetual bond, the value of a “trill” would be infinite.

Right now, the spread between the two numbers is relatively small, at 100bp. (Shiller seems to be using an expectation for long-term GDP growth of 3.4%; Merkel puts the yield on a hypothetical US perpetual bond at 4.4%.) If that spread fell further, the price of a trill would start rising exponentially. Similarly, if that spread were to widen much, the value of a trill would plunge. As a result, there would be a huge amount of market risk involved in buying trills: you could easily lose half or more of your investment if real long-term rates started to rise a lot.

And if trills are bad for the buyers, they’re equally bad for the seller. The whole concept of debt finance is predicated on the idea of investing in future growth: the country borrows money from investors for the present and future benefit of the nation as a whole. Shiller’s trills turn that concept on its head: the more successful the country becomes, the more it owes its creditors.

The underlying problem here is that sovereigns and individuals can’t sell equity in themselves. (That’s the main reason why the jock exchange never took off.) The S&P 500 might not be a perfect proxy for investing in the US as a whole, but it’s not a bad one either. If people want to buy a volatile investment which goes up, over the long term, in line with national GDP, the stock market is still the best place to look.

2 comments so far | RSS Comments RSS

Just because these trills may be volatile does not make them a completely useless product. If the product is available, the market will decide whether it is useful or not. What would be potentially more interesting is if this market could be subject to manipulation by national or supranational agencies… now that is an interesting prospect!

And in general it is very unlikely that the expected long-long term nominal growth rate of the economy would ever exceed the yield of this US perp bond. If anything, the presence of this additional security might help eliminate mispricing in the perp bond market!

wallstworker @ http://the-moneyverse.blogspot.com/

Posted by wallstworker | Report as abusive

“the more successful the country becomes, the more it owes its creditors”

This is, of course, more or less the point; conversely, the less successful the country, the less it owes its creditors.

Posted by dWj | Report as abusive

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