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This is fun

In particular, let’s look at something called index-linked government bonds. There were, apparently £540 billion of these in issue by the government at the end of June 2022.


On interest rates, if the inflation rate goes up so too does the interest rate. Formulas are used to calculate by how much, but the impact is pretty direct. So, if inflation rises so too does the government’s borrowing cost.

That’s a fact. I do not argue with that. But the amounts involved are not that big, overall. There is a cost, but not enough to change government economic policy.

I dunno really. 10% inflation means £50 billion there. Even with government money that’s an amount to think about.

The 10% inflation rate effectively increases the amount due on repayment of these bonds by 10% or (near enough) £54bn.

Yes, quite.

The question is, how to account for this?

I’ve not actually read this next bit yet but I am trembling with anticipation at what the shell trick will be.

Firstly, this accounting assumes that the £54bn is all due for payment now. But that is not true. On average it is due for payment in 2040. And for accounting purposes money due in 2040 does not have the same value as money due now.

Aha! He’s discounting. You know, that thing we must never, ever, do?

But this:

But I would actually argue the accounting is worse than that. The reality is the £54bn is not a capital payment. Due to the way the bond is designed it is all interest due as a result of inflation, in effect.

In that case, the £54 billion cost that will only be paid in 2040 should be spread over the 18 years between now and 2040. £54bn over 18 years happens to be £3bn a year. And that is precisely the amount by which the national debt should rise this year as a result of this cost.

The bond will never be repaid early by the government. There is, therefore, no reason to provide for the full cost of inflation now. And the bond was designed to reflect inflation over its whole life, not in any one year.

Let us now allow that idea. Just in the interest (Ahahahaha) of exploring it. Now what? Well, now, this year’s accounts should show that same portion of all past inflation adjustments to inflation linked gilts, shouldn;t they? And next year’s must do the same and so on.

It’s not the get out he thinks, is it?

4 thoughts on “This is fun”

  1. Fuck me. He’s unwittingly come wading into an area where even people who think they know what they are talking about often get it wrong.

    The coupon (‘interest’) on IL gilts is a small component of the cost. The 2041’s have a coupon rate of 0.125%, so:

    1) ‘if the inflation rate goes up so too does the interest rate’. No, complete bollocks, the ‘interest rate’ (called the ‘coupon’ you twat) is fixed at 0.125%

    2) ‘this accounting assumes that the £54bn is all due for payment now. But that is not true’ – Sort of bollocks. That £ 54 Billion is built into the amount outstanding on the Gilts TODAY, so the market value of the bonds reflects that incremental increase in value. TODAY. If the market were to trade 100% of the outstanding bonds today, the value traded would include that £54 billion (On whatever date the new indexation takes place). The transfer from Borrower (Gubmint) to Lender (Bond holder) of the total outstanding value is just put off until a future date, but it would still be owed today.

    2) ‘The reality is the £54bn is not a capital payment.’ – Complete bollocks. It is absolutely a capital payment, as the gain to holders will be treated as (Albeit a potentially untaxed) capital gain in the future.

    3) ‘Due to the way the bond is designed it is all interest due as a result of inflation, in effect.’ – Complete bollocks. See 2 above.

    Because he’s a moron, he’s also (as our host points out) got no idea that there is already an indexation amount due on all of the outstanding bonds each year since they have been issued, and will be until they all mature, so it might well be £ 3 billion per year for the next 18 years on this years indexation, but what’s due each year from the past, and perhaps more scarily, how much would the Dicktator be adding per year for the next 18 years for the next 18 years of inflation ? I mean soon you could be talking about big numbers.

  2. You what?
    Inflation linked gilts are for those who want to preserve money, not make it.
    So very small coupon (0.125%) PLUS potentially unlimited yield due to inflation. That 54 billion is due today or next week or whenever the date is on the gilts (half yearly dividend?). No discounting required, pay up 54 billion or default.

    And those index linked pensions have to be paid for too. I used to think they were a bad idea but possibly useful as a way of incentivising government not to piss money up the wall and create inflation. I was wrong. They’ve fucked that up too.

  3. 1) The terms of the bond are fixed at issue, there are two ways of doing the indexation – varying the par amount at maturity, or varying the coupon amount semi-annually, or annually. There may also be a cap on the indexation. Wouldn’t put it past them. Or muck about with the metric (RPI, RPIX, CPI, CPIH). Either way, the investor will receive some element of a floating rate, indexed to inflation, at some point.

    Murphy used “interest rate” instead of yield or YTM.

  4. Wait – which is it? Index linked (which to my mind must mean the coupon is, well, linked to some index) or fixed (which implies it isn’t).

    Or do they compound up the indexation onto the redemption value at maturity (which would be odd, because then the capital value will have to rise, making the yield – albeit not the YTM – fall).

    And that’s a MASSIVE balloon payment at the end – can’t imagine the incentives for politicians are good there…

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