Third, the structure of government debt matters. So, index-linked bonds have proved to be a terrible idea. They have apparently increased the cost of government debt by many tens of billions a year. But no one mentions that, on average, this debt won’t be repaid for more than fifteen years, which is when the average index-linked bond is redeemed, which is the only time when this liability can fall due. Instead, it is portrayed as a current cost. That, though, is not true. The real question is not the cost, but how funds are to be set aside between now and the redemption date to fund the cash cost at that time. Properly understood in this way, we have no index-linked bond funding crisis at all. There is a long period to accumulate a redemption fund, and the right question to ask is how the funds in question should be used now to produce the return required fifteen years hence. But with totally crap accounting data, that point is totally missed. It is scandalous that it is.
Finally, because we do not use a national balance sheet we do not talk about what should be on it.
So people make balance sheet adjustments for those costs of index linked gilts. And the complaint is that we don’t do things by a national balance sheet?
Is this not the Prof straying perilously close to the concept of discounting – a technique he rails against regularly? Legion examples of this on his blog, eg
Discounting is open to abuse in financial reporting – which is why it has no place there
The faux science of discounting is not science when it comes to financial reporting. It is instead in far too many cases bogus cover for management judgement used to smooth earnings to suit management purposes
“index-linked bonds have proved to be a terrible idea”
For whom? They’ve worked rather well for us.
Spendthrift governments hate indexed bonds. If the government didn’t run up inflation by printing money, people wouldn’t demand indexed bonds. Politicians hate them because the interest has to be paid in right now budget currency that could be better used in getting them reelected. The thing is that indexed bonds only give partial protection, the principal still gets eaten away by inflation.
This was Snippa on twitter yesterday
To be fair, even some of his more unhinged supporters did try and correct him
@Mohave
At least in the UK, both the coupons and the principal of I/L government bonds are indexed to the general price level.
So investors are hedged against inflation, subject to any revisions to the way the general price index is calculated.
The real return that is locked in may still be very unsatisfactory, of course.
I do like the way that ‘on average, this debt won’t be repaid for more than fifteen years’ becomes ‘we have fifteen years before we need to do anything’.
If the question is ‘how funds are to be set aside between now and the redemption date to fund the cash cost at that time’, I wonder how his idea of spending all the cash now and worrying about it in 14 years’ time copes with needing to set funds aside to redeem the bonds coming up in the next twelve months…
“There is a long period to accumulate a redemption fund…”
When maniacs like Murphy have their hands on the cash and get to spending it, 1,000 years isn’t long enough to accumulate a redemption find.