WHAT ARE WEALTH BONDS?
Until now we have used National Average Earnings, NAE, as our unit for measurement, thinking that it would grow at about the same rate as a wages index. Recent research suggests that using a National Average Wages Index may be better. Some say using the median value would be better than the average value. As with the inflation indices the best choice may depend upon the intended use. This is a discussion topic in its own right.
Here is a publication that covers this subject and more.
There are several formats for wealth bonds, depending on their use - government debt, business debt, or Mortgages.
The basic format for Wealth Bonds is that the capital is index-linked to National Average Earnings, NAE. It is intended that governments will issue these bonds to raise money or to provide a safe investment for people and entities to buy into.
The interest coupon could be as little as 1% p.a. because there is no risk unless the government is unable to repay the money. That is as risk free as you can get.
There are many things that need an investment that rises in value as fast as NAE, or wages – which should be rising at a similar rate.
For example, pension funds, reserves for lenders and insurance companies whose liabilities may rise at a similar rate in all such examples.
In contrast, an investment in fixed interest bonds also known as treasuries / gilts if issued by a government, can fall in value if the rate of inflation rises faster than previously, yet its value needs to be rising faster. These fixed interest bonds can rise in value when there is a depression, putting excess pressure on the government’s budget.
There is really no time that suits both parties – lender and borrower.
This adds to the cost of borrowing in two ways:
· A smaller market for them exists than could be available for Wealth Bonds, and
· Investors need to price in the risk (which they really do not know) of this investment performing less well than they need it to.
An investment of 10 NAE in Wealth Bonds, worth ten times the National Average Earnings at the time, would still be worth 10 NAE at maturity, any number of years later.
A pension fund could invest their clients’ money in Wealth Bonds so that no matter when the client put money in to their fund, provided it added up to (again) say 10 NAE at retirement, this could pay out 0.5NAE p.a. for 20 years, rising every year at the same pace as NAE as if the retired person was still working. Or a different sum p.a. for life.
WHY LINK TO NAE?
If earnings increase by 10% and people are not working 10% more hours, then it will take 10% fewer hours at work to repay that debt.
If working hours had increased at the same rate as NAE had been rising during the past century then the working day would by now be lasting well over 24 hours. This does not happen.
As a unit for measuring the value of debt or of savings, NAE has some merit. Maybe not perfect, but it is a simple measurement that is created by many governments’ statistical offices.
Unlike the Consumer Prices Index, CPI, and other related indices, it is not necessary to change the composition of the index very often if at all.
It is a simple and effective index that leads to marketable investments.
How would this compare with an investment in an index-linked Bond?
Imagine this: a fund valued at 20 National Average Earnings, 20 NAE, (around half a life-time’s earnings for an average person), was invested by your grandpa to keep pace with a prices index. A century later, when you were expecting to inherit this fortune, and to be able to spend half a lifetime spending it all, you are told that it might be worth just one year’s National Average Earnings, 1 NAE. That is a 95% loss of NAE over the century. You are shocked. It will not be worth half a lifetime’s NAE, earnings as intended, (the original 20 NAE), but closer to 1 NAE – just a single year’s average earnings. Other people got the main benefit, not you.
That is because it is usual for earnings to rise faster than prices. Here, the difference in the rate of increase between rising earnings and rising prices was assumed to have averaged 3% p.a. for 100 years. That is, about 3% p.a. real economic growth, which broadly, is accepted to mean the difference between the rate of average earnings growth (AEG% p.a.), and the rate of prices growth, (inflation). As earnings rise faster than prices we all become better off.
WHAT ARE TRILLS? These are a suggestion from Robert Shiller - they are bonds issued by governments in which the capital is index-linked to GDP. Each Trill (bond) has a value of one trillionth of a GDP.
These are based on a similar idea but are not so easy to explain to savers and other users. According to Dr. Chowa, the relationship between NAE and GDP is not as strong as one might expect.
Take Greece as an example. If 25% more people had work in Greece that would have a huge impact on the value of Trills. It would not have the same impact on the value of Wealth Bonds. NAE will not rise because the population rose by 25%.