GDP-Linked Bonds Are Complete BS

Professor Robert Shiller is again arguing for GDP-linked bonds. These bonds would be based on 1/1,000,000,000,000th of a country’s Gross Domestic Product. The shorter name is “Trill” for one-trillionth.

Shiller argues that we can solve the debt crisis by replacing treasury bills with Trills. The first mistake is that a debt problem is caused by…well, too much debt. A Trill is simply a different debt instrument. Changing the instrument of debt doesn’t change the existence of debt.

The other problem with Trills is that they don’t make any sense for the issuer. When Shiller first wrote about this two years ago, David Merkel noted that the rational price for a Trill is infinite, and Felix Salmon repeats this again today. Lots of people are confused on this point, but David and Felix are exactly right.

Of course, no one is going to pay an infinite price. Instead, when a rational price is infinite, it means that it’s not rational to issue a Trill to begin with.

Think of it this way: You’re in business and you want a loan. Let’s say that the loan is at 5%. This means that both you and the lender believe that you can get a return-on-equity of at least 5% with that money. If you don’t think you can, there’s no need for you to borrow it, and there’s no incentive for the loaner to lend it. With a Trill, it’s impossible for the borrower to ever exceed the interest payments. It’s a never-ending cycle. It would be as if you, the business person, had instead earned a 12% return-on-equity on the lender’s money. So now you owe 12% to the lender. What’s the point?

Here’s a comment I had left at David’s site on one of his Trill posts:

A few quick points.

There’s no way to pay off a Trill except by running a budget surplus or by issuing conventional debt, thus negating the need for Trills.

There might also be a slight risk premium due to the uncertainty of each coupon payment. It might be small but even a small amount comes of out taxpayers’ wallets.

The Q3 GDP for 1983 has been revised 10 times since it first came out. The last time was in 2009. Imagine the headache for Trills.

I keep coming back to your point that Trills would be worth an infinite amount. I think that’s exactly right. For the borrower, Trills are irrational. The US Treasury can get the exact same thing for less.

Posted by on February 22nd, 2012 at 7:58 pm


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