Not So Cheap Trills

by: David Merkel, CFA

What would you pay for a bond that offered to pay you $1/year, but would increase its payment by 3.4% each year? Assume that bonds that offer no increase in payment, but offer $1/year currently yield 4.4%, for a price of $22.73. Assuming there is no doubt about the creditworthiness of the issuer, one should be willing to pay $94.48 for the bond increasing its payment at 3.4% per year, accepting an initial current yield of 1.06%.

That is part of the idea behind bonds that Dr. Schiller is proposing. These bonds, called trills, would:

  • Pay one trillionth of GDP as interest each year.
  • Would be full faith and credit bonds of the US Government.
  • Would be consols — perpetual bonds that never pay the principal back.

The key here is how fast GDP grows in nominal terms. TIPS increase at the rate of the CPI-U. If there is growth over the inflation rate, a trill would be more valuable than TIPS, and at equivalent interest rates, people would pay more for trills.

My interest rate models indicate that if the US were to issue a consol, a perpetual bond, it would have a yield near 4.4%. Here’s the question: what do you think nominal GDP growth will be on average forever? If it is above 4.4%, one should be willing to pay an infinite amount to buy it. At lower rates of nominal GDP growth, the security will have a finite value that declines rapidly with lower nominal GDP growth.

Trills would be volatile securities. The prices would fall hard during periods where long term interest rates are rising, but where GDP is not expected to be growing as rapidly. Conversely, they would rise rapidly when long term interest rates are falling, but where GDP is not expected to be shrinking as rapidly.

I would not want the US Government to issue trills. Why? They suck a lot of money in, and do not consider what it will do to the government in future years. I can say with confidence that a large issuance of trills would lead to the demise of the US Government. There is no way that the government could keep up with the payments, because most finance today relies on the idea that the economy can grow out of the debt burden. With trills, that is not possible.

Trills sound like a nifty idea, and to indebted governments, they offer very cheap finance in the short run, but the eventual end is the insolvency of the government that cant keep up with the increase in interest payments.

Governments want to keep the option of inflating away their debts if they can. Don’t tell governments in the EU about this though. They sold that option too cheaply.

In summary, trills are a bad idea. They are just another way for the government to suck in a lot of money in the short run, while paying out far more forever.

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