Safest long-term investment

An inflation-linked bond will therefore be the safest investment option for a long-term investor looking to limit the uncertainty associated with the future real value of his capital. 

The market for inflation-linked bonds 

The market capitalisation of inflation-linked bonds is less than 10 percent of the market for government bonds and is dominated by the UK and the US. Linkers issued by authorities in these two countries make up almost 60 percent of the world market.

The authorities in a number of countries with a considerable economic output, including China, India and Russia, have not issued inflation-linked bonds. The same is the case in many smaller countries, and large developed markets in the benchmark index such as Japan and Germany have only small and relatively illiquid markets for inflation-linked bonds (see appendix).

In some markets, tax and regulatory conditions may affect the structural demand for, and therefore the supply of, inflation-linked bonds.

In a situation where there is a growing probability of deflation, inflation-linked bonds could have markedly different characteristics in different countries, as the underlying rules vary. Linkers are not identical across markets and are therefore difficult to view as a global asset class.

The combination of a long investment horizon, no short-term liquidity needs and a patient owner generally make the fund well-suited to bearing different types of systematic risk.

 Experience from the financial crisis in 2008 showed, however, that in periods of financial instability we cannot count on the same level of liquidity in the market for inflation-linked bonds. Tradability in these situations is lower, and we therefore bear a higher liquidity risk than for investments in nominal government bonds. 

 Linkers may, however, have a role in the operational management of the fund when it is possible to secure an attractive real return and inflation expectations are considered moderate.

Inflation

Inflation

Inflation is always and everywhere a monetary phenomenon – per Milton Friedman.

Inflation – being the economic process which erodes only the real value of money and other monetary items (not inflation simply meaning any price increase) – is a sustained rise in the general price level of goods and services inside a national economy or monetary union measured over a period of time. Prices and the values of all economic items are normally expressed in terms of unstable money (the unstable monetary unit of account).

The unstable monetary unit of measure is fixed in nominal value but unstable in real value during inflation, deflation and hyperinflation because it is currently impossible to inflation–adjust the nominal values of physical bank notes and coins.

All non–cash monetary items can be inflation–indexed or deflation–indexed on a daily basis during inflation and deflation. The entire money supply excluding actual bank notes and coins can be inflation–adjusted on a daily basis in terms of a Daily Consumer Price Index or a monetized daily indexed unit of account during inflation. Chile has been inflation–adjusting a portion of the country´s money supply since 1967 by means of the Unidad de Fomento which is now a monetized daily indexed unit of account. According to the Banco Central de Chile 20 to 25% of the broad M3 money supply in Chile is inflation–indexed on a daily basis in terms of the Unidad de Fomento.

Nicolaas Smith Copyright (c) 2005-2011 Nicolaas J Smith. All rights reserved. No reproduction without permission.

Inflation

Inflation

Inflation is always and everywhere a monetary phenomenon – per Milton Friedman.

Inflation – being the economic process which erodes only the real value of money and other monetary items (not inflation simply meaning any price increase) – is a sustained rise in the general price level of goods and services inside a national economy or monetary union measured over a period of time. Prices and the values of all economic items are normally expressed in terms of unstable money (the unstable monetary unit of account).

The unstable monetary unit of measure is fixed in nominal value but unstable in real value during inflation, deflation and hyperinflation because it is currently impossible to inflation–adjust the nominal values of physical bank notes and coins.

All non–cash monetary items can be inflation–indexed or deflation–indexed on a daily basis during inflation and deflation. The entire money supply excluding actual bank notes and coins can be inflation–adjusted on a daily basis in terms of a Daily Consumer Price Index or a monetized daily indexed unit of account during inflation. Chile has been inflation–adjusting a portion of the country´s money supply since 1967 by means of the Unidad de Fomento which is now a monetized daily indexed unit of account. According to the Banco Central de Chile 20 to 25% of the broad M3 money supply in Chile is inflation–indexed on a daily basis in terms of the Unidad de Fomento.


Nicolaas Smith

Copyright (c) 2005-2011 Nicolaas J Smith. All rights reserved. No reproduction without permission.

Inflation

Inflation is always and everywhere a monetary phenomenon: Milton Friedman.

Inflation is a sustained rise in the general price level of goods and services inside a national economy or monetary union (e.g. the European Monetary Union) over a period of time. Prices are normally expressed in terms of unstable money (the unstable functional currency) which results in the unit of measure or unit of account being an unstable measuring unit in an economy or monetary union. Inflation always and everywhere erodes the real value of the depreciating functional currency (money) and other depreciating monetary items over time. Inflation has no effect on the real value of non-monetary items. Disinflation is a decrease in the rate of increase of the general price level; i.e. disinflation is lower inflation. Inflation still erodes the real value of depreciating money and other depreciating monetary items during disinflation - just at a slower rate than before.

Deflation is a sustained absolute decrease in the general price level. Deflation creates real value in appreciating money and other appreciating monetary items over time, recently mainly seen in the Japanese economy.

Inflation reared its ugly head soon after the invention of unstable money. It only eroded the real value of depreciating money and other depreciating monetary items at that time as it does today. Inflation did not and can not erode the real value of non-monetary items – either variable or constant real value non-monetary items.

Nicolaas Smith

Copyright (c) 2005 - 2011 Nicolaas J Smith. All rights reserved. No reproduction without permission.

Fin24 18-3-11