Asymmetrical Information

The only way that this would work would be for lenders to insist that this is the ONLY way that they'll lend to Argentina. Since we are unlikely to find that kind of market discipline, the idea will remain in the realm of neat theories.

Of course, you have to trust the government of Argentina to accurately report its GDP -- and you have to imagine that giving money to third-world countries actually *improves* their GDP.

Hi -

Uh, interest rates are the discounted cost of future money.

They have everything to do with inflation and exchange rates and **nothing** to do with GDP.

And this would mean that any country with really strong growth rates would automatically pay higher interest rates? And those countries with virtually no growth rates due to structural problems and political incompetence - say, Germany - would benefit from low prices for money?

What is the man smoking? I really want to know, so that I can give some of that stuff to my competitors to make them come up with something as dumb as that...

John

Real interest rates corresponds pretty well with real GDP growth rates over time. Nominal interest rates have a lot to do with inflation, and something to do with GDP.

The idea is quite neat, however. But the creditors would be more like equity-owners when their rate of return corresponds with the value creation.

It would maybe be better to link the interest rates of the bonds with the presidents salary.

People make investments with the rate of return tied to the success of a business all the time. These are called "stocks". Of course, stockholders get to vote for corporate management once a year. Somehow I don't see the Argentina government giving NY bankers the power to vote them out of office - no matter how good that might be for all the other Argentinians.

It's an interesting article:

If personal pension accounts or provident funds are invested in GDP-linked bonds, the payments that retirees receive in 25 years will reflect the growth rate of the economy -- and that of the tax base -- to that date, which all makes good sense. Sweden's pension system recently created a link between national income growth and benefits, but the reforms did not include creating GDP-linked bonds, a natural adjunct to such a scheme.

Basically that hits a lot of my arguments on social security. But anyway, several misunderstandings here:

1. Schiller is proposing that a gov't issue a bond whose dividend payments are linked to GDP growth. This is not the 'rate' that the gov't will be borrowing at. The bonds are placed up for bid and the market determines their price. The price will determine what interest rate the gov't carries & it will change as the bond price moves up and down.

2. Jane forgets one of the easier formulas for nominal GDP. GDP=M*V=P*Q or basically money supply times velocity equals price times quantity of things produced. If Argentina tried to print its way out of debt and increased its money supply by 10% nominal GDP would increase by 10% and so would the coupon payment on the bond. Kind of sneaky IMO, an investor is protected from inflation even though he is receiving payments in the local currency.

3. Like audited financial statements, GDP figures could be certified by some respected agency. The discount that these bonds sell for represent the nation's cost of borrowing. Anything a gov't did that improved the reliability of its GDP numbers would result in the market lowering its 'Enron risk' premium. Also government today has an inventive to present inflated GDP figures. This would actually serve as a counter-incentive since inflating your GDP would inflate your dividend payments.

4. I don't see why a non-governmental agency couldn't try such a bond. For example, take Wal-Mart. They could issue bonds that pay dividends based on GDP growth in the US. Investors that think Wal-Mart will do better than the US economy as a whole will buy its stock. Those that think the US economy will do better will buy its bonds (assuming they feel safe Wal-Mart will do well enough to service their debt). Either way Wal-Mart wins because it can now raise capital from Wal-Mart skeptics as well as Wal-Mart supporters.

"These are called "stocks". Of course, stockholders get to vote for corporate management once a year"

Which is an overrated feature of owning shares in a large company...only the right to a portion of a company's liquidated assets net of liabilities ranks lower. Many types of preferred shares do not even carry voting rights!

If investors don't like management they will sell shares before voting management out. Even Disney, whose shareholders revolted in mass against Eisner, couldn't oust him (granted winning by such a small margin cost him prestige and accelerated his retirement anyway).

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Boonton: If too many shareholders dump their stocks, causing a severe drop in the price, management gets fired - either initiated from inside the company, or after a hostile takeover.

This idea puzzles me. Let's take it down to a scale I might be able to get ahold of. Should the interest rate charged on student loans for people who studied medicine be higher than for people who majored in art history? Wouldn't that mean that doctors would be subsidizing art history majors? Why is that a good thing?

True markm but my point is you don't need voting power to pull that off. Basically companies want a stock market not to hold a poll on the quality of their management but as a way to raise capital. If the market bids up share prices the company can sell fewer shares of itself and raise more money. Simply selling shares of a poorly run company can be punishment enough since it raises the cost of capital.

This idea puzzles me. Let's take it down to a scale I might be able to get ahold of. Should the interest rate charged on student loans for people who studied medicine be higher than for people who majored in art history? Wouldn't that mean that doctors would be subsidizing art history majors? Why is that a good thing?

This proposal wouldn't charge different interest rates. The interest rate depends on the bonds discount, not the 'notational' interst. Suppose a bond is $100 principal and pays dividends based on GDP growth. If GDP growth is 3% and the bond costs $100 then indeed the interest paid is 3% or $3. But suppose interest rates are really more than 3%. In that case the bond will not sell at $100. It might sell at $90 which means the government that issues the bond will have to pay back $100 plus $3 for the GDP growth. The return to the investor would actually be 14.44% ($10 appreciation upon paying off the bond, $3 interest due to GDP growth).

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