Fears of a “debt contagion” spreading from Greece to other debt-addicted countries in Europe and beyond are roiling stock markets and wreaking havoc with global currencies. The situation has underscored how governments have become over-reliant on debt in order to finance runaway public spending. But cash-strapped governments in Europe and elsewhere do have another option: They could issue equity.
Here’s how it would work: Much like the way corporations raise funds by issuing equity, governments could raise money by issuing a bond tied to the level of that country’s gross domestic product. The idea for this novel debt instrument was first proposed by Yale economics professor Robert Shiller
In a recent C.D. Howe Institute policy paper, Prof. Shiller and I suggest that the Canadian government issue a new bond we call the “trill” for short because it would pay each holder one trillionth the annual GDP of Canada in perpetuity. Currently, such a bond would pay out approximately $1.50 per year. We estimate that the trill would be priced over $60, perhaps as high as $150 depending on investor appetite. A $10,000 investment in a trill priced at around $60 would give investors an annual return of approximately $250
There is clearly a place for trills in the menu of debt issued by Canada and other countries. As we’ve seen during the past few weeks, the excessive buildup of government debt can trigger deep spending cuts or even tax hikes at a time when countries can least afford them – for example, during a severe and protracted recession. In contrast to debt currently issued by many governments, payouts from a GDP bond, or trill, would actually decline during a recession due to the corresponding decline in GDP. Much as corporations avoid liquidity crunches (and bankruptcy) by limiting their fixed debt obligations, governments could likewise diversify their debt obligations and avoid the sort of financing crises that have more recently thrown markets into turmoil.
And although our government could conceivably fund day-to-day operations with trills, the best use of trills for Canada might be to fund currently unfunded obligations such as employee future benefits, valued in the tens of billions both here as well as in most developed economies. A precedent for such an initiative would be the Canadian government’s move in 2000 to fund future employee pensions by issuing additional debt and building a dedicated pension fund. Establishing investment funds to cover unfunded liabilities is arguably desirable in its own right, and would permit the federal government to issue large amounts of trills without affecting its net indebtedness.
Perhaps the sharpest lesson to emerge from the recent financial crisis is that counterparty risk cannot be ignored, and diversifying over publicly available investments provides little cover against an economy-wide panic. The trill would be a valuable addition to most any portfolio for the diversification and protection it would provide. Such a low-cost security would diversify a government’s obligation, allow investors to diversify their investments, and serve as an innovative financial instrument that actually stabilizes rather than upturns the economy – in short, a classic win-win-win scenario.
If Canada were to make a product like the trill available, I would anticipate a very healthy appetite for these bonds from ma-and-pa investors as well as pension funds seeking safe harbour from the market turbulence of the past few years. Returns to a trill would grow with the economy, providing inflation-protected cash flows that allow individuals planning for retirement to enjoy the benefits of real economic growth in the Canadian economy.
Mark Kamstra is an associate professor of finance at the Schulich School of Business in Toronto and Visiting Scholar at Stanford University.
