In the City
The impact of indexing
Tony Rudd
Wrhen Sir Geoffrey Howe made indexed . government stocks available to all in Ms budget speech last week he did the equivalent of putting a piranha fish into the goldfish bowl. The new debt instrument is s? Potentially attractive that it is going to be difficult for many other forms of invest- ment to survive alongside it. Unless one believes that inflation is going to fall to near Zero and stay there an investment which is automatically inflation-proof must on historical grounds be the most attractive haven for savings ever devised. The evidence of the last twenty years shows just how attractive it is. Government stocks during the last two decades were of course an appalling rip-off so far as the holders were concerned. In real terms they have only a fraction of their original pur- chasing power left. The very high rates of interest over the last few years have been some compensation, but to any holder who Pays tax this hasn't really worked either, because the net return has been far less than the annual erosion of value caused by infla- tion. Ordinary shares have been a total failure too. The FT 30-share index went over 500 some twenty years ago and it's still in the 500-600 band now; to have offered Protection against inflation it should be way UP in the 3,000-4,000 range. The exotics of the investment world, such as works of art, have been good at times but these too can he extremely unreliable havens of value. Property and housing have been about the only real hedge, and the latter has owed a lot to artificial tax arrangements which could (and indeed should) be altered. So, on the basis of past performance the infla- tion indexed government stock is a clear winner. There is literally nothing to beat it, which means that other borrowers have got to get in on the act and offer similar but competing forms of indexed investment.
To begin with, companies need now to consider the advisability of issuing indexed debt themselves. From the point of view of the corporate treasurer an indexed twenty year debenture yielding say 3 per cent has much the same attraction as a zero coupon bond. Very high nominal rates of interest offer a great disincentive to any form of capital investment because they put such a strain on a company's financial resources; particularly in the early years before return has grown. Indexed debt solves that at a stroke. Furthermore the yield which com- panies are going to have to offer in this area is substantially below that which they have to make available when they raise money by the issuing of equity. And there is a tax point here. Dividends have to be paid out of tax profits whereas interest payments are allowable as an expense out of gross revenue. The nicest thing of all, from the point of view of an investor, would be the convertible indexed debenture, meaning an indexed linked loan which at some point in the future offers a conversion into the bor- rower's equity.
Then it is inevitable too that the building societies are going to be drawn into the act;
they can't be left out as the only major bor- rower offering non-indexed instruments to the public. We can expect to see inflation- indexed building society shares before long. In other wordS, the introduction of the in- dexing principle has ushered in to the securities world a completely new factor which is going to have a knock-on effect far greater than can-be appreciated at the mo- ment. All we do know is that things are go- ing to change and that it is the beginning of the end for goldfish.
The impact on the accountancy profes- sion will be profound, A considerable amount of work will have to be done on how companies who issue indexed debt will treat the debt and its servicing in their balance sheets and profit and loss account. There could also be a substantial impact on the insurance industry. And the impact on the securities industry itself also could be considerable. Why should the trustees of small self-administered funds want to employ managers, from the City, for their funds when they can simply deal with their investment problem by buying indexed stocks? Indeed a great deal of the fund management function may come to look somewhat superfluous. After all not all that number of investment trusts have kept ahead of inflation over the last twenty years. And the same certainly goes for unit trusts.
But perhaps the greatest impact of index- ation is going to be upon government finances themselves. If we assume that eventually savers demand indexed stocks in preference to those that are not indexed, then the government is going to have to pay for everything in real money terms. This will be a great change. Since the war suc- cessive governments have nationalised great tracts of British property, which however inefficiently they have been operated have grown in value in real terms and have financed these acquisitions by issuing non- indexed paper during a period of rising and persistent inflation. People tend to think of the railways for instance as an asset nobody would want. They are wrong. The present day value of the compensation paid for all the railways in 1947 would probably not equal the site value of one of the main line termini in London today. The land value of the railways is phenomenal. The terms of the effective acquisition price, because of the impact of inflation, amount to virtual expropriation.
Of course the burden of the national debt in real terms is also a fraction of what it would be but for inflation and perhaps we should all be thankful for that. But the ability of government to issue non-indexed paper during a great inflation is the single greatest instrument of economic power ever put into the hands of the central authorities. Thank heavens Sir Geoffrey Howe has brought us to the end of that day. If this country goes back into another great inflation, successor governments will never again be able to do what their predecessors managed to pull off in the 35 years after the last war.
Previous page
