- It is not unusual for inflation to be 1% in a month, which represents more than a 12% annualised rate of inflation. For any developed country, 12% inflation rates are politically unacceptable. Did the government default when that happens?
- If one month of high inflation is not enough, what period of high inflation qualifies? One year? One business cycle? A decade? A "generation"?
- Why is any form of inflation acceptable? We have had a political consensus amongst mainstream political parties that 2% annual inflation was acceptable. Was this a form of embracing mass default?
- The price level is highly sensitive to the price of oil. Do bond investors believe that the government has the ability to create unlimited amounts of oil at a fixed price so as to prevent oil price spikes?
- If there is such a default due to inflation, what is the government supposed to do? Have Treasury officials make sad faces on television? Track down bond holders and give them extra payments?
For the next questions, I will assume that 2% average inflation does not constitute a "default", but if you object to the 2% level, substitute whatever level you feel is appropriate.
- Is an average of 2.01% annualised inflation over some averaging period a default? What average does the inflation rate have to be to constitute default? Why?
- Why 2%? The number was an entirely arbitrary figure that appears to have been pulled out of the nether regions of the New Zealand Reserve Bank, and other central banks just did what the cool central banks were doing.
- Why cannot policymakers change their mind what is an acceptable level of inflation? Tax rates change all of the time.
- If an average inflation rate 1% above the acceptable level represents default, what happens if the average inflation rate is 1% below that level? Are bondholders going to give back their unwarranted incomes?
- If inflation represents a default, what legal covenants have been breached? Why are sovereign CDS not triggered?
- One variation is to say that “unexpected” inflation constitutes default. The “expectations” are determined in the bond market. What if the bond market participants are completely delusional about the path of inflation? For example, if bondholders are convinced that there will be deflation, are central banks obligated to engineer a debt deflation in order to avoid “default”?
- Why is default a property that is only ascribed to government bonds? We do not live in a world where the government sets prices by government diktat. If oil refining corporations raise their selling prices and raise the price level, why are their bonds not considered to be in default?
- Where in the bond prospectus is there a statement that the government will guarantee that bond holders will be spared any losses to the real market value of their holdings during the lifetime of the bond?
- Entire economic sectors are routinely thrown under the bus as the result of the shift of economic variables. For example, manufacturers and employees in the United States were crushed by trade agreements and dollar strength in the 1990s. Why are not those other shifts considered "defaults"?
(c) Brian Romanchuk 2015