The 'risk-free' asset

People accumulate wealth with their surplus income (save) during their productive years, so that they can convert that wealth into income (dis-save) when they are aged and can no longer work. This allows a person to live in comfort and safety.

The form of this wealth should be of such quality that it has a better than reasonable chance of meeting the time / space dichotomy. That is: wealth should be held in a form that retains its capability to convert into income over time; and wealth should be held in a form that retains its capability to convert into income over space.

If we are to define the ‘risk-free’ asset as that asset which provides the ability to convert wealth into income at a guaranteed rate over time / space, it is clear that no such asset exists. The bid / offer prices for goods & services change every day, and over different regions, depending on the utility of the marginal sellers and the marginal buyers. There is no asset which you can now purchase for income that can be guaranteed when sold over time / space to provide exactly the same or a higher income.

The asset that is the closest to providing the same or a higher income when sold over time / space is the most marketable good. The most marketable good has near constant marginal utility. A feature of the most marketable good is that it retains near constant marginal utility over time / space. Therefore the closest we can go to a ‘risk-free’ asset is the most marketable good, which is gold coin. Second to the gold coin in marketability is the silver coin. The real bill and then the gold bond (with sinking fund) would be other assets which approximate the ‘risk-free’ asset.

Through the lens of time / space it becomes clear that a local nominal government bond is far from the ‘risk-free’ asset. It is, however, the asset that most people in financial circles commonly refer to as the ‘risk-free’ asset. The so called ‘risk-free’ nature of local nominal government bonds reflects a general perception that the government will always be able to meet its payment obligations due to both its ‘unlimited taxing authority’ on the populous and its control of the fiat payment media through its central bank. It should be noted, however, that the payment media is local and therefore may not be able to be used through space, and that it is nominal and therefore may not be able to be used through time. A local nominal government bond falls a long way short of satisfying the time / space dichotomy required of the ‘risk-free’ asset.

Some may argue that inflation-indexed government bonds, where the nominal bond payments are indexed to inflation, is a ‘risk-free’ asset. The nominal bond payments rise with changes in an index, such as the consumer price index, which is an approximation for changes in purchasing power of the fiat payment media. Seductively this seems to satisfy our criteria of time. It also potentially satisfies our criteria of space as the inflation index is likely to reflect changes in the costs of goods acquired from a wide range of locations.

We don’t, however, subscribe to the view that an inflation-index government bond is a ‘risk-free’ asset. Firstly, inflation is an ill-defined term, the measure of which is therefore also ill-defined. The ‘basket of goods’ in the consumer price index may not correlate closely to your own purchasing habits. Also, it is not possible to quantify some components, such as changes in the quality of a product. Secondly, the payment media is compromised. The fiat payment media is effectively a cheque-kiting scheme between the Treasury and the Central Bank. The Central Bank holds the Treasury’s securities as assets and holds its own issued payment media as a liability, but the Treasury’s securities are payable in the Central Bank’s payment media. If the Central Bank were to buy back the Treasury securities held by the public (i.e. ‘Quantitative Easing’), then the Treasury securities are eliminated on consolidation, but the fiat payment media raised and then spent by the government is in circulation! Effectively the Treasury would be printing money to pay for its deficit spending. In Australia, the central bank hasn't undertaken a 'QE' program. The central bank has, however, supported the commercial banks to create fiat payment media through the act of borrowing short and lending long. If the public were to wake up to this ruse, then the marketability of that fiat payment media may well collapse, and it will not matter that the payments received on a government bond are ‘inflation-indexed’.

In summary, we don’t believe there is a ‘risk-free’ asset. We believe the closest to a ‘risk-free’ asset is the gold coin, followed by the silver coin, gold bills of exchange, and then gold bonds with sinking funds. Most importantly, we believe a local nominal government bond is not a ‘risk-free’ asset.