Today’s subject is real return bonds. Because I’d like you to keep reading, let’s start with a story of how clever financiers in Amsterdam helped build Holland strong in the late 16th and early 17th centuries.

Holland had none of the natural advantages of the other powers of Europe. No large coal deposits. No huge forests. No Paris. No vast tracts of land. No colonies laden with silver and gold to exploit.

The Dutch advantage was its comfort with paper wealth. The country’s tiny geography meant the only path to growth was through international trade, and creating a trading network based on trust was more efficient than constantly transacting in heavy coins. “The Dutch had an idea,” economist David McWilliams wrote in Money: A Story of Humanity. “Mass commercial participation underpinned by an agile financial system that got the most out of money.”

The Dutch East India Company, created in 1602, was the first to issue public shares. A monopoly over trade—exploitation might be a better word—in the colonies soon followed. This introduced the Amsterdam merchant class to the benefits of pooling risk. Amsterdam’s financiers began experimenting with other ways that paper could be used to amplify commerce. One innovation was the perpetual bond, a contract under which the issuer agrees to make interest payments in perpetuity. In return, the issuer is relieved of ever having to pay the principal. It was an expression of trust and optimism that is unimaginable today, especially in a country like Canada that by convention insists on resetting mortgage terms every five years. 

Holland’s against-all-odds rise to the status of economic power brings us back to real return bonds, or RRBs, which pay an inflation-adjusted principal at maturity rather than a nominal one. Like perpetual bonds, they signal confidence: the issuer believes so strongly in its ability to run a stable, low-inflation economy that it’s literally willing to put money on it. Most big economies use them.

Most, but not all.

Canada issued its first inflation-protected bonds in 1991, a moment when the government wanted to show the world that it was serious about getting its financial house in order after the inflation shock of the 1970s lingered through the following decade in the form of elevated price expectations, inflated deficits and a growing pile of debt. The federal government assigned the Bank of Canada an inflation target the same year. It was the start of a long period of relative economic strength and stability. 

Former finance minister Chrystia Freeland abruptly ended the RRB program in 2022. To this day, Bay Street doesn’t know why. Freeland’s Finance Department insisted demand for the product had diminished to the point that there was no point continuing. The investors who bought and sold the securities said that was news to them. The passage of time has brought little clarity. “I don’t know,” said Michael Wissell, chief investment officer at Healthcare of Ontario Pension Plan (HOOPP), one of the Maple 8 asset managers, when I asked him recently why the RRB program had been killed. “It’s not clear to us how reducing the differentiated demand you created by having two different sorts of securities is helpful, especially now.”

By “differentiated demand,” Wissell means optionality, or maneuverability. That’s how investment managers avoid getting backed into corners, which surely is something they are thinking about at the Finance Department. The November budget anticipated market debt of $1.8 trillion by 2027, a 40 per cent increase from the fiscal year that ended March 31, 2023. Mismanagement will be that much more costly. 

Inflation-linked bonds are riskier for the issuer because you end up paying more if the consumer price index spikes. But narrowing your range of options is also risky because cheaper debt gets expensive if you issue too much of it. Last week, two-year rates jumped after Bank of Canada governor Tiff Macklem said he couldn’t rule out multiple interest rate increases if the Iran war drags on. This week, the government of Canada auctioned $5.5 billion of two-year debt with a coupon of 2.75 per cent; the average yield it will pay on that debt is 2.95 per cent because that’s what bidders demanded to accept the risk. 

“Having a whole other range of demand for paper you’re issuing makes sense when you are issuing more of it,” said Wissell. 

There are other reasons to revive the RRB program. An active market for inflation-linked assets is an excellent weather vane for gauging inflation expectations. Also, a country that sees itself as a global financial centre should offer a full menu of financial products. Offering the world a way to hedge against inflation would bring investors to Toronto and Montreal, which fell to 29th and 34th, respectively, on London-based research group Z/Yen’s latest Global Financial Centres index.

But maybe the best reason for Prime Minister Mark Carney to bring back RRBs is to secure the help of the Maple 8 in his building project. The pension funds must protect their ability to send out retirement cheques. They do that by hedging their riskier bets with super safe ones. Inflation-protected sovereign debt is about as safe as it gets. Wissell said such assets make up half of his $105-billion portfolio of bonds, a growing number of which are issued by the U.S. Treasury Department because he can no longer get Canadian ones. “I need these securities as part of my risk mitigation,” Wissell said. “We would pivot right back to Canada, were we given that opportunity. I’m certainly not alone in that, I’m certain.”

I don’t know why a government that wants to create the equivalent of a wartime economy wouldn’t take advantage of Wissell’s offer. If they don’t, HOOPP and the other big funds will have little choice but to keep on funding the enemy. 

Kevin Carmichael is The Logic’s economics columnist and editor-at-large. He has spent more than two decades covering economics, business and finance for outlets including Bloomberg News, The Globe and Mail and the Financial Post, where he also served as editor-in-chief.