WE LIVE IN THE REAL WORLD

Businesses and Governments must finally live in the real world. To make prudent decisions REAL costs and returns require consideration of the effect of inflation. Real investment and loan decisions are best made by focusing on business logic, not upon guesses about monetary policies and the uncertainties of inflation. 

Inevitably, there are a number of variables and unknowns in any financial transaction. The best model of business decision making must flow from the most important element of a decision being fixed, not variable.  For example, to a borrower the real cost of the funds necessary to do a project is paramount to its success.  To a lender, the real return seen as necessary to prudently lend funds to a venture is paramount.  It follows that the interest rate charged should reflect real purchasing power over the term.   Only then will the results reflect the business interests of both parties.  Loans are now almost always based upon the sum of what the parties business plan requires PLUS a “best guess” of what inflation might be for the term.  This sum is the nominal interest rate now typically charged.  We propose to fix the real cost and return of a loan by deleting “best guesses” from the loan structure and using real rates of inflation when actually determined, not guessed and insured in advance with inevitable imprecision.  Only then will the transaction be prudently insulated (insured) against the vagaries of inflation.

How is this to be done in an efficient and transparent manner? 

Let us anchor our explanation to the Fisher Equation:

Fisher states that the real interest rate equals the nominal interest rate minus the EXPECTED inflation rate. We substitute actual known/published rate of inflation for advance guesswork we have precision.

RRM says that the best innovation and economic stimulation will come from nations that defend the purchasing power of their currencies by Starting in REAL and paying the equivalent number of nominal units to always deliver the agreed upon Constant Purchasing Power.

Fisher says you can beat inflation with good guesswork.

RRM states that if we  have the parties to the transaction simply agree to pay/receive a fixed/known/stable Real Rate of Return you WILL (not can) beat inflation.

Fisher opines that the nominal rate must quickly and frequently reflect the current expectation of the prospective inflation rate to keep instruments, products and lending activities to remain competitive. 

RRM states that the most effective and efficient means to increase competition, innovation and cost effectiveness is NOT to Guess what inflation with be prospectively. 

The prevailing model starts in nominal and pays in real. This has it backwards if outcomes are to meet REAL planned costs and returns. Instead, agree upon REAL and pay in the equivalent number of nominal units to equate to the agreed upon REAL outcome.

We have the detailed methodology including amortization and adjustment to calculate the equivalent current nominal over time.  

This technique enables knowledge of the value of everything, not just its price.

In our website, www.realreturnmethodologies.com, under NEWS… search for the piece titled ‘THE TAYLOR PRINCIPAL AND TOPPLE’ for background and supporting thoughts.