The facts show that, rather than increasing share prices, unanticipated inflation has tended to depress them. They also show that what shareholders have lost has not been diverted to other factors of production. How is this possible?

J.B. Williams’ Law of the Conservation of Value—a fundamental theorem of finance—states that the value of a cake is unaffected by the way one slices it. A company cannot make its shareholders wealthier just by splitting its stock, nor by shifting the relative emphasis between shareholders and debtholders in its capital structure. The only way to increase their wealth is to make the whole cake bigger.

If the Law of the Conservation of Value holds true for companies, it should also hold true for governments: The total value of claims against a government’s assets should be unaffected by the way those claims are packaged. Since a change in a government’s financing will not alter the riskiness of its underlying assets, in real terms their riskiness must be reflected in the riskiness of its bonds. The risk doesn’t disappear merely because the bonds are default-free. If government finances risky real assets with bonds whose value is certain in nominal terms, the rate of inflation must vary to take up any slack between the nominal return on the bonds and the real return on the assets.

It makes no sense to estimate the value of government bonds by predicting inflation rates. The real value of government bonds depends on the real value of government assets; the inflation rate is simply the mechanism through which this dependence works itself out.