THE fantasy that the unprecedented binge in both consumer and state credit has been successfully dealt with has been rudely punctured in recent months.

This began in November, when an entity in Dubai that investors had assumed was state guaranteed asked to defer interest payments.

The resulting ripples encouraged the rich neighbouring Emirate of Abu Dhabi to bail it out.

Concerns about the resolve of the UK government to address its deficit became aggravated after the Pre-Budget Report, leading to a rise in gilt yields, reviving concerns that the UK may lose its AAA credit rating.

More recently, the spotlight has fallen on Greece, where debt and competitiveness trends are in conflict with the Spartan straitjacket imposed by the country’s membership of the eurozone.

In the light of all this, investors are becoming unsettled by concerns that the economic fabric is too frail to sustain the recovery that the markets have priced into shares.

If government bonds are meant to represent the risk-free return, then doubts over their security could undermine the valuation of other assets, so it is worth pausing to consider whether government bonds do represent a risk-free return and whether the concerns about them are overdone.

Those who remember the period of high inflation in the 1970s know that being repaid the promised “face-value” number of pounds after prices have doubled is not risk-free.

As a result of the inflation- adjusted losses inflicted on savers, “real” bond yields were high for much of the 1980s and 1990s, even as inflation rates declined. The return from gilts yielding 8.6% in January 1995 (a year when inflation was under 4%) was considerably better than from the 15% yields in January, 1975 (a year when inflation was over 20%). In recent years, the “real” yield on bonds (over and above inflation) has declined below 1%, as governments have reflated and investors have increasingly taken for granted subdued levels of inflation.

Gilt yields of 4% leave little margin over the Bank of England’s inflation target after tax. One wag in 2009 described government bonds as offering “return-free risk” rather than the reverse.

You do not have to believe in hyperinflation to view the status of government bonds askance. A minor pick-up in inflation would be sufficient to erode the value of capital invested, much as it was devalued in the 30 years after 1945, when bond yields were similarly depressed. Nor do you have to fear widespread defaults – debt levels have been higher in the past and governments are able to correct imbalances over longer periods than private individuals.

However, the low current yields on gilts, allied to the temptation to condone higher inflation, suggest that investors need to protect their savings against the risks in “risk-free” investments by diversifying across a range of real assets. These appear to offer better prospects of preserving the real value of capital, though, of course, a safety buffer in cash and bonds protects against insomnia in the short term.