The Chris Cook Economics 3.0 column
There was an interesting piece of financial pornography in the Financial Times yesterday by Professor Michael Hudson, who was US Congressman Dennis Kucinich’s economic advisor during his brief Presidential candidacy last year. The until recently unprintable premise was that perhaps national debt, such as that of Iceland or Latvia, might perhaps no longer be sacrosanct.
“A pragmatic economic principle is at work: a debt that cannot be paid, will not be paid. What remains an open question is just how these debts will not be paid. Will many be written off? Or will Iceland, Latvia and other debtors be plunged into austerity in an attempt to squeeze out an economic surplus to avoid default?“
Clearly the pillars of global capitalism are crumbling, when such sedition may be found in the FT, but it does actually beg a few questions. In particular, why does a government have to repay debt at all, other than the fact that it is the convention?
Well, actually it doesn’t. There are currently eight issues of undated government “gilt-edged” debt of which the first was Consols. These came into existence in 1752 when all existing government stock was converted into one stock – “Consolidated” 3.5 percent Annuities. The rate of return was subsequently reduced to 2.5%, where it remains on the fairly trivial (these days) amount outstanding of £275m.
The other sizable chunk of undated debt is £1.9bn worth of First World War vintage War Loan which is, like all undated gilts, redeemable at any time. Presumably because of the low rates on these bonds, however, the Treasury has somehow never got around to repaying them.
These Perpetual Bonds – as they are known – are unusual, but simple in operation. If interest rates go up, they get cheaper, and if interest rates go down, they get more expensive. If long term interest rates were expected to remain below 3.5% then it is generally expected that the Treasury would redeem the War Loan.
The National Debt
Of course, there is far more public sector debt out there than just Treasury gilts, and plenty of other debt owed by quasi-state entities, PFI, and all the rest. Let’s just concentrate on gilts.
According to the Treasury’s Debt Management Office there was as of August 17th about £795 billion outstanding in gilts, the vast bulk of which have redemption dates varying from as soon as 7th December this year, to 7th December 2055. The rates of interest run as high as 9% and even 12% for those issued at times of high inflation, but with most around 4 to 5%.
In addition there are now 15 issues of gilts indexed to inflation. Most of these pay a rate of around 2.5% but as interest rates have come down, we have seen rates at 1.0% or even below. Indeed, on 27th July 2009 the Treasury issued no less than £5 billion at a rate of five eighths of one per cent (yes, 0.625%) per annum, repayable in 2042. The reason for this is the sheer scale of demand from pension funds for safe, inflation proof, investments.
So we have a gloriously fragmented bunch of different dates and repayment terms, and when buying a gilt an investor will probably sit down, put an ice-pack on his head, crank up his calculator, and work out the “net present value” of the stream of payments he can expect from that particular gilt. He may then work out what it is currently worth, bearing in mind his expectations as to inflation and so on.
In reality, most people actually employ, directly or indirectly, extremely highly paid financial experts to make these investment decisions for them.
To quote Wikipedia: (my emphasis):
“A perpetual bond, which is also known as a Perpetual or just a Perp, is a bond with no maturity date. Therefore, it may be treated as equity, not as debt.”
A National Equity
National Debts are a complete nonsense, of course: there never has been any reason for them other than the want of anything better. We may simply get rid of the repayment date by issuing a new generation of index-linked and/or conventional Perpetual Bonds and exchanging them for dated gilts in what is essentially a “debt/equity swap”.
At the moment of exchange, the index-linked or conventional income (a matter of choice for the investor) from debt will be exchanged for sufficient undated gilts to give that level of income. What changes is that – at a stroke – we get rid of the obligation to repay capital by creating what is in effect a National Equity.
It doesn’t take a Rocket Scientist to realise that this gives a one off cut in financing costs. It also consolidates all of the fragmented gilt issues into two massive pools of liquidity, so that anyone wishing to sell their investment will find it pretty easy.
Rather than fritter away all the windfall savings in financing costs on unemployment benefit, we should instead use at least some of the savings to create and issue new National Equity and use it firstly to refinance all other public or quasi public debt.
Then we may allow anyone who wishes to re-finance their homes – because they have negative or negligible equity, or simply wish to release equity – to do so through the simple but radical co-ownership approach I outlined. In this way, the income received in respect of affordable occupation of housing, pays the required reasonable index-linked return to long term investors.
Can’t Pay, Won’t Pay
Returning to Michael Hudson’s point in the FT concerning un-repayable debt, we now have a new tool in the international tool-box. Iceland, Latvia and any other nation lumbered with un-repayable debt to external investors could issue National Equity, and for as long as the dollar is the global reserve currency they could perhaps pay an index-linked dividend in dollars at an agreed rate.
If creditors insist on greedy rates of return then their risk is that the resulting dividend will be unaffordable which will depress the unit price. But the more likely it is that the dividend is affordable, then the less risky the investment, and the higher the price. The incentives we take for granted in conventional debt-based financing are turned upside down.
So, in the same miraculous way… “with a leap and a bound he was free!”…. that Bulldog Drummond used to escape from hellish tight spots, perhaps we can, too, simply by getting rid of the date on debt?