We are at war with a virus and we have been asking ourselves the question of: How the UK and indeed the global economy will ever repay money that it is borrowing? We decided to look back in history for a potential answer.
The first interest-bearing War Bond (loans to the government by investors) were issued in 1914 at an interest rate of 3.5%pa with a face value 5% discount. It raised £333 million and was repayable by the government between 1925–28 at full face value i.e. you also made 5% on the discount purchase price.
The second War Loan was in 1915, at 4.5% and a further £138 million by holders of 2.5% and 2.75% Consols (Consolidated Bonds – an open ended in perpetuity bond i.e. a guaranteed annuity income payment forever that cannot be closed or cashed in). The third War Loan was launched in 1917 at a 5% discount to face value and paying 5% interest (or 4% tax-free for 25 years), Holders of existing War Loans, Treasury Bills and War Expenditure Certificates could convert to the 5% issue. This raised £2.08 billion but most of it was from existing bond conversion and £845 million of it was new ‘war’ money;
World War II was funded by borrowing in the more traditional way of gilts and bonds, with the USA buying/lending most of it and also the ‘lend lease’ where they lent us money to lease war materials etc from them.
Put in context, UK borrowing was at 260% of GDP during the Napoleonic Wars, 180% GDP end World War I, 140% of GDP at the start of World War II, 240% of GDP by then end of World War II. Pre Covid-19 it was hovering around 80% GDP but with Covid-19, UK borrowing is widely anticipated to smash through 100% of GDP and was expected to fall to 95% of GDP next Spring. That was earlier this year but with a bigger 2nd coronavirus wave no upon us, government debt may go way above 100% of GDP with some predicting 120% to 140% of GDP.
It was only under Margaret Thatcher that it dropped to just over 20% of GDP, the lowest since before World War I. But this was no Thatcher miracle, this was government stimulated inflation. Get prices to rise meaning GDP output rises, inflation rises but in turn, it then devalues government debt.
Today, big financiers such as George Soros have already suggested that sovereign nations and central banks should return to issuing ‘Consols’ again, i.e. in perpetuity annuities similar to those used in World War 1 to finance a Covid-19 recovery. Certainly, the power then lies with government, who would no doubt issue attractive ‘in perpetuity’ interest rates compared to very low gilt, bond and interest rates at present to attract funds and to regain control of the economy and rebuild.
We suggest they could then let inflation run (to devalue the debt), lock the nation into low savings rates now, in perpetuity, that look attractive today but in 10 years they may not be after inflation and interest rate hikes and then 'call the bets in' by simply offering an incentive to move to a higher fixed term bond rate or force the closure by buying back.
When interest rates are negative, 3%pa Consols look very attractive. To quote a Labour MP back in 1917 on War Loans "No foreign conqueror could have devised a more complete robbery and enslavement of the British Nation”. We think this could be yet another ‘déjà vu’.