Monday, December 29, 2014

Generational Debt: That Debt From 1720? Britain’s Payment Is Coming

Article on how bailout debts taken out by Governments can last many centuries. To me another take home message was that these debts become small change with time because of inflation.

LONDON — Share prices went through the roof, speculation ran wild and money poured into ill-fated ventures before the boom turned, inevitably and catastrophically, to bust.

After that financial crash in 1720, called the South Sea Bubble, the British government was forced to undertake a bailout that eventually left several million pounds of debt on its books. Almost three centuries later, Britons are still paying interest on a small part of that obligation.

Now, prompted by record low interest rates, the British government is planning to pay off some of the debts it racked up over hundreds of years, dating as far back as the South Sea Bubble.
George Osborne, the chancellor of the Exchequer, said this month that in 2015 Britain would repay part of the country’s debt from World War I, and that he wanted to pay off other bonds for debt incurred in the 18th and 19th centuries.

That includes borrowing that may have been used to compensate slave owners when slavery was abolished, to relieve the famine in 19th-century Ireland and to bail out the infamous South Sea Company, which caused the bubble in 1720.

Economically, the move is no different from a homeowner’s decision to refinance a mortgage at a lower rate. In an era when the government can borrow at 1.5 percent or less, paying out to holders of historic debt anything from 2.5 to 4 percent per year, as it is now, makes little sense.
But the maneuver is also a reminder of how debts incurred by governments are passed down through generations.

In many cases, the underlying debt has already been refinanced, sometimes multiple times, since being incurred. The bonds paying interest on the debt have been bought and sold and passed down through generations, still paying interest indefinitely, until the government decides to pay them off. So old are some of the bonds that closing the books on them may require an act of Parliament in some cases.
Gary Shea, head of the school of economics and finance at the University of St. Andrews, said historic debt is “real,” even if the vast majority of public borrowing is fairly recent. “The taxpayer is still financing the interest payments on it,” he said.

One of the bonds Mr. Osborne plans to pay back next year is a 3.5 percent war loan issued in 1932 in exchange for earlier bonds. It still has more than 120,000 holders, including 38,000 who own bonds with a face value of less than £100, or about $155. In March, those who still own the bonds will get the original stake back at a cost to the government of £1.9 billion.

Also set for repayment are “4 percent consols,” or securities, issued in 1927 by Winston Churchill, then chancellor of the Exchequer, partly to refinance National War Bonds originating from World War I. Now worth £218 million, they will be repaid in February.

Reissuing bonds was a big administrative endeavor in earlier eras. In 1932, the conversion of an earlier war loan to one paying lower interest required so many temporary clerks that 700 lambs were prepared to feed them one evening, according to a history of Britain’s debt by Jeremy Wormell. Now, in the computer age, the task is relatively straightforward, officials say.

Within a total debt of around £1.4 trillion, the historic liability accounts for a small portion — about £2.5 billion, or less than two-tenths of 1 percent of the total outstanding.
But over the centuries, Britain’s borrowing has at times been huge and has come in different forms, sometimes including loans from other governments.
It was not until 2006, for example, that Britain fully repaid its lend-lease debts to the United States from World War II.

Some international loans from the aftermath of World War I were never fully paid and were effectively put aside in 1934, though Britain also failed to recoup debts it was owed by other nations.
The recent eurozone debt crisis is creating a similar legacy in countries that took bailout loans. Ireland is not scheduled to make its final repayment to international creditors until 2042. Greece is scheduled to do the same in 2054.

Britain’s current stock of open-ended historical debts does not include international loans but is made up of a variety of bonds known as gilts, a name that comes from the original British government certificates that had gilded edges.

Of course, much of the original debt has been eroded by inflation. According to research for the British Parliament, prices rose by around 118 times from 1750 to 1998.

The debt originating in part from the South Sea Bubble, the oldest still on the books, was consolidated into bonds issued in 1853, and those who now own them receive an annual payout of 2.5 percent.
According to the Bank of England, that original debt of around £4 million was probably incurred around 1722, though other sources suggested it might date from a few years later.

Experts say that some of the government bonds issued in the years after 1720 were created to replace earlier ones that had paid higher interest — a principle that Mr. Osborne is following three centuries later.

“We are now in a period,” said Mr. Shea of the University of St. Andrews, “in which interest rates are even lower than they were in the 18th century.”


Sunday, December 28, 2014

Prostitution and Illegal Drugs give UK GDP a boost.

Britain becomes a bigger economy than France with the inclusion of Prostitution and Illegal drugs for GDP calculation. Official estimates show prostitution added about £5.7bn to the UK economy in 2013, while illegal drugs were worth about £6.62bn.
  • Britain spends more on illegal drugs than it does on Beer or Spirits (liquor)
  • Britain spends more on illegal drugs and Prostitution than on Vegetables, Milk, or footwear
Also read how increased health care costs allowed US GDP to become 5%

Wednesday, December 3, 2014

US Debt: $18 Trillion; U.S. Debt/GDP ratio over 300%

So much for fiscal prudence in the US. 

$4.9 Trillion added by George Bush Presidency.  $8 trillion by the Obama Presidency.

Total U.S. debt has increased by 70 percent under Obama, from $10.625 trillion on January 21, 2009 to over $18.005 trillion today (Dec 2 2014)

Each household in the U.S. now carries the burden of $124,000 in national debt alone - or $56,378 per individual. This does not include the massive private debt or household debt burden - people’s  mortgages, personal loans, credit card debt, student loans, car loans and other household debt.

$200 trillion of unfunded liabilities such as medicare, medicaid and social security not included in US National Debt.

$12 trillion Household debt--including mortgages, credit cards, auto loans and student loans not included in US National Debt.

Tuesday, December 2, 2014

How Russia outmanoeuvred the west in Ukrainian finance

I think this should be essential reading for the gurus who negotiate or issue bonds for the SL govt directly or indirectly.  e.g. The Petroleum Corp, oil price hedge fiasco.

How Russia outmanoeuvred the west in Ukrainian finance by John Dizard

“F*** the EU!”
Victoria Nuland, US assistant secretary of state, commenting on Ukrainian  policy on her mobile phone, as recorded and publicly distributed by the Russian special services in February 2014.

“Treason is a matter of dates.” Attributed to Prince Charles Maurice de Talleyrand-Perigord, drawing up European borders at the Congress of Vienna, 1815

The quality of US representation in eastern Europe seems to have declined, sadly, since the days of George Kennan and George Marshall in the 1940s and 1950s. European diplomacy, though, appears to have maintained the tradition of ethical flexibility that Prince Talleyrand embodied.
Whatever your opinion of the morality of Russia’s intervention in Ukraine, or whether the Putin government’s larger strategy will have more gains than losses for the Russian state, there is no doubt the Russians have tactically outmanoeuvred the US and Europe in the financial markets. I am told the Pentagon is already studying Russia’s financial market moves in Ukraine to see how similar tactics might be used in future military crises.

The new Ukrainian government ministers, being chosen and sworn in since the new parliament first met on Thursday, have to deal with a collapsing currency, a corrupt energy pricing scheme that has helped bankrupt the state, and large imminent hard-currency payments to enterprises owned by the very state violating its borders with tanks and “volunteer” troops.

This is all pretty visible. Yet interestingly, the prices in an actively traded market in Ukraine’s internationally held foreign currency bonds do not reflect these realities. An issue due in September 2015 was priced at around 85 cents last week, for a yield of 28 per cent; another bond due in July 2017 could be bought for 80 cents, for a yield to maturity of 19 per cent. 

All of these bonds are “foreign law” issues, which means the terms cannot be altered unilaterally by the Ukrainian government using its own parliament and legal system. Until the end of next year, their interest and principal payments are, effectively, shielded by English law, Scandinavian arbitration boards and the Russian and Russian-backed forces at, and over, Ukraine’s borders.

Russian institutions have been quick learners in understanding the uses of international law bonds. The terms under which it sold gas to previous Ukrainian governments reek of corruption, but also good technical lawyering, the effectiveness of which was only slowly understood by people who should have known better, such as the US administration.

Take, for example, what the Americans now call “the booby-trap bond”, a $3bn bond issued by Ukraine to Russian holders a year ago, which is due in December 2015. It is not only enforceable under English law, but was registered on an Irish exchange. It has cross default clauses that are triggered if Ukraine misses a payment to any other entity controlled or majority owned by Russia. That includes a $1.6bn payment to Gazprom due at the end of this month. Oh, and Russia can call a default (which triggers a further default on the rest of Ukraine’s roughly $16bn bonded foreign debt) if the country’s debt to GDP ratio rises above 60 per cent – due, perhaps, to extortive Russian gas prices and a Russian-backed invasion and insurgency.

Thanks to a deep devaluation of the Ukrainian hryvnia, as well as the greater impoverishment of the population, Ukraine’s current goods and services account is probably close to balancing. However, its debt service burden is beyond the capacity of its foreign exchange reserves and forex earning capacity over the visible future. 

So the western countries can either grit their teeth and put up much of the money needed to pay off Ukraine’s maturing debts to Russia, whatever the fairness of the contracts behind them, or watch the economy collapse completely. If such a disaster happens, the US, Europe, the IMF and the other multilaterals will have to compete with Russia to offer humanitarian aid packages, which could be even more expensive.

For the next year, official western and multilateral agency funds will support payments on Ukrainian obligations such as that $500m, 6.875 per cent bond. At 85 it is arguably underpriced, since it comes due before the maturity of the Russian “booby trap bond” in December. However, by the time we get to 2017 or 2019, there could be a crushing burden of official and multilateral debt outstanding, which will claim seniority over privately held foreign bonds. At that point, a drastic outright “haircut” or “reprofiling” of maturities into eternity looks a good bet.

The only way for Ukraine to rebuild enough economic strength and earned foreign exchange to avoid the consequent legal and economic mess is to voluntarily impose effective anti-corruption measures and market-based pricing for energy and other goods that end the oligarch model of development. In turn, these reforms would need to evoke not just reductions in wasteful and corrupt use on the demand side, but new production on the supply side.

To anyone who has past experience with Ukrainian officials, this would appear to require intervention from, say, an archangel with a flaming sword. In this miserable winter, though, there may be enough popular sentiment against past practices to get the job started.

From the bondholders’ point of view, that is probably the only path to their being paid on schedule after the end of next year.