The Treasury is making a song and dance about its decision to repay bonds issued to finance World War I. But is it really such good news? Simon Wilson reports.
What’s happened?
A hundred years on from the outbreak of World War I, Chancellor George Osborne has announced that the UK is to repay some of the debt raised to help finance the conflict. The war debt that the Treasury is ‘retiring’ (or ‘calling’) on 1 February 2015 is £218m of undated perpetual bonds paying 4% a year, known as the 4% Consolidated Loan (or ‘Consols’).
Undated bonds are ones that the government never has to repay if it doesn’t want to, and this is the first time in 67 years that the UK has chosen to do so. The original National War Bonds were sold in 1917 as part of the effort to finance the ongoing war effort.
The Treasury’s slogan at the time was “if you cannot fight, invest all you can in 5% bonds. Unlike the soldier, the investor runs no risk.” As it turned out, that wasn’t true: in 1932 the coupon (the fixed yield on the gilt) was ‘voluntarily’ reduced from 5% to 3.5%.
Why ‘consolidated’?
In 1927, Winston Churchill was making a mess of his time as chancellor. He had insisted on returning to the gold standard at the pre-war rate, and as a result the British economy – and fiscal position – were looking flaky.
The Treasury looked like it would struggle to repay some maturing war bonds, so instead they were rolled up into a 4% Consolidated Bond – an undated gilt that at the same time refinanced some colourful historic debts, including an 1853 bond issued by Gladstone to consolidate (among other things) the capital stock of the South Sea Company, which had so infamously collapsed in 1720.
As Osborne tweeted, tongue-in-cheek: “We’ll redeem £218m of 4% Consols, including debts incurred because of the South Sea Bubble. Another financial crisis we’re clearing up after …”
Can Osborne really take some credit here?
Not especially. The Treasury’s press release implies that retiring this gilt is an astonishing achievement. “We are only able to take this action today thanks to the difficult decisions that this government has taken to get a grip on the public finances,” reads the statement. “The fact that we will no longer have to pay the high rate of interest on these gilts means that today’s decision represents great value for the taxpayer.”
That’s pretty cheeky, given that under the current government the UK has seen much less improvement in its deficit as a percentage of GDP than its big economic peers – and given that the Consols have in fact been quite a boon for HM Treasury over the years.
Not a good investment, then?
No – a terrible one. According to figures calculated for the FT by James Mackintosh, the average rate of price inflation since 1927 has been 4.77% – far in excess of the 4% coupon.
In other words, investors who lent Churchill the original £218m in 1927 have lost money in real terms – and not just a bit of it. In real terms, HM Treasury sold its Consols for £100 each, and is buying them back for (the equivalent of) £1.82 each.
To emphasise the apparent boost to today’s taxpayer, the Treasury last week trumpeted its calculation that “the nation has paid £1.26bn in total interest on these bonds since 1927”. In reality, however, the ‘nation’ has had by far the better side of the bargain and buy-and-hold investors have seen their capital all but disappear.
So why pay it back now?
Because in today’s environment of ultra-low interest rates and strong demand for the relative safety of sovereign debt, the Treasury calculates it can save a bit of money over the long-term by refinancing the 4% Consols now at a lower interest rate (even though, in theory, the Consols never have to be repaid).
In addition, the Consols are currently priced above par (their original nominal value of £100) due to the current strong demand for long-dated gilts. That means the Treasury can buy them back now for less than they are worth in the market, thus making an extra one-off saving.
Will Osborne now pay off the rest of the War Loan?
Perhaps, though there’s a less compelling case for doing so. Currently, the UK’s longest-dated 54-year gilts yield just 2.96% (the price at which the Treasury sold £4bn of debt last week). The last time the government paid so little to borrow was in August 1937, 34 years before George Osborne was born. So there is clearly a case for refinancing the whole of the 3.5% War Loan (around £2bn).
Indeed, the government has said it is thinking about it – “looking into the practicalities and value for money of repaying this debt in full”. On the other hand, calling the War Loan when it trades below par value (currently it trades at £91.70, a yield of 3.8%) is a much less clear-cut question.
Hold the Champagne
According to the Treasury, the war debt can be paid off now thanks to confidence in the UK’s fiscal and macroeconomic policies, and the low interest rates that are supposedly the result.
But as M&G fund manager Jim Leaviss pointed out on the Bondvigilantes.com blog this week, some of the lowest bond yields in the world are in Japan (40-year bonds at 1.77%) – one of the rich world’s most fiscally irresponsible countries. In other words, ultra-low government bond yields may say less about fiscal discipline than they do about fears of ultra-low growth rates.
“If anything, you could argue that rather than something to celebrate, low bond yields – and the redemption of the War Loans – are a worrying signal, since they suggest very low economic growth potential.”