Consoling ourselves with Churchill’s debt fix

Never is so much owed by so many as after wars. And pandemics.

Governments’ debt burdens have soared over the course of the past two years. By the end of the second quarter of this year, they collectively owed a whopping $86tn, compared with $71tn at the end of 2019, according to the Institute for International Finance’s latest Debt Monitor.

Most of that additional borrowing has been done by richer countries, taking their total debt-to-GDP ratios to north of 130 per cent — from 110 per cent pre-Covid.

Regular readers may be aware that we’re not especially concerned about the size of that burden. But we’ve been interested in looking at whether policies offered in the past can provide some guidance on how to manage the fresh liabilities.

With that in mind, an idea presented in a new paper from the Adam Smith Institute piqued our interest. It’s based on a tool used by none other than Winston Churchill to refinance the first world war debt during his spell as chancellor in 1927: to issue Consols.

Consols are ultimately means to mitigate rollover risk. While they pay a coupon to the bearer, they have no fixed repayment date. The Consols issued by Britain to finance the Napoleonic Wars were, the Adam Smith Institute points out, only repaid in 2014.

The think-tank notes that Consols “should not be used for routine big-spending projects, but rather, rare and unexpected emergencies like wars and pandemics that create an immediate large need for borrowing.”

Being the Adam Smith Institute, it wants the UK Government to specifically legislate to convert existing Covid debt into ‘Covid Emergency Bonds’ based on Consols, with a commitment to repay when the economy recovers.

The paper’s here for those who want to read more.

What to make of this? We don’t usually find ourselves in agreement with the Adam Smith Institute, but there’s a lot going for this idea. At the moment, with debt markets being what they are, why not lock in ultra cheap financing costs for future generations, rather than having to roll over the debt in ten or thirty years time, when rates may be much higher?

We decided to ask Norma Cohen, formerly of the FT and currently a fellow at Queen Mary University, who has written for us twice on the relevance of the post-World War One situation to the current predicament. (See here and here.)

Here’s what Norma had to say:

The cost of debt service today, even with the massive pandemic related borrowing, is a fraction of tax revenue compared with the interwar period when the debt/GDP ratio was similar to today. In the 1923/24 fiscal year, debt service equalled 40 per cent of tax revenue. It is in low, single digits today . . . 

. But the reason I favour the issuance of Consols is that the lesson of the interwar years is that there is such a thing as ‘rollover risk’. There is another reason; longevity risk is emerging as a huge risk both to individuals and financial institutions. If government could borrow from investors, service the debt in full and on time, but avoid capital repayment following the death of investor, it could avoid rollover risk on a portion of its borrowings. This was used not only by Britain but by the Dutch and Italian city states all through the middle ages. It would be like government-issued annuities. Perhaps insurance companies would also buy them as a hedge.

Annuities from insurers are considered poor value for money now because rates are so low. But government issued annuities might be able to be more generous because governments do not have reserve requirements nor do they have marketing, advertising and sales costs.

V for Victory.

With the Bank of England set to raise rates, the sooner the government gets its act together the better. Disagree? Thoughts in the usual place.

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