George Soros recently made an interesting, and potentially controversial, call for the European Union to issue what are called perpetual bonds.
Perpetual bonds are unusual beasts, and not very commonly issued. There is very good reason for this. They do, in effect, guarantee to pay a fixed sum in interest forever, but never promise to redeem the capital locked up in the bond, although the option to do is usually retained by the issuer. It takes a lot of faith for an investor to believe that these two offerings represent value.
It is also quite challenging to understand just what that offering really represents. Their categorisation as financial instruments is, as a result, sometimes open to dispute. That is because as there is no plan to repay them they have the appearance of being equity capital i.e. they do in some ways behave like shares. On the other hand, unlike most shares, they carry a fixed right to be paid interest whether or not the entity issuing them has made a profit in the period, and whether or not its directors agree that such payment is appropriate or otherwise, which is required in the case of shares.
That confusion, and the fact that almost no one believes that any company will last forever, mean that perpetual bonds are almost unknown now in the commercial world.
They have, however, been issued by governments. The most famous, at least in the case of the United Kingdom, is the 3.5% war bond issued in 1915, which was always problematic. Although this debt was issued as a perpetual, in practice it was redeemed in 2015 at the whim of the UK government.
That bond issue was not, of course, equity. No one thought it was. It was just a bond issued at a moment of crisis that was intended to fund an exceptional circumstance when no one knew when the capacity to repay might exist. It would seem that such circumstances have to exist for perpetual to be considered.
So, why might perpetual bonds be of appeal at present? There are three very good reasons.
The first, and perhaps most obvious of these, is that current interest rates throughout most major economies are at record lows, and after adjusting for inflation usually represent negative return upon any bond that is currently issued. This, it has to be stressed, has not prevented such issues: the fact that governments alone can issue bonds that are guaranteed not to fail so long as the government in question has its own central-bank creates an appeal to the investors seeking security that very few other investments or deposit-taking mechanisms can supply. The demand for bonds is high when all else looks like it could fail. We are living in such times. That means a government that knows it is likely to borrow in perpetuity(and that is true of almost every government on earth now) can now lock into these low rates knowing that they will, because of the impact inflation, almost certainly also diminish over time.
Second, it is simply because they can. In exceptional circumstances exceptional things can be done. And when all else is impermanent a permanent bond offering can be made when usually that would not be possible.
But third, and perhaps most importantly, the change in nature of the market for government securities makes perpetual bonds a very attractive proposition for government at present. If it is known, and many governments do have this understanding, that a government will be repurchasing some or all of the bonds that they issue through a quantitative easing programme, then to have perpetual bonds in issue makes their central banking operations significantly easier to manage. This is again for three reasons.
First, this removes the need to keep rolling over bonds subject to QE as they come to redemption as is required at present. This is a process that requires significant market intervention, some cost if rates change and certainly some transaction cost, all of which can be avoided by perpetual bonds that have never to be redeemed.
Second, the cancelled interest (because interest is not paid on QE bonds, since it would merely be the government paying itself) is conveniently small forever, and so can never be claimed to be distortionary.
And third, this is in effect monetisation by any other name without actually having to say that it is: after all, there is absolutely no pressure to return these bonds to the market, or to have to return to the market to replace them, and that means such bonds can be used as cover to create money in perpetuity. That is as close to an equity issue of financial instruments as any government can get.
So, when what is required right now is equity to rebuild out economy perpetuals make sense. But within reason. Equity, and anything that looks like it, should be used for investment. And that means that perpetuals can be used to fund the recovery and rebuilding from this crisis by delivering a Green New Deal.
George Soros seems to think that. So do I. The question of the day is, then, should we be issuing perpetual bonds to fund the Green New Deal?
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“Perpetual bonds ….. ….. in effect, guarantee to pay a fixed sum in interest forever, but never promise to redeem the capital locked up in the bond, although the option to do is usually retained by the issuer. It takes a lot of faith for an investor to believe that these two offerings represent value”.
Maybe not for pensioners, who are effectively in the position of rentiers. Pension funds and insurance business always require a large amount of low risk, or virtually no risk investments that provide a secure rent to pay pensions; some of which may be funded by annuities. All the pension fund will, in turn need to pay the pensioner, is the life rent of the annuity.
From that perspective it takes a lot of faith to invest in instruments that carry much risk. Presumably the whole point of perpetual bonds is that the rent is risk free. Furthermore, if the bond was repaid by the issuer, what is the pension fund going to do with the repayment capital? Presumably immediately Invest the proceeds in a bond…..
Quite so
If only more were investing in low risk assets…
It was a good article by George Soros. However, we should note that the “controversy” of EUR perpetual bonds relates NOT to their lack of a repayment date it was about “joint and several liability” of all EU states. In short, “The North” being wary of “The South’s” profligacy. He saw perpetuity as a neat way of persuading “The North” to accept it. Unfortunately, they have not.
For the UK it is a different story as we are a sovereign state issuing in its own currency – nonetheless, some of George’s more technical points DO apply to the UK.
In a sensible world where MMT was accepted as obviously true there would be no discussion of “how do we finance?”. The argument would run “Is investment in Green infrastructure a good idea?”. “Yes? Then let’s do it and worry about whether we print, borrow or tax later”. But the world does not embrace MMT (yet) so we should engage with the “how do we pay?” argument if it will get us closer to where we want to be.
50 year UK government debt yields 0.38% which is incredibly low but a look at “real” rates is even more startling. 50 year inflation linked debt yields RPI minus 2% – meaning that in real terms, for every pound the government borrows today it will only have to repay 37p. If that is not a reason to borrow then I am not sure what is. Any project that is even vaguely worthwhile should done.
The reasons rates are so low are complex (regulation, risk appetite, long-term econonic outlook, demographics, traders’ positions etc) but they are where they are and the government should issue more debt to meet the demand. (This probably true even if we have nothing we can think of spending the money on, we should do it as a service to savers… that is us, the public, via our pensions!).
Why 50 year? Why not 100 year or perpetual? Frankly, it does not matter. From a risk perspective investors look at “duration” of a bond and duration increases (but not linearly) with maturity. The market is desperate for duration so perpetuals would fit the bill nicely. They also have the benefit of “fungibility” which means that every time the government issue new bonds it adds to the pool of existing bonds to create a single bond with a huge outstanding volume. This would make it more liquid and that has value to investors. That there is no end date really does not bother bond traders.
Issuing tactics would be important. Typically the DMO (Debt Management Office) announces a strategy and schedule of issuance. While the theoretical rate today on a perpetual bond might be 0.4% any announcement to issue would send rates higher. The DMO need to announce a first issue of modest size so as not to frighten the horses and then issue further tranches on an opportunistic basis. Personally, I would view any rate below 2% as a good deal for the government and if rates rise above that then (consistent with inflation management) I would get the BoE to buy them.
I was rather hoping you would comment
Thanks for doing so
Points noted
And I agree re MMT – but we dont live in that world as yet
Thanks, Clive, nicely put.
On a separate note. German 30 year bonds have negative yields – you get no interest and get paid back less that you invested!
They could probably issue perpetual bonds at 0%…. so you buy the bond, get no interest and never get your money back. Who in the right mind would buy that?
Well, in fact we all do….. just open your wallet and pull out a bank note.
For me, this illustrates that MMT is the right explanation of the way money works.
Very good…
I love it! Surely that must go in to the economics list from yesterday’s question of the day?!
1) Believe a little while ago I referred to favourable issuances of Gilts such as this, described by Soros…
UK Government needs to do fill up the coffers for the short-medium term, to enable VAST spending on important initiatives (see below) that will buttress up the economy going forward & benefit the public.
However, might need more than just favourable interest rates to attract such investment.
2) Local Authority Bonds also sound like a brilliant adjunctive/complementary proposal.
3) UBI gaining traction in Scotland (although amounts £ bandied around are closer to my UBG proposal)
4) https://www.independent.co.uk/news/uk/home-news/universal-basic-income-ubi-scotland-uk-nicola-sturgeon-coronavirus-a9498076.html?fbclid=IwAR2WcnFjVfW-WVUCZGKP5IZwJ5g2HyolxVCDZMU6cAZzapDyk_CpQ2I_xRs
5) UBI/UBG scheme for the rest of the UK is imperative, to help stabilise inequality going forward.
Doesn’t have to be permanent, but 6 months – 12 months will absolutely reduce abject poverty for millions of people across the UK.
Perpetual bonds, ‘funded’ by QE, are surely game set and match for the concept that money cannot be created out of thin air/at will…
True
Are Perpetual Bonds a bit like a Parent giving the kids a monthly “allowance” or a UBI but without the U?
Wish my Dad had bought a load!
🙂