“Financial War Bonds”

By Ben Davies, CEO of Hinde Capital

December 9 (King World News) - At the breakout of World War I in 1914 the British government appointed the imperial warhorse Lord Kitchener as Secretary of War to bring in much needed military experience to the cabinet.  Kitchener was a national hero for his colonial exploits in the Sudan, Palestine and Cyprus.  The UK Prime Minister, Herbert Asquith, was tasked with recruiting a large army to fight Germany.  With the help of a war poster that featured Kitchener and the words: “Join Your Country’s Army – Your Country Needs You!” over 3 million men volunteered in the first two years of the war.


Over the course of the 20th century many different governments used this form of propaganda poster to appeal to the patriotism and conscience of the people in an attempt to drum up support for war efforts.  Posters were used as an affordable means of mass communication by governments.  More often than not it was not just human recruitment but the recruitment of the people’s capital.  Sovereigns asked for money to finance the military costs of war.  They did this by issuing war bonds.

War bonds were debt securities issued by government for the sole purpose of financing the military operations.  They had only one purpose: to raise as much money as possible for nations already struggling to meet large war budget deficits.  Invariably such nations were struggling with growing and high inflation – a symptom of accelerated resource constraints from the fallout of war demand, broken supply chains and less resource availability.  Furthermore, governments and central banks were indulging in deficit financing as capital was scarce to fund the war machine.  This exacerbated still further already rising inflation. 

War bonds are quite simply a form of financial repression.  Governments engendered guilt amongst their people to do their patriotic duty.  Those who failed to support their government and hence their nation were made to feel almost as if they had been treasonous. 

Canadians issued “Victory Bonds” after 1917.  The first Victory Loan was a 5.5% issue of five, ten and twenty year gold bonds.  They were oversubscribed – worth their weight in gold. 

Germany during World War I became isolated from international capital markets and turned constantly to their people to raise funds, invoking support with posters and language such as, "This is how your money helps you fight! Turned into submarines, it keeps enemy shells away! That's why you should subscribe to war bonds!"

Now, in the developed countries, monetary and fiscal policy 'politically' speaking is at its limits, although theoretically there is no limit.  In short, countries have run out of capital, and like any good ol’ Ponzi scheme the game is up when your outflows are greater than your inflows. 

Madoff came unstuck when redemptions exceeded subscriptions during the great deleveraging of 2008.  Similarly governments have hit this point of financial transversality--i.e., when debt servicing costs exceeds a country’s nominal GDP, they can’t keep borrowing more.  The grim reaper has called time in the game.

You know when you are at this point when the war bond-esque propaganda program starts again.  The posters are out in force once again.  Whilst in years gone by mass communication took place by posters, today TV and the internet are the primary tools.  Today we see an alarming rise in countries emotionally blackmailing their people to give money in the form of a number of bond structures, eerily reminiscent of the war bond days.

Governments have begun to witness higher funding needs and in some cases experienced failed auctions as investors exact a toll on profligate nations.  Politicians have resorted to desperate measures.  The political propaganda machine is in full flow.

Italy, faced with imminent funding issues, has in sheer desperation announced two national “BUY BTP” days.  Although it was instigated by a private citizen, Giuliano Melani and supported by the Association of Italian banks, no doubt it was government sponsored. 

Retail investors were enticed with zero commissions and vocal encouragements of sports stars, again no doubt implicitly government sponsored.  The democratising response was never far away though; a renowned Italian financial blogger eloquently posted his disapproval of such repression

Elsewhere in Europe, destitute periphery countries are enthusiastically selling bonds to their public.  Spain and Belgium are the most notable example.  But besides the Spanish central government advertising with the slogan “Elijo Tesoro” (“I choose the public Treasury”) the autonomous regions have also experienced major cash shortages and so have appealed to their local population’s sense of duty.  In Catalan “bonos patrioticos” – literally patriotic bonds – were issued and the region secured €4.2 billion in financing from over 200,000 Catalans. 

Earlier in the year Ireland’s government ramped up Prize bond issuance or State Savings in an attempt to find much needed capital.  In return for funding the state you get – wait for it –the enormous sum of nothing – yes, you guessed it, zero coupon payments.  You do, however, get the tax-free one in infinity chance of winning a top prize of €1 million in the monthly lottery draw. 

Turning to the Orient, readers will be unsurprised to see that the debt- and demographically-challenged Japan has also joined the guilt game.  Tapping into the Japanese sense of duty and honour they have further sought to raise money to help rebuild the north-east coastal regions devastated by the tsunami. 

They have even incentivised retail investors to buy more than 10 million yen ($129,000) worth of Reconstruction bonds and hold them for more than three years with a 0.05% yield, but again, wait for it – a 0.55 troy ounce gold coin valued at 10,000 yen.  Even those who buy 1 million yen’s worth will receive a 1 troy ounce silver coin.  Judging by Japan’s recent gold export numbers investors will probably sell them. 

More recently the UK has entered into the fray.  The UK treasury is planning to use “an innovative form of bond financing” to galvanise a £200 billion infrastructure investment plan in the five years up to 2015.  If it isn’t enough that the UK is saddled with debt 5 times GDP, the UK government believes this Keynesian ‘wand’ will spur mass employment and future output.  The law of diminishing returns is ever present in our mind. 

The UK, as does the US, needs a significant overhaul of its infrastructure, but alarmingly George Osborne, the UK finance minister, wants UK pension funds to take down 70% of the bonds.  The UK public as the primary source of pension capital will effectively be coerced into taking on significant risks.  The British don’t have a great record of large-scale construction – think Wembley Arena.

I almost guarantee there will be other such state directives aimed at pension funds and maintenance of higher fixed income holdings, which will guarantee defined pension schemes having larger liability mismatches than already exist.  I suspect growing losses will be the trigger for government bailouts and a return to state run pension schemes. 

The law of diminishing returns presents a singularly malevolent proposition.  The state, in order to maintain the creation of pseudo-capital to keep the system from disintegrating, will take more and more direct control of the entire money creation process.  An implicit nationalisation of money and credit, i.e. financial oppression.

In our recent HindeSight Investor Letter, Singularity - Transcendent Money, we discussed how private capital will be procured.  A great phrase for this is ‘conscripted capital’, coined by Russell Napier of CLSA.  The emergence of these modern day war bonds seems benign.  They are not.  These are the first and not the last desperate attempts to procure YOUR capital.


Patriot, Reconstruction, and Lottery bonds - the last type aptly describes the risk I ascribe to all these bonds.  The risk an individual is undertaking by financing governments at these yields today is indeed a complete lottery on whether you will ever receive your full principal back.  Independent of this, with global real rates at negative 3.5%, bond buyers (creditors) are merely transferring wealth to the government (debtor) via inflation.  Alternatively put, central banks are maintaining interest rates artificially below the true value of money so government can expropriate your assets through inflation.  You will be paid back in a diminished amount.

Source: Variant Perception

Post Script – the ECB Announcement 8th December 2011.

I spoke on KWN yesterday at considerable length about a rumour the ECB would loosen collateral criteria so banks could have cheaper access to ECB cash.  They would be offered this cash as a longer-term loan.  The rumour proved to be right.  I gave Hinde’s interpretation of this action in the interview, but we wanted to reiterate it here for clarity.

The decision by the ECB to offer loans (liquidity) to banks on maturities up to 3 years at the same time as reiterating that buying sovereign bonds would violate the EU treaty is contradictory.  It underscores the notion that while the ECB may certainly be prohibited against outright QE in the same way as the Fed and the BOE have engaged in, it is now being just as reckless as its counterparts.  By offering essentially unlimited liquidity to the banking system at up to 3 years the ECB is de facto conducting QE by stealth and is trying to eliminate roll-over risk and a general liquidity squeeze in the interbank market.  The QE element comes in by allowing banks to exchange liquidity at the ECB for assets which the ECB will hold in collateral.  This liquidity can then either be held in highly liquid deposits at the ECB or be used to fund sovereigns, and at the same time help the banks recapitalise themselves to indirectly meet the higher Basel III capital adequacy directives. 

Finally, it is important to re-emphasize the maturity of these loans.  By extending the maturity of these liquidity provisions to three years (from one year), the ECB is essentially aiding in re-capitalising the banks as they may now exchange obviously below-par assets for highly liquid assets (deposits at the ECB), or further government bonds (indirect monetisation), and keep this liquidity for as much as 3 years. 

Liquidity is rising globally and the ECB has just added to the mix.  The major beneficiary of rising liquidity will be gold.  The best explanation for the change in gold prices is Gibson’s Paradox.  Gibson’s Paradox refers to the relationship between real interest rates and gold prices, and can be used to infer a negative relationship between the two.  It does a remarkably good job in mapping the annual change in the gold price, and can be used to help predict it.

Source: Variant Perception

Our proprietary model for gold, which builds a trend around the gold price, predicts strong returns for gold, with it poised to reach hit its initial objective of $2,100 in the early part of 2012. This I stated at the beginning of 2011.

Ben Davies

Director & CEO

Hinde Capital

Davies new interview is extremely important as he lays out what the central planners are up to and how it will influence readers and listeners portfolios.  The KWN interview with Ben Davies will be available shortly and you can listen to it by CLICKING HERE.

© 2011 by King World News®. All Rights Reserved. This material may not be published, broadcast, rewritten, or redistributed.  However, linking directly to the blog page is permitted and encouraged.

Eric King

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© 2011 by King World News®. All Rights Reserved. This material may not be published, broadcast,

rewritten, or redistributed.  However, linking directly to the blog page is permitted and encouraged.

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