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Background A few years ago I was a student of an economic course about loans, debts, interests, NPV etc. The trainer mentioned "The UK took a loan to fund wars against Napoleon. This has no term, and only interests are being paid back. So this will never be ended." I could not believe it, but ok, this was not my scope of job.

Later I returned to this topic few months ago and tried to search about this loan. Unfortunately, there is lack of any detailed data in the Internet.

For example, this article only mentions (the context is that the Government wants to buy back the loans from the WW1):

Also included in the government buyback are: loans originally taken out to cover losses from the collapse of the South Sea Company in 1720, debt taken on to fund Britain's fight against Napoléon Bonaparte, and some that helped finance the Slavery Abolition Act of 1835.

These loans are unusual because they were issued as perpetual bonds. This means that they payed out interest but have no maturity date, in effect making them more like owning a stock that pays a dividend than a traditional bond. The government has the right but no obligation to pay off the debt.

This article is related to the same event, but providing no more information:

Some of the debt being repaid relates to the South Sea Bubble crisis of 1720, the Napoleonic and Crimean wars, the abolition of slavery and the Irish potato famine of the mid-18th century. (...)

In 1888, chancellor George Goschen converted bonds first issued in 1752 which were later used to finance the Napoleonic and Crimean Wars, the Slavery Abolition Act (1835) and the Irish Distress Loan (1847). This debt will be repaid through the redemption of the 4% consols.

The Wikipedia article has only one sentence:

Perhaps the oldest bonds still outstanding as a result of war are the British Consols, some of which are the result of the refinancing of debts incurred during the Napoleonic Wars.

The Consols article leads to Perpetual bond article, also having one sentence:

Examples of perpetual bonds are consols issued by the UK Government.

It seems (maybe I am wrong) that before 1900 only the British government issued perpetual bonds. What stood behind this practice? Why was it better to issue a perpetual bond than "normal" loan?

At the moment the Government seems to be wanting to pay them off, of course financial market has changed, but I can't believe the economists of the era did not expect or at least suspect the things can change after 200 years. They left the door open (The government has the right but no obligation to pay off the debt.), but I'm still wondering why was it considered better than not to pay it off as soon as possible.

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    Britain did not only issue perpetual bonds, but AFAIK all the Consols were. Perpetual bonds have some attractiveness because HM Government is not obligated to pay back the principal ever, except when it wants to. Which allows for the situation where the government profits by not paying back the loan, when it can invest the principal elsewhere to get higher returns than the bonds' coupon rates. – Semaphore Jun 12 '15 at 9:07
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    To give specific example, say the Bank of Semaland pays 5% interest on deposits. If the Government of Britain issues perpetual bonds at 2% interest, it could borrow £100 billion and deposit it all with the BoS - earning 3 billion for free. 100 years later, the economy of Semaland crashed so the BoS lowered interest rates to 1%. The British scheme is up and they're losing $1 each year, so Britain redeems all "perpetual" bonds straight away. But in the meantime, it had already made £300 billion (+compounded) interest - money it would not have, if it tried to pay off all debt as soon as possible. – Semaphore Jun 12 '15 at 9:14
  • I don't understand. Bank of England and 1st Baronet of Somethingshire are equal parties of the loan. The 1st Baronet gives to HM say 10,000 pounds and the deal is that he will receive - say - 10 pounds yearly until the end of the world. Then 200 years later, the 7th Baronet still receives 10 pounds yearly (including inflation etc, say it is now 1000 pounds). But 1st Baronet could also invest his money in Semaland, he is not stupid. How would Bank of England attract the 1st Baronet to invest his money in HM Government rather than making him leave the money to 2nd, 3rd and other descendants? – Voitcus Jun 12 '15 at 9:58
  • The same reason people buy US Treasury bonds today - safety. The Consols (and British government bonds in general) were regarded as one of the safest possible investments around, since they were back by the tax revenues of Great Britain and there was faith that HM Government would not default on debt obligations. – Semaphore Jun 12 '15 at 10:07
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    The question is historical, because it seems that only UK was taking such type of loans, and the question is why – Voitcus Jun 12 '15 at 19:13
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As the wikipedia article on consols mentions, Britain actually started issuing these perpetual bonds in 1751. So their use during the Napoleonic Wars some fifty or so years later was far from unprecedented. As noted in the comments, the attractiveness of this style of loan (to the borrower) was a combination of the low interest rate and putting the management of the loan in the hands of the borrower (who could decide if and when to pay off the debt). The latter was important because during the 18th Century Britain was frequently at war. A fixed-term loan always had the potential to fall due during a period of conflict when repaying (or refinancing) could have crippling consequences.

In considering how and why Britain could manage to arrange these perpetual bonds, it's important to consider the role of the Bank of England. This institution had expanded to become, essentially, a part of the government of Britain. It was the Bank of England that performed the task of raising and paying the interest on government loans.

From "The Foundations of British Maritime Ascendancy: Resources, Logistics and the State, 1755-1815" by Roger Morriss (Cambridge UP, 2011),

The security provided by the integration of the Bank and state functions permitted the British government to raise very large sums at relatively low rates of interest. Much of the money was raised by subscription to irredeemable interest bearing bonds or stock on London's capital market. The investments formed a long-term loan to the government. Their annual scale grew from £8.5 million to more than £20 million between 1756 and 1815. As a proportion of total expenditure, they rose from 37.5 per cent to 39.9 per cent at the end of the War of American Independence, then declined during the Napoleonic War to 26.6 per cent.

In respect of selling the bonds, he says,

Central to the state's success in raising loans was the group of City [of London] business men known as the "moneyed interest". In 1757 they represented Dutch and Jewish interest; and the directors of the Bank of England, the South Sea Company, the East India Company and the insurance companies. Less central, but important, was a range of bankers, government contractors and other business men.

Initially a large part of the money raised came from overseas (chiefly from the Dutch). However, due to the changing political situation by the time of the Napoleonic War, the money from the Dutch had mostly dried up. However,

...by then Britain's domestic economy was generating wealth. Surplus business capital provided the core of investment in government debt...When country banks came into existence, they remitted surplus funds to London which were made available to the state through the purchase of consols and securities. As the economy grew, money for loans to government always seemed available: In December 1796 a "loyalty loan" of £18,000,000 was subscribed in four days.

In contrast, the French took a different path with regard to their economy up to the Napoleonic period;

France, during the Seven Years' War, adopted the same financial method as Britain and Holland in paying for hostilities predominantly with loans: government borrowing met 59 per cent of French war expenses, taxes only 29 per cent. However, the French Monarchy managed its debt less wisely, opting to fund it with short-term annuities with high-interest rates rather than using long or perpetual loans at lower rates. It therefore increased the cost in interest and the amount of the peacetime debt to be serviced...After the War of American Independence, despite similar amounts of revenue and expenditure, the British were able to service a much larger debt (£240 million in 1787) than the French (£201 million in 1788) on lower interest rates (3.7 per cent) than the French (6-6.5 per cent)

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Why did Britain decide to issue perpetual bonds during Napoleonic era?

  1. They needed money to pay for war expenses.
  2. It was possible to sell the bonds without the promise to pay back the principle. Cheap year by year! Smart but unwise, see Greece today.
  3. Interest could be lowered at will, so no reason ever to pay back.
  4. Year by year there never was a politically viable reason to pay back the principle. And this was a profitable loan without blame attached. And governments are addicted to loans after all. During the Great Depression there was no money to do it.

Only now these days deflation returns. Wake-up call for all loan owners!

references:

https://en.wikipedia.org/wiki/Consol_(bond) http://www.theguardian.com/news/datablog/2011/jan/13/interest-rates-uk-since-1694

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