LONDON LETTER:The 1917 war loan still stands sentry as the chancellor campaigns to win depositors' funds, writes MARK HENNESSY
IN JANUARY 1917, Britain struggled through some of the darkest days of the first World War, running out of men to fill the trenches in Flanders but, just as importantly, running out of money.
Faced with emptying coffers, the treasury produced the third war loan, a perpetual bond sold at a 5 per cent discount to its face value and offering 5 per cent interest.
Holders of less-generous bonds issued previously were allowed to swap for the new, higher-paying creation, while British living abroad were exempted from paying income tax on interest.
Years later, in his book, The Financiers and the Nation, Tom Johnston wrote: “No foreign conqueror could have devised a more complete robbery and enslavement of the British nation.”
In 1932, chancellor of the exchequer Neville Chamberlain moved to restrict the benefits, offering holders the choice of selling their bonds or else accepting a 3.5 per cent interest rate.
Most of the three million heeded his call to their “good sense and patriotism” to accept the lower interest rate – still attractive then – rather than cash in the bond.
In March 2012, £1.9 billion remained outstanding, although the bond once deemed so profitable suffered badly from rampant inflation in the decades after Chamberlain’s move.
Today, however, it is back in favour, since an interest rate of 3.5 per cent is attractive in a world where investors are now paying the Swiss for the privilege of holding their government debt.
In 1990 the war loan traded at a price below 30p in the pound, while even last November, each bond was valued at just 91.5p of its face value.
Times have changed.
This week, it traded above its face value for the first time in the reign of Queen Elizabeth, who is now coming to the end of her diamond jubilee celebrations.
Indeed, it would be cheaper for Chamberlain’s successor in the treasury, Conservative George Osborne, to call in the bonds and pay them off, since he can borrow more cheaply elsewhere.
For months there have been rumours that Osborne might just do that, although the 90-day notice that must be given could be problematic in unsettled times such as these.
Equally, the current holders would be hard to track down since the war loan was bought largely by individuals, rather than institutions. Many of the original holders were Irish.
For now, Osborne may have enough on his plate, given that the British economy is showing few of the green shoots he once believed would emerge quickly after the 2010 election. However, he is thinking about bonds.
This week, it was learned that he had instructed treasury officials to find ways to encourage savers to invest in a new “growth bond”.
Billions lie earning little interest in bank accounts, money that could be used to fund the drive to build new infrastructure needed to add impetus to the UK’s flagging economic figures.
Under the treasury’s nascent plan, it would partially underwrite the risk that would be taken by small investors, by offering to take the first stream of losses, should they emerge.
“While a lot of families are struggling and have no disposable income, there are others who are quite cash-rich but have nowhere secure to put their money,” said one minister.
“Because interest rates are as low as they are, there is the potential to tap into this money and get it invested in infrastructure which will have a dramatic effect on Britain’s long- term growth,” he added.
The coalition has already tried something similar to help small businesses, using the government’s credit to raise up to £20 billion more cheaply than the businesses could.
The direct appeal to savers would run in parallel with a plan to attract investment from British pension funds, but talks between them and the treasury have so far failed to result in agreement.
Some will argue that the alliance of Conservatives and Liberal Democrats should fund the infrastructure itself by borrowing internationally, since it can raise 10-year money for just over 1.5 per cent.
However, the reason it can do so is because international markets look on approvingly, mostly, at the public spending curbs introduced by Osborne.
The curbs, however, have had the effect of ensuring Osborne does not have money for capital spending. Indeed, he has had to cut it severely in his bid to win the approval of markets.
Like everything in politics, however, a successful growth bond would bring its own difficulties, since, if it were successful, it would reduce the deposits held by the banks.
Treasury officials have yet to be persuaded of the benefits to be won, with Liberal Democrats deputy prime minister Nick Clegg believing their objections to be “neurotic”.
“From the top of government, a few weeks ago we decided this was the route we’re going to take,” he said last week. “That’s the instruction we’ve issued to the treasury.”
In the meantime, the 1917 war loan stands on sentry duty. Many of its bonds, long forgotten, are still to be found in drawers and cupboards throughout Ireland.