Forever is a long time to fund someone

The author is an FT editor

In July 1595, the brothers Francisco and Pedro de Maluenda granted a loan to Philip II, the Habsburg king of Castile, Aragon, Naples, Sicily, New Spain, Peru and at times England, Ireland, Portugal and the Netherlands. The brothers were financiers from the Castilian market town of Burgos.

The king had obligations across Europe but no administrative way to pay them on a regular basis, so he relied on lenders like the de Maluendas to do it for him. The loan was a asiato, a short-term agreement to make 12 monthly payments to Philip’s army in Lisbon. Philip was to repay the brothers with the arrival of the silver fleet the following year. Instead of waiting for the fleet, however, they made use of a clause that allowed them to repay themselves in the short term asiato through the sale of Juros, long-term loans on which the king paid interest. These included some eternal ones Juros — Loans on which the king would pay interest forever.

In October of this year, financier George Soros proposed that Rishi Sunak issue perpetual gilts – bonds that pay interest forever. Sunak is only prime minister of England, Scotland, Wales and Northern Ireland, but Soros argued that the perpetual loan would satisfy stumped institutional investors looking for a stable long-term asset, and he drew on England’s 1752 consolidated loans, also perpetual ones Precedent.

There are many other perpetual bonds – including those sold by the de Maluenda brothers – that show how difficult historical precedent can be. Traditionally, perpetuals had to be funded. That is, they needed a dedicated, specific source of tax revenue to guarantee the interest. And they haven’t always behaved predictably like long-dated bonds. Forever isn’t just longer than 30 years. It’s a strange amount of time.

What matters is that all Juros The de Maluendas sold were financed – interest payments were guaranteed by sales taxes levied by the cities of Castile. As described in a 2018 article by Carlos Álvarez-Nogal and Christophe Chamley, the brothers raised cash through the sale Juros to 74 Castilian and Genoese investors.

Almost all were sold as annuities. The investor chose someone, usually a child, and this jury paid out 14 percent while the child—the head—was still alive. Most investors bought on two heads; they would choose two children, and the jury 12 percent would pay off while you were still alive. And only two investors chose the third option, a perpetual one jury that paid out only 7 percent. The yield curve of these bonds was inverted. The longer the duration, the lower the return. And while 7 percent forever seems like a pretty good deal, almost nobody has embraced it. The perpetuals were financed no more securely than the other annuities, and forever is a long time to trust anyone – even Philip II, king of everything.

We can trace annuities back to medieval monasteries granting land in exchange for subsistence either in cash or in kind. As historian James Tracy points out, when French cities began to issue pensions, they distinguished between them rents viagères — a lifetime pension — and annuity inheritance, heritable or perpetual annuities.

A lifetime annuity could be issued on city credit, but a perpetual annuity needed a little more security and was usually funded by the income from a specific, named city property. In 2003, Yale University’s Beinecke Library purchased a 1648 perpetual bond from a Dutch water board, which continues to pay interest to this day. But according to historians Jan de Vries and Ad van der Woude, most early modern Dutch water boards funded this interest with a special property tax, often as high as the property taxes levied by the state. The Dutch have created deep, liquid capital markets for government bonds, partly because they have been particularly inventive with new forms of taxation.

Even the 1752 consoles, which George Soros mentions as a model for the debt Sunak was now to issue, were also funded. The various debt issues that replaced the consoles had been funded by specific taxes on things the English could not do without: carriages, windows, and especially wine and spirits. When the Treasury released its consoles, it kept all of those taxes and rolled them into a special sinking fund, a vehicle used to pay interest on the consoles and eventually buy back some of them.

So far, the prime minister seems reluctant to accept Soros’ proposal. As a financier himself, he might believe that today’s government bond markets have already found a reasonable compromise between the extension of short-term debt and the complexity of perpetuity. However, when considering perpetuals, he needs to think about how to finance them. Perhaps with a sinking fund and a special new tax on whiskey, whiskey and gin, he could keep his diverse United Kingdoms prospering.

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