Financial Facts about the U.S. (and UK) War Bonds

 

By James Patton

Shortly after declaring war in 1917, the Wilson Administration was faced with the reality of having to pay for the massive military build-up that would be required. Both tax increases and monetary expansion were employed, and the public were also asked to buy debt instruments. Ultimately, 58 percent of the cost of the war was financed by these bonds, 22 percent by tax increases and 20 percent by new monetary creation. Statistics show that the money supply expanded by about 70 percent between 1916 and 1920.  However, that’s not the storyline of this article. 

The bonds program was as follows:  

• On 24 April 1917, the Emergency Loan Act authorized $5 billion. $1.9 billion in bonds were issued at 3.5 percent, 30 years maturity, callable at year 15. The interest on up to $30,000 in bonds held was income tax-exempt.

• On 1 October 1917 the Second Liberty Loan Act authorized up to $15 billion. $3.8 billion in bonds were issued at 4 percent, 25 years maturity, callable at year 10.

• On 5 April 1918 the Third Liberty Loan Act authorized another $3 billion. $4.1 billion in bonds were issued at 4.15 percent, 10 year maturity. Limited to $45,000 per holder.

• On 28 September 1918 the Fourth Liberty Loan Act authorized another $6 billion. $6.9 billion in bonds were issued at 4.25 percent, 20 year maturity, callable at year 15. These were redeemable in ounces of gold if held to maturity. 

• On 21 April 1919 the Victory Loan Act authorized a final $4.5 billion at 4.7 percent four year maturity callable at year three. These were redeemable in gold certificates and the interest was income tax-exempt.

All of these bonds were sold directly to the public by banks. In order to stimulate sales Bond Rallies were held, featuring parades, speeches and free performances by movie stars. The Four Minute Man campaign featured short speeches in public assemblies where prominent local persons urged the purchase of bonds. There was an installment purchase plan whereby persons could buy 25-cent War Savings Stamps, affix them to a special book and, when 200 of these stamps had been acquired, the book could be exchanged for a $50 bond. This concept was copied  in the 1950s when retailers used stamps to reward regular customers (e.g. S&H Green Stamps).

The Liberty Bonds were a milestone in American public finance; for the first time the common citizen was making long term investments in government spending. Altogether the bond issues raised about $17 billion from about 20 million investors. Investors were permitted to trade earlier issues for later ones to get more favorable terms, which led to many being converted to the 4th issue bonds redeemable in ounces of gold.  You can learn much more about the Liberty Loan program from this article by the Federal Reserve. LINK 

Most of the debt from the first three Liberty Loan issues was retired between 1921 and 1928 via calls or trade-ups. However, when the 4th Issue was called on 15 April 1934, the Treasury refused to pay off in ounces gold, citing HJR 192 of 5 June 1933 PL 73-10:

 “ … every provision contained in or made with respect to any obligation which purports to give the obligee a right to require payments in gold or a particular kind of coin or currency, or in an amount in money of the United States measured thereby, is declared to be against public policy; and no such provision shall be contained in or made with respect to any obligation hereafter incurred. Every obligation, heretofore or hereafter incurred, whether or not any such provision is contained therein or made with respect thereto, shall be discharged upon payment, dollar for dollar, in any coin or currency which at time of payment is legal tender for public and private debts. Any such provision contained in any law authorizing obligations to be issued by or under authority of the United States, is hereby repealed, but the repeal of any such provision shall not invalidate any other provision or authority contained in such law”. 

The bondholders were paid off in US money, which resulted in a speculative loss to them (nearly $2.9 billion in total) since the value of gold had changed since 1918. This default was litigated all the way to the Supreme Court, which quixotically ruled in favor of the investors  (Perry v. United States, 294 U.S. 330, 354), but no bondholder ever received any compensation for this loss, because the Court also ruled that Executive Order 6102 signed by President Roosevelt on April 5th 1933, prohibited the private ownership of gold, thereby eliminating a market value for gold.  Ergo, the bondholder’s loss was unquantifiable, so due to the increase in the value of an ounce of gold,  to repay in 1918-valued ounces of gold would be an "unjustified enrichment". 

The Liberty Loan Acts were never repealed and have been used to issue additional bonds through the years, most recently after 9/11 for the reconstruction and revitalization of affected parts of New York City.

Let’s compare the U.S. performance to that of the United Kingdom (UK), which borrowed a total of £11.2 billion (equal to about $53 billion). The UK also inflated the money supply  by about 88 percent between 1915 and 1918. The program got off to a shaky start. The first bond issue of £350 million at 3.5 percent was very under-subscribed—about £90 million were sold. In order to avert disaster, the Bank of England had to buy over £300 million by inflating the money supply. 

Beginning in 1927, the UK refinanced all of the bonds with 10 year maturities by converting them to “consols”, which  initially paid 4 percent interest (later reduced) and had no fixed maturity. In a publicity stunt timed with the centennial of WWI, the last £1.9 billion of consols were paid off on March 9 2015, the first redemption in over 60 years. However, this  redemption was financed by selling new bonds with fixed maturities. The Bank of England still owes the U.S. Federal Reserve £866 million on intergovernmental account deficits. If applicable the interest in arrears from 1934, when the Exchequer stopped making payments, would come to over $12 billion. Paradoxically, the UK is also stuck with £2.3 billion of bad debts due from Russia, Italy, and France.  None of these debts are likely to be repaid. LINK