CARDIFF GARCIA, HOST:
Hey everybody. This is THE INDICATOR FROM PLANET MONEY. I'm Cardiff Garcia.
We have talked a lot on THE INDICATOR about the trade war between the U.S. and China - how it has intensified, how it might end up affecting the economies of both countries and the global economy. Today's episode is something a little different. It's about how the trade war could get weird, or it's about one way that the trade war can get weird.
See, more than a century ago, back when China was still being run by an imperial dynasty, the country issued bonds. It sold bonds to the public to raise money to develop. And it ended up not paying back a lot of those bonds. It was in default. And everybody kind of just forgot about it. The world went on, right? Well, now people are remembering, and those bonds might be used as weapons in the trade war itself.
Today on the show, we're going to speak with Tracy Alloway from Bloomberg. She's back on the show. She's one of our wonkiest and our most favorite guests. And she's going to tell us what the deal is with these bonds based on an article that she wrote for Bloomberg. And that is coming up right after the break.
OK, so joining us from her Bloomberg offices in Hong Kong where she's based is the excellent and super wonky Tracy Alloway. Tracy, welcome back to the show.
TRACY ALLOWAY: Thanks, Cardiff. I'm so happy to be one of your wonkiest guests and yet one of the favorites. I think that's quite an achievement.
GARCIA: This is, like, the quintessential Tracy Alloway story. So get us started here. So these bonds that China issued more than a century ago - what were they for? What's their story?
ALLOWAY: Sure. So China, you know, a hundred years ago - sort of late 1800s, early 1900s - was pretty similar to a lot of emerging markets now. They needed a lot of financing to develop their economy, to build big infrastructure projects like railways. And so they were trying very, very hard to get this money.
And people were really eager to get a piece of the China market at that time, and so what they ended up doing is they would extend financing. They would lend money to China for all these various projects. And they would often do it at really punitive terms, terms that would guarantee them a particular slice of, say, revenue from whatever railway was built using their money.
GARCIA: Tracy, give us some sense of just how popular those bonds were to people overseas, to the public.
ALLOWAY: Oh, hugely popular, which is why today you can find them in a lot of unexpected places, like basements and attics across the United States. So there is one estimate that I saw saying that 2.5 billion, in nominal terms, of foreign capital flowed into China before 1938. That would mean that China was the most popular destination for international investors next to India, so hugely, hugely popular in terms of a place for people to actually invest in.
GARCIA: OK. And then what happened to those bonds in the subsequent years after they were sold to the public?
ALLOWAY: It was a really turbulent period for China, basically. So the imperial dynasty basically got overthrown in 1911. Eventually, you had the Republic of China that came up in its place. And then you had a lengthy civil war between the Republic of China and the Communist Party. And then you had World War II. And, eventually, in 1949, you had the official establishment of the People's Republic of China, the PRC, as it's known now. This is modern China.
But by 1938, most of those bonds were firmly in default.
GARCIA: Which means that China, in part because of all this tumultuous political activity and maybe because of those punitive terms, those high interest rates, could not pay back those bonds.
ALLOWAY: Well, the People's Republic of China has never officially recognized the debt. So to them, they argue that it falls under this sort of nebulous legal concept that we call odious debt, which is really a great name, right?
ALLOWAY: Like, odious debt. Odious debt is something that you can argue should never have been incurred in the first place and, therefore, it is unfair to ask the people to basically pay it back now. But I should stress that odious debt is a pretty untested legal concept, so it's very hard to actually argue that from a legal perspective.
I should say, though, that this isn't entirely unusual. You have had previous instances of new governments doing exactly this. And the most famous example would be the Soviet Union, which repudiated debt that had been issued by the czars before it came to power. So again, a similar dynamic.
There's another great example, which is North Korea, that had borrowed a lot from the Czech Republic back when the Czech Republic was part of the Communist bloc. And at some point, they offered to pay it back with a shipment of ginseng instead of actual money.
GARCIA: I think I would accept that. I love ginseng tea.
GARCIA: OK. So, like, how are these bonds now relevant to the ongoing trade war? I mean, these bonds are so old, and the trade war has just started in the last couple of years.
ALLOWAY: Well, trade wars have an unnerving tendency to kind of throw a bunch of skeletons out of various closets, so this thing that they did a hundred years ago suddenly becomes very relevant again.
What it is is there is a group of bondholders who have been trying to get payment on this China debt basically since 2001. And they have been meeting with President Trump and also members of the Trump administration, including Treasury Secretary Steve Mnuchin. And the hope is that with Trump taking a hard-line stance against China on a number of not just trade but financial issues, the hope is that maybe this is something that he would be willing to take on as well and perhaps discuss with China as part of these trade negotiations.
GARCIA: OK. And what exactly is the legal case that China actually owes this money?
ALLOWAY: It is legitimate debt in the sense that the bonds were issued by a legitimate government at the time, which was then replaced by another legitimate government. And the norm in international markets is that most governments do choose to recognize debt issued by their predecessor governments because they don't want to develop a reputation for not honoring their debts. They want to be able to come to the market again. So that's the sort of standard. And the fact that China hasn't done this is slightly unusual, even though you've had other cases before that I've mentioned.
Margaret Thatcher, as part of a 1987 handover agreement for Hong Kong, actually managed to negotiate a payout for British bondholders of the same debt. All of that was agreed through diplomacy, not through the courts. It's very difficult to get a foreign government to come to a U.S. court to repay debt that they don't even recognize. But you could theoretically have someone like Donald Trump argue as part of a trade deal with China that it should also, perhaps, consider these old debts as a sort of sweetener in any trade deal.
But again, it's really, really hard. You're talking about bonds that basically are considered antiques on eBay and a lot of collectible websites. You're talking about trying to bring those into modernity.
GARCIA: Yeah. And in terms of what happens next, what should we be following?
ALLOWAY: I think from the Treasury's perspective, they see these as very difficult, if not impossible, to reactivate. But you could see from Trump's perspective - and I'm sort of speculating here. From Trump's perspective, wouldn't it be nice to go back to China and say, we don't owe you $1 trillion worth of U.S. Treasurys; you owe us a significant amount because of these outstanding debts?
GARCIA: Then you could say, well, we'll just give you back your bonds and we'll call it a day, instead of paying back those Treasurys. But that all seems like real - that almost seems like sci-fi, right? Like, you'd actually be asking the Treasury to voluntarily go into default on U.S. debt, which could have all kinds of other insane implications for financial markets.
ALLOWAY: Oh, it's definitely out there. But I also think the fact that we're talking about hundred-year-old Chinese bonds at all is sort of indicative of what's possible in the current climate, isn't it, Cardiff?
GARCIA: Yeah, it's true. Yeah, no, it is. It is all crazy. What a great story. Tracy Alloway, always a pleasure.
ALLOWAY: Thanks so much, Cardiff.
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GARCIA: Thanks for listening, everyone. THE INDICATOR is a production of NPR.
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