The Heart of Western Civilization
Posted: Fri Nov 06, 2015 7:50 pm
[quote=Porter Stansberry]Let's start here… The bond market is the heart of western civilization. Now, I know, that's a big claim. Most you will never believe it. But here's why I do.
First, the modern bond market traces its origins back to Martin Luther and the Protestant Reformation of 1550. Luther thought there was nothing wrong with charging "fair" rates of interest. God whispered in his ear that 5% should be the standard. Calvin, meanwhile, apparently heard 6%.
Gold merchants, mostly Jewish, apparently didn't care what God thought and charged what the market would bear. They created the basis of the modern financial markets over the next hundred years – beginning mostly with discounting receivables (bills). This is how the concept of the time value of money was developed.
Before this, charging interest on a loan was illegal in most Western countries. It was considered immoral and defined by the church as "usury." Without access to capital and without capital markets, the West had suffered a tremendous decline for more than 1,000 years. Your teachers called it the Middle Ages. They probably never considered that the Renaissance, with its amazing scientific, artistic, and political progress – and then the Industrial Revolution that followed later – was funded and made possible by Europe's bond markets.
The conventions, rules, and traditions of the modern bond market were established by the greatest single bond issue of all time. In 1752, the entire English national debt was refunded with a single bond issue that "consolidated" all of the previous bond issues. These bonds, which were perpetual (they never matured), paid 3% at par and were known, for hundreds of years, as "Consols."
They paid interest, in gold, until the end of World War II, when the British government tricked its bondholders into accepting sterling (paper money). The poor fools were then summarily wiped out over the next 30 years as Britain bankrupted itself by adopting socialism. It's truly amazing how 200 years of credit, wealth, and power can be so quickly squandered. But bad ideas have huge consequences.
Still… the 200 years or so that the British Crown paid, honestly and on time, set an important standard. Consols led to the development of more capital markets through Eastern Europe and, most important, America.
Founding father Alexander Hamilton copied the idea and funded our government with perpetual bonds that paid 6%. Later, the Populist president Andrew Jackson wisely paid off all of these debts. What a novel idea! Let's not discuss the track record of our last two presidents in this regard. They have issued bonds that we will never, ever be able to repay. You're welcome, kids and grandkids. Good luck.
The binary nature of bonds – they're either paid back in full or they default – was established by the British merchant class (known as "Whigs"). They were in favor of using the power of the central government (taxes) to fund their investments. As a result, they structured the Consol bonds to make sure they were always paid interest no matter what.
As private bonds were issued, the same traditions held: Bond payments carried the force of law. There was no way for a bond issuer to pay back part of the note. They either paid in full or they were in "default." For a long time, default meant not only losing your assets, but also going to prison if your assets didn't make your bondholders "whole." He who borrows what isn't hizzn, must pay it back or go to prison.
This binary nature is extremely important. It means that bonds are nothing like stocks. Managers must meet the terms of the bonds they've issued. They must pay interest. And they must pay principal. Sometimes, they must even pay more than principal. Some bonds have a "convertible" feature that allows you to opt to be paid back in stock if the stock is worth more than the money owed.
The binary nature of bonds – perform or default – is the main reason I believe most investors are far better off in bonds than in stocks. (There are plenty of other reasons, which I'll detail later on.) Ask anyone who has worked closely with or has closely observed the inner workings of a public company's management team and I'm sure he will agree.
There's an almost endless variety of ways that corporate managers can screw over shareholders. For example, instead of paying dividends, they can buy back stock. This will certainly increase the value of their options, but it may or may not deliver value to shareholders. (See our list of companies engaging in highly suspicious buybacks.) They can use corporate assets to buy other companies, which may or may not be accretive to their own shareholders, but will almost always lead to big bonuses and payouts for management.
Even the most ethical managers will, in some way, be swayed by the mismatch of incentives between managers and shareholders (owners). Managers have a huge incentive to acquire larger and larger piles of assets. Doing so inevitably leads to more job security (more capital to manage), larger staffs, more power, and more prestige. Thus, management teams will always seek to build larger and larger "fiefdoms," even when doing so hurts shareholders by lowering growth rates, reducing returns on equity, and leveraging the balance sheet.[/quote]
First, the modern bond market traces its origins back to Martin Luther and the Protestant Reformation of 1550. Luther thought there was nothing wrong with charging "fair" rates of interest. God whispered in his ear that 5% should be the standard. Calvin, meanwhile, apparently heard 6%.
Gold merchants, mostly Jewish, apparently didn't care what God thought and charged what the market would bear. They created the basis of the modern financial markets over the next hundred years – beginning mostly with discounting receivables (bills). This is how the concept of the time value of money was developed.
Before this, charging interest on a loan was illegal in most Western countries. It was considered immoral and defined by the church as "usury." Without access to capital and without capital markets, the West had suffered a tremendous decline for more than 1,000 years. Your teachers called it the Middle Ages. They probably never considered that the Renaissance, with its amazing scientific, artistic, and political progress – and then the Industrial Revolution that followed later – was funded and made possible by Europe's bond markets.
The conventions, rules, and traditions of the modern bond market were established by the greatest single bond issue of all time. In 1752, the entire English national debt was refunded with a single bond issue that "consolidated" all of the previous bond issues. These bonds, which were perpetual (they never matured), paid 3% at par and were known, for hundreds of years, as "Consols."
They paid interest, in gold, until the end of World War II, when the British government tricked its bondholders into accepting sterling (paper money). The poor fools were then summarily wiped out over the next 30 years as Britain bankrupted itself by adopting socialism. It's truly amazing how 200 years of credit, wealth, and power can be so quickly squandered. But bad ideas have huge consequences.
Still… the 200 years or so that the British Crown paid, honestly and on time, set an important standard. Consols led to the development of more capital markets through Eastern Europe and, most important, America.
Founding father Alexander Hamilton copied the idea and funded our government with perpetual bonds that paid 6%. Later, the Populist president Andrew Jackson wisely paid off all of these debts. What a novel idea! Let's not discuss the track record of our last two presidents in this regard. They have issued bonds that we will never, ever be able to repay. You're welcome, kids and grandkids. Good luck.
The binary nature of bonds – they're either paid back in full or they default – was established by the British merchant class (known as "Whigs"). They were in favor of using the power of the central government (taxes) to fund their investments. As a result, they structured the Consol bonds to make sure they were always paid interest no matter what.
As private bonds were issued, the same traditions held: Bond payments carried the force of law. There was no way for a bond issuer to pay back part of the note. They either paid in full or they were in "default." For a long time, default meant not only losing your assets, but also going to prison if your assets didn't make your bondholders "whole." He who borrows what isn't hizzn, must pay it back or go to prison.
This binary nature is extremely important. It means that bonds are nothing like stocks. Managers must meet the terms of the bonds they've issued. They must pay interest. And they must pay principal. Sometimes, they must even pay more than principal. Some bonds have a "convertible" feature that allows you to opt to be paid back in stock if the stock is worth more than the money owed.
The binary nature of bonds – perform or default – is the main reason I believe most investors are far better off in bonds than in stocks. (There are plenty of other reasons, which I'll detail later on.) Ask anyone who has worked closely with or has closely observed the inner workings of a public company's management team and I'm sure he will agree.
There's an almost endless variety of ways that corporate managers can screw over shareholders. For example, instead of paying dividends, they can buy back stock. This will certainly increase the value of their options, but it may or may not deliver value to shareholders. (See our list of companies engaging in highly suspicious buybacks.) They can use corporate assets to buy other companies, which may or may not be accretive to their own shareholders, but will almost always lead to big bonuses and payouts for management.
Even the most ethical managers will, in some way, be swayed by the mismatch of incentives between managers and shareholders (owners). Managers have a huge incentive to acquire larger and larger piles of assets. Doing so inevitably leads to more job security (more capital to manage), larger staffs, more power, and more prestige. Thus, management teams will always seek to build larger and larger "fiefdoms," even when doing so hurts shareholders by lowering growth rates, reducing returns on equity, and leveraging the balance sheet.[/quote]