More than a decade ago now, I got interested in the sovereign debt defaults in the 1930s. Debt was in the wind, between the severe economic recession and financial crisis and the Reinhart and Rogoff book. And so it was while I was working at The Treasury that I first became aware of New Zealand’s sovereign default in the 1930s. A couple of years later that story ended up written up here and our (quite limited) default joined the published lists of sovereign defaults.

The biggest defaults globally weren’t, and often still aren’t, in such lists. I wrote here a few years ago about the US government’s abrogation of gold clauses in debt instruments, in effect depriving bondholders of a big chunk of their real purchasing power, all as written up in UCLA economist Sebastian Edwards’s accessible book.

But on a global scale the most important series of defaults in the 1930s were those on liabilities arising from World War One. There was German war reparations of course: by the depths of the Great Depression there was little appetite to keep claiming them, and rather less willingness on the German government’s part to keep paying them.

But there were also big debts among the governments of the World War One allies. Once the US entered the war in 1917, Britain and France in particular had borrowed large sums from the US government, and Britain in particular (France to a much lesser extent) throughout the war had lent large amounts to her allies (including New Zealand). Britain had made substantially more intergovernmental loans than she had received (and was a net lender even once the large loans to Russia, never likely to be repaid after the revolution, were set to one side). For the UK, intergovernmental debts alone were about 20 per cent of nominal GDP (the war had also given rise to a lot of market debt, offshore and domestic)

In his new book, University of Nottingham political science and international relations professor David Gill writes about The Long Shadow of Default: Britain’s Unpaid War Debts to the United States 1917-2020. The “long shadow” is, in part, an allusion to the literature which suggests that in practical terms memories of sovereign default often seem quite short, with defaulters often relatively rapid able to re-enter the market.

After World War One there was a considerable strand of thought in Europe – and some in the US – that the intergovernmental war debts should simply be cancelled. The war had, after all, from 1917 become a common project, and if the US had been the net lender to its allies, those allies themselves had paid a much higher prices in lives and physical destruction. To the extent it was not going to be cancelled, pressure for substantial reparations from Germany would be increased (particularly from France, whose combined debts to Britain and the United States, with few offsets, exceeded Britain’s gross debts to the US).

The cost of cancellation would of course have fallen primarily and substantially on the US, and its taxpayers (Britain would have borne some costs, while France and Belgium would have been significant beneficiaries). Gill never points out that the total debts owed to the US government were equal to perhaps only 10 per cent of US GDP (although note that the US federal government share of GDP itself at the time was very small), but he is a political scientist primarily, and anyway what mattered was (much) less the economics and much more the politics. There was little or no appetite in the US, and specifically in Congress, for the Europeans to do anything other than repay the debts their governments had voluntarily taken on. US opinion seemed particularly reluctant to accept any connection between the intergovernmental debts and German reparations.

During the 1920s each European sovereign borrower reached its own agreement with the US government on servicing and repayment terms for the war debts. The main focus here is the UK, and in 1923 Chancellor of the Exchequer Stanley Baldwin had settled with the US on terms that involved payment of the following 62 years (and an effective discount on the debt of 28 per cent of the original total), and provisions which prevented the US government marketising the debt, selling it off to retail and wholesale investors. Signing was controversial (sign now or wait: many states that waited secured more generous US terms a few years later) but was regarded by officials as broadly satisfactory, since the UK negotiated in parallel in respect of its own wartime loans to allies and was left expecting its outgoing would be broadly met by receipts on those loans to allies). At prevailing exchange rates, servicing the US (USD) debt was costing the UK (gross) less than 1 per cent of GDP per annum.

Most European countries that had borrowed from the US during the war defaulted in 1932. European countries had largely agreed among themselves, although the agreement was never ratified, to end both reparations payments and the service of intergovernmental war debts among themselves. After making token payments in 1932 and 1933 (accepted by the US as not formally defaulting), the UK government chose to default in 1934. (Of all the sovereign borrowers, only Finland maintained an unbroken record of payment, making a final payment in 1975 eight years ahead of schedule (to a toast from President Ford at a state banquet in Helsinki)).

As Gill makes clear, the issue for the UK itself was never primarily about ability to pay. Yes, the Great Depression had happened – but it was much less severe in the UK than in the US (or Germany, or New Zealand/Australia) – and going off gold in 1931, and the subsequent exchange rate depreciation, had raised the sterling servicing costs of the US war debt. But even by 1933, UK real GDP is estimated to have been only about 2.5 per cent below the 1929 peak, and by 1934, when the final default decision was made, UK real GDP was hitting new highs. The issue was primarily one of willingness to pay, a willingness that was no longer there (amid a European desire – which would not have benefited the UK financially – to have wiped the war debts/reparations slate clean). From Gill’s account there was little appetite in political circles, government or opposition, or in the wider public to keep on paying (though of course by 1934 impressions will have been influenced by other countries having defaulted in 1932).

The US was another matter, even though it had been President Hoover who had in 1931 initiated a one-year moratorium of all intergovernmental war-related payments. There were attempts to negotiate with the US but they were ultimately futile. Even though there were some prominent figures in the Hoover administration who favoured a more generous settlement, Congress was the main obstacle and in the depths of Depression there was no public mood sympathetic to writing down the debts. In fact, in early 1934, Congress passed, and Roosevelt signed, the Johnson Act, under which no government in default to the US would in future be able to borrow in the United States (enforced via heavy criminal penalties on anyone in the US involved in buying or selling such bonds). Gill notes that there are suggestions that Roosevelt may have been sympathetic to this measure, but whether he was or not, he had other fights he chose to spend his political capital on. The Johnson Act was in place when the UK made the final decision to default.

Much of the book is about the aftermath of default. As Gill notes, the defaults (not just Britain’s) appear to have reinforced the aversion to involvement in European affairs that resulted in the Neutrality Acts. But the most tangible effect, that came increasingly into focus, was the inability of the UK to borrow in US markets, something it would not normally do in peacetime anyway, but which would be likely to be necessary in the event of a new general European war (there had been considerable UK government on-market borrowing in the first couple of years of World War One, while the US was still neutral). Gill cites documentary evidence that in 1938 and 1939 senior British officials, and presumably ministers, were well aware of this emerging constraint (he isn’t writing about France, but it would be interesting to know if French officials were equally well aware). The issue wasn’t likely to arise in the very short-term (foreign reserves and existing holdings of marketable securities could be used to generate USD) but could easily became a binding constraint in any protracted (and British preparations assumed any new conflict with Germany would be protracted).

The issue came to a head by late 1940, as the British had placed defence orders in the US (and taken over some of those placed by France before the fall in June 1940). Its own sharply declining export receipts exacerbated the intensifying pressure on the available foreign reserves (USD and gold holdings) and it was increasingly apparent to both British and American officials in late 1940 that by some point in 1941 Britain would no longer be able to pay for the orders that were being placed.

By this point Roosevelt – whether he envisaged the US eventually entering the war or not – had concluded that Britain’s successful resistance was in the best defence interests of the United States.

And thus the genesis of the Lend-Lease programme under which aid could be granted to other countries, when doing so was judged to be in the defence interests of the US. Huge amounts were to go to the UK and the USSR in particular without any real expectations of post-war repayment (the idea of returning equipment after the war was there at the start). There was, by this time, a real aversion on all sides to a repeat of the entanglement of debts, and tensions post-war, of World War One (although the British – with survival at stake, the continued ability to fight the war – would have borrowed if they could, and did borrow heavily from within the sterling area).

But even with Lend-Lease well underway, and the US itself entering the war in December 1941, as Gill documents the memory of the 1934 default still hang over financial dealings between the UK and the US. In a decision he later regretted (describing it as his worst mistake in office) Truman cut off Lend-Lease assistance as soon as the war ended. The UK’s own export industries were not going to fully rebound overnight, and the UK still had significant foreign currency commitments (including occupation forces in Europe), and without a significant decline in living standards and/or a deep depreciation of the exchange rate (which finally came in 1949), the UK needed a gift or a loan (a large amount either way) from the US. People debate whether the US should have been more generous, but Gill’s book documents the way in which the memory of the past default shaped public and congressional opinion in finally agreeing the onerous terms of the loan (some of which quickly proved unsustainable,and were not sustained). This approach in turn jeopardised Britain’s willingness to proceed to join the IMF and World Bank (the very late British vote to finally proceed – mid-December, less than 3 weeks before the deadline – may have further reduced the prospects of New Zealand joining at the foundation).

You might have supposed to surely by this point, a whole new war having flowed under the bridge, the old debts – and memory of the default(s) would have passed into history, with no ongoing significance. And I think a fair reading of the book would be that that was largely so in the end in substance. But not in law, and – Gill has a book to sell – there have been surprising returns of the issue in the decades since, which have kept officials (and lawyers) busy, even apprehensive, from time to time. The US has never written off the World War One debts and has continued to record them with accrued interest in their own government accounts (Gill reproduces a US Treasury table from 2009, showing US$37.2 billion of debt outstanding, $16.7bn of which is owed by the British government. The British government accepts that the debt has not been written off – although since World War Two got fully underway they have not received six-monthly demands for payment – and has also long had the position that its own loans to World War One allies (including New Zealand) have not been written off either (of the New Zealand loan, Condliffe’s 1959 economic history records that after 1952 New Zealand no longer included its debt – 24.1 million pounds remaining, before any accrued interest – in our public debt statistics, but still recognised it then as a contingent liability). Gill even recounts the story of a court case arising out of a decades-old (1920s) will where, after the death of the life-interest beneficiaries the proceeds (by this time the 1990s) were to go towards Britain’s war debt to the US, in which officials in both countries had to decide what signals might be sent by their stance towards the litigation (to change the terms of the bequest). US courts ruled that there was a valid outstanding debt, which was legally enforceable.

But still the legacy of the default was not exhausted. When the UK first sought sovereign credit ratings in the late 1970s there appears to have been considerable discussion around whether and what to disclose regarding the 1934 default (which did not stop the UK getting AAA ratings.

There was talk in the 1960s, when France had accumulated large reserves, and was threatening to convert them to gold, of suggesting an offset with the French war debt. In the early 70s, a hundred US congressmen signed a resolution on collecting the old debts (at the time, the US was successfully pursuing debt arrears with several other sovereign borrowers). As recently as 25 years ago, then US Treasury Deputy Secretary Lawrence Summers was involved in a controversy within the US government regarding the accounting treatment of these debts and the signals that might be sent by particular choices. In this century there have been occasional questions in the UK Parliament regarding these debts. They sit, it seems, in a limbo in which it is in nobody’s interests to seek to press for payment (no one wants to reawaken the entire chain on other debts and claims, including German reparations) but no mileage in seeking to get the debts formally written off either. Perhaps they will forever.

In case you are wondering, the Johnson Act is still on the statute books – I have a hard copy of this very short piece of legislation in front of me as I type – but it was amended in 1948 to state that the provisions do not apply to any country that was a member of the IMF and World Bank (the UK has done some occasional borrowing in the US). New Zealand, of course, did not join the IMF until 1961, but then we had neither borrowed from the US government nor defaulted to them.

It is a fascinating and well-written book, drawing fairly extensively on archival material. New Zealand pops up surprisingly often: that outstanding debt to the UK still (apparently) not legally written off. There is absolutely no doubt that the default and the Johnson Act constraints mattered a lot over 1939-41, although I can imagine some other scholars perhaps mounting an argument that the post-war story, curious and interesting as it is, is a little over-egged (and I didn’t find his account of NZ’s debt difficulties in 1939 particularly convincing). Gill often raises the “what might have been” (but impossible to answer) questions. That could have been from both sides – whether more courageous political leadership in the mid-late 20s might have lead to a cancellation of all inter-government war debts, or whether (since it was able to pay) the UK continuing to service the debt after 1934, perhaps easing the grounds for finance in the early years of World War Two. It is impossible to tell but, intriguing factoids aside, perhaps what I took away most was the astonishing and courageous nature of the British decision to push towards confronting Hitler in a war knowing that the only international credit market where they might otherwise have raised funds was firmly closed to them. (If you wonder how Hitler got on, having no borrowing markets open to him, think pillage and plunder (“occupation levies”) of three of the most advanced industrial countries under Germany occupation by mid 1940.)

How much debt defaults really matter – especially for on-market debt raising – is primarily an empirical questions. But some years ago at a function I was talking to someone senior in local government finance in New Zealand. Somehow NZ’s credit record came up and I mentioned that in the article (linked to in the first paragraph) about New Zealand’s 1933 default I had noted in passing a couple of NZ local government debt defaults in the 1930s. My interlocutor was somewhat rattled as apparently information memoranda to potential latter day investors in local government securities had reported that no local government in New Zealand had ever defaulted. The defaults of a couple of small local authorities 80 years earlier probably had little useful information on probability of default now, but it still seemed to attract a little attention.

Now I’m almost curious as to what would happen if I sent $50 to the Minister of Finance or Treasury towards settling New Zealand’s outstanding World War One debt to the UK.