Episode Two of Clauses and Controversies: Imperial Chinese Bonds

Mark Weidemaier & Mitu Gulati

To prepare for later discussions about how to address the looming debt crisis caused by Covid-19, our first few episodes of Clauses and Controversies look backwards, albeit to historical events with current salience. Episode Two is our first official episode and is about pre-PRC Chinese bonds that have been in default since before World War II. One of us (Mitu) loves this topic and the other (Mark) increasingly flies into a rage whenever it comes up.

Our guests are the wonderful Tracy Alloway of Bloomberg (whose article about these bonds last year went viral), sovereign debt guru Lee Buchheit (who knows more about the history of these types of bonds than anyone – here’s the FT's Robin Wigglesworth on Lee), and Alex Xiao, a former student who is working on a paper on this topic.

The subject of defaulted Chinese bonds is back in the news, largely in connection with U.S.-Chinese trade talks. (Are there trade talks?) A group of ardent Trump supporters have apparently accumulated a bunch of these bonds. Izabella Kaminska of the FT wrote about this a recently, and so did Fox Business a couple of days ago. (The Fox Business piece was a bit more enthusiastic, shall we say, than the others.) Previous lawsuits seeking to enforce them have failed on sovereign immunity and statute of limitations grounds, so these investors are lobbying the President to negotiate a recovery for them as part of his trade talks. And there is some reason to think the administration might be interested. The President is inclined to anti-China and anti-Chinese rhetoric, and these defaulted bonds are an opportunity to indulge that impulse further. Plus, Chinese institutions hold huge amounts of U.S. government debt, and some have floated the loony idea that these defaulted Chinese bonds could be used to offset some of that debt. For a deeper dive, here is a fun piece, The Emperor’s Old Bonds, by three former students.

So, why do we have a love hate relationship with these bonds? Here are the remarks we sent our expert guests as a prelude to asking for their views.

Mitu

How could one not love these bonds?  They are so incredibly full of history, politics and drama. Starting from the Hukuang Railway bonds, resentment about which precipitated a revolution, to DJT’s rumored interest in them as a means of extracting trade concessions, they are a window into why sovereign bond disputes are always about so much more than the words on the contract agreement.

Take the words on the front of at least one of these defaulted imperial bonds, that say (roughly) that the obligations are those of the current government and all successor governments. That raises the core question in all of sovereign debt of whether a government – even a corrupt monarchy under the thumb of western imperial powers – can bind future generations for time immemorial. Or what about the priority clauses in some of these bonds? These are clauses that say that particular bonds will be paid with first priority over all other obligations.  If the clause says something like this, is there an ongoing violation every time the current government in China pays any of its recently issued bonds?

Mark

Yes, these bonds are interesting. But I have two problems with them. First, in any sensible legal system they would be unenforceable. We should stop giving ammunition to people who want to pretend otherwise. The argument for getting around the statute of limitations, as Mitu alludes in his comments, focuses not on China’s breach of its promise to repay (because any suit for breach of that promise is clearly time-barred). Instead, the argument points out that some pre-PRC bonds include a promise to give bondholders priority over other claimants. The argument is that China violates this promise, and thus starts the statute of limitations clock running anew, whenever the Chinese government makes a payment on its public debt—essentially, from now until the heat death of the universe. The argument implies that the statute of limitations will never run, that parties can write contracts that dispense with the statute altogether. But they can’t. The statute of limitations exists in part to avoid wasting public resources on enforcing stale claims, and these are as stale as claims get.

Now, nothing prevents representatives of the U.S. government from demanding that China compensate a bunch of people holding legally-invalid claims. But the idea that the Trump administration would spend negotiating capital on that—rather than, you know, on the legitimate economic and security interests of the United States—irks me. Is it possible to imagine a less deserving group of claimants? They bought wall art and are now cosplaying aggrieved lenders.