1 Running Head: BRITAIN USING BONDS TO FIGHT WARS Britain: Using Bonds to Fight Wars and Become World Leaders Nicholas White Sacred Heart University 2 BRITAIN USING BONDS TO FIGHT WARS Abstract The purpose of this paper is to discuss how Britain unknowingly created a disruptive innovation in the form of bonds which ultimately shaped how debt markets function today. With the implementation of the first government bond by Britain, many countries followed suit, and it played a key role in war victories. Without the up-front capital, Britain might not have won the wars they did and in turn become the world leader that they were. The evolution of the bond and debt markets as a whole posed challenges for the world, with the collapse of economies and the Global Financial Crisis in 2008. Concerns surrounding debt are that countries as well as individuals can become over-leveraged where they will be unable to pay back their debts when the time arrives. With this in mind, countries and people have learned more about how to balance financing with paying up-front. Through the history explained below it is apparent that we must continue to monitor our debt levels, and while we must use debt to our advantage, we must do so in moderation to avoid catastrophe as seen in the past. 3 BRITAIN USING BONDS TO FIGHT WARS Introduction A commonly used phrase used by people is that “the world is ever-changing.” It is apparent in people’s lives every day, with advancements being introduced frequently. When looking at these advancements, one must dig deeper to find the meaning of it: is this a disruptive innovator? Disruptive Innovation (DI) is broadly defined as “any situation in which an industry is shaken up and previously successful incumbents stumble” (Christensen, Raynor, & McDonald, 2015, p.4). The world is currently experiencing this on exponential levels as the years go by, with more and more innovations disrupting how industries operate. The main reason for more innovations being realized is due to the rapid advancement of technology over the last three decades. Although technology is not a disruptive innovator, it is the main ingredient in the creation of DI. Although the term “Disruptive Innovation” was coined in 1995 by Professor Clayton Christensen, it has proven to be something that has been around many centuries before. Dating back to the 1750’s, the British created the first tradeable bond, called a “consol”. This consol assisted Britain in winning many wars throughout history that might’ve lost without it. Although they incurred massive amounts of debt which later proved to hinder them, the consol provided the country with a strong foundation to build their infrastructure and propel them to victory. The consol was a disruptive innovator for the time by letting their people attain an asset that was tradeable among themselves, where people were able to not only help their country win wars, but also receive interest on their consol in the meantime. Disruptive Innovation The first official government bonds were issued by the Bank of England in 1694. These were issued in order to assist in fighting a war against France, and Bank of England became a vital part of the success of Britain in raising funds. It was important that Britain was able to raise funds, as they were at war many times during the 18th century, so they had to provide incentives and appealing terms to 4 BRITAIN USING BONDS TO FIGHT WARS potential investors in order to raise capital. As bonds grew more popular, Britain issued its first tradeable bonds in 1751. The Bank of England helped execute the raising of funds as well as paying the interest on the bonds. In the novel The Foundations of British Maritime Ascendancy: Resources, Logistics and the State, 1755-1815" by Roger Morriss (Cambridge UP, 2011), Morriss states “The security created by the integration of the Bank and state functions permitted the British government to raise very large sums at relatively low rates of interest. Much of the money was raised by subscription to irredeemable interest-bearing bonds or stock on London's capital market. The investments formed a long-term loan to the government. Their annual scale grew from £8.5 million to more than £20 million between 1756 and 1815. As a proportion of total expenditure, they rose from 37.5 per cent to 39.9 per cent at the end of the War of American Independence, then declined during the Napoleonic War to 26.6 per cent” (Morriss, 2014, p. 94). What Morriss is stating here is that because of the Bank of England, Britain was able to borrow large sums of money due to the scale of the bank, and there are some pretty staggering growth rates here. Author Peter James Marshall states in his novel “The Making and Unmaking of Empires: Britain, India, and America c. 1750-1783” that “central to the success of government borrowing by the mid-eighteenth century was a relatively small group of rich men dubbed ‘the moneyed interest’ by contemporaries. An analysis of the principal lenders of that year shows that big sums were allocated to five principal investors, representing Dutch and Jewish interests among others, with large blocks going to the directors of the Bank of England, the South Sea Company, the East India Company, and the insurance companies. They played an essential role in the British state’s capacity to fund the deployment of naval and military power throughout the world (Marshall, 2009, p.71). Britain first collected most funds from the Dutch, until roughly the start of the Napoleonic War, which “by then Britain's domestic economy was generating wealth. Surplus business capital provided the core of investment in government debt...When country banks came into existence, they remitted surplus funds to London which were made available to the state through the purchase of consols and securities. As 5 BRITAIN USING BONDS TO FIGHT WARS the economy grew, money for loans to government always seemed available: In December 1796 a "loyalty loan" of £18,000,000 was subscribed in four days” (Morriss, 2014, p.95). Due to the issuance of bonds, Britain was able to secure massive amounts of outside funding as a means for bolstering infrastructure and the military during a period in which they were at war plenty of times. At first, money came from overseas, but as the investment became more well-known by the people of Britain and the economy continued to become stronger, they were able to secure funding just in time for the start of the Napoleonic War. Napoleonic War The Napoleonic War was a time in which the French were looking to assert dominance in Europe, still not appeased with what transpired in the French Revolution in terms of the war. It was a time just at the beginning of the nineteenth century when in 1803 the war started, with the first battle happening in 1805: the Third Coalition. Before this battle, most of Britain’s debt was secured from overseas investors. Looking at 1750 through the late 1760’s it is shown that the percentage of overseas nominal holdings in Britain had reached a peak of 16.6%, but once it hit its peak it gradually declined (Wright, The Contribution of Overseas Savings to the Funded National Debt of Great Britain, 1750–1815, 2003, p.3). During the start of the Napoleonic War the percentage of overseas nominal holdings in Britain had dropped between three and four percent (Wright, The Contribution of Overseas Savings to the Funded National Debt of Great Britain, 1750–1815, 2003, p.3). Taking a deeper dive as to why overseas investment fell, it was “possibly because of the much lower interest rates that held after the turn of the century, overseas investment in Bank- registered stocks declined by £3 million to 1806 and by another £2 million by 1810. At that point nominal investment since the beginning of the war against France was a mere £15 million out of a total of £379 million” (Wright, The Contribution of Overseas Savings to the Funded National Debt of Great Britain, 1750–1815, 2003, p.18). Due to the low interest rate environment at the time, it was not as attractive as it had once been for an investor, with them 6 BRITAIN USING BONDS TO FIGHT WARS usually getting higher returns for lending their money to the British government. It was realized that during the start of the Napoleonic War, 95.9% of borrowing came domestically, with 103.6% being domestic in 1802-1810, and 100.1% in 1811-1815 (Wright, British Government Borrowing in Wartime, 1750‐1815, 2003, p.6). This was tough for the British government, during a time where they were still fending off battles from nations and looking to assert their dominance. It was at this moment that they needed to better introduce consols as well as tradeable stocks through companies such as the South Sea Company and East India Company. It was apparent their efforts had worked when data shows that the nominal debt increased during 1793-1801 from 1781-1784 by roughly 71.5%, a jump from £73.2mm to £257.2mm (Wright, British Government Borrowing in Wartime, 1750‐1815, 2003, p.6). This was a staggering increase and one of the driving forces behind Britain’s victory in the Third Coalition, which was won due to the exceptional infrastructure and assembly of ships. Without this large increase in debt used through consols as well as tradeable consols, Britain would have been unable to finance the war.