Government as bond issuer
A relatively small country with its own currency will sometimes find that flogging its bonds has become less easy than hitherto. Fearing a currency devaluation, major buyers may turn leery, believing existing bonds may soon be trading at a discount, or at a discount steeper than the current one. Nobody wants to buy an asset that may soon drop in price.
Such a government understandably looks for some way to assure prospective buyers their bonds are a safe buy. But when the usual quantity buyers of bonds turn skittish, only a higher rate of interest on new issues is likely to entice them to take on the risk of ownership. ..Yet, a higher rate of interest on new bonds obviously makes that government’s situation worse, if making the payments on its existing debt is already straining its finances.
When future payments in money pose a problem, then an obvious solution is to pay in something other than money. ..Hence, a commodity bond, whose interest payments are in some specified commodity. Which for present purposes say is sea salt –however unlikely a choice that may seem.
Consider a bond carrying an interest rate of 6% ..(which is 60 euros per 1000 euro bond; ..60,000 euros for bonds worth one Mega euros). ..Now let’s swap that bond for one paying 4 tons of sea salt per 1000 euro bond; ..4000 t per Mega euros of bonds; ..or on 5 Mega euros of bonds, 20,000 t of sea salt (a smallish shipload).
The bondholder may take either physical delivery of the salt or the cash proceeds of its sale at public auction. {Some bondholders might prefer to arrange a private sale, price undisclosed.}
The difference for the government.
Consider what differences this makes for the government issuing such commodity bonds:
– First, as Commodity bonds pay interest in physical product instead of in money, there is no currency exchange risk, which will appeal to any buyers wh0 think the currency of the issuer is a risky proposition.
-Then also, whatever the commodity is, perhaps it will bring in more money in future years, and the prospect of greater future income will affect what buyers today are willing to pay for the bonds today.
-The commodity will cost the gov’t something, either in a direct purchase, or because it accepts this commodity from some entity in lieu of taxes otherwise owing; (or perhaps it is a new levy unrelated to any previous tax).
-But say the gov’t purchases the commodity and holds it for the bondholders, or to whoever presents certificates entitling them to a stated quantity of that commodity, this being (in effect) a coupon attached to each bond.
-Most bondholders or presenters of certificates are likely to live outside the country, while the commodity producers are within. In buying the annual amount to be distributed to coupon presenters, the government is paying local producers who employ local people. This helps the local economy.
-Otherwise, were these ordinary bonds paying money interest, most of that money would flow out of the country and do no good for the local economy.
-Now, a stronger economy means greater income for the gov’t and less social expenditures on the unemployed, since people are employed producing, selling and forwarding the commodity (whatever it is), and perhaps also in local industries making use of it.
However, there is one negative for a government issuing commodity bonds. Prices for that commodity being likely to rise over the years, this benefits the bondholders whose income from these bonds is likely to match the rate of inflation. But of course the expense to gov’t in purchasing that commodity also rises over time. In short, the issuing gov’t forgoes the advantage that inflation works on debt interest paid in a fixed sum of money, but it gains the benefit of an ongoing local industry producing the said commodity, and those people employed do pay taxes to government.
Moreover, when such commodity bonds are for a long term — such as thirty years — then the terminal payment of the face amount upon the bonds’ maturity will be in depreciated currency. So there is no difference in that respect with ordinary bonds whose interest payments are for a fixed amount of money.
Commodity bonds may be useful if the commodity in question generates a fair amount of employment and income for locals providing that commodity to their government. Using them is a form of economic development.
See other item — Commodity Bonds as Development Tool