The worsening situation of these companies is down to their reckless use of index-linked bonds to finance their borrowing. Index-linked bonds guarantee that people lending to a company will get their money back having allowed for the impact of inflation when it is repaid.
The interest rate these bonds pay is usually quite low but people who buy them don’t do so for the interest. They buy them because these bonds guarantee repayment of the original sum lent as adjusted for inflation, meaning that the value of the bond does not fall in real terms.
Let me offer a quick example. Suppose a bond is issued for £1 million with a 1% interest rate, and it is index linked. Assume inflation was nothing for 5 years. In those years the interest was £10,000 a year.
Then, though, inflation hits 10% all of a sudden. Now the cost of repaying the loan goes up by £100,000 in the year that happens. And interest is now paid on £1.1 million, the new repayment sum owing. So that year’s interest costs £111,000. That’s a massive increase.
If the inflation continues for a second year you can see how this might ruin the profitability of a company. If it moves into a third – as now seems possible in the UK – it could mean the end for a vulnerable company with a lot of these bonds.
When the Treasury accounts for interest on inflation linked gilts in exactly this manner then they’re wrong according to Spud. But the truth is always subject to the narrative, isn’t it?
And even better:
So, the only cash cost to be paid is the cost of the interest on the new bonds issued to replace the bonds and share capital now in issue. Let’s assume the total compensation package is £60 billion in a couple of years, by which time base interest rates will have fallen a lot.
Let’s say the borrowing cost will be 4%. That’s a cost of £2.4 billion per annum when the average interest and dividends paid by the companies over the last amount to £3.4bn a year. Even if £90bn compensation was paid (and that would be crazy, in my view) the cost would be £3.6bn.
In other words, this industry can pay for its own nationalisation out of its own cash flow.
If the cash flow covers the capital costs then it’s not insolvent and requiring nationalisation, is it?