Inflation can destroy the value of long term fixed-rate bonds, especially when that inflation is volatile or rising. If inflation gets out of control, it can become difficult to find willing lenders in a currency people have little faith in. For much of the mid-20th century, France was plagued by inflation that was high by the standards of developed economies, and this was making it difficult for governments and companies to borrow money in French francs for long horizons at fixed interest rates. In response, issuers and investors turned to bonds whose returns were linked to variables reasonably expected to be correlated with inflation. The most notable of these were French sovereign bonds linked to gold, the Pinay bonds.
After the end of the Second World War, France was plagued by inflation. Rising prices were triggered by an enlarged supply of currency and scarcity of goods. Post-war governments nationalized industries, ran large deficits, and expanded bank credit, all of which worsened the rising prices. Inflation strained the French financial system and left capital markets moribund.
After all, who would want to invest in fixed-rate securities when the value of the franc was so uncertain? As an alternative, people stored wealth in gold. However, unlike in securities, there was little way to tap wealth stored in physical gold for productive purposes and this was a persistent problem successive French finance ministers tried and failed to solve.
One of the favored ways of storing gold wealth was by holding ‘napoleon’ coins. With a denomination of twenty francs, these were struck since the early 19th century. By 1952 though, they were worth four thousand francs apiece as the franc depreciated against gold. In addition to hedging against inflation, storing wealth via physical gold offered a means to avoid tax upon gifting or bequeathing that wealth. The tax authorities could not trace transfers of physical gold so easily as those of real estate or securities.
Antoine Pinay, France’s Prime Minister in 1952, devised a means of directing the gold wealth of Frenchmen towards the state. He introduced government bonds linked to the price of a gold napoleon coin. The value of a rente Pinay, or ‘Pinay bond’, would increase with the market price of the napoleon. The bonds could also be redeemed for the value at which they were purchased, setting a lower limit on their value in the then-unlikely event gold prices fell. Pinay bonds paid 3.5% interest, something gold hoarded under the mattress couldn’t do. Investors paid for their bond investments in gold napoleons.
While curious creations, bonds indexed to the value of the franc in one way or another had been issued before. A government bond issued in 1925 was linked to the franc exchange rate and another such bond was issued in 1937. Still, the post Second World War experiment with such securities would be far larger.
Pinay hoped to marshal the private wealth of Frenchmen for war reconstruction projects. Whatever the merits of the projects, he was certainly successful in raising the money. Within four days of being offered to investors, the Pinay bonds released seventeen tons of gold from people’s private holdings, assets that were now in the hands of the French treasury. The bonds were such a success that a new issuance of Pinay bonds was made in 1958. The experiment showed that even amidst a depreciating franc, private savings could be accessed for investment purposes provided securities were created that directly addressed inflation risk.
In the 1950s, bonds linked to prices would be issued in countries outside France, from Chile to Finland. Within France, in the aftermath of the 1952 issuance of Pinay bonds, there would be sixty issuances of bonds indexed to prices or other variables by private or public issuers. For example, Électricité de France, then a state-owned company producing and distributing electricity, issued a bond linked to the price per kilowatt hour of electricity. Other French companies, particularly other state-owned companies like the railway operator SNCF and Gaz de France, issued bonds linked to prices. The bonds issued by SNCF were linked to the price of third-class railway tickets.
Also gaining fashion in France at this time were bonds linked to variables other than prices, like companies’ sales volumes or dividends to shareholders. As some examples, Michelin issued a bond in 1955 linked to sales volumes and Citroën bonds from 1954, 1955, and 1956 were linked to company dividend payments. Bonds indexed to a variable like price movements or sales volumes could be issued at lower interest rates than fixed-rate bonds. Though the issuer was taking some risk that movement in the linked variable could favor investors and increase interest costs, since this variable was also associated with company revenues, like the price of railway tickets in the case of SNCF, this wasn’t problematic.
For a while in the late 1950s, most new bond issuances by French corporations contained a variable feature of some sort. The fact Citroën issued many and that, at least through 1959, no companies had repaid such bonds earlier than required suggests issuers preferred these variable bonds to fixed-rate debts. For most bonds that are anything but fixed-rate, the risk is often thought of as a risk to the issuer but because these were linked to something correlated with company success, like revenues or dividends, they were quite friendly to borrowers in practice.
Still, the experiment wouldn’t last long. Issuances of variable-rate bonds, especially those whose principal repayment was linked to movements in a price or index, occupied a legal gray area and frequently drew of ire of French courts. In 1961, the French government effectively banned issuance of new indexed bonds. The government feared that the bonds accelerated inflation by tying incomes to prices that were themselves rising; banning them, the government hoped, would reduce the likelihood of an inflationary spiral. The already outstanding indexed bonds, especially the gold-indexed bonds, would deliver stronger returns to investors than ordinary bonds in the period from 1960 to 1975. The high and persistent inflation had much to do with this.
The Pinay bonds made a return in 1973, this time known by the name of then Finance Minister and future President Valéry Giscard d’Estaing. The ‘Giscard bonds’ were intended to consolidate the two older bonds of 1952 and 1958 and raise new money for the French government. They were also linked to gold but paid a higher 7% interest rate over a 15-year term.
Through the inflation of the 1970s, which increased the price of gold in terms of francs, the value of the bonds surged. By January 1980, Giscard bonds were worth seven times their face value. In 1987, as the Giscard bonds’ maturity came near, the bonds were worth nearly nine times their original value. This proved to be an expensive loan for the government and not on an entirely insignificant scale. The cost of the final repayment came to approximately fifty-six billion francs, a sum equivalent to 4% of France’s national debt.
Still, this experience did not discourage future creativeness. France remained something of an innovator in issuing bonds linked to the purchasing power of the franc. In 1998, France became the first country in Europe to issue inflation-linked sovereign bonds. The decision was intended to reduce borrowing costs and offer investors securities that protect them from inflation risk. The desire to maintain an innovative and attractive bond market heading into the Eurozone experiment was also a motivation.
Most of the demand for this new bond came from French insurance companies and mutual funds but demand from the United Kingdom and other European countries was also high, proving they had a broader demand in Europe generally, where this concept was still novel. Today, inflation-linked bonds are more common.
Inflation-linked bonds, or similar variable-rate bonds, may restore public confidence in securities during periods of high inflation. When issued by a government, they may even suggest a commitment to reining-in inflation. France’s experience with the Pinay bonds suggests that the mere issuance of such securities can unlock the private hoardings of reluctant investors before moderation in inflation has even been achieved.
Of course, if the government fails to bring inflation under control, then issuing bonds whose returns to investors are linked to the purchasing power of money can prove an expensive way to borrow. However, it’s this very alignment of the interests of the creditor with those of the debtor that makes investing in securities more appealing, and the lack of such an alignment is what keeps money from being invested in securities and ultimately towards social betterment or productive purposes.
More from the Tontine Coffee-House
Read about foreign currency bonds issued by the United States government in the 1960s and 1970s. Also, compare France’s problems in the 1950s to the even more difficult monetary conditions in Germany immediately after the war. Consider subscribing to this blog’s newsletter here.
1. Deacon, Mark, et al. Inflation-Indexed Securities: Bonds, Swaps and Other Derivatives. John Wiley & Sons, 2004.
2. “Foreign News: Gold-Edged Security.” Time, 9 June 1952.
3. “Gold-Backed Giscard Bond Poses Problems for French.” The Northern Miner, 21 Dec. 1987.
4. Jacquillat, Bertrand, and Richard Roll. “French Index-Linked Bonds for US Investors.” Journal of Portfolio Management, 1979, pp. 24–30.
5. Rozental, Alek A. “Variable-Return Bonds–the French Experience.” The Journal of Finance, vol. 14, no. 4, Dec. 1959, pp. 520–530.