War bonds are a ticking debt bomb

By Jonathan Levy  / 

Fri, Aug 23, 2013 - Page 8

Will the rumored reconciliation between the Chinese Nationalist Party (KMT) and the Chinese Communist Party (CCP) trigger a little-known clause that will force the redemption of billions of dollars in defaulted Chinese government debt?

In 1949, Chiang Kai-shek’s (蔣介石) Nationalists made a successful last stand on the island outpost of Taiwan against the almost victorious red tide of Mao Zedong (毛澤東). However, prior to 1949, Chiang’s Republic of China (ROC) was a profligate issuer of sovereign bonds, most of it backed by gold. These bonds sold around the world and were underwritten by the largest banking houses like HSBC, Barings, Bank of China and JPMorgan. They were viewed as gilt edge investments with a high rate of interest.

The bonds were used to finance the wars against Japan and the Communists, Chinese infrastructure like railroads, and they helped to modernize China. The bonds also put China deep into debt. By 1939, the war with Japan had forced China to suspend payments on most bonds, though additional victory and liberty bonds sold in China and the US helped finance the successful war effort against Japan.

By 1949, China had redeemed some of its World War II debt, and had Chiang defeated the Communists, he would undoubtedly have dutifully begun to pay off the remainder, some of it dating back to the Imperial days of China’s Boxer Rebellion reparations, in order to keep the nation’s credit rating above water. However, after being forced to retreat to Taiwan in 1949, the Republic of China in exile had no alternative but to put the bonds into hibernation.

The ROC Presidential Order on Oct. 29, 2003, implemented from March 1, 2004, by the Order of the Executive Yuan Article 63 of the Act Governing Relations Between the People of the Taiwan Area and the Mainland Area (台灣地區與大陸地區人民關係條例) states:

“To the extent not contrary to the public order or good morals of the Taiwan Area, it shall be upheld the legal effects of any civil matter together with any right or obligation thereof created in the Mainland Area, prior to the coming into force of this Act, between any of the people of the Taiwan Area and the Mainland Area, or between any two or more of the people of the Mainland Area, or between any of the people of the Mainland Area and any foreign national.

“The provisions of the preceding paragraph shall not apply provided that there had been laws or regulations in effect, prior to the coming into force of this Act, restricting the exercise or transfer of the rights referred to therein.

“The following debts shall not be repaid prior to national unification:

“1. Outstanding foreign currency bonds issued in the Mainland prior to 1949 and the short-term Gold Bonds of 1949.

“2. Various debts owed by any government bank, as well as any other financial institution accepting deposits before their retreat from the Mainland.”

According to former minister of justice Cheng Chung-mo (城仲模): “The intent of this Act in regards to pre-1950 Chinese bonds was to reaffirm their existence as defaulted foreign debt obligations of the Republic of China owed in the United States and elsewhere and to defer their resolution until national unification. These bonds referred to in Article 63 were all issued by the former Kuomintang government of the Republic of China or were ratified by the Kuomintang government.”

When the bonds were effectively put in cold storage in 1949, the economy of the embattled KMT-controlled Taiwan was minuscule and could not reasonably be expected to pay back the combined debts of a 60-year Chinese borrowing spree. Today however, the combined economies of the PRC and Taiwan are formidable. Poverty would not be a reasonable excuse if Article 63 were triggered by a KMT brokered reconciliation.

Institutions and banks have, at least publicly, written off the defaulted Chinese bonds long ago. The US Securities and Exchange Commission considers these bonds to be historical documents worth only what a collector would pay to a collectible bonds dealer, or on EBay, to own a bit of the past. Con artists have also used the bonds to defraud their victims.

On the other hand, the bonds were recently still trading on the Paris Euronext Exchange, albeit at a fraction of face value. The individual bondholders are a tenacious lot and have refused to accept that the bonds are unredeemable. The American Bondholder Foundation takes one tack claiming that the PRC will redeem the bonds on its own initiative. This is unlikely since the KMT, not the PRC, was the issuer, although the foundation has had enough pull to get several US congressmen to support their scheme.

Another large group of individual bondholders combined to sue the KMT in the Taiwan Civil Rights Litigation Organization (TCRLO) versus Kuomintang Business management Committee federal court case in California. Although the bondholders sought a default judgement backed by Article 63; the US court declined jurisdiction, citing too much time had elapsed from 1950. However, the bondholders did manage to bring forward Article 63 and obtain Cheng’s expert opinion.

The court, while dismissing the case as too dated, did not dispute the logic or lawfulness of the Article 63 reaffirmation. See Taiwan Civ. Rights Litig. Org. v. Kuomintang Bus. Mgmt. Comm., 2011 U.S. Dist. LEXIS 124812 (USDC ND Cal., Oct. 13, 2011); Affirmed by Taiwan Civ. Rights Litig. Org. v. Kuomintang Bus. Mgmt. Comm., 2012 U.S. App. LEXIS 21621 (9th Cir. Cal., Oct. 17, 2012).

How much debt is out there? Most bondholders agree the aggregate debt could be in the billions. Some of the bondholders are hoping for the full value of bonds, interest and penalties, all keyed to the value of the gold backing the bonds, an astronomical sum. Others are like the bondholders in TCRLO v. KMT who were seeking a more modest amount of interest dating from 1950 when the KMT put the bonds on ice.

No one would be happy with the small fraction of face value which was offered to British bondholders in 1997 as an accommodation to the UK government upon the transfer of Hong Kong to Chinese suzerainty.

A KMT-CCP accord on the mainland, however, would by law trigger Article 63. Former president Chen Shui-bian (陳水扁), no fan of the CCP and currently a political prisoner of the KMT, was the man who reaffirmed the bonds via Article 63. Indeed, Chen no doubt knew that by keeping the debt issue simmering on the back burner, reconciliation would be less likely given the potential amounts at stake.

Taiwan itself, under Republic of China occupation since 1945, had no part to play in racking up the debt. Taiwan was a possession of Japan from 1895 until 1945, the very dates when almost all of the debt arose. Taiwanese would not stand for insult being added to injury by being forced to pay off a hefty portion of the KMT’s debt in China, which financed the industrial infrastructure that the PRC today exploits. Yet, the KMT that stands to profit from a reconciliation seems to believe that Taiwanese will meekly pay any cost.

By filing a lawsuit about the debt time bomb, the bondholders and TCRLO have exposed the seamy underside of KMT politics. The price tag of reconciliation would no doubt fall disproportionately on Taiwanese and, while the PRC might pay some of the old debt, they would not pay all or even most of it.

Then there is the question of what happened to the gold that backed the bonds in the first place. Before the KMT fell, it evacuated, by air and sea, many of its hard assets from China. TCRLO and the bondholders contended that this gold formed the basis of the KMT’s billions, the so-called black gold that has financed so many KMT business and political operations over the years.

The KMT would be loath to give up its billions, now dispersed among its business subsidiaries and banks, and it would never permit an audit. Again the people of Taiwan would be forced to take up the slack and give generously to finance a reconciliation with the CCP that they do not need or want.

Ultimately, the bondholders should be paid a fair return by the PRC, which still benefits from the infrastructure the bonds paid for, and from the KMT, which apparently absconded with the gold to fund its own enrichment. The rehabilitation of Chen’s legacy is the first step in a process that hopefully will lead to both the independence of Taiwan and breaking the back of the KMT’s unjust enrichment.

Jonathan Levy is a member of the International Criminal Bar and an adjunct faculty member at Norwich University’s Diplomacy Program. The author represented the bondholders and TCRLO in TCRLO v. Kuomintang and has also represented former president Chen Shui-bian. The opinions expressed herein, however, may be attributed to the author, who speaks only for himself and not his former clients.