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Longshot bet on ancient Chinese bonds could pay off thanks to trade war

Bloomberg logo Bloomberg 8/29/2019 Tracy Alloway

President Donald Trump’s next move in an increasingly fraught trade war with China could be one for the history books, literally. The Trump administration has been studying the unlikely prospect of reviving century-old claims on Chinese bonds sold before the founding of the communist People’s Republic.

The defaulted China bonds can be found in the attics and basements of thousands of Americans, or on EBay, where the certificates sell as collectibles for as little as a few hundred dollars each. The PRC, which succeeded the Republic of China after it replaced the imperial dynasty, has never recognized the debt, though that hasn’t stopped decades of attempts to collect payment on it.

Now, with Trump ratcheting up the trade rhetoric with China, holders of the antiquarian bonds are hoping he’ll press their case, even as other parts of the U.S. government are accusing people of fraudulently selling the same paper.

Perhaps the only thing more peculiar than the story of the Chinese debt and the unlikely bid to seek payment on it, is the cast of characters drawn into its orbit. President Trump, U.S. Treasury Secretary Steven Mnuchin, and U.S. Commerce Secretary Wilbur Ross have met with bondholders and their representatives. Kirbyjon Caldwell, pastor of a Texas megachurch and spiritual adviser to George W. Bush, has been charged by the U.S securities regulator for selling the debt to elderly retirees. (Caldwell has pleaded innocent and maintains that the bonds are legitimate.)

“With President Trump, it’s a whole new ballgame,” says Jonna Bianco, a Tennessee cattle rancher who leads a group representing pre-revolutionary China bondholders and who has met with the president. “He’s an ‘America First' person. God bless him.”

Hundreds, if not thousands, of these 5% Hukuang Railways Sinking Fund Gold Loan of 1911 bonds — issued in 1911 by a consortium of banks in London, Berlin, Paris, and New York — appear to have survived. Hundreds, if not thousands, of these 5% Hukuang Railways Sinking Fund Gold Loan of 1911 bonds — issued in 1911 by a consortium of banks in London, Berlin, Paris, and New York — appear to have survived.

The Hukuang Railway bond is a thing of beauty. Printed with an ornate border and carrying a large chop, the debt was sold in 1911 to help fund construction of a rail line stretching from Hankou to Szechuan.

The U.S. once referred to the money that flowed into China at the turn of the 20th century as “dollar diplomacy”—a way of building relations with the country (and its massive untapped market) by helping it industrialize. The Chinese have another term for it: For them it fits squarely into China’s “Hundred Years of Humiliation,” when the Middle Kingdom was forced to agree to unfair foreign control.

For Trump, the bonds could be something else: leverage in his fight with China. That’s what Bianco, who co-founded the American Bondholders Foundation in 2001 to represent holders of the debt, is hoping for.

Bianco says she’s spent years researching China’s legal obligations and recruiting high-profile proponents to the ABF team, including Bill Bennett, who was U.S. Secretary of Education under Ronald Reagan; Brian Kennedy, senior fellow at the Claremont Institute; and Michael Socarras, Bush’s nominee for Air Force general counsel. By Bianco’s reckoning, China owes more than $1 trillion on the defaulted debt, once adjusted for inflation, interest, and other damages—a sum roughly equivalent to China’s holdings of U.S. Treasuries. 

“What’s wrong with paying China with their own paper?” says Bianco.

From left: President Trump, Jonna Bianco, and Brian Kennedy on Aug. 12, 2018, at the Trump National Golf Club in Bedminster, N.J. © Jonna Bianco From left: President Trump, Jonna Bianco, and Brian Kennedy on Aug. 12, 2018, at the Trump National Golf Club in Bedminster, N.J.

She met with Trump at his sprawling golf course in Bedminister, N.J., last August, in an encounter she describes as “wonderful.” Since then she’s met with Mnuchin, though she won’t reveal what was discussed. ABF reps, including Bennett, Kennedy, and Socarras, met with Commerce Secretary Ross in April, Bianco says.

People familiar with the Treasury Department say the China bonds have been studied, but ABF’s suggestions—including the possibility of selling the defaulted debt to the U.S. government to then exchange with China—aren’t legally viable. Spokespeople for Treasury and Commerce declined to comment. People familiar with the views of Chinese officials say they’re aware of the meetings, but they don’t think the claims can be revived.

At issue is a statute of limitations that has long run its course and the fuzzy legal obligations of governments that inherit their predecessor’s debts following civil upheavals. In one of the most famous cases, the Soviet Union repudiated bonds sold under the Tsar, inflicting losses on thousands of investors who had snapped up the paper. Still, most agree that as a legal principle, political regimes inherit their predecessors’ debt; most governments choose to honor old bonds, in part because they don’t want to alienate investors who might buy new ones.

“I think everyone who works for Trump at the Treasury Department thinks this is loony,” says Mitu Gulati, law professor at Duke University and a sovereign-debt restructuring expert. “But I can’t help but be tickled pink, because at a legal level these are perfectly valid debts. However, you’ve got to get a really clever lawyer to activate them.”

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Clever lawyers have tried before. The closest anyone got to wringing payment out of China was a class action suit brought by bondholders in 1979 that managed to bring the PRC to court to defend itself for the first time. Gene Theroux, formerly senior counsel at Baker & McKenzie LLP, helped represent the Chinese government in court.

Theroux, now retired, remembers the landmark case well. “The requests of us as lawyers were occasionally unusual,” he says, including China nixing any citation of previous cases with “Republic of China” in the title, given its refusal to recognize the regime under its “One China” policy. (Eventually, Baker & McKenzie resolved the problem by citing old cases as “Republic of China [so-called].”)

The suit was thrown out on the basis that the 1976 Foreign Sovereign Immunities Act, which allows U.S. courts to hear cases against foreign governments for commercial claims, could not be retroactively applied to bonds issued at the turn of the century.

Since then, a 2004 Supreme Court decision ruled that the FSIA could apply retroactively in a case immortalized in the movie Woman in Gold. The ruling paved the way for Maria Altmann to reclaim paintings by the famous Austrian artist Gustav Klimt decades after they’d been seized by the Nazis. 

That still leaves the problem of reactivating modern legal claims on debt that is now decades old. Gulati argues that this could perhaps be done—for instance, by arguing that China making payments on modern bonds violates pari passi (equal payment) clauses embedded in the historic debt. Such clauses were successfully used by hedge funds seeking payment from Argentina a few years ago. It’s a legal long shot, but one that Gulati has assigned to his law students as a theoretical exercise.

The U.S. Securities and Exchange Commission is studying the debt, too. In a 2018 complaint against Pastor Caldwell and a self-described financial planner named Gregory Alan Smith, the SEC accused the pair of raising at least $3.4 million by persuading 29 investors to buy the pre-revolutionary bonds. Some of the buyers, mostly elderly retirees, liquidated their annuities to invest, the SEC said.

Messages left for Caldwell’s lawyer, Dan Cogdell, weren’t returned. In a press conference in March, Cogdell said the charges against his client were “false.” Caldwell, who was educated at Wharton before working as a bond salesman at First Boston and going on to officiate at Jenna Bush’s wedding, said the bonds are “legitimate” and has returned money to investors at their request. Smith entered a plea agreement to the charges last month.

“Defendants falsely represented to these investors that the bonds were safe, risk-free, worth tens, if not hundreds, of millions of dollars, and could be sold to third parties,” the SEC said in its complaint. “In reality, the bonds were mere collectible memorabilia with no investment value.”

With Saleha Mosin, Jennifer Jacobs, and Steven Yang.

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