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Pre-Revolutionary Chinese Debt: An Investment for the Truly Stable Genius

posted by Mark Weidemaier

Mark Weidemaier & Mitu Gulati

About a year ago, an unusual securities action was brought against a pastor at one of the largest Protestant churches in the country and a financial planner. The accusation was that the two, Kirbyjon Caldwell and Gregory Smith, had duped elderly investors into buying participation rights in bonds issued by the pre-revolutionary Chinese government. The bonds have been in default since 1939. Here is the SEC’s press release; Matt Levine at Bloomberg talked about the case here. Among other things, the SEC accused Caldwell and Smith of violating the registration requirements of the federal securities laws and of committing fraud.

This case got a fair amount of attention because Mr. Caldwell is no ordinary pastor. He leads one of the largest congregations in the country, with roughly 14,000 members, and was a spiritual adviser to George W. Bush and Barack Obama (see here).

The core of the fraud case seems to be that Caldwell and Smith promised investors safe, quick returns. Allegedly, the plan was to sell the bonds for a profit or to get the Chinese government to pay up. From the SEC’s perspective, this was like promising to squeeze water from a stone; since the communist takeover in 1949, Chinese governments have steadfastly refused to pay the bonds.

It all sounds rather daffy. Also, weirdly specific. It can’t be easy to persuade people to open their pocketbooks for antique Chinese sovereign bonds. Still, we were struck by the SEC’s characterization of the bonds, in both the press release and the complaint, as “defunct” and as “collectible memorabilia with no meaningful investment value” (here and here). The characterization presumes the answer to a question that has long fascinated us, which is whether a sufficiently motivated claimant could enforce these bonds against China.

Under the relevant international law, the law of state succession, a state’s obligations continue notwithstanding changes to the identities of governing officials, to official political ideology, or to the form of government itself. So a government can’t justify non-payment by noting that its political philosophy radically differs from that of the government that incurred the debt. To the extent the bonds are subject to municipal law—such as English or New York law—the same principle would likely apply. So at least in theory, the holder of one of these instruments could sue the current Chinese government for non-payment.

Of course, there are plenty of legal barriers to such a claim. Among others, the statute of limitations will have likely have run in almost every jurisdiction where a holder might sue. A plaintiff would also have to overcome the protections that the law of foreign sovereign immunity affords to sovereigns and their assets, which would be heightened because bonds issued during this period did not include waivers of sovereign immunity. For one of the prior cases on this, Morris v. PRC (SDNY 2007), see here. (As an aside, we constructed an assignment for students in our sovereign debt class a few years ago for them to try and figure out whether there were any plausible ways to get over these legal barriers.)

As it turns out, another group of holders of these old Chinese bonds has tried to recover on these “collectible memorabilia” using different means. The Tennessee-based group has the official-sounding name “American Bondholders Foundation” and, according to articles in the Economist (here) and Axios (here), wants President Trump to intervene on its behalf with the Chinese government.

Most intriguing, though, is the story from this article by conservative political commentator and talk show host Steve Gill, writing for the Tennessee Star in November 2018. Gill reported that President Trump and his senior advisers had actually taken seriously the possibility that these debt claims could be used as strategic weapons in the trade battle with the Chinese.

How, you might ask? Gill explains that the ABF sees itself as having a claim worth over a trillion dollars (presumably calculating interest upon interest and so on). On the flip side, China owns somewhere in the range of a trillion dollars (give or take a few hundred million) in U.S. government bonds, and the U.S. government worries that China might eventually dump these bonds, causing mayhem in the market for U.S. treasuries.

Might these old Chinese bonds be transferred to the U.S. and used to offset the debt owed to China? Here’s Gill:

Representatives of the ABF met with Trump in August and [Jonna] Bianco [the head of the ABF] says he and his financial and economic advisors were almost universally in support of pursuing payment from China, or using it to claim an offset against the U.S. debt obligations to China. As Trump and Chinese President Xi prepare to meet in Argentina at the G-20 Summit later this week, it will almost certainly be an issue that will come up in the discussions, though they will primarily seek to deal with the contentious trade fight.

Yes, we know this sounds utterly ludicrous. Surely, no one in the Trump administration is really taking this idea seriously? As best we can tell, it was not a topic of discussion at the G-20 summit in late 2018. That said . . . this is an administration unlike any other, and it’s easy (for us, anyway) to imagine the idea having a certain intuitive appeal as a bargaining chip for President Trump. (You think we owe you $1 trillion? Nah, we owe $0!)

We really, really hope Caldwell’s lawyers will subpoena senior officials at the U.S. Treasury as witnesses to ask them whether they view pre-revolutionary Chinese government bonds as “defunct” collectibles, valuable only as wall art...

China 1912 5pct gold bond


Pardon me for asking what may be a dumb question (but I did not see it addressed in any of the linked stories). What about Taiwan? I thought that Taiwan has historically claimed that it is the real, legitimate Chinese government, although they have more recently softened or backed off from a claim of sovereignty over the Chinese mainland.

Thus, at least for a time, the government of Taiwan has claimed to be the actual successor to (or continuation of?) the regime that issued the bonds. Even if Taiwan has decided to stop asserting territorial claims to the mainland, does that change their position that a direct line can be traced to the pre-1949 government?

So, has anyone tried to enforce the bonds against Taiwan? I recognize that the same statute of limitations issues may exist. Has Taiwan historically ratified, assumed or sought to enforce any pre-1949 rights or obligations? Are people chasing the PRC, but not Taiwan, for political reasons, rather than a difference in the strength (if any) of the legal position against either regime?

This sounds like a typical day in Utah.

FJP I was wondering the same thing. I wonder how the PRC would react to some kind of legal recognition of the ROC as being the legitimate successor as the government of China. They might, conceivably pay off the bonds (or at least settle for pennies on the dollar) just to prevent this.

I have a folder of Russian railroad bonds issued in the 1890s and early 1900s. The coupons from 1917 on are still attached. Maybe I can get the Democrats in Congress to get me the 100 years of interest and capital owed my family.....

And yet certain Tsarist bonds were paid off by the Soviets/and or Russia, no?

Tim Worstall: Yes, indeed they were--for French bondholders if memory serves. The PRC did the same for British bondholders in the 1980s. No question the US could broker a similar deal here. But to (legally) use the debt to set-off the US national debt...? Not so much.

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