Perspectives on economics and finances with GFD

The Confederate Cotton Zombie Bonds

  Confederate bonds are now prized by collectors of Confederate memorabilia. Since the bonds were never redeemed, thousands of these remnants of the South still exist for anyone to own. One of the more interesting bonds produced by the Confederacy were the Erlanger bonds which were issued in London in an attempt to raise much needed foreign currency for the Confederacy. These bonds were authorized by an Act of the Confederacy on January 29, 1863, and were the only bonds issued in foreign markets by the Confederacy. One of the more interesting aspects of these bonds is that they were Cotton Loan Bonds, backed by and redeemable in bales of cotton. The reason for issuing Cotton Loan Bonds was that anyone who bought Confederate bonds faced the risk of default if the Confederacy lost the war. Even if the Confederate States were to survive the war, the Confederacy lacked the gold reserves requisite to back the bonds. However, the South had plenty of cotton, a commodity that was essential to the mills in England and the rest of Europe. The Cotton Loan Bonds which were backed by bales of Confederate “white gold” at a price that would provide a profit to potential buyers if the bonds were paid off in kind rather than in cash. The £100 bonds (about $485 in gold before the war) were redeemable for 8 bales (4000 pounds) of cotton. Additional bonds were issued at £250, £500 and £1000. The bonds paid 7% interest and were redeemable in 20 years. The Erlanger bonds traded on both the London and the Amsterdam Stock Exchanges. The performance of the bonds reflected traders’ faith in the Confederacy. Declines in the value of the bonds occurred as the war turned against the Confederacy, and it became more evident that the Confederacy would lose the war and be unable to redeem the bonds. A similar indicator of faith in the Confederacy is reflected in the gold premium for the Confederate Dollar. At the beginning of the war, one paper Confederate Dollar was redeemable for one dollar in gold, but as the war progressed, the premium on gold rose. As you can see in the graph below, the Confederate Dollar depreciated consistently against gold during the war. Initially, this decline was due to inflation in the Confederacy since it was funding the war primarily through paper money and through issuing bonds. Toward the end of the war, the risk of default drove the rise in the gold premium. The conversion rate for “bluebacks” as the Confederate currency was known, rose from 1.2 Confederate Dollars to a Gold Dollar at the beginning of 1862 to 3.25 at the beginning of 1863, 20 at the beginning of 1864, and 60 at the beginning of 1865. By April 1, 1865, just a week before the peace treaty was signed at Appomattox, the rate was at 70. After the South surrendered, the rate quickly collapsed, hitting 1500 by May 1, 1865. This can be seen in the graph below.
Changes in the price of the Erlanger bonds also reflected the declining fortunes of the Confederacy. Surprisingly, the Erlanger bonds continued to trade on the London Stock Exchange for years after the war was over out of hope that the Federal Government would redeem the bonds either in full or in part, or at least provide the cotton that had been promised by the Cotton Loan. The United States Federal Government was adamant that it would not redeem any Confederate Bonds, State Bonds, Confederate Currency or State Currency that had been issued during the war. The Fourteenth Amendment to the Constitution was passed on July 9, 1868 and Section 4 of the Fourteenth Amendment explicitly stated that “Neither the United States nor any State shall assume or pay any debt or obligation incurred in aid of insurrection or rebellion against the United States, or any claim for the loss or emancipation of any slave; but all such debts, obligations and claims shall be held illegal and void.”  

Confederate Bonds became Zombie Bonds. Though officially dead, speculators continued to keep them alive. Since British and French courts felt that the United States government was responsible for Confederate liabilities, despite the Fourteenth Amendment, speculators in London continued to buy the 7% Erlanger Cotton Bonds. As the graph below illustrates, the price of the bonds collapsed in 1865, and fluctuated between £3 and £8 pounds from 1865 until 1871 when the bonds stopped trading on the London Stock Exchange. Thereafter, the bonds were usually quoted around £1, except between 1879 and 1884.  

Two hoards of Erlanger Cotton bonds remained in London after the war. Between 1879 and 1884, some bond holders felt that a new effort to wrest money from the Federal Government might succeed. Speculators began buying the bonds at 2% of their value, causing bonds to flow into London from the former Confederate states. When these bonds dried up, Dutch counterfeits were produced to meet the demand. A committee was formed to make the case for the bondholders, but to no avail. By 1885, the efforts had come to nothing, and most of the bonds were returned to their owners. Some bonds remained unclaimed and these bonds settled in the vault of Coutts Bank. This hoard was sold in 1987 for over £350,000. The zombies had finally come back to life a century later. Another hoard of bonds lay in the vaults of Erlanger Bank. This included about one-third of the bonds that had originally been issued, but not sold. In addition to this, in 1863, the Erlanger Bank had bought up some of the bonds in an effort to support their price. The bonds remained in the bank’s vault for the next 100 years, surviving even the Nazi bombing of London during World War II. In 1966, Douglas Ball, one of the experts on Confederate bonds, visited Mr. Leo Erlanger concerning the bonds in the bank’s vault. The bank had been sold in 1964, and Erlanger was winding down the bank’s operations. Douglas Ball, who was researching confederate bonds in preparation for his dissertation, wanted to know how many of the bonds were left. When Mr. Erlanger said they still had the bonds, Douglas Ball let him know that he could probably make Erlanger over $100,000 by slowly releasing the bonds onto the collector’s market.

The Worst Bear Market in History


Which country has the dubious distinction of suffering the worst bear market in history?

To answer this question, we ignore countries where the government closed down the stock exchange, leaving investors with nothing, as occurred in Russia in 1917 or Eastern European countries after World War II. We focus on stock markets that continued to operate during their equity-destroying disaster. There is a lot of competition in this category. Almost every major country has had a bear market in which share prices have dropped over 80%, and some countries have had drops of over 90%. The Dow Jones Industrial Average dropped 89% between 1929 and 1932, the Greek Stock market fell 92.5% between 1999 and 2012, and adjusted for inflation, Germany’s stock market fell over 97% between 1918 and 1922. The only consolation to investors is that the maximum loss on their investment is 100%, and one country almost achieved that dubious distinction. Cyprus holds the record for the worst bear market of all time in which investors have lost over 99% of their investment! Remember, this loss isn’t for one stock, but for all the shares listed on the stock exchange. The Cyprus Stock Exchange All Share Index hit a high of 11443 on November 29, 1999, fell to 938 by October 25, 2004, a 91.8% drop. The index then rallied back to 5518 by October 31, 2007 before dropping to 691 on March 6, 2009. Another rally ensued to October 20, 2009 when the index hit 2100, but collapsed from there to 91 on October 24, 2013. The chart below makes any roller-coaster ride look boring by comparison.

The fall from 11443 to 91 means that someone who invested at the top in 1999 would have lost 99.2% of their investment by 2013. And remember, this is for ALL the shares listed on the Cyprus Stock Exchange. By definition, some companies underperform the average and have done even worse, losing their shareholders everything. For the people in Cyprus, this achievement only adds insult to injury. One year ago, in March 2013, Cyprus became the fifth Euro country to have its financial system rescued by a bail-out. At its height, the banking system’s assets were nine times the island’s GDP. As was the case in Iceland, that situation was unsustainable.
Since Germany and other paymasters for Ireland, Portugal, Spain and Greece were tired of pouring money down the bail-out drain, they demanded not only the usual austerity and reforms to put the country on the right track, but they also imposed demands on the depositors of the banks that had created the crisis, creating a “bail-in”. As a result of the bail-in, debt holders and uninsured depositors had to absorb bank losses. Although some deposits were converted into equity, given the decline in the stock market, this provided little consolation. Banks were closed for two weeks and capital controls were imposed upon Cyprus. Not only did depositors who had money in banks beyond the insured limit lose money, but depositors who had money in banks were restricted from withdrawing their funds. The impact on the economy has been devastating. GDP has declined by 12%, and unemployment has gone from 4% to 17%.

On the positive side, when Cyprus finally does bounce back, large profits could be made by investors and speculators. The Cyprus SE All-Share Index is up 50% so far in 2014, and could move up further. Of course, there is no guarantee that the October 2013 will be the final low in the island’s fourteen-year bear market. To coin a phrase, Cyprus is a nice place to visit, but you wouldn’t want to invest there.

Dow Jones’s 22,000 Point Mistake

  One of the long-term components of the Dow Jones Industrial Average has been IBM. The company was originally added to the Dow Jones Industrials on March 26, 1932 in a reshuffle involving eight stocks including Coca-Cola, Nash Motors (later American Motors) and Proctor & Gamble. On March 13, 1939, however, both IBM and Nash Motors were removed from the average and replaced by American Telephone & Telegraph and United Aircraft Corp. (now United Technologies). AT&T was in the Dow Jones Utilities Average until June 1, 1938. Until then, the Dow committee had interpreted utilities in a broader sense to include electric, gas, and communications companies as providers of essential services. In 1938, the Dow Jones committee decided to restrict membership in the Utilities Average to power utilities. The resulting reshuffle removed nine stocks, including AT&T, International Telephone & Telegraph, and Western Union, all of which were communications utilities rather than power utilities, from the Dow Jones Utilities Average. Since AT&T was such a huge company, it was moved over to the Dow Jones Industrial Average which required that another stock be removed to make room for AT&T. Thus, IBM was kicked out of the Dow Jones Industrial Average. What if the Dow Jones committee had not redefined the Utilities Average to only include power utilities? What if IBM had stayed in the Dow Jones Industrial Average between March 13, 1939 when it was removed and June 29, 1979 when IBM replaced Chrysler in the Dow Jones Industrials? Obviously, the Dow Jones Industrials would be higher than it is today, but how much higher? International Business Machines incorporated on June 16, 1911 as The Computer-Tabulating-Recording Co., a merger of The Computing Scale Company of America, The Tabulating Machine Company and The International Time Recording Company of New York. The company listed on the NYSE in November 1915, and on February 14, 1924, the company acquired International Business Machines and changed its name in a reverse acquisition. IBM has been one of the best performers on the stock exchange in history. If you had invested $1 in IBM when it started trading OTC in August 1911, it would have grown to $40,000 today on a price basis. If you had reinvested your dividends, your $1 investment would have grown to $1,434,300. In the past 100 years, IBM has given over a million-fold return. The graph below shows the performance of IBM stock over the past 100 years.
AT&T incorporated in New York on March 3, 1885 and began trading on the NYSE in May 1900 after it had acquired American Bell Telephone Co. in March 1900. The company was forced to split up into “Ma Bell” and the “Baby Bells” by the U.S. Government on December 31, 1983. On November 18, 2005, AT&T Corp. (“Ma Bell”) was acquired by one of the Baby Bells, SBC Communications, which then changed its name to AT&T Inc. in a reverse acquisition. AT&T has not performed as well as IBM over the past 100 years. If you had invested $1 in AT&T in May 1900, your investment would have grown to only $4.26 on a price basis, or $639 if you had reinvested all of your dividends back in the company, by the time AT&T was broken up in February 1984.  

So what if the Dow Jones Committee had kept IBM in the Dow Jones Average between March 1939 and June 1979 and had never admitted AT&T, keeping it in the Utilities Average? What would the result have been? IBM closed at 187.25 on March 14, 1939 while AT&T closed at 166.125. IBM closed at 73.375 on June 29, 1979 while AT&T closed at 57.875. Price wise, the results appear to be similar. The difference is that both stocks split, and the stocks had several rights offerings in the intervening 40 years. The cumulative effect of these stock splits and rights offerings is significant. You would have to adjust the stock price of AT&T by 7.15 to allow for the impact of stock splits and rights offerings, but you would have to adjust IBM stock by a factor of 562.48. If neither stock had split or provided rights offerings in those intervening forty years, AT&T stock would have been at 414 in June 1979, but IBM would have been at 41,272. IBM increased one hundred times more than AT&T during those intervening forty years.  

The DJIA stood at 151.1 on March 14, 1939 and 841.98 on June 29, 1979. Since the DJIA is price weighted, you can remove the impact of AT&T on the DJIA by subtracting out the price of AT&T allowing for the splits, and replacing this amount with the value of IBM stock, allowing for the splits in IBM. If you do this, you would find that the DJIA would have been at 23,582 in June 1979, not 841.98. In other words, IBM would have added 22,740 points to the DJIA had it never been removed.
The DJIA is currently trading above 16,000. If you add 22,740 points to this value, you would arrive at a DJIA close to 39,000. If IBM had stayed in the DJIA, CNBC and The Wall Street Journal would be preparing for the DJIA’s approaching rendezvous with 40,000. However, since the Dow Jones Committee removed IBM from the Dow Jones Industrial Average in 1939 and kept it out for forty years, we will have to wait several more decades to reach that goal.

Six Ounces that Saved a Hundred Billion-Dollar Company

  Today Pepsi is one of the strongest brands in the world with a capitalization of nearly $125 billion. But this wasn’t always the case. It may be hard to believe, but Pepsi was on the verge of bankruptcy during its first forty years of business. In fact, Pepsi-Cola’s financial situation was so bad that three times between 1922 and 1934, Pepsi-Cola approached Coca-Cola and offered to sell out to their competitor. All three times Coca-Cola rejected their offer. Coca-Cola’s rejections could be among three of the biggest marketing snafus in history, while Pepsi’s “12 ounce” jingle campaign turned out to be one of the most successful marketing efforts of all time. Not only did the campaign prove a success for Pepsi, but it revolutionized the soda industry as a whole. This case study is an interesting one indeed and shows how perseverance in the marketplace and promotional advertising can be worth billions.

A Secret Recipe: Pepsin and Kola Nuts

First introduced in North Carolina as “Brad’s Drink” in 1893 by Caleb Bradham, the name was changed to Pepsi-Cola in 1898 mainly because of Pepsi’s secret ingredients. Digestive enzymes named pepsin and kola nuts were used in the creation of this special drink. However, when Bradham unsuccessfully speculated on wildly fluctuating sugar prices (shown below), the company faced bankruptcy.
A series of buyouts and structural re-organizations occurred between 1922 and 1934. In 1931, the National Pepsi-Cola Co. reorganized as Pepsi-Cola Co., selling its assets to Roy C. Megargel. After Megargel also failed to make Pepsi-Cola Co. profitable, he sold the company to Charles Guth, President of Loft, Inc. Loft, a candy manufacturer and retailer that owned Happiness Candy Stores had been around for 20 years prior to acquiring Pepsi . The Loft-operated Happiness Candy Stores had soda fountains and saw the marriage as a good fit.

Pepsi– Rejected by Coke, Acquired by Loft