Perspectives on economics and finances with GFD


  Yields on United States 10-year bonds rose above 3% at the beginning of January 2014. The yield on the 10-year had reached its lowest point in history in July 2012 at 1.43% as a result of the Fed’s policy of Quantitative Easing. Since then yields have doubled as markets have incorporated expectations of Fed tapering the purchase of U.S. Government securities.  

$12,000 Mortgage Payments Anyone?

What will happen in the United States when tapering and quantitative easing come to an end? How high could interest rates rise? Could interest rates move up from 3% per annum to 3% per quarter, revisiting the levels of 1981? When the yield on US 10-year Treasuries hit 15.84% in 1981, as seen in the chart below, mortgage rates hit 18.63%. And it was not uncommon during this time for home loans to be as high as 20%! Imagine a 20% APR on your mortgage. This would make a standard $3,000 monthly payment of 2014 rise to $12,000 per month. There are eerie parallels today with the experience of World War II when the yield on US 10-year bonds also fell below 3%. Bond yields had fallen below 3% in 1933 as a consequence of the Great Depression, but the government kept interest rates below 3% until the 1950s to reduce the cost of funding World War II. The Treasury pledged to keep the interest rate on Treasury bills at 0.375% or below while the United States was at war. Interest rate repression is nothing new for the Fed.
The problem with the Fed’s World War II policies was that interest rate repression eventually led to inflation of 14% in 1947 and 8% in 1948, making real interest rates negative. To stop this, the Fed put pressure on the Treasury to allow interest rates to rise to their market level, which the Treasury finally did in 1951. As you can see in the graph above, interest rates rose for the next thirty years.  


What about a 3% per month increase in interest rates? That works out to 42% per annum. Although interest rates have never been that high in the United States, they have hit those levels in other countries. The yields on 3-year bonds in Mexico were over 50% back in the 1990s as is illustrated below. Other countries, such as Argentina, Brazil and Chile (the ABCs of hyperinflation) have seen similar interest rate levels.  

Interest rates at these levels can only occur because of inflation. The problem is that as inflation rates rise, bond yields become more unstable and unpredictable. Consequently, the maturity of debt instruments shrinks as uncertainty increases. Annual interest rates become meaningless, and the maturity of debt shrinks to months, weeks, days or in extreme cases, even hours. Interest rates even hit 3% per week in Germany during its hyperinflation. In 1923, the interest rate charged at the Berlin Stock Exchange in October 1923 hit a high of 7950%, the equivalent of 9% per week. One of the worst cases was Brazil in 1990 when interest rates hit over 3% per day!
Don’t get me wrong, I’m not saying that Payday loans will someday be considered a bargain, or that they will soon become as popular as Starbucks, but regardless of which way interest rates head, there is reason to be concerned about the ultimate consequences of the path we have embarked upon.

The January Effect

  We are about half way through January and many analysts, investors and market enthusiasts are wondering which way that markets are headed. Typically, the markets go through the “January Effect” which is a general increase in stock prices during the month of January. This rally is generally attributed to an increase in buying, which follows the drop in price that typically happens in December when investors, seeking to create tax losses to offset capital gains, prompt a sell-off. For 2014, this move has been less evident, as a matter of fact, the markets have been flat for the US and Europe (expect Greece) where as Asia has been down. What is going this January? Could it be that many investors are re-balancing their portfolios by selling part of their profits from 2013 in stock and re-allocating the proceeds to bonds? January is a common time for re-balancing and tax harvesting. The S&P 500 gave us about 30% returns in 2013 and profit taking is common to lock in some of those gains. Will 2014 bring us similar returns to 2013?

The Piranha of Portugal: The Greatest Counterfeiter of All Time

  The new US $100 bill is out, as you may have seen this holiday season. Our dear old Uncle Ben is a technological wonder with a dozen different anti-counterfeiting devices on it. Since there are more $100 bills circulating outside of the United States than inside, the U.S. Government has to insure that counterfeiters are unable to replicate the government’s most treasured export. This raises the question, who was the greatest counterfeiter of all time?  

Government Counterfeiting

Although governments have done more to destroy their own currencies than all the counterfeiters in the history of mankind put together, the government is not the correct answer. Governments have debased their own currency for millennia. Historical examples of government-induced debasement include:
  • The Roman Empire replacing its silver Denarii with billon Antonininii;
  • The Khans of China creating the first paper inflation in the 1300s;
  • The United States making its first currency, the Continental Dollar, worthless;
  • Germany hyperinflating out of its debts by creating trillions of marks;
  • Or the US Federal Reserve blowing up its balance sheet.
In holding governments accountable, we are also not talking about one government counterfeiting the currency of another government as the
  • Barbarians did of the Roman gold Aureus
  • British did of Continental Dollars and French Assignats during the 1700s
  • Germans did of British Pounds during World War II in Operation Bernhard
  • United States did of Japan’s Occupation currency of the Philippines
  • North Koreans did of US Dollars, making them one of their principle exports.
Governments have consistently destroyed their own currency and those of other countries without ever being held accountable for their “crime” the way a counterfeiter is punished. No, we are not talking about governments; we are talking about individual counterfeiters. It is one thing for the government to expand the money supply in order to stimulate the economy and help the unemployed. It is quite another for counterfeiters to do the same –albeit on a much smaller scale– to benefit themselves. Counterfeiters provide competition to the government, and though government officials are applauded when they inflate the economy, counterfeiters are condemned to prison – when caught.  

A Classy Counterfeiter

Our vote for the greatest counterfeiter of all time goes to Artur Alves dos Reis whose story was recounted by Murray Teigh Bloom in The Man Who Stole Portugal. Reis was both smart and classy, and his criminal operation reflected these qualities. To my knowledge, Reis put together the most audacious counterfeiting scheme in history. He conceived his master plan while he was in jail in Oporto for embezzling the funds of a company he had taken over. Some criminals sit in jail and try to avoid repeating their misfortunes. Others, like Reis or Tony de Angelis, think-up bigger, more foolproof schemes. While he was sitting in his cell, Reis put together his master plan that would make him the richest, and possibly the most influential man in Portugal in only one year.Although you may not realize it, counterfeiting is a very complex operation. To be successful, (i.e. not get caught), be able to spend your money, and not receive free room and board from the government, you have to do three things successfully. First, you have to create counterfeit currency that can’t be detected. Second, you need a way of laundering the money and converting it into real assets so you can enjoy the fruits of your ill-begotten labors. Third, you must make sure that you avoid the triple curse of detection, arrest and conviction. Let’s see what Reis’s solution was to this age-old problem.  

Step One: Create an Undetectable Banknote

First, create a counterfeit that can’t be detected. During the 1920s, the Banco do Portugal had the exclusive right to print currency in Portugal. The bank used foreign printing companies with superior anti-counterfeiting technology to protect their banknotes. The English company, Waterlow & Sons, printed the 500 and 1000 Escudo notes (equal to about $25 and $50 in 1923) for the Banco do Portugal. So why not get Waterlow & Sons to print the notes for Reis as well?Reis was a natural-born forger. He forged his diploma as an engineer from Oxford as a “joke”, but this helped land him a job as a government railroad inspector in Angola at the age of twenty-two. In 1924, he forged $100,000 worth of checks and used the money to take over control of Ambaca, the Royal Trans-African railway Company of Angola. He then used the money in the company’s treasury to cover his own checks. He was arrested in July 1924 for embezzlement, but was released two months later when a court decided his was a civil and not a criminal case. It was during the two months he was the guest of the Oporto police that he conceived his infamous counterfeiting scheme. The key was to find someone with a respected name who could help him convince Waterlow & Sons to print banknotes secretly for Reis. He found three men of questionable repute, but with connections to help Reis: Jose Bandeira, Gustav Adolf Hennies and Karel Marang. Bandeira got his brother, the Portuguese Minister to the Netherlands, to give Marang a letter introducing him as a respected Dutch citizen who had a power-of-attorney for Alves Reis to negotiate the printing of the banknotes. Marang went to Waterlow & Sons in London, and presented his letter of introduction as the “Consul General of Persia” on forged Banco do Portugal stationary to Sir William Waterlow. Marang spun the story Reis had instructed him to give. A private syndicate was being formed to save the colony of Angola from its current dire financial condition with a $5,000,000 investment. In return for the loan, the syndicate would be allowed to print and circulate banknotes in Angola. Waterlow & Sons would print the banknotes for the syndicate, and once the notes reached Angola, the banknotes would be supercharged with the word ANGOLA so they wouldn’t be confused with notes from the mother country. The whole affair had to be kept secret lest Angola fall into further financial difficulties due to ill-placed rumors of pending economic ruin. Of course, Sir William knew that supercharging notes was normal practice for Portugal’s colonies, and that the Banco Ultramarino had the exclusive right to print banknotes for the Portuguese colonies. This was an opportunity for Waterlow & Sons to get this business away from Bradbury, Wilkinson & Co., the current printer of banknotes for the Banco Ultramarino in Angola. Marang asked Waterlow to print the 500 Escudo note with Vasco da Gama on it. The deal was signed on January 6, 1925, and for the printing cost of $7,200, Reis and his conspirators would receive $5,000,000 in banknotes, a 70,000 percent return on their investment. Bandeira picked up the first group of notes from Waterlow & Sons on February 10, and by March 20, they had 100 million Escudos ($5,000,000) in Portuguese banknotes. Bandeira used his orange diplomatic card to transport the bills in luggage marked the “Legation of Portugal” across the borders without detection. After the first step had been successfully completed, they placed an order for an additional 190 million Escudos in banknotes ($9,500,000). Of course, the banknotes never made it to Angola. 
The greatest risk in the scheme was having banknotes with duplicate numbers discovered, but this was the lesser of two evils. If Reis and Marang had requested banknotes outside the numerical range of the 500 Escudo notes, the spurious notes would have been quickly discovered. The lower risk lay in duplicating the existing serial numbers, and hoping the counterfeiters were able to successfully release all the banknotes before the law of large numbers caught up with them.  

Step Two: Laundering Money with Your Own Bank

Step One of the plan was complete, now for Step Two: laundering the money. A small-scale counterfeiter can pass bills through petty criminals, but the notes Reis and friends had were equal to almost 1% of Portugal’s GDP. This was the equivalent of over $150 billion if the same amount had been released in the United States today. Even if Reis hired every petty criminal in Lisbon and Oporto, he wouldn’t be able to unload a fraction of the banknotes.


Reis was going first class with his counterfeiting scheme, and he decided the only way to launder the money was to have his own bank. Reis used his newly printed banknotes to encourage corrupt Portuguese officials and politicians to grant him his bank charter, and on June 15, 1925, the Banco Angola e Metropole’s application was approved by the government. Of course, the bank would have multiple branches in Lisbon and Oporto to speed up the distribution of their treasure. Want to exchange foreign currency? The Banco Angola e Metropole provides the best rates. Want to borrow money for a business or mortgage? The Banco Angola e Metropole will be happy to extend you the loan in cash. Want high interest rates on your deposits? Go to the Banco Angola e Metropole? In the meantime, Reis, his wife, and their compatriots spent their money freely, buying jewelry, cars, real estate, and sending money abroad. Reis flooded Portugal with his freshly minted banknotes, and the economy of Portugal was booming. And as Reis would rationalize, how was this any different from what a real government did? Was there really any difference between Keynesianism and counterfeiting?  

Step Three: Avoid Detection (For a While)

Step Three and the most important of all was how to avoid detection, arrest and imprisonment. For this, Reis had a brilliant solution. Since they were counterfeiting Banco do Portugal banknotes, only the Bank could initiate proceedings to prosecute them. But what if –just what if– Reis controlled the shares in the Banco do Portugal? The bank had already exceeded its statutory banknote limit many times over and the directors of the Banco do Portugal had never been prosecuted, so why should they prosecute Reis? Or as Reis put it, “How can they arrest us when they’re us and we’re them?”Like most European countries, Portugal had suffered inflation after World War I. Prices had increased 48% per annum between 1919 and 1924, and the Escudo had depreciated by 87% against the Pound Sterling. Although the Banco do Portugal was only supposed to issue banknotes thrice its capital, it had, in fact, issued banknotes a hundred times its capital. By comparison with this, Reis’s monetary manipulations were minor by comparison. The chart below shows the depreciation of the Portuguese Escudo against the U.S. Dollar after World War I.

Reis began buying up as many shares of the Banco do Portugal as he could, so he could gain a controlling interest in the bank to protect himself. Should his scheme ever be detected, Reis would, quite naturally, refuse to prosecute himself. By November 1925, Reis controlled over 10,000 shares of Banco do Portugal stock. “Just another month” and Reis would have control of the Banco do Portugal. Then he could live in luxury for the rest of his life. As in all of these cases, whether it be counterfeiting currency, pumping and dumping, forging corporate books, hiding money in offshore accounts, or any of the other financial schemes that crooks are heir to, it was hubris and greed which undid Reis. He took part of his proceeds and invested them in a mineral and oil exploitation scheme in Angola hoping to increase his wealth even more. In December 1925, Reis and Hennies were on their way back to Portugal from Angola. Aboard the ship, they learned that the Banco do Portugal was doing an investigation of the 500 Escudo notes. A lowly, underpaid teller who worked part-time at a jeweler to help make ends meet had become suspicious of the Banco Angola e Metropole. The Escudo notes he received were never in numerical order (Reis’s plan to shuffle the banknotes to avoid detection actually caused detection), and the pages that recorded foreign exchange transactions at the bank were torn out. The teller alerted the Banco do Potugal, an investigation began, and soon duplicate banknotes were discovered. Hennies, sensing that the scheme was up, decided to sail on, but Reis disembarked in Lisbon. His goal was to lay the blame for the duplicate banknotes on officials at the Banco do Portugal by forging documents that the Governor of the Banco do Portugal was the originator of the whole plot.  

The Scam Exposed

The crisis broke on December 4, 1925 when the newspaper O Sêculo published an expose of the Banco Angola e Metropole. When one of its branches was closed, huge caches of duplicate 500 Escudo banknotes were discovered. Reis, his compatriots, and almost anyone associated with the Banco Angola e Metropole, (save Hennies who had sailed on), were arrested. Incredibly enough, the Governor and the Vice Governor of the Banco do Portugal were also arrested, so convincing were Reis’s forged documents. It was as if Ben Bernanke and Janet Yellen had been arrested for counterfeiting!The Banco do Portugal faced a tough decision. What should it do with all the 500 Escudo notes? It was impossible to differentiate between the original and the duplicate banknotes because they were printed by the same printer using the same plates. The Banco do Portugal came to the only conclusion possible. Every single Vasco da Gama 500 Escudo note would have to be withdrawn from circulation. People could exchange up to 200 of the Vasco da Gamas for 1000 Escudo notes until December 26. After that, they would be worthless. The revelation of the counterfeiting plot created a huge loss of confidence in the corrupt, democratic government. Military officers who were aggrieved over their pay failing to keep up with inflation, overthrew the democratic government on May 28, 1926. This eventually led to the dictatorship of Portugal by Dr. Antonio de Oliveira Salazar (who had been Portugal’s Finance Minister) in 1932. Salazar remained dictator of Portugal until his death in 1968. A scheme to counterfeit currency and make a forger rich had led, indirectly, to the downfall of a democracy which was followed by a forty-year dictatorship. Reis remained in jail and was found guilty on June 29, 1930 of falsely introducing 330,000 banknotes into Portugal. He was sentenced to twenty years in prison. His compatriots were found guilty as well, but received lesser sentences. Reis was released from prison on May 14, 1945, and died ten years later. Sir William Waterlow was sued by the Banco do Portugal for damages for printing the banknotes. Of course, Waterlow had no knowledge of the counterfeiting scheme and as his lawyers argued, no actual damage had been done to the bank by the banknotes. If anything, Portugal was better off as a result of Reis’s unconventional stimulus plan. Though Waterlow spent a million dollars on lawyers defending him, he lost the case and Waterlow & Sons was forced to pay of £610,392 (about $3,000,000) in damages. There must be a certain irony in the fact that as a result of the lawsuit, the main beneficiary of the scheme to counterfeit the banknotes was the Banco do Portugal itself. Sir William died of peritonitis in 1931 and the case was settled in April 1932. Reis was the last of the great counterfeiters. His scheme had style and panache, as did he. His story ripped through the papers just as his scam ripped through the economy. This case study should not be forgotten nor should we forget Reis and the ingenuity that rested behind his schemes. The piranha of Portugal may be gone, but there will always be a new Wolf on Wall Street attempting to profit at the expense of others.


  When most people think of Venice, they think of the visuals of Venice: the canals, the gondoliers, the paintings by famous artists such as Canaletto or Titian, the Bienniale, or St Mark’s Square (named after the saint whose relics the Venetians stole from Alexandria in 828 by hiding them beneath pork to get them past the Muslim inspectors) and its pestering pigeons.  


When I think of Venice, I think about three things. I think about the first time I went to Europe with my dad. For an entire week before we got to Venice, all I heard about was his insistence on going on a gondola, and passing through the canals while the gondolier sang his Venetian songs. By the time we got to Venice, I was so sick of this that the first thing I did was take him to the place where you hired gondoliers so I would never have to hear about the canal ride again. My dad asked our potential gondolier how much the ride was, and when he found out it was the equivalent of $50 (this was a long time ago), he swore at the gondolier and said he wasn’t wasting $50 on a stupid boat ride. I was ready to kill my dad, but I didn’t cherish the idea of spending the rest of my life in a Venetian prison and having to pass over the Bridge of Sighs. Since I am an economist, the other two things I think about deal with finance. First, Venice was one of the three city-states in Italy (Florence in 1252, Genoa in 1253, and Venice in 1280) that reintroduced gold into the Italian peninsula eight centuries after the fall of Rome. The other important financial contribution that I associate with Venice are the prestiti: the government bonds Venice began issuing in the 1100s to fund its wars. The prestiti were the first Eurobonds and if Moody’s and S&P had been around in the 1300s, they would have been the first AAA-rated government bonds, though they eventually would have been downgraded.  


Venice was the first country to issue government bonds to its citizens in the same way governments currently issue government bonds. Before the Venetian prestiti, and even after, kings, queens, emperors and others borrowed money to fight wars or feed their royal megalomania. When the rulers were unable to pay back the loans, they simply defaulted, often bankrupting their creditors. Venice was different. Venice was the medieval equivalent of Athens, a democracy for the elites. In 726, the Venetians rebelled against their Roman/Byzantine rulers over the Iconoclast controversy and elected the first of 117 doges before Napoleon conquered the city in 1797. Venice became a city-state, expanding its commercial reach, and became an imperial power, eventually capturing and sacking Constantinople in 1204 during the Fourth Crusade. By the late thirteenth century, Venice was the most prosperous city in all of Europe. At the peak of its power and wealth, it had 36,000 sailors operating 3,300 ships, dominating Mediterranean commerce. Defending their empire meant wars with other Italian city-states, such as Florence and Genoa, and wars meant borrowing money.  


Venice introduced the prestiti in the twelfth century. Subscriptions were obligatory on wealthy citizens in proportion to their wealth, and the elites of Venice found forced loans preferable to outright taxation. In 1262, Venice lost control over Constantinople, and the outstanding loans, which had been considered temporary, were consolidated into one permanent fund called the monte vecchio. This move institutionalized the prestiti as long-term loans rather than short-term borrowings. The prestiti paid a nominal interest rate of 5% on the outstanding capital, two installments of 2.5% paid per annum. After 1377, interest rates were variable, and rates were reduced to 4% in the 1400s. In 1482 a new series of prestiti, the monte nuovo, was issued based upon a new kind of tax and the interest rate was restored to 5%. Another new series, the monte novissimo, was issued in 1509 during the war with the League of Cabrai, and finally the monte sussidio was introduced in 1526. The prestiti were perpetuities that had no specific maturity date. No physical bonds were issued, but all bonds were registered through the Loan Officers, the Ufficiali degli Prestiti. The claims on these bonds could be sold and transferred to others who then had all the rights of the original purchasers. When possible, the Venetian government repaid the principal. The prestiti became popular forms of investment for Venetian nobles. They were used as endowments for charities, and were used as dowries for daughters upon their marriage. Since the elites of Venice owned prestiti and were part of the government, this reduced the likelihood the city would default on its debts (though the government did forgo interest payments in 1379-1381, 1463-1479 and 1480). Owning prestiti was a privilege. Foreigners, who trusted the Venetian government more than their own, could only obtain prestiti through an act of the Council of Venice. The prestiti were fully paid off by the government of Venice in the late 1500s. As with any bond, as the price of the prestiti went down, the yield went up. During a war, the price of prestiti would fall as new bonds were issued and owners faced the risk of delays in payment of principal and interest. During peace time, the price rose as the risk diminished. Since the price of trades in prestiti was a matter of public record, potential purchasers could use these prices to determine the riskiness of their investment. Thus, the prestiti became a barometer of the Venetian Republic. When there was peace, the government would repay outstanding prestiti, sometimes by issuing new prestiti, rolling over old loans into new, but when Venice was at war, the government would issue new prestiti. The prestiti were exempt until 1378 from assessment of new forced loans if held by the original owner, and new assessments were levied largely on real estate. Venice was successful with the issue of prestiti because the right to transfer the bonds through the Ufficiali degli Prestiti made the bonds liquid and fungible. The Venetian government established a long record of regular payment of interest even when war and disaster threatened the state, assuring investors that they would not lose their money from a royal default. As Venice prospered, confidence in payments rose. The government was under a legal obligation to pay the prestiti, and payment was not left to the whim of the king. During peace time, extra revenues were directed to repayment of the prestiti, rather than setting aside money for the Venetian war chest or expanding services. The government had a deliberate policy of repurchasing prestiti whenever their price fell. In short, the prestiti were the AAA bonds of their day, and as Venice prospered, so did the city and its bondholders.  


As all nations know, wars do not always go as planned. Sidney Homer, in his History of Interest Rates, provides historical data on the prices of prestiti, and you can see how the price of the bonds and their yield fluctuate in response to the fortunes of Venice. When Venice imposed large assessments, as in 1311-1314, the price of the prestiti fell, and when Venice made large repayments, as in 1344, the price could exceed 100. The worst decline in the fourteenth century came during the War of Chioggia between 1378 and 1381 with Genoa, during which Venice imposed very large assessments, suspended interest payments, made the prestiti no longer immune from tax levies, and expanded the debt 6 to 9 times its level in 1344. The price sank as low as 19 as a result. After the War of Chioggia ended, the prestiti fought their way back as confidence in the Venetian government returned, causing the price to rise to the 60 level. Unfortunately, the fifteenth century was one of ongoing wars in the Mediterranean. Venetian wars with Hungary in 1412, the Turks in 1416, Milan during the 1420s, and wars with both Florence and Milan in 1450 and the costs associated with these wars reduced confidence in the Venetian government’s ability to fund the prestiti. Emboldened by the fall of Constantinople in 1453, Sultan Mehmet II declared war on Venice, leading to a disastrous and protracted conflict between 1464 and 1479 which drove the price of prestiti back to the 20s. This led to the reissue of new prestiti as monte nuova in 1482. The graph below shows the yield on the prestiti from 1285 to 1502, assuming a 5% coupon (though in reality the prestiti paid a variable rate after 1377 and 4% during part of the 1400s). The impact of the War of the Chioggia in the 1370s and the wars with Milan and the Turks after 1420 are clearly seen. As the Venetian Republic’s empire shrank, holders of the prestiti suffered. Venetian bonds would definitely have been downgraded as the heavy impact of the Venetian wars had their effect on the city-state’s finances.

Venice never recovered from the devastating war with the Turks, not only because of the loss of its colonies in the Mediterranean, but because Portugal’s discovery of a sea route to India and Christopher Columbus’s discovery of America shifted the locus of economic power from the Mediterranean to the Atlantic. The ocean-faring sailing ships of France, England and the Dutch Republic replaced Venice’s oared galleys. Amsterdam replaced Venice as the financial center of Europe, and during the 1600s and 1700s the East India Company dominated the oceans around Asia the way Venice had dominated the Mediterranean until then. On May 12, 1797, Napoleon Bonaparte brought an end to the Venetian Republic.
Though Venice is no longer a city-state, it has left us a beautiful city which tourists cherish. It also leaves us an important financial legacy: a record of the first international government bonds which were used throughout Medieval Europe by investors who wanted a safe place to store their wealth. Today, U.S. Government Bonds play the same role in the twenty-first century that prestiti played in the fourteenth century. Let’s hope U.S. Government Bonds can continue to pay that role for the century to come.

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