How sovereign debt becomes leverage – a lesson from history

"America Looks at its Neighbors" (political cartoon, 1932).

"America Looks at its Neighbors" (political cartoon, 1932).

I grew up in South Africa and for a time my birth country was the only worthwhile stop on the long sea journey that spice traders would make from Europe to India and back. South Africa was colonized by Europeans for this reason. A guy called Jan Van Riebeeck was ordered to set up camp there by the Dutch East India Company.

In November, 1869 the 10 year construction project on The Highway to India, aka the Suez Canal, was completed and South Africa became just another colony. Since then the Suez has had a colorful history, but there’s one specific teachable moment in the history of the Suez the United States could learn from…

In July 1956 the president of Egypt, Gamal Nasser decided to nationalize the Suez Canal. This irked a few stakeholders and on October 29, 1956, Israel invaded Egypt. The next day Britain and France threw their hats into the ring and started bombing Cairo.

At this point in history, Britain was suffering under a mountain of debt. Here’s a historical graph of Britains debt to GDP ratio to give you some perspective:

British Public Debt from 1900 to 2010

British Public Debt from 1900 to 2010

The United States held much of the debt that Britain was in. Some of the bonds were owed to the US as part of Britains World War II debt to the US government, corporations and individuals and some of them were part of the Marshall Plan to help rebuild Europe post WWII.

The US used this debt to put tremendous pressure on Britain to halt the invasion. Eisenhower ordered Humphrey, secretary of the treasury to prepare to sell part of the US governments sterling bond holdings. His British counterpart advised his prime minister, Anthony Eden, that if the US did sell their bonds, the British pound would devalue to such an extent that they would no longer be able to import what they needed to sustain the islands. Eden announced a cease fire on November 6th.

The US is now at around 90% debt to GDP ratio with a total debt of just over 14 trillion. Around 4 trillion of that is held by other countries, China being our biggest “investor”.

Lets put it this way: It’s hard to not take the call when your single largest investor needs a favor.