Britain's inflationary route to default Most of this 1930s debt was in the shape of War Loan taken out to finance the war effort. A very high proportion of tax revenue was being gobbled up merely servicing the interest rate costs, crimping expenditure on everything else and threatening an eventual fiscal crisis. The solution settled on by the then Chancellor, Neville Chamberlain, was to cut the coupon on War Loan from 5pc to 3.5pc, a feat he was able to perform without any act of technical default but merely by redeeming the old stock and persuading a patriotic public to take new, lower-yielding bonds. From the Government's point of view it worked just as prescribed, transforming the public finances and helping to cement the lower interest rate environment which was to be the bedrock of the UK's later economic revival. But for investors it was a disaster. The new stock immediately traded at a big discount to its predecessor. What wasn't given up in the immediate aftermath of conversion was later lost to the ravages of inflation. War Loan is the same sort of gilt as Mr Osborne now proposes, and still trades actively to this day. The calculation isn't exact, but £100 invested in War Loan back then would in today's money be worth just £20. The lesson is that it doesn't pay to hold fixed-interest investments over very long periods of time. Inflation will eventually rob you of your capital. Britain has never defaulted outright on its sovereign debt. Oh no, it's got a much cleverer way of relieving the investor of his money - inflation. It was hard to find a single investor yesterday who thought Mr Osborne's idea a good one. Theoretically, it might appeal to pension funds, which need to match assets with very long-term liabilities, but there's not a pension fund in the land with liabilities stretching as far out as 100 years. For them, the main appetite is in any case for index-linked gilts, or the sort of hedge against inflation which 100-year bonds are patently not. Still, there's no accounting for the stupidity of investors. There will always be some willing to trade their capital for a guaranteed income stream. What's more, if we get deflation rather than inflation, then even at today's interest rates, the investor would be quids in. Yet personally, I wouldn't want to be on the other end of such a bet, given that the Government can generate inflation at the drop of a hat, and its propensity, evidenced by the experience of War Loan, simply to chop the coupon if it seems too high. Does anyone honestly believe that today's historically low interest rates are here to stay even for the next 20 years, let alone the next 100? If so, it would defy most historic experience. For much of the last four years, deflation has routinely been seen as the major threat, but actually what we've had is the very reverse - stubbornly high inflation. Fighting the deflationary bogey has been the policy equivalent of the Maginot Line - preparing for attack from the wrong direction. For how much longer can governments sustain the "financial repression" which lies behind today's negative real interest rates? Mr Osborne claims Britain's safe-haven status by way of explanation for these rates, but might they not have just a little to do with the fact that the Bank of England is effectively hoovering up every pound's worth of gilt-edged stock the Government issues to finance the still burgeoning deficit? By the time the Bank completes the present round of quantitative easing, it will own approximately a third of the national debt. Government has also rigged the solvency rules to ensure a steady stream of demand for its debts from banks, pension funds and life assurers. The gilts market has become entirely fixed, and does not properly reflect underlying realities. One hundred-year gilts are therefore something of a red herring.