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GROWTH-LINKED
SECURITIES

John Williamson
Growth-Linked Securities
 John Williamson

Growth-Linked
Securities
John Williamson
Chevy Chase, Maryland, USA

ISBN 978-3-319-68332-4    ISBN 978-3-319-68333-1 (eBook)

https://doi.org/10.1007/978-3-319-68333-1

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 Preface to Professor John Williamson’s
Book GDP-Linked Securities

There is growing recognition of the need for more stable capital flows to
help moderate the boom-bust patterns of capital flows that are so disrup-
tive for the real economy and can cause such costly financial crises. Indeed,
the major Eurozone debt crisis has, to a great extent, been preceded by
very large capital flows, showing that this is not just a major concern for
developing and emerging economies, who have suffered from so many
previous crises, but also for their developed country counterparts. It is, in
fact, surprising how little emphasis has been placed on the role that capital
flows, mainly within Europe, played in causing the Eurozone debt crisis.
More generally, a major challenge for both developed and developing
countries is to ensure that both national and international financial sys-
tems are more stable. It is therefore very important to develop instru-
ments that can in concrete terms diminish this boom-bust pattern.
Growth-linked bonds, or securities—as John Williamson more precisely
calls them in this very important book—are an excellent example of such
a market-based instrument.
The global financial crisis focused attention on instruments that would
allow countries to minimize the risks associated with increasing capital
flows. The idea of a growth-linked debt instrument is not new. In fact
John Maynard Keynes not only sketched the concept within his overall
concern for allowing space for counter-cyclical fiscal policies but also
designed a so-called bisque clause that allowed the UK to pay less on its
debt to the USA, after World War II, in years when its economic condi-
tions deteriorated, while paying normally when the economy grew above
a certain level.

v
vi PREFACE TO PROFESSOR JOHN WILLIAMSON’S BOOK GDP-LINKED SECURITIES

A first wave of more general interest in indexing debt to GDP (gross

domestic product) emerged in the 1980s and received fresh impetus after
frequent debt and currency crises in many developing countries. The idea
has been supported by several of the world’s most distinguished econo-
mists such as Nobel Prize winners Robert Shiller, who pioneered interest
on this topic, and Joseph Stiglitz, as well as by John Williamson himself.
Eduardo Borensztein and Paolo Mauro at the IMF, as well as other
authors, have carefully outlined the modalities, advantages, potential
problems, and how to overcome them in several important articles,
reviewed in this book. At the United Nations, the author of this Preface
co-authored a study and organized several meetings, with very valuable
support from José Antonio Ocampo and John Williamson. In recent years,
the Bank of England has done important research work on the topic and
has been working with the private sector to design a standardized term
sheet for such a GDP-linked security, as well as launch a very valuable ini-
tiative for the G-20 to study and promote GDP-linked securities; other
central banks, including the Banque de France and the Bundesbank, have
also been researching these instruments.
There were only two further steps necessary for the successful imple-
mentation of these valuable instruments. The first is the need for the pub-
lication of a comprehensive study of the idea, from all angles, by a leading
economist, deeply acquainted with the topic. This book by John Williamson
precisely provides us with this invaluable contribution in a timely way. This
book explores the macroeconomic and other advantages of issuing such
bonds, but then digs deep into the various modalities that can be used for
introducing them, as well as possible challenges for introducing these
securities, and how to overcome them. The second, and major, step is of
course for countries to start issuing growth-linked securities and for finan-
cial markets to start buying them.
Indeed, it would be ideal for governments to issue growth-linked secu-
rities in a precautionary manner when their macroeconomic fundamentals
are strong and investors are keen to invest in their bonds. At such a
moment any novelty premium of the new instrument would be relatively
low. The problem is that in good times, governments have less incentive
to issue such bonds, as they see downturns or crises as unlikely, especially
during their mandate. GDP-indexed debt has to date only been issued to
a limited extent and mainly by countries that were having difficulties in
servicing their debts. However, the global financial crisis, as well as so
many preceding ones, made the case for these bonds far stronger. At the
 PREFACE TO PROFESSOR JOHN WILLIAMSON’S BOOK GDP-LINKED SECURITIES
   vii

same time, world economic recovery, including recently in the Eurozone,

makes this a good time to issue growth-linked securities.
This book clearly outlines the overwhelming benefit of borrowing via
issuing GDP-linked securities in the reduction in the danger of default,
which is in fact important for debtors, creditors, and the international
financial system. But there are several additional advantages to borrowers
in doing so in GDP-linked form: the fact that this increases fiscal space; the
fact that a growth-linked security acts as a potent anti-cyclical instrument,
for fiscal policy, thus helping maintain fiscal spending in bad times and
curbing its excessive growth in good times, which leads to smoother
growth, that contributes to higher investment and employment; the fact
that members of a currency union benefit by expressing their mutual
indebtedness in this way; the increase in the potential ways of reconstruct-
ing debt if this proves necessary; and the shift of risk to lenders; lenders are
easily able to diversify away most of their increased risk in a way that is not
practically possible for borrowers.
Investors would stand to benefit from the introduction of GDP-indexed
securities in two main ways. Firstly, these securities would provide an
opportunity for investors to take a position on countries’ future growth
prospects, offering them equity-like exposure to a country or a number of
countries and thus providing a diversification opportunity. If GDP-linked
bonds were to become widespread across countries, investors could take a
position on growth worldwide—the ultimate risk diversification. The sec-
ond main benefit for investors from GDP-indexed securities would be a
lower frequency of defaults and financial crises, which often result in costly
renegotiation and sometimes in outright large losses.
On an international scale, GDP-indexed securities can be viewed as
desirable vehicles for international risk sharing and as a way of avoiding the
disruptions arising from formal default. They can be said to have the char-
acteristics of a public good in that they generate systemic benefits over and
above those accruing to individual investors and countries. By reducing
the likelihood of defaults, these instruments would benefit a broader range
of investors than those directly affected, as well as the economies and mul-
tilateral institutions that may have to finance bail-out packages.
John Williamson perceptively notes that the above analysis is done from
the standpoint of the borrowers, the international financial system, and
the ultimate lender or investor, with the latter’s interests not necessarily
coinciding with those of some financial intermediaries. In general several
financial intermediaries benefit from market instability, since it is this
viii PREFACE TO PROFESSOR JOHN WILLIAMSON’S BOOK GDP-LINKED SECURITIES

which gives rise to the large profits and hence the high salaries that char-
acterize the financial sector. The important political economy question
raised by John Williamson is whether an instrument that is likely to reduce
market instability may not have difficulty in winning acceptance in key
parts of the financial industry. Noise traders, and traders who make their
high salaries by exploiting the mistakes of uninformed traders, are prob-
ably right to see the emergence of these instruments as a threat.
Accordingly, they can be expected to oppose initiatives to create such
instruments. That is why it is important to contemplate active steps by
public institutions, and specifically multilateral or regional development
banks, to help initially introduce such instruments: they are clearly in the
interest of the ultimate actors but not in the interest of all the private
financial intermediaries, who normally make most of the day-to-day
decisions.
From a purely economic perspective, an important point is that the
system-wide benefits provided by these instruments are greater than those
realized by individual investors. Hence, there are externalities that do not
enter the considerations of individual financial institutions or even coun-
tries. Other factors that discourage beneficial financial innovation include
the fact that the markets for new instruments may be illiquid. A concerted
effort is therefore needed to achieve and ensure a critical mass so as to
attain market liquidity, as discussed in depth in this book. Related to this
are coordination problems, whereby a large number of countries have to
issue a new instrument in order for investors to be able to diversify risk.
There is consequently a clear case for involving multilateral institutions.
Concretely, multilateral or regional development banks could play an
active role as “market makers” for GDP-linked bonds. They could begin
by developing a portfolio of loans, the repayments on which could be
indexed to the growth rate of the debtor country. Once the institutions
have a portfolio of such loans to different developing countries, they could
securitize and sell them on the international capital markets. Such a port-
folio of loans could be particularly attractive for private investors, as it
would offer them the opportunity to take a position on the growth pros-
pects of a number of economies simultaneously. Alternatively, the multi-
lateral development banks could buy GDP-linked securities that developing
countries would issue via private placements.
As correlations among growth rates tend to be lower at the global level,
the World Bank may be best placed to perform such securitization.
However, regional development banks, such as the European Investment
 PREFACE TO PROFESSOR JOHN WILLIAMSON’S BOOK GDP-LINKED SECURITIES
   ix

Bank, which lends to developed, emerging, and low-income countries,

could play a very valuable role. The new development banks, owned exclu-
sively or largely by emerging economies, such as the NDB (or New
Development Bank, often called the BRICS Bank) and the AIIB (Asia
Infrastructure Investment Bank), could be the innovators and take the
first step of lending in ways that the repayments on these loans could be
indexed to the growth rate of the debtor countries. Once financial markets
and borrowers become familiar with such instruments, and their advan-
tages, it may be possible for these multilateral or regional development
banks to reduce their role or even stop playing any role.
Another avenue for GDP-linked securities to be issued could be for
developed countries, whose GDP growth typically has varied less than that
of emerging and developing economies, to start issuing such bonds. In the
past this has been a fruitful avenue for financial innovation, as occurred
with the introduction of valuable collective action clauses into debt con-
tracts that was done first by developed economies and then followed by
emerging economies.
Stephany Griffith-Jones
 Contents

1 Introduction   1

2 History and Precedents   5

3 The Variants of GDP-Linked Securities  17

4 The Benefits of GDP-Linked Securities  49

5 The Costs of GDP-Linked Securities  65

6 Topics in the Demand for GDP-Linked Securities  71

7 Topics in the Supply of GDP-Linked Securities  77

8 GDP Revisions  93

9 Would BM Really Be Anti-cyclical? 109

10 Selecting the Best Form 113

xi
xii CONTENTS

11 The Disadvantages of Financial Innovation 117

12 Concluding Remarks 123

Index 127
 List of Tables

Table 4.1 Calculation of the riskiness of a mixed portfolio 60

Table 4.2 Data for calculation of riskiness of a mixed portfolio 62
Table 8.1 Argentina’s GDP growth rate, 1999–2003 95
Table 8.2 Revisions of Argentine real GDP greater than 3%,
1980–200599
Table 8.3 Assessment of revision of GDP formula by country,
1984–2007100

xiii
 CHAPTER 1

Introduction

Abstract This chapter provides an introduction. It argues that the tradi-

tional term for the instrument (“GDP-linked bond”) is wrong, inasmuch
as a bond has by definition a fixed return. It defines a GDP-linked security
as any instrument that pays a rate of return that depends upon GDP or its
growth rate. The remainder of the chapter is devoted to outlining the
chapters that follow.

Keywords Bond • GDP-linked bond • GDP-linked security • Outline

Financial innovation should involve the introduction of novel instruments

which benefit consumers of financial products, by featuring properties
which particularly appeal to them. Yet during the supposed “golden age”
of financial innovation, before the financial crisis, there was indeed plenty
of financial innovation, but its beneficiaries were overwhelmingly the peo-
ple in the financial sector itself, rather than their clients. (Think of credit
default swaps (CDSs), which enabled the financial sector to pass the risk of
default on to those supposedly better equipped to bear it, or collateralized
debt obligations (CDOs), which enabled the financial sector to splice and
dice the risk of mortgage or other obligations while doing nothing to
prevent millions of households risking losing their homes.) This book
concerns one financial innovation which the financial sector has still not

© The Author(s) 2017 1

J. Williamson, Growth-Linked Securities,
https://doi.org/10.1007/978-3-319-68333-1_1
2 J. WILLIAMSON

taken up but that, I would argue, would certainly benefit the ultimate
users of the financial sector.
I have chosen to call the instrument in question a “GDP-linked secu-
rity” (or, equivalently, growth-linked security) rather than using the
more familiar “GDP-linked bond” because the (relevant) definition of a
bond is “a certificate issued by a government or a public company prom-
ising to repay borrowed money at a fixed rate of interest and at a speci-
fied time” (Compact Oxford English Dictionary, emphasis supplied). The
distinctive feature of the GDP-linked security is precisely that the rate of
interest is NOT fixed ex ante, but depends upon circumstances.
Specifically, in the most common example, it depends upon the growth
rate achieved by the country that is borrowing. To pick the same exam-
ple as that used by Borensztein and Mauro (2004), consider a country
that has grown at an average rate of 3% per year over the previous
20 years, and which is able to borrow from the international capital mar-
ket at 7% per year. Suppose that it sells securities which pay 4% + the
country’s actual growth rate. (It would be expedient to have a minimum
payout of zero, to avoid the trouble of trying to collect payments due
when growth proves severely negative.) This is a GDP-linked security,
with the same expected payoff as the bond if in fact the past gives a good
guide to the future.
We may define a GDP-linked security as any instrument that pays a rate
of return that depends upon GDP or its growth rate. In practice by far the
most obvious issuers are sovereigns (i.e. countries). Countries are far
more obvious issuers than private corporations because the latter have the
option of issuing an equity. In addition to conveying the right to an own-
ership claim, a benefit of little significance for a normal minority share-
holder, purchase of an equity gives the right to a stream of earnings. These
depend mainly on the profitability of the issuer.1 But there is no compa-
rable instrument available to a sovereign borrower, and no comparable
opportunity for an investor to speculate on national growth rates. Because
of this, it is reasonable to assume that GDP-linked securities would be
grouped in their own separate asset class soon after the concept had
proved itself.
The second chapter of this study contains a more detailed examination
of the history of the idea, and of such precedents as presently exist. There
are not in fact examples of countries that have issued GDP-linked securi-
ties, but there are several cases of countries—Costa Rica, Bulgaria, Bosnia-­
Herzegovina, Argentina, Greece, and Ukraine—that have issued some
form of security as part of a debt reconstruction that paid out to the
 INTRODUCTION 3

i­nvestor if GDP exceeded certain parameters. It is worth examining

whether there are lessons to be learned from their experiences.
Chapter 3 is devoted to noting that there are fundamentally different
ways in which GDP-linked securities could be structured, and to contrast-
ing these different versions. It reports on a conference held recently by the
Bank of England which sought to answer many of the questions posed in
this book.
Chapter 4 is concerned with establishing the advantages of issuing and
holding such securities in contrast to plain vanilla bonds. This is ground
that has been covered in many previous presentations, so some readers
may wish to tread lightly over this material, but even those already familiar
with the subject may find novelty in the examination of the differing extent
to which the different variants would satisfy each of these advantages.
(The differences between different variants turn out to be quite major.) To
readers who are unfamiliar with the topic, this section is essential reading,
since it gives the essence of the arguments for GDP-linked securities.
Chapter 5 gives a parallel treatment of the costs of dealing in GDP-­
linked securities.
Chapter 6 considers the demand side of the market. A key issue is
whether such assets deserve to receive special dispensations according to
sharia law, making them particularly attractive to Muslims, who are likely
to constitute a disproportionately large proportion of the potential inves-
tors in such assets.
The lack of supply has until now provided the crucial constraint.
Problems of asset supply are dealt with in Chap. 7. The obvious issuers are
national governments of both advanced countries and emerging markets,
particularly those with ambitions for monetary union. However, there is
nothing to prevent sub-national units of government, state enterprises, or
even commercial enterprises from borrowing in this way. But if the govern-
ment perceives it to be in the national interest, they need to provide incen-
tives. Before it seeks to borrow a government needs to lay out a term sheet
specifying the terms on which it seeks to borrow. A draft of such a term
sheet has been prepared by a committee sponsored by the Bank of England
as a result of its conference. Since the resulting term sheet applies only to
one specific variant, we took it upon ourselves to offer an alternative.
Chapter 8 concerns one of the major problems that arise in designing
such assets. In practice, the problem is how to handle the major revisions
in GDP statistics that inevitably occur from time to time in any country
that tries to keep its statistics up to date. Several possible solutions are
outlined, and one particular one is commended.
4 J. WILLIAMSON

Another issue, taken up in Chap. 9, is whether the counter-cyclical

properties claimed for some of the securities might be undermined by lags
in the reporting of GDP statistics. It is concluded that the problem is real
but easily avoided by prompt reporting.
Chapter 10 is a key chapter of the book. In the light of the foregoing,
it seeks to answer the question as to which form of security is best calcu-
lated to advance the interests of particular issuers or investors. It concludes
that none are dominant in all respects, but nonetheless offers a specific
conclusion.
Chapter 11 asks why these assets have not already been invented. The
answer seems to lie in the lack of incentives for financial innovation and
the fact that many of the benefits of issue are externalities. In particular,
any country that pioneers not only has to face the likely novelty premium
but also cannot expect competition to keep premia down.
Chapter 12 summarizes.

Notes
1. It is true that the return on an equity can also be influenced by policies of
management like payout ratios and takeover policy, but if they deviate far
from the stream of dividends permitted by profits the management is liable
to find itself out of a job.

Reference
Borensztein, Eduardo, and Paolo Mauro. 2004. The Case for GDP-Indexed
Bonds. Economic Policy 19: 165–216.
 CHAPTER 2

History and Precedents

Abstract The idea of GDP-linked securities was first advanced by Robert

Shiller (Macro Markets: Creating Institutions for Managing Society’s
Largest Economic Risks. Clarendon Press, 1993), so those following his
proposal are dubbed RS-variant. Some years later Eduardo Borensztein
and Paolo Mauro proposed a different version of GDP-linked securities
(dubbed BM), and during a meeting in the UN in 2005 Daniel Schydlowsky
made yet another proposal (dubbed DS). The chapter recalls the academic
debate about these proposals. Meanwhile the financiers were incorporat-
ing GDP warrants in many of the debt reconstructions that occurred as
countries sought an exit from the debt crisis. Because warrants have only
been used in debt reconstructions, the use of GDP in defining debt has
acquired a stigma.

Keywords RS-variant securities • BM-variant securities • DS-variant

securities • Warrants • Stigma

In view of the likelihood that a number of major sovereign debtors

will have to raise far more money in the near future than they have been
accustomed to raising from the international capital market, and in view
also of the historically high levels that debt/income ratios have reached in
many countries, it seems time for a more systematic treatment of the idea
of one novel form of security than the idea has previously received. The

© The Author(s) 2017 5

J. Williamson, Growth-Linked Securities,
https://doi.org/10.1007/978-3-319-68333-1_2
6 J. WILLIAMSON

novel form of security that is examined in this book is what has tradition-
ally been called a GDP-linked bond.
The idea of GDP-linked securities was first advanced by Robert Shiller
in his Clarendon Lectures as one possible form of what he called macro
markets (Shiller 1993), meaning markets that enable people to achieve
objectives that are precluded by conventional markets. They have been
advocated in a number of places in recent years, most importantly in a
conference of the Bank of England which is reviewed in Chap. 3 and in an
article by Eduardo Borensztein and Paulo Mauro (2004), although the
form of security that they envisaged was in fact distinct from that proposed
by Robert Shiller. Variants have occasionally been used in debt reconstruc-
tions, by Costa Rica, Bulgaria, Bosnia-Herzegovina, Argentina, Greece,
and Ukraine. In this chapter we outline the proposals of the pioneers and
recount the experiences of countries that have used such instruments.
GDP-linked securities have in the past been referred to as GDP-linked
bonds. As explained in the Introduction, I decided to change the term
for a good reason. These instruments do not qualify as bonds under
the ­standard definition, which defines a bond as an instrument whose
return is pre-set. In contrast, the return on a GDP-linked security
depends upon the growth rate of GDP (normally, the GDP of the issuer).
If and when such instruments are issued and become a regular part of
investors’ portfolios, they will surely be recognized as constituting a sepa-
rate asset class, because their performance depends upon quite different
factors to those which govern bonds.
We define a GDP-linked security as any instrument that pays a rate of
return that depends upon GDP. In practice by far the most obvious issuers
are sovereigns (i.e. countries), and the growth rate upon which one expects
the return to depend is the growth rate of the country that issued the
instrument. Countries are far more obvious issuers than private corpora-
tions because the latter have the option of issuing an instrument called an
equity. In addition to conveying the right to an ownership claim, a benefit
of little significance for a normal minority shareholder, purchase of an
equity gives the right to a stream of earnings. These depend ultimately
mainly on the profitability of the issuer,1 which therefore constitutes a
natural base on which to borrow. But there is no comparable opportunity
available to a sovereign borrower.
The GDP-linked securities discussed in this book are envisaged as a way
to raise money, not a way to reconstruct debt. In this chapter we examine
such historical precedents as there are, but it is important to understand
 HISTORY AND PRECEDENTS 7

that up to now these have all involved debt reconstructions. This means
that the capital market does not have a natural way of disciplining an issuer
who attempts to cheat by fiddling its statistics, or whatever. Matters would
be very different if borrowers were regularly raising new money by issuing
such instruments: a country that was seeking to reduce its payments improp-
erly would surely be charged more for new issues by the market once its
impropriety were widely known. The market itself would do the disciplin-
ing, without any need for this to be written into formal agreements. This
fundamental point seems to have been missed by many of the critics.
Consider therefore a sovereign that wishes to raise $x million (or a sum
denominated in any other currency, including most importantly its own).
It may choose to issue the security in the US market, or its national m
­ arket,
or some other market (of which London is the most important). The
authorities may insert the issue into a regular borrowing program and
issue it themselves, or they may approach an appropriate financial institu-
tion2 with a notification of the sum to be raised. Assume that the security
to be issued takes what is subsequently called the BM (after Borensztein
and Mauro) form, which is to say that it would involve a promise to pay
the maximum of

a + b ( y i − y e ) , zero

in each period i that it is outstanding, where a and b are constants, yi is the

growth rate in the reference period i, and ye is an estimate of the average
future growth rate, plus repaying the principal when the term of the
­security expires. The financial intermediary would presumably advise on
the choice of ye, which one would expect often to be chosen as the average
actual growth rate of some preceding period (like 10 or 20 years). One
assumes that b would normally be set at unity, leaving a to be chosen as a
residual so that the securities would sell roughly at par. If the parameters
a and ye were chosen so that the securities sold exactly at par, then an
issue of $x million would yield the country exactly $x million (less the
charges of the financial intermediary).3 To the extent that the financial
intermediary misestimated the market, the securities would sell at a dis-
count or premium determined by the market, and the borrower would
receive less or more than had been requested. The expected interest rate
would be (a + bye) ± δ, where δ is the discount or premium divided by the
term of the security.
8 J. WILLIAMSON

It may help to have an arithmetical example: I choose to present the

same example as that used by Borensztein and Mauro. Consider therefore
a country whose expected growth rate ye is 3%, perhaps because that was
the actual growth rate it achieved on average over the previous decade.
Suppose that it usually borrowed on a plain vanilla bond yielding 7% a
year. Then, assuming b = 1, the annual interest yield would be 4% (= a)
plus the achieved growth rate (subject to a minimum of zero).
As noted above, the obligations to pay the seller and to service the debt
could be denominated in an international currency like the dollar or in the
national currency (or in a third currency). The choice between these is
essentially similar to that which arises in the case of a conventional interest-­
bearing bond. Investors will have greater confidence that the instrument’s
value is not going to be reduced opportunistically by inflation if it is
denominated in an international currency like the dollar, but against this
the debtor may have more difficulty in meeting its obligations. A weaken-
ing of the currency will lead to an increase in the burden of debt service
under a dollar security, and that will increase the danger that the debtor
has difficulty in maintaining service under adverse circumstances.

2.1   Intellectual History of the Idea

A series of economists, of whom the author of this book was one of the
pioneers (Lessard and Williamson 1987), urged the virtues of linking bond
yields to commodity prices, including oil for oil exporters. This has
occasionally been done, especially for oil, but it has never become widely
practiced. It has been argued that this is because insurance is more efficiently
provided through signing a separate financial contract rather than insisting
that the insurance be provided by the creditor. (Most countries, of course,
do not bother to insure, which involves an upfront payment being authorized
by the current finance minister to relieve his successor of a risk.)
The first economist to suggest a GDP-linked “bond” was Robert
Shiller. His pioneering book Macro Markets is essentially concerned with
developing the case for creating markets in which individuals would be
able to swap their existing income streams for less risky ones. Ideally an
individual would sell (go short on) his income stream in return for a claim
on (a long position in) the world income stream, while the owner of the
exchange would take the contrary positions. These would, by definition,
collectively cancel out. This is envisaged as a reform that would be widely
advantageous, permitting insurance against one of life’s greatest risks, the
 HISTORY AND PRECEDENTS 9

risk that one’s earning power will be lower than expected. Some of us may
doubt whether all the benefits that he attributes to this reform, such as a
tendency for international income equalization, would materialize, but at
the least it would curb the tendency for income to fluctuate on account of
idiosyncratic factors. One may also question whether he does not under-­
estimate the danger that the old conflict between the incentive to produce
more and income equality would present a problem for his proposals.
His discussion of a GDP-linked security (p. 38ff) was incidental, pre-
sented as one example of the type of security that he had in mind. It is a
claim that the individual would have against an exchange, rather than the
country’s government, with the exchange balancing its books by taking
claims with sufficient heterogeneity to guarantee that it would remain sol-
vent in any state of the world. He analyzed perpetual claims rather than
claims with a finite life, but essentially for reasons of analytical simplicity:
one doubts if any of his conclusions would be susceptible to this simplifi-
cation. The dividend on his security “would always be proportional to the
announced national income”, and would be paid on every date that a new
value of the index (i.e. national income) was announced.
Shortly thereafter Robert Barro (1995, published in 1999) analyzed
what was implied by the objective of tax smoothing in a model of optimal
debt management. This was to link payment on “bonds” to consumption
and government expenditure. But he then argued that a more practical
alternative was to use GDP-indexed “bonds” as a second-best, which
would also present fewer problems with respect to moral hazard and
measurement.
Jacques Drèze (2000) mentioned that he and three colleagues had
­proposed the restructuring of developing country debt in the form of
“bonds” indexed on a country’s national income net of a deductible. The
deductible was intended to exempt incomes below a subsistence level from
contributing to debt service and earmarking some government revenue
for meeting basic human needs before servicing the debt. Beyond that, a
country would be expected to service debt in proportion to its ability as
measured by national income.
An important contribution to this literature was made by Eduardo
Borensztein and Paulo Moro, both then at the IMF, in a paper presented
to the Economic Policy Panel in 2003 and published the following year in
Economic Policy. They considered a security that was much more similar to
a standard sovereign bond, which they implicitly assumed was issued by a
national government. In fact, they assumed that the only difference to a
10 J. WILLIAMSON

standard sovereign bond would be that the interest coupon would be

given by the maximum value of

a + b ( y t − y e ) , zero

where a is a constant, yt is the issuing country’s growth rate in period t, and ye

is the expected average growth rate over the period the bond is outstanding.
The result is to make the return to the investor a variable, rather than being a
constant. A number of advantages, principally to borrowers but also to lend-
ers, were outlined, of which the most important were the lesser external pres-
sure imposed on a country with an unexpectedly low growth rate and an
attenuation of the incentives for pro-cyclical fiscal policy.
In 2005 a meeting entitled “GDP-Linked Bonds: Making It Happen”
was organized by Stephany Griffith-Jones and Krishnan Sharma in the
United Nations. It was at this meeting that a third form of growth-linked
securities analyzed in Chap. 3 was proposed by Daniel Schydlowsky, then
of the Peruvian Debt Management Office. According to this variant, the
sum that a country would pay was to vary depending on the growth rate,
with the balance being capitalized.
Another meeting on the topic was organized by Stephany Griffith-­
Jones and John Williamson at the IMF in 2006. Trevor Manuel was one
of the speakers at this meeting, and raised the possibility that the variation
in payments would not in fact be cyclically stabilizing, because payments
would necessarily lag the cycle. This contention was subsequently ­analyzed
(only for the BM-variant of the proposal) for Colombia and Thailand in a
simulation study by Dagmar Hertova (2007). Her finding was that there
was indeed a possibility of failing to stabilize, but that if payments were
made reasonably promptly (notably with a lag of six months rather than a
year and with reasonably prompt payment of interest) one would still have
had a cyclically stabilizing impact.4

2.2   History of the Use of GDP-Linked Securities

There have already been several instances in which GDP-linked securities
have been launched, though none aimed to raise new money by the sale
on the open market of such securities or established GDP-linked securities
as a substantial part of savers’ portfolios. Most of these have involved
­debt-­distressed countries giving their creditors a stake in their recovery by
 HISTORY AND PRECEDENTS 11

attaching GDP warrants to their new replacement bonds. A previous

recounting of several of the experiences cited here, on which the author has
drawn, is Griffith-Jones and Hertova (2013). These instruments, which the
holders have sometimes been permitted to sell for cash, promised to pay the
holder a sum which depended upon the issuer’s GDP growth.
Perhaps the first instance in which a sovereign issued a GDP-linked
security was Costa Rica’s attachment of a GDP value recovery clause in its
debt reconstruction of 1989. This was attached to the 6.25% Brady bonds
issued in settlement of Costa Rica’s sovereign borrowing at the time that
the Latin American debt crisis broke. The value recovery rights promised
to pay in each “Recovery Year” an amount sufficient to bring the total bill
for interest plus recovery rights up to the same level as the interest bill
would have reached in 1990, provided that the level of GDP was over
120% of that in the base year of 1989 and that the total annual bill for inter-
est plus recovery rights did not exceed 4% of GDP (2% after the interest
payments ceased after 25 years).
Another instance arose during the Bulgarian debt reconstruction of
1994. Citibank arranged that the new discount bonds (which themselves
paid LIBOR plus a conventional 13/16) should have additional interest
payments equal to 0.5% interest for every 1% of positive GDP growth in
the year prior to the interest payment, provided that GDP was at least
125% of its 1993 level. Unfortunately the term sheet did not specify the
GDP concept to be used: whether it referred to constant value versus
current value, or dollar versus lev valuation of GDP. The Bulgarian
­
­government chose what most economists would regard as the obvious
interpretation, local-currency constant-value GDP, but the general market
view was that a natural interpretation was dollar-denominated current
value GDP. Anyway, the bonds were callable at the option of the debtor,
as they were indeed called in 2004 (though the immediate provocation
was a threat to sue on the part of two hedge funds rather than the cost of
the interest payments). Since the market did not anticipate the o
­ pportunity
of making serious money through additional interest payments, they were
never valued very highly. If one wishes to issue such securities, it is obvi-
ously necessary that they embody clear definitions and that they not carry
call options, a lesson that appears to have been learned in the draft term
sheet presented at the Bank of England conference.
When Bosnia-Herzegovina reconstructed its share of inherited Yugoslav
debt in 1997, at the conclusion of its civil war, it issued two sets of
new bonds to bondholders. Both were DM-denominated. One had an
12 J. WILLIAMSON

orthodox, though initially very low, interest rate; this increased

­progressively over the following ten years so that it now pays a typical rate
of LIBOR plus 13/16. The other (B) bonds were initially valued at almost
nothing and were given automatically to the holders of the A bonds. These
B bonds would only kick in and pay interest (and, as from 2017, principal)
after a minimum of ten years and after GDP per head had exceeded $2800
(in dollars, converted at the market exchange rate) increased by the
German CPI inflation rate for two consecutive years. There have subse-
quently arisen doubts about exactly when Bosnia-Herzegovina reached
this threshold. No one doubts that it needed to pay from 2007 on (since
2007 and 2008 clearly were above the threshold), but it is not clear
whether the threshold was also reached in 2006. Initially GDP per head
was thought to be below the threshold, though the German CPI was
revised so there was even doubt about where the threshold lay. But then
the Bosnian statistical office counted a part of the unofficial economy in
the official GDP statistics so it looked as though it would exceed the
threshold. Then the World Bank (whose statistics are used to adjudicate,
though the series officially named had ceased to exist) revised up its popu-
lation estimate and pushed GDP/head below the critical threshold once
again. In any event the B bonds had a value about 30 times as great as
initially in the middle of 2008, when the subject was under study.
Another instance in which GDP-linked warrants were attached to the
bonds resulting from a debt reconstruction was in the Argentine restruc-
turing following the crisis of 2001. The bondholders were initially so
skeptical of the value of such warrants that they attached almost no value
to them. Even before the warrants were formally detachable, the holders
had started selling their rights for a song. The investment banks and hedge
funds that first bought the warrants therefore made a mint. A positive
result of this experience has been to stir an interest in Wall Street, although
the fact that GDP links have been issued only in the course of debt
reconstructions has inevitably created suspicion of such instruments
­
(“stigma”) in financial markets.
The Argentine warrants promise to pay 0.05 (“excess GDP”) (number
of units of GDP-linked securities held as a proportion of total GDP-linked
securities), where the “excess GDP” is the amount by which the actual real
GDP exceeds the base-case real GDP. This is subject to several provisos:
that real GDP exceeds a base-case, that real GDP growth exceeds a m ­ inimum
which started in 2006 at 4.26% and declines gradually to 3% by 2015, and
that total payments on the warrants do not exceed a pre-­specified cap. It is
 HISTORY AND PRECEDENTS 13

worth noting that the payment varies with the excess level of GDP over a
cap, rather than with the growth of GDP. This means that because Argentina
had robust growth in the early years it is now committed to paying out a
substantial sum in any year when real GDP growth is in excess of the critical
level, even if the excess is marginal, so that it could end up worse off in
consequence of higher growth. The warrants expire in 2035 or when the
payments cap has been reached, whichever occurs sooner.
A quite different motivation for the issue of growth-linked securities
drove Singapore to make an issue in 2001. Singapore wanted to give
Singaporeans a stake in the future of the country, and therefore gave
Singapore citizens untradable shares that promised them that in the future
holders would collectively be entitled to receive 3% of Singapore’s growth.
One cannot hope to draw lessons from this experience of relevance for
public sale of growth-linked securities.
Greece also issued GDP-linked warrants as part of its debt reconstruc-
tion of 2012. Once again, these provided for payment only if nominal
GDP was in excess of a specified reference level, and real GDP growth
exceeds 2.9% (2% as from 2021). The formula for the annual payment
from 2015 to 2042 is 1.5 (excess of real growth over reference rate) (face
value of GDP-linked warrants) with a maximum value of 1% of the
face value of the GDP-linked warrants, and where the “reference rate” is
currently 2.9%, falling to 2% in 2021. The warrants are detachable, issued
to those who participated in the debt restructuring, and have so far carried
little value. They paid nothing in the first year (2015), due to Greece’s
negative growth.
Ukraine also issued GDP-linked warrants in the course of its debt
restructuring of 2015. These were for a notional sum equal to the reduc-
tion in the value of bonds outstanding. The payout on them depends
upon GDP growth being at least 3%, as well as the level of GDP being at
least $125.4 billion, for each year in the period 2021–2040. The payout is
lower for growth of between 3 and 4%, but for over 4% it is essentially
0.15% of GDP + 40% GDP (excess of real growth over 4%). The warrants
also carry a put option in the event of Ukraine breaching the covenants of
the bond contract or declaring a moratorium, in which case Ukraine
would be obliged to pay the notional value of the contracts. Otherwise
there is no amortization.
That appears to exhaust the instances in which sovereigns have issued
securities carrying a link to the value of their growth (or GDP). This his-
torical experience, while not extensive, does suggest three very strong les-
14 J. WILLIAMSON

sons. First, it is important for the contract to be unambiguous and spell

out exactly what concept of GDP is to be used, and especially to avoid
naming only one statistical series, especially if it may cease publication (les-
son of Bulgaria). It is much better to explain the concept that one wishes
to approximate, and allow a relevant series to be found. Second, it is
important to avoid discontinuities such as the fact that a year’s debt servic-
ing in Bosnia hung on whether GDP was a few dollars above or below
some threshold: it would have been much better to phase in debt-service
payments gradually so that a marginal difference in GDP would have made
only a marginal difference in the payment. Third, there is no point in hav-
ing a growth-linked bond that is callable by the issuer, as in Bulgaria; inves-
tors want and are willing to pay for an upside, and if one removes this then
one cannot expect a GDP-linked security to generate much market inter-
est. It is good to see that these lessons appear to have been thoroughly
absorbed in the draft term sheet presented in Chaps. 3 and 7.

Notes
1. It is true that the return on an equity can also be influenced by policies of
management like the payout ratios and who they take over, but if they devi-
ate far from the stream of dividends permitted by profits the management is
liable to find itself out of a job.
2. In the old days one would have said investment bank, but they have more or
less ceased to exist since the financial crisis; their functions have been taken
over by the financial supermarkets that bought out those that didn’t go
bust. They will be referred to below as a financial intermediary.
3. It was suggested in the Bank of England conference that it is important for
certain investors that the security sells at par on the day of issue, for which
purpose a “principal factor” adjustment is introduced in the term sheet that
was discussed. If this is done, then the δ introduced in the text would be
zero.
4. Her study, which is referred to further in Chap. 9, considered whether
Colombia and Malaysia would have had a cyclically helpful change in the
timing of their payments if part of their 1995 sovereign debt had consisted
of BM bonds with a = 8.44 for Colombia and 7.08 for Malaysia, b = 1, and
the average expected future growth rate was the same as the actual recorded
average growth rate of 1980–1994, 3.71% for Colombia and 7.02% for
Malaysia. It compared actual interest payments over 1996–2004 with those
that would have been due had half the debt been swapped into GDP-linked
securities with the features described above, under two different scenarios
about the timing of interest payments. Under one scenario, growth rates are
 HISTORY AND PRECEDENTS 15

measured annually, so that 1996 payments are based on 1995 growth.

Under the other scenario, growth is measured every six months and there is
a lag of six months from the end of the reporting period before interest is
paid, so one payment based on growth for the first half of 1995 is already
made at the end of 1995 and included in the 1995 figures.
The study implies that the more prompt payments due under the second
scenario would have been of major benefit in ensuring that the cyclical varia-
tion of the payouts was beneficial. It is not in fact clear that there would have
been much benefit in terms of a counter-cyclical impact at all under the first
scenario: for example, Colombia’s big fiscal saving would have come in
2000 rather than the year of recession 1999, while it would still have had a
net saving in the boom year 2003 because of the sub-par growth in 2002.
In contrast, payment on the basis of six-monthly GDP figures with a six-
month lag of publication leads to a much more satisfactory time profile,
with most of the fiscal savings in the big recession year 1999 and above-
average payments already in 2003.
One problem with making debt-service payments promptly so as to ensure
that they vary anti-cyclically is that it obliges debtors to call a relatively early halt
to the GDP revisions on which they base payments. This is a problem addressed
by Borensztein and Mauro (2004, pp. 199–200), who conclude after an empiri-
cal exercise that the resulting errors would not be major. If investors still worried
about this problem, a solution would be to employ the Schydlowsky scheme at
the margin. That is, the borrower would make its debt-service payments at
specific times, say six months after the end of the reporting period, but then
further revisions would be capitalized. So if the borrower paid out debt service
of x percent on the basis of a reported growth rate of 5%, and the growth rate
were subsequently revised up to 6%, an additional 1% would be added to the
value of the debt that would ultimately fall due. This would safeguard the anti-
cyclical impact of the proposal (except possibly the repayment of the principal,
a problem further discussed in Chap. 6) while simultaneously safeguarding
investors against malpractices like the borrower delaying the announcement of
unexpectedly high growth rates until after the payment had been made.

References
Barro, Robert J. 1995. Optimal Debt Management. NBER Working Paper No.
5327.
———. 1999. Notes on Optimal Debt Management. Journal of Applied Economics
2 (2): 281–289.
Borensztein, Eduardo, and Paolo Mauro. 2004. The Case for GDP-Indexed
Bonds. Economic Policy 19: 165–216.
16 J. WILLIAMSON

Drèze, Jacques H. 2000. Globalisation and Securitisation of Risk Bearing. Belgium:

CORE, Université Catholique de Louvain.
Griffith-Jones, Stephany, and Dagmar Hertova. 2013. Growth-Linked Securities.
In Global Economics in Extraordinary Times: Essays in Honor of John Williamson.
Washington, DC: Peterson Institute for International Economics.
Hertova, Dagmar. 2007. Fiscal Implications of GDP-Linked Bonds, Mimeo.
Lessard, Donald, and John Williamson. 1987. Capital Flight: The Problem and
Policy Responses. Washington, DC: Institute for International Economics.
Shiller, Robert J. 1993. Macro Markets: Creating Institutions for Managing
Society’s Largest Economic Risks. Oxford: Clarendon Press.
 CHAPTER 3

The Variants of GDP-Linked Securities

Abstract An RS-variant would give the right to receive a given fraction of

GDP; that is, it is the principal which increases with GDP. A BM-variant
is structured more like a conventional bond; the coupon varies positively
with the increase in GDP. In a DS-variant the charge to the debtor is as in
a BM-variant, but the part paid over to the creditor is as in a plain vanilla
loan; the balance is capitalized. It looks as though BM changes more than
RS in response to a quantity increase, but we have no proof that this is
always so. The chapter proceeds to describe a conference, which included
presentation of a draft term sheet, convened by the Bank of England on
what it described as GDP-linked bonds. It concludes by summarizing
issues like the pari passu clause that have to be resolved in any bond
offering.

Keywords Inflation-proofing • Reactions to real growth different to

expected • Bank of England conference • Term sheet • Governing law

A GDP-linked security is defined as one in which the payment to the

investor depends upon the behavior of GDP. However, two quite different
concepts of how this might be effected have been prominent in the litera-
ture, and in the course of discussions a third possible variant has been
proposed. Further versions can surely be conceived; indeed, Borensztein
and Mauro (2004, p. 175) present several possible alternatives, and a

© The Author(s) 2017 17

J. Williamson, Growth-Linked Securities,
https://doi.org/10.1007/978-3-319-68333-1_3
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fact that she herself was the cause of their silence. Luke indeed did not notice
that Rachel was not talking, or that he himself had very little opportunity of
doing so, for he was naturally a silent man, having contracted the habit from
having so talkative a mother.

Happily after lunch, Mrs. Greville had to go to some parish engagement so

that Rachel and Luke had their chance of a talk; and finally Luke was called
off to see someone and Rachel had the Bishop to herself.

The talk did her good, specially as she made him laugh over the matter of the
two pies.

"Now that lunch is over," she said laughingly, "I am thankful that I changed
them. I believe it would have given my mother-in-law a terrible shock if she
had found out that I neither wanted nor liked her pie. And perhaps it would
have ended in an estrangement between me and Luke as he would have
probably heard of it, and I am quite sure he would never have understood.
And fancy! All because of a pie! How silly and small I am."

CHAPTER IX.
GWEN.

"I expect that Gwen has been in one of her naughty moods," said Rachel, as
she passed the letter she had received from her mother to Luke when they
were at breakfast. "I was the only one who could do anything with her."

"I see that she is coming instead of Sybil."

"Yes, and I am sure that is the reason. I shall love to have her."

"I think I shall be somewhat afraid of that young person," said Luke with a
laugh. "She is one of the independent kind I noticed at our wedding."

"She is a darling, and I know you will love her. But I own that at times she is
an enfant terrible, one never knows what she is going to say next. One thing,
however, we may be sure of, she is absolutely true, and says what she really
thinks. You must prepare for the worst," she added, laughing, "and you must
overlook her faults. I shall not forgive you if you don't love her. To me she is a
most fascinating little thing."

And Gwen arrived the next day. She was a girl of fifteen, tall and slim, not
exactly pretty; but there was a charm about her that could not be denied, and
Rachel, as she met her at the station, could not help hugging her. She was a
bit of home, fresh and sweet; and carried about with her the atmosphere of
golden cornfields and scented hedges. Rachel had not seen anything so fresh
and full of life since leaving home.

On the other hand Gwen had never seen anything like the darkness and dirt
of the town through which she was passing to Rachel's home. She grew silent
as they drove through the streets.

Rachel wondered what she was thinking of, and tried to distract her attention
by questions about her mother and sister; but only received short answers
and in an absent tone of voice.

At last they reached number 8 Wentworth Road.

"Is this it?" asked Gwen incredulously.

"Yes. It is not pretty, but I have tried to make it nice inside; and have quite got
to love it," answered Rachel. She was a little distressed at Gwen's tone of
voice.

When they had given directions to the cabman to leave the luggage a few
doors further up, Rachel took her sister over the house, and they finally settled
down by the drawing-room fire, as the evenings were beginning to get chilly;
though they had not begun fires, Rachel was bent on having one on the day of
Gwen's arrival.

Gwen drew her chair up almost into the fender, and then clasping her hands
behind her head said, "Now I will answer your questions properly about home.
I really couldn't do so in that awful cab and passing through the town. What a
place it is!"

"I suppose it strikes you as very uninviting, but I have got so used to it that I
hardly notice its deformities."

"Well it is time that someone should come and spy out the land," said Gwen. "I
am sure that Mother has no idea of your surroundings."

Rachel laughed.

"Well don't you go and make the worst of them to her," she said. "I have
purposely not enlarged on the subject, as I did not wish to worry her. Besides,
she would imagine that I was not happy, which would be very far from the
truth. I would far rather live in an ugly dirty town with Luke than in the most
beautiful country in the world without him. When you are a little older, Gwen,
you will understand that."

"No I shan't. No man in the world would make up to me for the country. I
should simply die if I had to live here," she added, looking round the tiny room.
"In fact I can't imagine a really unselfish man asking such a sacrifice from the
girl he loves best in all the world."

Rachel laughed merrily. Gwen had got on to her favourite theme, the
selfishness of men. She was always harping on that subject, Rachel
remembered, at Heathland.

"Well, let us leave that and tell me of home," she said, as she was hungering
for news. Then she suddenly drew Gwen's chair closer to her.

"You dear little thing," she said, smoothing her hair tenderly. "How glad I am to
have you. I'm afraid, however, that you have come because you have been
troublesome at home. Is that so?"

"I've come to spy out the land," answered Gwen with a mischievous smile;
"and it's high time."

"Don't be silly, tell me about Mother and Sybil."

"Mother is a dear and lovely as ever. I wish I had not made her cry last week. I
own I was horrid."

"Oh Gwen! You don't know what it is to be without Mother."

"I'm thankful I don't," said Gwen energetically. "If Mother had seen this place
before you married Luke she would never have let you come. By-the-bye, I
suppose that funny little creature that opened the door for us is not Polly who
you write about?"

"Yes, she is Polly. We are great friends."

"But she is not the only one?"

"Of course she is. Why you don't suppose this tiny house requires more than
one servant do you?"

"But that minute specimen cannot do all that is needed by herself."

"Of course not. I help her. Now don't be stupid Gwen; tell me some more
about home."

Gwen shut her mouth indicative of intense disapproval for a moment; then she
began to talk of Heathland; and Rachel listening, could almost feel the wind
blowing over the moors, and see the hedges just touched with hoarfrost in the
morning. She pictured her Mother walking about the garden with her pretty
soft shady hat which they all thought suited her so well, or lying on the cane
sofa in the verandah speaking to the old gardener in her low musical voice.
The vision of her was so vivid that the tears rushed into Rachel's eyes, and
would have fallen had it not been for Gwen's presence. She was determined
that the tiresome child should not have any excuse for supposing she was not
as happy as a queen.

It was at supper that Luke met the 'young person' as he called her, and had to
confess to himself that he was more alarmed at her than she was of him.

Gwen was afraid of no-one, specially of a mere man, as she had made up her
mind that they were a set of selfish human beings who needed to be taught
what was really required of them, and that one woman was worth ten men;
specially such a woman as Rachel whom she loved devotedly.

In fact the selfishness of Luke had chiefly consisted in her mind in taking her
favourite sister away from her. She knew little but that about him, and though
she had been sent away from home in order that a change might help her to
get rid of her very tiresome mood, she preferred looking upon her visit to
Rachel in the light of a spy.
Was Luke worthy of her? Had he made her comfortable? Did he look well after
her? These were the questions that she intended answering during her visit,
and taking the answer back to her mother and sister.

But she soon found that it would not do to make the object of her visit too plain
to Rachel, as the latter showed signs of being vexed; and she might defeat
her own plan. So when Luke came in to supper she was on her best
behaviour, though at times she could not prevent her lips curling at one or two
of his remarks. It seemed to her that he was wrapped up in his own interests
and noticed nothing else. She did not realise the immense importance of his
interests which were centred in his work.

"We must try and give Gwen a little amusement," said Rachel next morning
before her sister arrived for breakfast, "or we shan't keep her with us. Don't
you think we could take her to the wood this afternoon?"

He told her by all means to go to Deasely Woods, but that he had work which
could not be neglected.

To be in the woods again with Gwen satisfied a longing of Rachel's heart.

They left the dullness and dirt of Trowsby behind them, and wandered among
the trees, treading on the soft carpet of fallen leaves and inhaling the scent of
the damp earth.

"How delicious," Rachel exclaimed.

"Do you often come here?" asked Gwen. She knew what the answer would
be.

"No, Luke can't afford the time. You see the calls on his time are endless in
such a parish."

"Bother the parish!" said Gwen.

"No, no, you must not say that. I don't think you quite realise that a
clergyman's life is quite different to that of other people. You would not
approve of a doctor neglecting his patients for pleasure. Well a clergyman is a
physician of souls. And after all souls are more important than bodies."

"I don't know anything about souls," said Gwen.

"Of course you do, don't talk nonsense."

"No, I don't. I don't think I am sure that we have souls. But I am not peculiar in
this. The papers and books are full of doubts of all sorts."

"But my dear child, why do you read such books? We want to build ourselves
up in our most holy faith, and not to read all the views on the other side. How
do you see these books?"

"I find them in the library. Sometimes I wish I had not read them, but you know
I read everything I can get hold of."

Rachel made up her mind to ask Luke to have a talk with Gwen. She was very
distressed at what she told her.

"Luke says that we must not be surprised at all the doubts and strange
theories that are about just now, as he believes we are living in the last days
and must expect the devil to be extra busy. I am sure he is right."

"Don't let us talk of the last days," said Gwen, "but enjoy the country while we
have a chance. You must pine for it in that horrid place."

"I am too busy to think much about it," said Rachel, and she added, "when I
do I turn my thoughts to Luke, and feel how much I have to be thankful for in
having him."

Gwen laughed a little unbelievingly; and on returning to Trowsby, she felt she
could not endure more than a few days in it although her favourite sister lived
there. Of course she helped Rachel with the household work, and made fun of
it; but she hated it for all that, and could not understand how Rachel could
endure it after her life at home. She studied Luke attentively and critically;
nothing escaped her, and a day or two before she left, he heard a knock at his
study door and on opening it found Gwen facing him.

"I want to talk about something very important," she said.

Luke was in the midst of writing a paper to be read at a clerical meeting, and
was sorry to be interrupted; but he invited her in with a smile and drew up a
chair for her. She seated herself and then looked up at him gravely. He
wondered what was coming. Gwen's expression of face was severe.

"I suppose you know how unwell Rachel is," she began.

"Unwell?" said Luke startled.

"Yes, she is quite different to what she was at home. She has lost all her
spirits and looks. Do you mean to say you have not noticed?"

"No, certainly I have not," said Luke. "She is always very bright."

"That's just like a man," said Gwen scornfully. "They never notice when their
wives look ill. They are all alike. Rachel is working far too hard, it will wear her
out."

Luke rose greatly concerned and leant against the mantle piece looking down
at his severe young judge, anxiously.

"Are you sure?" he asked.

"Perfectly sure. She can't stand this life; having never been used to it. It is all
very well for girls who have been taught how to do things. Some of them quite
like it. But Rachel has never been taught and it is killing her, slowly."

Luke leant his head on his hand which rested on the mantle piece and fixed
sad eyes on the girl. He was too perplexed and worried to speak.

"Rachel positively slaves for you," continued Gwen unmercifully, "but you don't
see or notice. Why only the other evening she carried a heavy coal scuttle into
the dining-room and you were so deep in your paper that you never saw. You
don't see or know half that goes on. But all men are alike. Certainly from all I
see of married life I never intend to marry; if I do I am determined to be an old
man's darling rather than a young man's slave."

Worried as Luke was, he could not resist a smile, as the thought crossed his
mind that Gwen would probably never have the chance of being either. He
could not imagine any man falling in love with such an audacious young
person. His smile however quickly disappeared as Gwen said:

"I suppose you love her still?"

"Love her!" He grew white and his eyes flashed so fiercely that Gwen for a
moment quailed.

"Child, you don't know what you are talking about," he said, and stood looking
at her with amazement and anger.

"Well you don't seem to. At home when you were engaged I now and then
intercepted glances between you that almost reconciled me to losing my
favourite sister, as I was assured by them that she was all the world to you,
and that you would take care of her. But now you scarcely seem aware of her
presence, and she might be a piece of furniture for all the attention she gets. I
can't think how she can bear it."

Had Luke not remembered his calling, and had he not been accustomed to
keep himself in check, he would have shaken the girl who had constituted
herself as his judge. As it was he went towards his writing table and began
arranging his papers, saying:

"I am sorry I cannot spare you any more time. When you are a little older you
will understand more of the meaning of love," he added looking at her gravely,
"that a man and his wife are so one that it is perfectly unnecessary for them to
remind each other of their existence or of their love for one another. Happily
for me Rachel understands and absolutely trusts me."

Gwen rose.

"But that does not explain about the coal scuttle business," she said, "I do
hope Luke," she added, "that you will take care of her. She has given up
everything for you."

Luke held the door open for Gwen politely, and was silent. Then he locked it
after her and sitting down by his desk tried to write. But he found this was
impossible. He felt all on edge. How dared the child talk as she did; but when
his irritation had subsided the remembrance of her words fell like lead on his
heart. Was it a fact Rachel had lost her spirits and that Gwen saw a real
change in her since her marriage?

He began pacing up and down his study while a terrible anxiety weighed upon
his mind. Was she not happy? Did she regret the step she had taken? And the
fear that every now and then had attacked him as to the rightfulness of taking
her away from her happy home, gained ground.

He could laugh off the ridiculous fuss Gwen had made about the coal scuttle.
Of course he had been quite unaware of Rachel carrying the heavy weight
across the room. He was able so to concentrate his attention on what he was
reading that he seldom noticed what was passing round about him, unless he
was trying to solve some difficult problem, when every sound disturbed him.
But he was so used to reading while Rachel moved about the room that he
had noticed nothing till he remembered Gwen had called out to him, "Luke,
don't you see that Rachel is carrying the scuttle?" when he had risen at once,
but too late.
That it proved in the very least that he was not careful of her he would not
admit for a moment. Neither did he pay any heed to Gwen's ridiculous fancy
that because he was not always showing his devotion to his wife by his
glances, his affection had waned. These ideas did not trouble him; but the fact
that Gwen had noticed Rachel was looking and had lost her spirits was quite
another thing, and it worried him exceedingly.

Meanwhile Gwen had gone into the drawing-room where she found Rachel
writing home. She turned round at the sound of her entrance.

"What have you been talking to Luke about?" she said a little anxiously. "You
have been a long time in the study."

"I have been giving him a lecture," answered Gwen, seating herself on a low
chair by the writing table.

"What?" exclaimed Rachel. She could hardly believe she heard aright.

"I have been giving him a lecture," repeated Gwen. "Husbands occasionally
need one."

"My dear child what do you mean?" said her sister laying down her pen. "I had
hoped you might have been having a nice helpful talk with him."

"Well, I hope it has been helpful to him."

"You sound as if you had been rather impertinent," said Rachel not pleased.
"What have you been saying?"

"All husbands are alike," answered Gwen. "They get nice girls to marry them,
taking them away from their homes, and no sooner have they got them than
they seem to forget their existence. I have been studying husbands lately, that
is to say since my friend Mabel married. Men are fearfully selfish."

Rachel looked gravely at her sister.

"Gwen, I advise you to wait to give out your opinions till you are a little older.
You really talk like a very silly child. I hope if you have been saying anything
impertinent to Luke that you will apologise to him before you are an hour
older. I am quite horrified at you."

Rachel's face was flushed, and Gwen saw she was more angry with her than
she had ever been in her life. But she was not daunted. Here was her
favourite sister, whom she adored, tied for life to a man who was engrossed in
his parish and had no time whatever to think of her. She felt boiling with rage.

"I certainly shall not apologise," she said, "it would take away any little good
my words may have done. I think I have come to spy out the land none too
soon, and that Luke will awake to see that what I have said anyhow has some
sense in it, and that he will not let you carry the coal scuttle another time."

Rachel looking at Gwen's earnest and rather anxious face repented that she
had been so stern with her. After all she was only an ignorant child. She could
not expect an old head on young shoulders; besides, Gwen was always
putting her foot into it, talking of things about which she really knew nothing.
The family took her sayings for what they were worth and laughed at them.
She wished she had not taken her so seriously.

But the fact was, that Rachel was conscious that Luke sometimes surprised
her by not doing what he would have done during their courtship. He had
been very chivalrous in those days, and more careful of her than was
necessary. Now he often let her do things for him which he would in those
days have done for her. At times the consciousness of this had a little hurt her;
he seemed to have lost, where she was concerned, his old world courtesy.
She remembered feeling ashamed when Mrs. Stone had come to tea, that he
had let her, his wife, do all the waiting while he sat still and talked. He was so
interested in his conversation that he had never noticed it.

But these were such very little things after all, that Rachel had made up her
mind not to notice them. However, the fact that Gwen had noticed them made
her feel sore and somewhat indignant with her sister. But glancing again at the
child who had tears in her eyes at the thought that Rachel was wasted on
Luke, anger fled, and an amused smile took its place.

"Oh Gwen dear," she said, "I wish you could see how ridiculous you are. What
do all those little things matter when people love one another as Luke and I
love? You see you are too young to understand. I really advise you to put
away your silly imaginations." She ended up with a laugh.

"Well then," said Gwen, "I will give you advice, rather than Luke. Why don't
you teach him what to do?"

Rachel laughed out loud. "Don't be foolish," she said.

"I'm not foolish," said Gwen earnestly. "But I have read, and I think it is
probably true, that a woman can make a man what she wants him to be."
"Explain yourself," said Rachel amused.

"I mean that you should teach him to remember that as a husband he is
bound to follow your wishes. Tell him, for instance, to fetch the coals for you;
to open the door when you have your hands full; and to hand the tea about
when you have people. I have noticed that Mrs. Graham, who has one of the
best of husbands, does this, and the consequence is that he waits on her as if
he were her slave. You know, Rachel, at present you are Luke's slave."

"Well now you have done your lecture," said Rachel good-humouredly, "So
we'll go out, and I hope to hear no more of it; but I feel strongly you ought to
ask Luke's pardon for what must have struck him as great impertinence."

"I shall do no such thing," said Gwen. "I think you will find that he profits by my
words."

But as Luke took her home as usual at night, leaving her at the door of the
house in which was her room, having talked to her as if nothing had,
happened, Gwen felt rather small. It did not look much as if he had profitted or
indeed remembered her lecture. This was decidedly snubbing, but then Gwen
was used to being snubbed.

CHAPTER X.
THE TRAINING BEGINS.

Rachel was not very sorry to remember that Gwen would be leaving in a few
days. She might do a great deal of mischief if she stayed longer with them.
Anyhow she would probably make Luke unhappy if she talked to him in the
same way as she had spoken to her.

But there was only one part of Gwen's conversation that had effect on Luke,
and that was the fear of Rachel's health suffering from the change from the
country to the overpopulated town.

When he had left Gwen at the door of her lodging, he hurried home, and after
hanging up his hat in the hall, made his way to the drawing-room where he
knew he would find Rachel. She was working, but on his entrance looked up,
and their eyes meeting, both knew that Gwen was the subject of their
thoughts. Rachel was the first to speak.

"I don't know exactly what that silly child has been saying to you," she said,
"but I'm afraid she has been very impertinent."

"Well I can't deny that she has said some outrageous things," he said
laughing, "but after all she is only a child."

"And you must forgive her," said Rachel. "We never take any notice of what
Gwen says. She gets the most ridiculous notions into her head. I hope you are
not letting the thought of her worry you."

"A great deal of what she said was sheer nonsense," he answered, "but I own
what she hinted about your health distresses me. I only hope it is not true."

"My health? But what did she say? I am perfectly well."

"She has made me so anxious that I want you to go home with her for a few
weeks."

"Go home! And leave you behind! No thank you. It would do me no good at
all. Besides, I am perfectly well and don't need a change. What a stupid little
thing she is; but do look over her folly and try and like her," said Rachel. "She
has such good points. For instance, she is perfectly true."

"Possibly," said Luke, smiling; then he added, "I can't say I am exactly
enamoured of her."

"No, but when you know her better you will see her virtues. I am afraid she
has been really impertinent to you."

Luke did not answer. He leaned forward and looked at Rachel anxiously.
"Are you sure that you are feeling well? Gwen seems to think that you are
tired out. Is that the fact?"

"Tired out? What with? I have only this tiny house to see after; in fact I don't
think I have enough to do."

Luke sighed a sigh of relief.

"Then I needn't worry?"

"Certainly not. Put it right from your mind. It is only a child's nonsense."

And Luke did as he was asked and worried no more about her.

He left her to write some letters before going to bed, and Rachel sat working;
but her thoughts were busy.

Although Gwen had talked a great deal of nonsense was there not a grain of
truth in some of her words? "A woman can make a man what she wants him
to be," she had said: she had evidently read this in a book, it had not come out
of her own little head. Rachel supposed there was some truth in the words;
and possibly she had been unwise herself in not insisting more that the
attentions that had been shown her during her courtship should not be
dropped now that they were man and wife. She was afraid that she had
unwisely done things herself instead of asking Luke to do them, and then was
surprised that he had lost the habit of waiting upon her. She had got in the
way of waiting on him and of saving him all extra effort when he came in from
his work in the parish.

She knew that in Luke's case it was often simply absentmindedness that
prevented him seeing of what she was in need at the moment. Once buried in
a book nothing would arouse him save her voice; or if he was in the midst of
an argument with a fellow clergyman, he would quite unconsciously allow
Rachel to help them both to tea though it meant rising from her seat. At times
she had felt a little indignant at the two men sitting while she served them; but
on the other hand if at her request he handed round the hot tea cake, he
would stand with the plate in his hand talking, while the contents got cold, or
would absently hold the kettle while Rachel watched in anxiety lest the water
should pour out on to the carpet, or on to his foot. It was easier to do these
things herself. She had not known that anyone notice these little omissions on
Luke's part; but evidently Gwen had taken count of them at once.
"A woman can make a man what she wants him to be." Yes, but save in these
few insignificant matters Luke was exactly what she wanted him to be, and in
these small matters perhaps she had been at fault, not him. Gwen had
opened her eyes; though she would not tell her so. Rachel felt that she had
made it easy for him to neglect little home courtesies. When the child had
gone she would behave somewhat differently.

Gwen came to breakfast next morning just as if nothing had occurred between
her and her brother-in-law: and Luke, who had put away the thought of
Rachel's health being affected by living in Trowsby, was too large-minded to
bear any grudge to the girl for the audacious things she had said to him. He
banished them from his mind, recognising the fact that Gwen was after all only
a child, and would learn better by-and-bye.

Rachel, however, found her a little trying, as Gwen after breakfast, took her to
task about more than one matter.

"You should be the President of a Mutual Improvement Society, Gwen," she

said laughing. "You have got terribly into the habit of setting people to rights,
or rather trying to do so. You want to go through a course of snubbing, my
child. Have you apologised to Luke yet?"

"Certainly not. And you know Rachel I can't help thinking that my lecture has
done him good. When I came in I saw him actually pouring the water into the
tea pot for you."

Rachel laughed, but she did not inform Gwen that she had begun the training
of her husband that morning. And that Luke had risen to it as if it were a
matter of course. He was, in fact, perfectly unconscious that he had not
always poured the water from the kettle into the teapot for his wife.

"You see I was right after all," continued Gwen. "Men only want to be taught
what to do."

"You were a very impertinent little girl," said Rachel. "And Luke felt you to be
so, only he is too kind and noble to remind you of it this morning."

"Well I shall remind him of it later on," said Gwen calmly, "as I have a few
more home truths to tell him."

"I forbid you to do anything of the sort," said Rachel, really angry now. "You
have no idea how ashamed I am of you, nor how much harm you might have
done if Luke was not as good and kind as he is."
Gwen, who was helping to clear away the breakfast things, stood still with the
plates she was carrying and looked at Rachel.

That the sister to whom she was so devoted could possibly speak to her in
such a severe tone of voice when she had been doing all she could, as far as
she knew, to help her, went to her heart. She stood still and looked at her with
tears in her eyes.

"Are you really ashamed of me?" she asked with a catch in her voice.

"Yes I am. I can't think how you could possibly have spoken impertinently to
Luke."

Gwen gave a little sob.

"I didn't mean to be impertinent," she said, "It was only because I love you so
much and couldn't bear to find you in this horrid pokey little house and looking
ill and tired. I don't see why you should feel ashamed of me when it was all my
love that did it," and Gwen laid down the plates to find her handkerchief.

Rachel's tender heart relented.

"Don't cry Gwen dear," she said, putting a hand on her shoulder. "I know you
didn't mean to do any harm; and as a matter of fact I am sure no harm has
been done; but you must remember it does not do to talk over a wife with a
husband. It is not wise."

Gwen threw her arms round Rachel promising to ask Luke's pardon for
speaking as she did. She assured Rachel she would do anything in the world
for her. And she kept her promise. No sooner did she hear Luke open the front
door and go up to his study just before dinner, than she ran after him. She
was no coward.

"I expect I was impertinent to you yesterday," she said, looking at him straight
in the face, "at least Rachel tells me I was. I didn't mean to be; only I meant to
tell you the truth and you know husbands do sometimes need the truth to be
told them."

Luke laughed heartily.

"Happily," he said, "it was not the truth so it does not signify in the least. I
shan't think of it again."
"Oh but it was the truth," said Gwen flushing, "but I don't mean to say anything
more about it. I might perhaps have said it more gently and in a more polite
manner; and I'm awfully sorry that Rachel is ashamed of me."

Luke fancied he heard a little catch in her voice and looked at her kindly. He
could hardly refrain from laughing out loud at her.

"Well you can put it out of your head and not think of it any more. I quite
appreciate the fact that it was out of your love and anxiety for Rachel that you
spoke as you did, and so we will be good friends again."

Gwen looked down and her lips trembled. "Thank you," she said. "And you will
take care of her, won't you."

He patted her on the shoulder and told her to run away as he was busy. And
Gwen, having no more to say, obeyed; but she felt rather small.

She resented the pat on her shoulder just as if she were a child. She was not
sure that she liked Luke at all.

"I can't think," said Gwen after dinner, as she and her sister were sitting
working in the drawing-room, "how it is that you don't show in the least that
you do any house work. You look as dainty and as pretty as ever."

Rachel laughed.

"When I began to realise that a great part of my day would be taken up with
dusting," she answered, "I bought the prettiest overall I could find."

"You look as if you had just come straight out of the garden and ought to have
your hands full of roses." Gwen looked with adoring eyes at her sister, adding:

"But there is a new expression on your face somehow. I think you are really
prettier than ever."

"If so it is love that has made me so," said Rachel.

Gwen laughed. "I don't quite believe that," she said.

Rachel smiled to herself, as she thought of the day on which she had bought
the overall, and had shown it to her mother-in-law with pride.

Mrs. Greville had looked at it critically, remarking:

"But you need not have gone to the expense of getting such a fanciful thing.
You could have got a yard or two of some good strong material and made it up
yourself. It would have served your purpose quite as well."

"I don't think so," Rachel answered laughing, "you see I like to be ornamental
as well as useful."

"You need not worry about making yourself ornamental," said Mrs. Greville.
"What you really want to do is to strive to be useful."

"Oh mayn't I be both? I do believe in beauty. I think our houses and everything
we possess should be made as beautiful as possible. It makes life easier and
happier." Unconsciously she looked round at the drab walls and ugly furniture.

Rachel would not on any account have complained of either to her mother-in-
law; and her glance round had not been meant to imply anything of the sort to
her. It had been done before she realised what she was doing or how her look
might be interpreted. But by the sudden change in Mrs. Greville's expression
of face she recognised what a mistake she had made.

Mrs. Greville had put a great restraint on herself ever since Rachel's arrival,
and had been most careful not to show her disappointment in Luke's choice of
a wife, to her daughter-in-law.

But Rachel's unappreciative glance round at the walls and furniture hurt her
inexpressibly, as she had lain awake many nights planning how she could
make the little house as homelike and attractive as possible. She quite
thought she had succeeded. Having lived all her life with early Victorian
furniture she saw nothing ugly in it; and indeed it struck her as both homelike
and comfortable. She had, moreover, spared several pieces of furniture which
she had decidedly missed when she had had to turn out into a barely
furnished room for the sake of her son's wife. But evidently nothing that she
had done for Rachel's comfort was appreciated. The disappointment was so
great that she turned a little pale.

"I am sorry Rachel," she said, in a strained tone of voice, "that we were not
able to supply you with Sheraton furniture. You see you have changed a
luxurious home for a poor one and must bear the consequences. We have to
cut our coat according to our cloth. I am sorry that our efforts are so painful to
you."

Rachel had flushed crimson.

She was tongue-tied for the moment. She could not tell a lie and say that the
furniture, which she had labelled in her mind as hideous, was to her taste. She
looked beseechingly at Mrs. Greville.

"I am sorry, my dear, if I have distressed you by my remark," said Mrs.

Greville, "but don't try to explain the look you gave at the furniture, I could not
possibly mistake its meaning."

Then while Rachel in her confusion and distress murmured her regret, Mrs.
Greville looked round the dining-room.

"I think perhaps I ought to have had the walls papered afresh and a lighter
colour," she had said. "I daresay it looks a little dull to a young creature like
you, and," she added, remorse getting the better of her, "I ought to be grateful
to you, for though you don't like my papers you love my son," and Mrs.
Greville ended by bestowing a hearty kiss on her son's wife before hurrying
away.

Rachel was left standing in the middle of the room with her eyes full of tears.
Something about her mother-in-law had touched her for the first time; and she
began to wonder if she might not possibly in the future learn to love her. She
wondered too how she could ever look her in the face again. She must have
seemed so terribly ungrateful and ungracious, not to say ill mannered. But her
glance round the room at the walls and its furniture had been quite involuntary,
and she had had no intention whatever of letting Mrs. Greville know how she
disliked them.

She smiled now as she remembered her mother-in-law's criticism on her

pretty overall, but the smile faded as she realised that though she had taken
the Bishop's advice and was trying hard not to allow her thoughts to rest on
the trials that she had had to meet in her new home, she had not by any
means yet succeeded in learning to love her mother-in-law.
 CHAPTER XI.
THE CHOIR THREATEN TO STRIKE.

It had not taken Rachel long to discover that she had married an untidy man.
Being very tidy and dainty in her ways herself, this discovery was rather a
shock to her. But she came to the conclusion that Luke's mind was so full of
the things that really mattered, that the less important things were nothing to
him though they meant a great deal to her.

Remembering her promise, the morning after she had prepared his study for
him, she had awakened earlier than usual and had gone there the first thing.
She had promised him that she would be responsible for keeping it in order
and that Polly should have nothing to do with it. On opening the door she
stood still and laughed at what she saw.

It looked to her in terrible disorder! Though he tried to convince her afterwards

that there was such a thing as a tidy untidyness. He knew just where
everything was, he said, and could lay his hand upon it.

But to Rachel's eyes disorder reigned.

Because the waste paper basket was not just at hand, he had thrown on to
the floor his many torn up letters. Books were piled on the ground. His table
was strewn with papers: there was scarcely a chair without some volume of
reference on its seat.

Rachel picked up all the torn letters putting them into the waste paper basket,
arranged the books, with a certain amount of trepidation, on the shelves, and
finally lifted up every letter and paper from the table to dust them, laying them
back in exactly the same position as she found them. She opened the window
carefully, anxious lest some of the papers that strewed the desk should take to
themselves wings and fly away.

It amused her the first morning, she felt that Luke had indeed needed a study.
But the care of the room added to her work and took time as she had to be so
careful not to disturb anything. And in her heart of hearts she wished that Luke
was tidy!
Another thing that troubled her was the fact that on the muddiest days Luke
would run upstairs without wiping his boots. He was always in such a
desperate hurry to get through the numberless letters that awaited his
attention on his study writing table that he would hurriedly hang up his hat in
the hall, and then spring upstairs two steps at a time and shut himself in. The
necessity of rubbing his boots never occurred to him. His mind was full of
important matters, things that had just taken place, and letters that had to be
posted. Then to brush his coat and hat before going out never crossed his
mind. He was always so hurried, and Rachel supposed that he expected to
find everything that was necessary to be done, done for him.

When the snow came in December she remonstrated with him once about his
boots, and on looking at the marks of his footsteps on the stairs he was filled
with remorse, as he recognised that he had made unnecessary work for
Rachel.

But he forgot it next time, and his wife felt that to remind him again and again
would only worry and fret him. For she recognised that the work he had to get
through was immense and that it was her duty to make life as easy for him as
possible. He worked far too hard, and it seemed to Rachel that the time he
could spend in his own home grew shorter every month. She was getting used
to it, and though at times the winter evenings felt long to her, and it was
somewhat of an effort not to give way to low spirits, she fought bravely against
melancholy, and always had a smile of welcome for her husband.

She had made a few friends by the winter and now and then Mrs. Stone would
run in with her knitting to spend the evening with her.

Rachel was conscious that Luke by his outspokenness made enemies and
that all was not harmonious in the parish, so it was a comfort to know that in
Mrs. Stone, both she and her husband had a valiant supporter, and that she
would act as peacemaker whenever she had the chance.

It must be confessed, however, that Mrs. Stone liked the role she had
undertaken for she was very fond of giving advice. She had taken a fancy to
Rachel and pitied her. Mrs. Greville, senior, was no favourite of hers, and
though Rachel was far too loyal to talk over her husband's mother with any
parishioner, Mrs. Stone could not but gather sometimes from silences on
Rachel's part, and by what she saw and heard from others, that Mrs. Greville
was deeply disappointed in her son's wife; and naturally a sensitive girl like
Rachel must be aware of the fact. It was to Mrs. Stone's credit that she kept
her views to herself and discussed no-one belonging to the Vicar with his
parishioners.