WHEN YOU BORROW, READ THE LENDER’S TERMS CAREFULLY

August 15 is a milestone for me.  I remember exactly where I was that Sunday evening 50 years ago on my 32nd birthday and the market turmoil that followed the next morning.

When RJR bought Sea-Land, the tobacco company contracted to build 8 new state-of-the-art ships, an SL-7 Class. Construction proceeded on five ships in Germany and three in the Netherlands. The 1970 annual report listed their interim financing (December 31, 1970 exchange rates) with banks in Germany and the Netherlands – to be replaced with long-term foreign financing as the vessels were completed.[i]

Reynolds was “internationally unsophisticated.” In a few months, this debt would reveal how little RJR knew about international finance.  The company borrowed the money in German and Dutch currency at a good interest rate.  But on Sunday night August 15, 1971, President Nixon moved the U.S. off the gold standard, and currencies began to trade at a floating exchange rate.  RJR people knew this was a problem, given its foreign currency commitment.[1]

The dollar weakened.  RJR paid much more because it had not hedged the currency, spending nearly twice as many U.S. dollars as they had expected. The contracts for the entire price of the ships were in foreign currency, so RJR paid on both the purchase price and the debt.  The annual reports carefully skirted this issue and said little about it.  [Judging from the annual reports, the debt cost about $125 million in currency exchange losses and the SL-7s were booked at $600 million, $200 million over the original stated price] The $400 million ships really cost $775 million.

[1] I was at Chase Manhattan Bank in New York the next morning.  The stock market soared on the news, even though pundits had always declared that leaving the gold standard would be disastrous for security markets.  I called Winston-Salem and said I supposed RJR treasury people would soon be heading to Germany and the Netherlands about our debts there.  I was told, “They didn’t wait until today, the Treasurer left for Europe last night, right after Nixon’s speech.’  He knew we were in trouble.  

[i]  For more information on the troubled history of the SL-7 ships, see Newlin on Sea-Land.