My mother lives on the Swedish island of Gotland, a big, flat island almost slap bang in the middle of the Baltic Sea – roughly 330km as the crow flies from Kaliningrad, home to Russia's Baltic Fleet.
Nato knows Gotland matters: control of the island would have major implications for security across the Baltic region. As a result, the Gotlanders have recently been relearning habits they thought they had left behind decades ago.
Over the past couple of years my mother has taken part in bomb shelter drills and evacuation exercises, the kind of civil preparedness Sweden's largest island hasn't seen since the Cold War.
People living on or near Russia’s borders are living with a level of security awareness that those in Britain and other Western European countries haven’t considered. Senior British military figures have repeatedly warned that the UK has spent decades optimising for peace rather than preparing for conflict, leaving difficult questions about capability, resilience and funding.
This raises an increasingly awkward question for policy makers and for the public – if Europe is entering an era of permanently higher defence spending, how should that spending be funded?
One idea that's been gaining attention is the concept of a National Security Bond, a government-backed security, sold directly to private investors, allowing citizens to help finance national defence.
This article is for information only and not personal financial advice. If you’re not sure what’s right for you, a financial adviser can help.
The War Loan Scandal
First – a little bit of fascinating history.
Britain's First War Loan, launched in November 1914, sought to raise £350 million to fund the war effort.
For generations, it was regarded as a patriotic triumph. In reality, it fell well short of its target. Only around £91mn raised, from a narrow pool of wealthy financiers and companies.
Demand was so weak that the Bank of England quietly stepped in – its Chief Cashier and his deputy personally bought up the unsold bonds, which were then reclassified on the Bank's own balance sheet as ‘Other Securities’ to disguise their true origin.
The Chief Cashier later swore a formal statement that the full £350mn had been sold to the public. It had not.
John Maynard Keynes, one of the few people in on the secret, called the cover-up ‘a masterly manipulation.’ The Financial Times, which had reported the loan as triumphantly oversubscribed at the time, issued a correction in 2017 – 103 years later, after researchers finally got access to the Bank's ledgers.
That doesn't mean national security bonds are doomed to fail. Later war loans raised substantial sums and became an important source of financing during both World Wars.
However, the experience offers a useful lesson. Successful retail borrowing cannot rely on patriotism alone. Investors still expect attractive terms, competitive returns and confidence that the proposition genuinely makes financial sense.
Why governments might like the idea
Today's circumstances are different. The question is no longer about financing a wartime emergency. Instead, governments across Europe are grappling with the prospect of significantly higher defence budgets over many years.
Whatever the precise NATO targets ultimately become, the direction of travel appears clear. Defence spending is rising. That means governments must either raise taxes, reduce spending elsewhere, borrow more, or pursue some combination of all three.
A defence bond sits firmly in the borrowing category
The backdrop is a remarkable shift in defence spending across Europe.
The UK’s Defence plan, published this week, has spending as a proportion of GDP rising to 2.7%. Poland is spending close to 5% of GDP, the highest proportion in NATO. Lithuania spends around 4%, while Estonia and Latvia are both above 3%. Germany, long criticised for underinvesting in defence, now spends more in absolute terms than the UK, with annual defence expenditure approaching €100bn.
Even if Britain reaches its ambition of spending 3.5% of GDP on core defence over the next decade, it will still sit behind some of the countries that feel most exposed to the threat posed by Russia.
Put into pounds and pence, the numbers become even more striking. UK defence spending currently runs at roughly £60-65bn annually. Moving from around 2.5% of GDP to 3.5% could add tens of billions of pounds to annual spending by the mid-2030s. Over a decade, the cumulative cost would run into hundreds of billions.
The UK retail investor base
International and institutional investors play a vital role in funding public finances, but capital can be mobile. A larger domestic investor base may provide greater stability during periods of market stress or political uncertainty.
The rising attraction of gilts
Since 2022, rising interest rates have transformed the attractiveness of gilts. Investors who previously ignored fixed income, have rediscovered the asset class, drawn by yields that were unavailable since the financial crisis of 2008. These holdings could yield an attractive income, with the bonus of there being no capital gains tax to pay on UK government debt.
A National Security Bond would therefore be entering an established market.
That creates both an opportunity and a challenge.
Patriotism may get investors to look at a bond, but fervour alone won't be enough to persuade them to buy it.
In fact, if policymakers wanted to generate meaningful demand, they might need to go further. One idea occasionally raised is an inheritance tax exemption.
For investors already considering how to pass wealth between generations, that could make a National Security Bond significantly more attractive than an otherwise similar gilt. The question is whether a government searching for revenue can realistically justify creating a new tax relief at the same time.
Investing can help your money grow, but the value of investments can rise and fall, so you could get back less than you put in. Investing is for the long term, typically 5 years or more. Past performance is not a guide to the future.
It’s still just borrowing
Keir Starmer said in the Commons this week that a defence bond is still just borrowing. He’s right. Selling a bond does not magically create resources. It simply changes who is providing the financing. The government still incurs debt. The taxpayer is still ultimately responsible for repayment.
That matters because a National Security Bond does not solve the bigger political question.
If Britain and its allies choose to spend more on defence, society must decide where that money comes from. Higher borrowing can delay difficult choices, but it cannot eliminate them.
The bigger signal
The real attraction of a National Security Bond is not that it would solve Britain's funding challenge. It would not. Even a successful retail bond would cover only a fraction of the sums involved.
However, it would raise awareness of our increased military spending requirements and could help broaden domestic ownership of government debt, at a time when borrowing needs are growing and governments are becoming more conscious of who funds them.