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Bond Markets and Republics:

The Duc de Saint-Simon, in his famous Memoirs, wrote of his opposition to Louis' embrace of John Law's "System" of a French state bank issuing paper money, back when Law proposed the scheme in 1715. The estimable Saint-Simon noted, with extraordinary shrewdness, that such a "System," a state bank with the ability to issue fiat money and float bonds, could only work

in a republic or in a monarchy like England, whose finances are controlled by those alone who furnish them, and who only furnish as much as they please. But in a State which is weak, changeable, and absolute, like France, stability must necessarily be wanting to it; since the King, or in his name a mistress, a minister or favorites ... may overthrow the Bank — the temptation to which would be too great, and at the same time too easy.

The comparison (emphasis added) is arresting - the republic of merchants, self-controlling from self-interest alone the issuance of debt and paper money by the sovereign, as against absolutist France, "absolute" and therefore "weak." And later the Duc goes on to remark that absolutist France must lose wars to parliamentary England, because the absolute Louis must borrow for his wars at interest rates far exceeding those of England, whose war bonds are sufficiently largely purchased voluntarily by its own population as to be trusted by foreign investors as well. The English can conduct many more campaigns over many more years than the French.

I draw this from the marvelous book by James Macdonald, A Free Nation Deep in Debt: The Financial Roots of Democracy (FSG 2003), which is even better on these topics of financial-political history than Niall Ferguson's early, then-still academic work on the bond markets and war.

But the lesson is not precisely what one might first have thought - that excessive government debt is the road to ruin. It is. The lesson of Macdonald's book is a determinedly libertarian one. Provided that the bond financing is provided voluntarily by those who will have to service and pay it through their taxes, and who will have to bear the risks of the bonds losing value if the money supply is inflated to void the debt, and who will bear the risk of default by the state (enough among the citizenry so that foreign investors do not dilute those conditions and re-align those interests), then debt is a mechanism that chains government.

The title, A Free Nation Deep in Debt, comes from an anonymous eighteenth century pamphlet, expressing a common view of the philosophes, that sovereign debt owed to a state's own citizen-creditors, was a bulwark against absolutism, despotism and tyranny. Much of the rest of Macdonald's book goes on to show historically how the relationship between citizenry and creditor/bondholder was gradually broken both from 'within' parliamentary republican society as class interests within society increasingly diverged along with the political power attached to them, and from 'without' through increasing amounts of foreign investment that gradually re-aligned incentives of state, citizens, and foreign creditors alike from what they were when foreign creditors rode along with the citizen-creditors.

So a question is, given two admittedly highly stylized conditions — 'citizen-creditors' or, alternatively, the separation of the economic bondholders from the political citizens, which is to say, the separation of economic ownership from political control — which better characterizes where we are headed today. The existence of high levels of state debt as such, for the very particular purposes of this question, does not answer things. The question asks the relationship between economic ownership and political control. A 'republic of merchants' or a state that is absolutist, weak, and changeable?

rosetta's stones:

But in a State which is weak, changeable, and absolute, like France, stability must necessarily be wanting to it; since the King, or in his name a mistress, a minister or favorites ... may overthrow the Bank — the temptation to which would be too great, and at the same time too easy.



I think Mssrs. Bush, Paulsen, Bernanke and the Congress answered this question for us last year, didn't they?

Not sure which is the mistress, the minister or the favorite, but they were tempted, and it was easy enough.

I haven't laid eyes on a savings bond in 35 years. Are they still around?
6.3.2009 3:12pm
one of many:
The Rhetoric of the ruling parties is aligned towards the later view however I am not so sure the reality is as extreme as the language would suggest. There is a possibility that we will reach a financial situation similar to that of the Capetian kings but I am not so certain that the current swing is strong enough to overcome the inertia of the existing 'citizen-creditor' state.
6.3.2009 3:17pm
American Psikhushka (mail):
The comparison misses a very important variable. And that is whether the currency is an unbacked fiat currency or a currency backed by some kind of commodity - a gold or silver standard. When a country has an unbacked fiat currency there is ultimately no constraint on spending, the government can order more money printed to pay off the debt, devaluing the currency at the same time. Since governments cannot create gold or silver out of thin air ultimately there is constraint on spending and debt under a gold or silver standard.

The variable of fiat currency moots the question you ask: Under a fiat currency system there is ultimately no constraint on spending for either a 'republic of merchants' or an 'absolutist' government. One could try to argue that under a 'republic of merchants' there would be pressure to keep spending in check and also not to print money and devalue the currency, but much of the public does not understand this mechanism and the dominant economic school in academia and government is Keynesian, which sees a small, steady, controlling devaluation of the currency at times as optimal.

Plus regardless of anyone's promises or claims, there is always heavy pressure on the government to spend more and to do more, which also requires spending. That is why the Founders, in their wisdom, tried to put the currency system out of the government's grasp by enshrining a gold and silver standard in the Constitution. But of course this was promptly ignored and is now regarded as some kind of strange and archaic relic, when in fact it is the key to constraining and disciplining government spending and maintaining a stable and prosperous economic system.
6.3.2009 3:28pm
Closet Libertarian (www):

Provided that the bond financing is provided voluntarily by those who will have to service and pay it through their taxes, and who will have to bear the risks of the bonds losing value if the money supply is inflated to void the debt, and who will bear the risk of default by the state (enough among the citizenry so that foreign investors do not dilute those conditions and re-align those interests), then debt is a mechanism that chains government.


I see only a perverse way in which the current US debt is a chain on government. Money spent on interest can't be spent on other programs. The size of the government is only limited by how much we think we can continue to borrow from China, etc.. In that way the debt is a limit. I'm not even sure the current borrowing for the financial crisis would pass Congress (as the secrecy of the Fed hints).

Debt is only limiting government the same way that the laffer curver limits tax collection. At some point you run out of other people's money.
6.3.2009 3:33pm
Gramarye:
That is why the Founders, in their wisdom, tried to put the currency system out of the government's grasp by enshrining a gold and silver standard in the Constitution.


That's certainly the first time I've heard that argument made. How exactly do you read the gold standard as a constitutional mandate?
6.3.2009 3:34pm
The Unbeliever:
Provided that the bond financing is provided voluntarily by those who will have to service and pay it through their taxes,
Ah, but is this still an automatic assumption? Today's environment combines complex and loophole-ridden tax codes, with (relatively) unrestricted flows of capital across national boundaries. It is now possible, more so than ever before, to disassociate your investments in a country with the amount of taxes you have to pay.

Also, domestic bondholders are increasingly represented by institutional investors** or financial entities who may purchase bonds in large blocks for strategic capital reasons. The tax structure is different for these institutions, as well as the benefits they wish to extract from the government. If they can realize profit based on the government's unsound financial moves, or the churn associated with continually adjusting to (for example) the Fed's fluctuating monetary policy, then why would they utilize debt as a barrier in the sense that Macdonald uses the word?



(**For argument's sake, it may be possible to completely ignore the small investor, a middle class taxpayer who may buy a few thousand dollars' worth of bonds over his lifetime. Not because he doesn't exist--I paid for my final year of college with savings bonds my grandparents bought for me starting at the age of 3--but because he is less likely, on the margin, to exert political pressure as a result of monitoring the money supply or bond markets.)
6.3.2009 3:38pm
martinned (mail) (www):
@Gramarye: You haven't heard that before? It's a well known Ron Paul hobby horse.
6.3.2009 3:40pm
Paul B:
Gramarye and martinned,

I'm not in a position to give you citations on this, but I do remember that Robert Bork made this point at his confirmation hearing. His point was the limitation on originalism, saying that while historical research was pretty clear on the point that the Constitutional Convention had intended for national currency to be limited to gold, far too many years had passed for any court to rely on that original intent to impose that requirement upon the country.

I'm sure that respect for precedent would not have stopped Ron Paul however.
6.3.2009 4:02pm
Blue:
McDonald's book is absolutely fascinting--but don't take it to the beach for a read! You have been warned!

One of my take aways from that book is that the US isn't close yet to the range of debt/GDP that leads irresistibly to national insolvency.
6.3.2009 4:31pm
anaes (www):
@Gramarye and martinned

You might reread Article 1 Section 10 of your Constitutions:

"No State shall enter into any Treaty, Alliance, or Confederation; grant Letters of Marque and Reprisal; coin Money; emit Bills of Credit; make any Thing but gold and silver Coin a Tender in Payment of Debts; pass any Bill of Attainder, ex post facto Law, or Law impairing the Obligation of Contracts, or grant any Title of Nobility."

The Constitution doesn't specifically restrict the federal government to gold and silver, but one could argue that it's implied.
6.3.2009 4:32pm
G.R. Mead (mail):
anaes wrote:
The Constitution doesn't specifically restrict the federal government to gold and silver, but one could argue that it's implied.


Silly. The Constitution is a LIMIT on POWERS.

Ipso facto, we can ONLY ever imply more POWERS -- not more LIMITS.

What an odd idea.

;>
6.3.2009 4:44pm
martinned (mail) (www):
In other news, I'd like to take this moment to sing the praises of my native country, who borrowed a truly breathtaking amount of money in order to finance their invasion of England in 1688. Why were they able to do that? Because the people the state borrowed from were the same people who ran it. (The consequences of the glorious revolution for the economic growth in Britain and the ability of the Crown to borrow money are a popular subject of economic research, cf. here for a summary.)
6.3.2009 4:44pm
Monty:
This all assumes you can't selectively default on your bonds. Even if a large share is owned by your political citizens, they principally care about thier own investment, would they start a revolt if you honoroed thier bonds, but no one else's?

My understanding is that the bearer bond is out of fasion, does the gov't even issue them? If not then it would be easy to dishonor only foriegn owned ones.

I'm not saying its a good idea, it would certainly raise the cost of future borrowing, not to mention the ramifications to the global economy, but its just as plausible as a general default...
6.3.2009 5:05pm
paul lukasiak (mail):
A 'republic of merchants' or a state that is absolutist, weak, and changeable?

the problem here is that the merchants have assumed the role of the "mistresses, ministers &favorites" -- it was the "merchant" class that enriched themselves thanks to the irresponsible fiscal policies of the Bush years.

Additionally, the whole question of "reserve currencies" seems to be missing from MacDonald's thesis -- and by leaving out the dollar's role as the world's reserve currency, the entire question becomes moot.
6.3.2009 5:08pm
G.R. Mead (mail):
I am intrigued by the book and its biblical opening.

The earliest biblical reference to an explicit tangible bond instrument I have yet read of is in the deuterocanonical Book of Tobit (ca. 2d c. B.C.), in which the son of Tobit is given an evidence of debt (a counterpart half of an intentionally cut signed note) for some silver his father left with a cousin on the trade routes in Media. His son goes to collect, with the angel Raphael masquerading as his kin in tow, and a dog, of course -- and there this fish -- and a seventh-time-lucky honeymoon demon -- and well, ... it's a good story all around, you know, even for the finance types.

Needs a screenwriter.
6.3.2009 5:09pm
rosetta's stones:
martinned, turned out good for you and the Brits, but they proceeded to stomp on my people to the north, leading to Culloden, the Highland Clearances, and finally death, or forcing them onto leaky boats and on to these wretched colonies.
6.3.2009 5:15pm
martinned (mail) (www):
@rosetta's stones: And think of how well it all turned out for the Irish!
6.3.2009 5:19pm
Perseus (mail):
Article 1, section 10 is a list of limitations on the powers of state governments, not the federal government, so it's not much help in determining the whether the federal government has the power.
6.3.2009 5:24pm
Thales (mail) (www):
Historic note re re metallic standard: In addition to the prohibition on state legal tender laws, the putative limitation on the national government issuing fiat money is that the enumerated power in Article I is only to "coin money" and regulate the measure and value thereof, etc. One can't coin paper, and the verb arguably refers to making only something of already intrinsic value money, rather than the issuance of paper bank notes with a face amount unbounded by metallic backing.

This argument was decisively rejected in the Legal Tender Cases in the 1870s, in what is not a particularly convincing opinion. But it's dead letter--zero chance of ever reversing it, and obviously a strong global reliance interest has developed over the years in the use of sovereign fiat currencies.
6.3.2009 5:46pm
Kenneth Anderson:
Interesting comments - granted, this is all in the category of Non-Falsifiable Historically-Based Speculation - that's all it was intended to be. Mostly I was very impressed with the Duc's shrewdness. Martined - Holland, of course? There's an excellent, excellent discussion of Dutch war finances, particularly the wars with Spain. But I want to emphasize, the most interesting part of Macdonald's historical thesis is the implied analytic of the historical separation of economic ownership from historical control.
6.3.2009 6:16pm
Perseus (mail):
In addition to the prohibition on state legal tender laws, the putative limitation on the national government issuing fiat money is that the enumerated power in Article I is only to "coin money" and regulate the measure and value thereof, etc.

Hamilton did not view the constitutional prohibition on state legal tender laws as binding on the federal government. He also seemed to have viewed "the stamping of paper money" as being quite similar to coining money. Also, if the federal government gets to coin money AND regulate its value (which means that it can change the value at will), then the distinction between fiat and coined money gets a bit blurry.
6.3.2009 6:24pm
methodact:
6.3.2009 6:45pm
Thales (mail) (www):
Perseus: Agreed the provisions are not crystal clear, just pointing the historical/defunct legal argument out. Although Hamilton did believe in metallism for backing of federal notes, though not entirely clear whether he thought it was mandatory or just sound policy --I was just reading Ron Chernow's excellent biography the other day and this point came up.
6.3.2009 7:49pm
corneille1640 (mail):

The comparison misses a very important variable. And that is whether the currency is an unbacked fiat currency or a currency backed by some kind of commodity - a gold or silver standard. When a country has an unbacked fiat currency there is ultimately no constraint on spending, the government can order more money printed to pay off the debt, devaluing the currency at the same time. Since governments cannot create gold or silver out of thin air ultimately there is constraint on spending and debt under a gold or silver standard.

In such a system, wouldn't loans made on interest actually "create" money, even if money were supposedly backed by specie of some sort? I really don't know, not being and economist or a lawyer, but I seem to remember in econ. 101 that money is "made" from interest generated by loans (it is of course possible I had other things on my mind at that young spritely age).
6.3.2009 8:55pm
methodact:
The documentary "Money as Debt" (2006) can be viewed online in its entirety.

As an aside, some fear KELO V. is the nation's backing for the currency.
6.3.2009 9:52pm
Perseus (mail):
Although Hamilton did believe in metallism for backing of federal notes, though not entirely clear whether he thought it was mandatory or just sound policy

Hamilton's arguments in his "Report on a National Bank" suggest that he believed that it was sound policy rather than mandatory: "the spirit of the prohibition ought not to be disregarded by the Government of the United States. ...it may even be affirmed so certain of being abused, that the wisdom of the Government will be shewn in never trusting itself with the use of so seducing and dangerous an expedient." "Ought not" and the "wisdom of the government" sound more exhortatory than mandatory.
6.3.2009 11:36pm
A. Zarkov (mail):
MacDonald's book hits the bulls eye. The fundamental cause of fiat money is war. The US has fought every war thorough the use of fiat money. For example we had the "Continentals" in Revolution and the "Greenbacks" during the Civil War. But after WWII we entered the modern era of permanent war. First the Cold War, and now the War on Terror. That's why we have fiat money. Without fiat money and the persistent inflation it causes, these wars would have to stop because the people would not pay for them. Now the whole thing is out of control.

The Fed evidently has (according to Bloomberg News) $9 trillion off balance sheet. That's in addition to the $2 trillion it created since October 2008. This should scare everyone. They should be particularly frightened because the Fed IG was extremely evasive about when questioned before Congress. Look for yourself here. Fiat money is now out of control.
6.4.2009 12:04am
[insert here] delenda est:
In the context of the book, I believe (not from actually reading it I admit) that the book describes in detail the transition from 'sovereign' and personal debt to 'national' and enduring debt. In the context of the book, the point seems to be the difference between owing your electors (so in a very real sense unable to default) and owing foreigners, who don't compel you nearly as much?

In which case the question for today would be, who does the US government fear more, the people dumb enough to have voted for them or the people dumb enough to have bought their debt? ;)
6.4.2009 10:59am
American Psikhushka (mail):
corneille1640-

In such a system, wouldn't loans made on interest actually "create" money, even if money were supposedly backed by specie of some sort? I really don't know, not being and economist or a lawyer, but I seem to remember in econ. 101 that money is "made" from interest generated by loans (it is of course possible I had other things on my mind at that young spritely age).

Not under a gold standard. Under a gold standard the debtor would be paying the interest on any loans with currency that also has to be backed by gold. It's all part of a pool of currency that can't grow that rapidly because governments have to acquire the gold to mint the coins. I think you're confusing that with how debt is monetized with fractional reserve banking and a fiat money system.
6.4.2009 1:31pm
markm (mail):

"No State shall enter into any Treaty, Alliance, or Confederation; grant Letters of Marque and Reprisal; coin Money; emit Bills of Credit; make any Thing but gold and silver Coin a Tender in Payment of Debts; pass any Bill of Attainder, ex post facto Law, or Law impairing the Obligation of Contracts, or grant any Title of Nobility."

The Constitution doesn't specifically restrict the federal government to gold and silver, but one could argue that it's implied.


This list cannot be taken as restricting the powers of the federal government. It starts with a core function of the federal government - making treaties.
6.5.2009 7:21am
Ian Argent (www):
I'm going to say the same thing I say every time I see this come up - there isn't enough gold.

And it's not like non-fiat money never inflates either.
6.5.2009 11:04am

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