Avoid the Rush

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To preserve
the independence of the people, we must not let our rulers load
us with perpetual debt. We must make our election between economy
and liberty, or profusion and servitude. Considering the general
tendency to multiply offices and dependencies, and to increase
expense to the ultimate term of burden which the citizen can bear,
may it never be seen here that … government shall itself consume
the residue of what it was instituted to guard. To take from one,
because it is thought that his own industry and that of his fathers
has acquired too much, in order to spare to others who, or whose
fathers have not exercised equal industry and skill, is to violate
arbitrarily the first principle of association, "the guaranty
to every one of a free exercise of his industry, and the fruits
acquired by it."

Thomas Jefferson
Letter to Samuel Kercheval (12 July 1816)

[I]f experience
teaches us anything at all it teaches us this: that a good politician,
under democracy, is quite as unthinkable as an honest burglar.
His very existence, indeed, is a standing subversion of the public
good in every rational sense. He is not one who serves the common
weal; he is simply one who preys upon the commonwealth.

H.L. Mencken, "The Politician"
Prejudices: A Selection (4th Series, 1924)

The largest
employer in the world announced on Dec. 15 that it lost about
$450 billion in fiscal 2006. Its auditor found that its financial
statements were unreliable and that its controls were inadequate
for the 10th straight year. On top of that, the entity's
total liabilities and unfunded commitments rose to about $50 trillion,
up from $20 trillion in just six years. If this announcement related
to a private company, the news would have been on the front page
of major newspapers. Unfortunately, such was not the case — even
though the entity is the U.S. Government.

To put
the figures in perspective, $50 trillion is $440,000 per American
household and is more than nine times as much as the median household
income. The only way elected officials will be able to make the
tough choices necessary to put our nation on a more prudent and
sustainable long-term fiscal path is if opinion leaders state
the facts and speak the truth to the American people … We hope
the media and other opinion leaders do their part to save the
future for our children and grandchildren.

David M. Walker
Comptroller General of the United States
"America's Red Ink" (The Washington Post, 24 December

the Rush: Prepare Now for America's Bankruptcy

Grahamite investors
analyse companies and securities. They focus upon businesses and
their operations rather than markets' and economies' fluctuations.
Hence their decision to purchase a given security stems from an
analysis of the underlying company's past and present. This decision
does not hinge upon any specific prediction about the security's
future price; still less does it include detailed assumptions about
the overall market's or economy's prospects.

These points
are widely misunderstood — even among people who purport to be value
investors. Grahamites do not, as is often asserted, ignore market
and economic conditions; nor do they exclude these considerations
from their analyses. Instead, they ask questions such as: "how
unusual are the results (profits, dividends, etc.) that X Ltd has
generated over the past 5–10 years? Have monetary and overall economic
conditions given these results an artificial or unusually favourable
boost? Given general corporate "base rates" and those
for similar companies, how likely is it that these results can continue?
Are there grounds to believe that X's results in the future will
regress towards some long-term mean? If so, does a purchase at today's
price provide a margin of safety that sufficiently offsets the risk
that X's future operations might not match those of the present
and recent past?"

Precisely because
they draw conclusions about the prices of many securities, Grahamites
also hold views, which are rough and prone to error, about market
indices today and several years hence. And because they form judgements
about the normality or otherwise of today's economic conditions,
they also develop opinions about booms and busts down the road.

Graham, for
example, famously warned in the late 1950s about unduly and perhaps
dangerously high asset prices (see, for example, his articles "The
New Speculation in Common Stocks" and "Stock Market Warning:
Danger Ahead!"). Conversely, he rejoiced when in the mid-1970s
he detected attractively cheap prices (see "The Renaissance
of Value" and "The Future of Common Stocks," all
of which appear in Janet Lowe, ed., The
Rediscovered Benjamin Graham: Selected Writings of the Wall Street
, John Wiley & Sons, 1999). Similarly, citing
implausibly high prices and correspondingly meagre prospects, in
1969 Warren Buffett closed his investment partnership. And at several
points since the late 1990s he has warned investors to temper their
expectations about the results they might reasonably expect during
the years and decades to come (for examples, see the references
on Leithner &
Co.'s links page

views about markets, interest rates, overall profitability, etc.,
thus play a distinctly second fiddle to their analyses of individual
companies and securities. They incorporate these views into their
individual analyses; but within these analyses, company-specific
factors and figures always predominate. Their approach resembles
that of Lawrence Sloan, who in Every Man and His Common Stocks
(McGraw-Hill, 1931) posed three questions about the funk then gripping
the U.S. (and most other countries). First, was the country in the
midst of a severe and possibly prolonged slump? The answer, he believed,
was "yes." Second, could astute observers have discerned
signs of trouble ahead of time? Sloan thought that they could have;
and one economist, Ludwig von Mises, certainly did (see in particular
Percy Greaves, ed., The
Causes of the Economic Crisis and Other Essays Before and After
the Great Depression
, Ludwig von Mises Institute, 2006).

Sloan's third
question is perhaps the most important. Could investors have protected
their portfolios from the Depression's worst effects? Maybe — but
only if they were prepared to ignore the crowd and think for themselves.
The problem was that during the boom, signs of bust were apparent
only to those who sought them. As the Depression unfolded, mixed
and positive signs remained numerous enough to persuade investors
with optimistic and even neutral views of the world that all would
soon be well. Then and now, the most sensible stance — particularly
when one's analysis of the past yields the conclusion that today's
prices and profits are improbably high, and that tomorrow's harvest
might be rather thin — is to expect ructions, adopt a rather dour
attitude and incorporate cautious macro possibilities into one's
micro analyses. Mind the downside, in other words, and the upside
will mind itself.

How to apply
this mindset to the conditions prevailing early in 2007? First,
disregard high and possibly rising international tensions. They
are real, but much less severe than those prevailing during most
of the 20th century. Most notably, the
risk of terrorism in Oz is trivial
. Also, forget about the bird
flu scare. As Jeffrey Tucker shows in Bush's
Fowl Play
, it is largely the concoction of budget-maximising
bureaucrats. Finally, ignore global warming. It's a possibility;
but so too, as Lawrence Solomon shows (Will
the Sun Cool Us?
), is global cooling. And perhaps warming is
a good thing. Whatever it is, it's not a hard fact. It is, rather,
an accelerating barrow energetically pushed by (a) scientists whose
status and income depend upon the state and (b) politicians and
other zealots eagerly grasping the latest opportunity to aggrandise
themselves and plunder everybody else (see, for example, Climate
Chaos? Don't Believe It
by Christopher Monckton). Even if global
warming exists, says Bjrn
in The Sceptical Environmentalist,
the interventions demanded to combat it will likely produce more
harm than good.

Put out of
your mind, in short, the exotic and hypothetical risks that are
stirring ever more people into a collectivist frenzy. Instead, focus
upon a danger that is much more pedestrian, whose evidence is much
firmer, whose consequences politicians are doing their best to ignore,
and that has thus come to few investors' attention. Why wait? Be
the first on your block to recognise that the U.S. Government likely
is — or before long will probably become — bankrupt.

Also, prepare
financially and psychologically for the fallout that might occur
if and when people realise that Uncle Sam is broke. One unambiguously
good result would be the abandonment of the idiotic (in its conception),
inept (in its execution) and disastrous (in its results) "war
on terror." Even better would be the consignment of America's
interventionist foreign policy, which has wrought so much damage
upon so many people, including Americans, to the same historical
junkyard littered with the relics of Roman, British, French, Russian
and other imperialisms. Only people with a material or reputational
interest in warfare, such as the laptop bombardiers on the editorial
page of The Australian and The Decider's lapdogs in Canberra,
have anything to fear from the resurrection of George Washington's
Farewell Address
and America's return to its Jeffersonian roots. The power the anointed
lose is the liberty the benighted recover.

Another positive
(younger people are more likely to enjoy its benefits) of America's
bankruptcy would be the drastic pruning of and the weaning of people
from Social Security, Medicare and other alleged government "benefits."
The bad news for all Americans is that their taxes may well rise
steeply; and for everybody, Americans and non-Americans, Uncle Sam's
lurch towards insolvency implies significantly higher inflation
and interest rates. That, in turn, augurs poorly for most financial

Let's Define
and Quantify Our Terms

Laurence Kotlikoff,
in a must-read paper entitled Is
the United States Bankrupt?
and published in 2006 by the St
Louis branch of the U.S. Federal Reserve, concludes that "countries
can go broke, that the United States is going broke, that remaining
open to foreign investment can help stave off bankruptcy, but that
radical reform of U.S. fiscal institutions is essential to secure
the nation's economic future … Unless the United States moves quickly
to fundamentally change and restrain its fiscal behaviour, its bankruptcy
will become a foregone conclusion." Fed Chairman Benjamin Bernanke,
in his testimony to the Committee on the Budget of the U.S. Senate
Fiscal Challenges Facing the United States
, 18 January 2007),
used much more diplomatic and less apoplectic language, but did
not reject or even question Kotlikoff's conclusion.

Is the American
Leviathan destitute? Clearly not: it continues to possess an impressive
ability to confiscate from Peter, lavish much booty among its legions
of vassals and mascots, and distribute the rest among the Pauls
whom it wishes to control. How, then, can one possibly contend that
Uncle Sam is or is going bankrupt? Beginning in the 1930s, with
another spurt in the 1960s and climaxing during George W. Bush's
presidency, he has made promises to his growing hordes of dependents
and foreign creditors that, as time passes, he will be less and
less able to fulfil. The U.S. Government is insolvent in the sense
that the net present value (NPV) of its liabilities greatly exceeds
the NPV of its assets (or the assets it can be expected to raise
in order to meet these liabilities). Leviathan is bust in the sense
that, given its vast present and growing future shortfall of assets
relative to liabilities ("fiscal gap"), at some stage
it must acknowledge reality, liquidate and retrench. It is broke
in the sense that, as occurs in many workouts, it will pay its dependents
and creditors less than it originally promised them (see also Broken
Army, Broken Empire
by Pat Buchanan).

Although it
doesn't explicitly say so, the U.S. Government — or, rather, a recent
(15 December 2006) Treasury/OMB report entitled Financial
Report of the United States Government
— concurs (see also GAO
Chief Warns Economic Disaster Looms
and Demographic
Reality and the Entitlement State
by Ron Paul). During
2006, the fiscal gap continued to swell rapidly and now stands at
ca. $53 trillion. And that's just at the federal
level. One could increase it by adding various local and state shortfalls.
Further, this figure assumes the continuation of short- and medium-term
economic sunshine, i.e., that nominal GDP will grow at a rate of
least 5% per annum during the next five years. In other words, because
the Treasury's projections do not incorporate economic weakness,
this estimate of $53 trillion could easily err on the low side.

As a related
matter, it's important to emphasise that there's — literally! —
no accounting for the U.S. Government. Its internal auditor, Government
Accountability Office, found for the tenth year in succession that
Uncle Sam's financial statements are unreliable and that his financial
controls are inadequate (see the Comptroller General's comment
on this year's Financial Report). The U.S. Government is bankrupt
in the sense that, by private sector standards, its financial condition
is not just unaudited: it is simply unauditable.

The Pentagon's
balance sheet, for example, is laughably crude. It does not emerge
from standard methods: instead, an estimated list of liabilities
is simply subtracted from a vague list of assets. A report compiled
in 2003 by its own Inspector General stated "we identified
$1.1 trillion [yes, that's a "t" and not a
"b"] in department-level accounting entries to financial
data used to prepare DoD component financial statements that were
not supported by adequate audit trails or by sufficient evidence
to determine their validity. In addition, we also identified $107
billion in department-level accounting entries to financial data
used to prepare DoD component financial statements that were improper
because the entries were illogical or did not follow accounting
principles. . . . [In conclusion], DoD did not fully comply with
the laws and regulations that had a direct and material effect on
its ability to determine financial statement amounts."

More generally,
the financial management of most (up to 20) of the federal government's
24 largest agencies fails to meet requirements enacted by Congress
in 1996. Uncle Sam resembles nothing so much as an inept, hopelessly
spendthrift and disorganised man who hurriedly stuffs a shoebox
full of whatever documents and receipts he can find — and then throws
the mess into a bewildered accountant's lap. In the private sector,
people who generate waste and loss face the ire of shareholders,
are usually denied access to capital, often receive pink slips and
running shoes and sometimes find themselves in gaol. In the coercive
sector, however, mismanagement is virtually never punished: indeed,
it is typically lauded and rewarded.

Also note that
this fiscal gap does not incorporate the costs associated with the
invasions and occupations of Iraq and Afghanistan. In The
Economic Costs of the Iraq War
, Joseph Stiglitz and Linda Bilmes
estimate that its NPV is $1 trillion or more, and growing (see also
The Hidden Cost of War
by Ron Paul). This, to put it mildly,
is somewhat
than the initial and breezily confident estimates of
Administration and neocon insiders. Defence Secretary Ronald Dumsfeld,
for example, opined (19 January 2003) "well, the Office of
Management and Budget has come up with a number that's something
under $50 billion … How much of that would be the U.S.'s burden,
and how much would be other countries', is an open question."

A study by
Jagadeesh Gokhale and Kent Smetters (Measuring
Social Security's Financial Problems
, NBER Working Paper No.
11060, January 2005) concluded that the U.S. Government's "fiscal
gap" is closer to $65.9 trillion. That's more than 500% of
America's annual GDP and 200% of its accumulated wealth. The $53
trillion estimate equates to ca. 400% of America's
GDP in 2006, and has increased from about $20 trillion
— an amount equivalent to 200% of GDP in 2000.
(As a comparison, the net debt of Her Majesty's Government is ₤490
billion. That's equivalent to $US950 billion and to 38% of Britain's
GDP. Adding the NPV of "off balance sheet" liabilities
produces an amount that approximates 100% of its GDP.)

Finally, note
that Treasury has expressed this $53 trillion fiscal gap as a net
present value. To make it disappear tomorrow, tonight Uncle Sam
must confiscate that amount from his subjects and deposit it in
bank accounts earning hefty rates of interest (the GAO uses 5.7%
as the assumed long-term rate of return). But in Main Street U.S.A.,
these deposit rates do not exist. Because they didn't collect interest
on the money that they didn't deposit into these hypothetical accounts
this year, Americans will have to "deposit" even more
next year. As a matter of elementary maths, 5.7% of $53 trillion
is a bit more than $3 trillion — an amount ca. 15 times greater
than Uncle Sam's present annual budget deficit. Even if the deficit
suddenly became a very large surplus of, say, $500 billion and remained
at this level (a very unlikely proposition), the fiscal gap would
still continue to rise relentlessly. Accordingly, during the next
year it will likely swell by at least another $3 trillion — plus
whatever additional outrages the Racketeers in the White House and
on Capitol Hill can devise. So for the sake of argument let's add
another $4 trillion, making a total of $57 trillion, as an early
guess of the fiscal gap in 2008.

In last year's
Financial Report, the Treasury downplayed the gap. But this year
their talk is tougher. They state "the net social insurance
responsibilities (scheduled benefits in excess of estimated revenues)
indicate that those programs are on an unsustainable fiscal
path and difficult choices will be necessary
in order to address their large and growing long-term fiscal imbalance."
Further, "delay is costly and choices will
be more difficult as the retirement of the u2018baby boom' gets closer
to becoming a reality with the first wave of boomers eligible for
retirement under Social Security in 2008."

What do the
present magnitude, the growth in the recent past and the plausible
rate of growth in the near future of the U.S. Government's fiscal
gap mean? As Chris Martenson notes in the United
States Is Insolvent
, they imply three things.

  • First,
    it's unlikely that America can "grow out of the problem."
    Uncle Sam's financial position has deteriorated by over $22 trillion
    in 4 years and by $4.5 trillion during the last 12 months (see
    the table below, extracted from this year's Report). The economic
    sunshine of the past three years has not reduced the gap to narrow.
    Quite the contrary: it has widened and is deteriorating ever more

If the fiscal
gap can balloon so quickly during allegedly good times, what might
happen if and when the economic horizon darkens? It is unlikely,
to put it mildly, that any economic weakness will alleviate it.

  • Second,
    for many Americans, particularly younger ones and those completely
    dependent upon Leviathan, the future portends stagnant and perhaps
    much lower standards of living. How to close the
    fiscal gap? According to Laurence Kotlikoff, "the answers
    are terrifying. One solution is an immediate and permanent doubling
    of personal and corporate income taxes. Another is an immediate
    and permanent two-thirds cut in Social Security and Medicare benefits.
    A third alternative, were it feasible [as if the first two were
    politically palatable!] would be to immediately and permanently
    cut all federal discretionary spending by 143% [i.e., to eliminate
    all such spending and run a mammoth and unprecedented budget surplus]."
    When pigs fly …
  • Third,
    history shows us that every government that has so incompetently
    managed its finances has tried to "print its way out of trouble."
    Do American politicians possess generous amounts of the courage
    required to fix this mess? Given their country's fiscal problems,
    the prancing and babble of its presidential hopefuls, and the
    posturing and preening of politicians more generally, is at best
    a self-deception and at worst a cruel hoax upon the public. If
    they truly sought, in Ms Pelosi's words, "to build a better
    future for all of America's children," then they would drastically
    prune — if not completely abolish — the welfare-warfare state.

The truth,
of course, is that the Fed cannot painlessly inflate, nor the pollies
prattle, America's way out of this predicament. But no matter: because
draconian cuts of expenditure are not realistic solutions to its
impending bankruptcy, inflation is a much more likely possibility.
Inflation today — that is, the central bank's expansion of the money
supply — reduces the purchasing power of money tomorrow. Thanks
to the central bank's inflation, the extent of debts (measured in
nominal dollar amounts) may remain unchanged or even rise; but as
purchasing power falls, so too do real values. Inflation thus imposes
a hidden tax upon its victims. What's the material difference
between (a) 0% inflation and the confiscation of x% of your
money and (b) x% inflation and no overt confiscation? Nothing:
in each case, your purchasing power falls by x%.

The rhetorical
difference, of course, is that (a) is political suicide and (b)
is ignored or misrepresented in the mainstream media. (Its demand
that the central bank deliver "low interest rates" is,
in effect, a demand that the bank generate high inflation; and the
phrases "steady inflation" and "the gradual destruction
of the purchasing power of money" are virtual synonyms.) Do
not, therefore, expect that you will rise one morning to headlines
proclaiming that Uncle Sam is broke. Instead, anticipate that it
will be an extended and covert affair. The central bank's inflation
can promote only two things: the size and waste of the welfare-warfare
state and the penury of the middle and battler classes. Indeed,
to the extent that the U.S. Government's bankruptcy takes the form
of an enrichment of privileged "insiders" and the gradual
impoverishment of benighted "outsiders," it commenced
years ago and is proceeding silently apace.

The reality,
then, is that Americans and non-Americans are likely to face a future
of uncomfortably high inflation — and possibly worse if somewhere
down the track the $US loses its privileged status as the world's
reserve currency.

In the Beginning,
There Was Debt

Laurence Kotlikoff
notes correctly that solvency need have nothing to do with indebtedness.
A particular government, for example, might year after year maintain
its budget in surplus and never borrow a penny. It might laud itself
as a model of fiscal prudence. But if its liabilities outstrip its
assets, and if it cannot raise the assets required to meet its liabilities
at 100 cents on the dollar when they fall due, then this alleged
model of rectitude is actually insolvent. "To summarise,"
says Kotlikoff, "countries can go bankrupt but whether or not
they are bankrupt or are going bankrupt can't be discerned from
their u2018debt' policies. u2018Debt' in economics, like distance and time
in physics, is in the eyes (or mouth) of the beholder."

Well said.
Yet Kotlikoff overreaches when he says "the focus on government
debt has no more scientific basis than reading tea leaves or examining
entrails." Quite the contrary: although one must infer cautiously,
the source, timing and growth profile of the U.S. Government's "on-balance
sheet" debt can teach us much about America's rise and fall,
the causes of its present pickle and the possible source of its
redemption (see also William Bonner and Addison Wiggins, Empire
of Debt: The Rise of an Epic Financial Crisis
, John Wiley
& Sons, 2006). America's founder knew the lesson, but their
descendents have ignored it. In James Madison's words, war is the
most serious threat to liberty and solvency "because it comprises
and develops the germ of every other. War is the parent of armies;
from these proceed debts and taxes; and armies and debts and taxes
are the known instruments for bringing the many under the domination
of the few."

Wars and economic
"emergencies" are catnip to politicians because it is
during these times that the government's powers and patronage can
be extended most rapidly — and thus the individual harnessed most
securely to the yoke of the state. According to H.L. Mencken (Notes
on Democracy
, Knopf, 1926), "the whole history of the
[U.S.] has been a history of melodramatic pursuits of horrendous
monsters, most of them imaginary: the red-coats, the Hessians, the
monocrats, again the red-coats, the Bank, the Catholic, the slave
power, Jeff Davis, Mormonism, Wall Street, the rum demon, John Bull,
the hell hounds of plutocracy, the trusts, … Pancho Villa, German
spies, the Kaiser, Bolshevism. The list might be lengthened indefinitely:
a complete chronicle of the Republic could be written in terms of
it, without omitting a single important episode." In this respect,
the "war on terror" is simply the most recent display
in a long catalogue of deceptions. Monroe concludes that during
wars and emergencies, an "inequality of fortunes, and the opportunities
of fraud, growing out of a state of war, and . . . degeneracy of
manners and of morals [develops] . . . No nation could preserve
its freedom in the midst of continual warfare." Certainly the
U.S. hasn't (see in particular Robert Higgs, Crisis
and Leviathan: Critical Episodes in the Growth of American Government
Oxford UP, 1987).

The trouble
is that, since time immemorial, rulers have sought to wage war.
And to do so, they must confiscate their subjects' property. Since
the 1720s, when Sir Robert Walpole revolutionised the financial
basis of the British Government, a government able to command the
confidence of lenders has also been able to issue debt that need
never be repaid. It needs only to create a regular and dependable
source of revenue — a "tax base" — and then use a part
of it to pay the annual interest and the principal of maturing bonds. For
every bond it retires, it also issues a new one. In this way,
a "national debt" becomes a perpetual debt. It thereby
becomes an instrument of unending war. The Royal Navy extended British
sovereignty and influence around much of the world during the 18th
and 19th centuries, and Walpole's innovation underwrote
its activities. The establishment of a national debt not only
overturned the fear of Stuart tyranny: ironically, it entrenched
Jacobite objectives into the heart of British government. HMG, in
other words, could now maintain a permanent military establishment
and finance its wars without the regular and bothersome application
to Parliament. The British Empire, then, was built upon more
than the blood of soldiers, sailors and civilians: it was a superstructure,
and a permanent national debt was its foundation. This debt
had the added benefit (to politicians) of harnessing creditors to
the government. 

These developments
did not escape the attention of the America's founders. In January
1789, when General Washington mounted the steps of Federal Hall
(close to the top of Wall Street and opposite today's New York Stock
Exchange), took the oath of office and became the first President,
his newborn country's Treasury was virtually empty. It was also
burdened by debts of $77 million — an amount equivalent to ca. 30%
of the new country's rudimentary GDP (this and subsequent historical
debt-to-GDP ratios have been derived from Donald Stabile and Jeffrey
Cantor, The
Public Debt of the United States: An Historical Perspective, 1775–1990
Praeger, 1991). The rebellion against Britain had cost treasure
as well as blood, and the colonists were only slightly more willing
to submit to local than to Imperial taxes. Under the Articles of
Confederation, the admirably loose-fitting constitutional garment
that had joined the rebellious colonies, the nascent federal government
possessed no power to tax. The states could levy taxes and forward
them to the Continental Congress; but they too were hobbled by debt,
and popular hostility towards taxes was pervasive. Hence little
more than a trickle of funds flowed into the Congress's coffers
(see also Stabile's The
Origins of American Public Finance: Debates over Money, Debt, and
Taxes in the Constitutional Era, 1776–1836
, Greenwood, 1998).

means were therefore sought to finance the war. As it is doing today,
Congress resorted to external creditors and the domestic printing
press (see in particular Murray Rothbard, A
History of Money and Banking in the United States: the Colonial
Era to World War II
, Ludwig von Mises Institute, 2002).
As a result, by the time Washington vanquished Cornwallis in 1783,
American governments owed large sums to King Louis of France, to
Dutch bankers — and the thousands of American soldiers, farmers
and merchants who had lent their labour, goods and capital to the
cause. Virtually all agreed that it had been right and proper to
borrow in order to secure their political independence.

But what about
the new country's financial sovereignty? Over the next two decades,
how — indeed, whether — the debt would be repaid and the
budget balanced became the subject of a ferocious debate between
two leading lights: Thomas Jefferson and Alexander Hamilton. "Hamilton
was indeed a singular character," Jefferson wrote of his rival.
"Of acute understanding, disinterested, honest, and honourable
in all private transactions, amiable in society, and duly valuing
virtue in private life, yet so bewitched and perverted by the British
example, as to be under thorough conviction that corruption was
essential to the government of a nation." It is only a slight
exaggeration to say that their fiscal contest was the seed that
germinated "factions" and party politics in the U.S. Washington
sat uncomfortably between them at the cabinet table and lamented
the "internal dissensions" that were "tearing our

To most early
Americans, the very existence of public debt and deficit was inexcusable.
Many likened it to the seizure of property without the owner's consent.
Amassing debt to finance grandiose national projects, and then extending
this debt into perpetuity, was widely regarded as monarchical, English
and corrupting. But to a few élites, most notably Hamilton
and his mentor, Robert Morris, debt was just another word for money;
money was a potent form of power; and power, they believed, was
their birthright. "The [national] debt was a tremendous source
of power," wrote William Anderson in The
Price of Liberty: The Public Debt of the American Revolution

(University of Virginia Press, 1983), "for whoever controlled
it would in all likelihood possess not only the chief taxing power
but the prime allegiance of a large segment of the American population"
(see also Perpetual Debt:
From the British Empire to the American Hegemon
by Scott Trask,
which inspired the structure of the next couple of pages).

whom Washington appointed as America's first Secretary of State,
agreed — and hastened to add that the very existence of a national
debt, to say nothing of its growth, would centralise political and
economic influence into a small number of privileged hands. It would
thereby foment some of the very injustices that had prompted people
to migrate to America — and had prompted Americans to rebel against
George III. Legally and ethically, said Jefferson, "we should
consider ourselves unauthorised to saddle posterity with our debts,
and morally bound to pay them ourselves."

Hamilton, America's
first Secretary of the Treasury, on the other hand, believed that
if a budget deficit and national debt were used wisely they could
promote social harmony and economic growth. The states seldom saw
eye-to-eye, he observed, and so bundling their financial burdens
into a single national debt would help to unify them. If all citizens
felt equally beholden to the country's debt, then they might begin
to regard themselves more as Americans and less as Virginians or
New Yorkers. "A national debt, if not excessive, will be to
us as a national blessing … It will be a powerful cement of our
union." Hamilton prophesied that his young country would need
to borrow — probably heavily — before many years would pass. Maintaining
a perpetual national debt and reliably paying interest, he maintained
forebodingly, would "establish a public credit that could be
drawn and expanded during economic crises or wars."

Madison and the Injustice of Binding Children

In a letter
written in 1789 to James Madison, Thomas Jefferson asked whether
"one generation of men has a right to bind another." He
denied that it did. Further, he also believed that this principle
has "very extensive application and consequence, in every country." Applying
it to borrowing by the government, he argued that it was "unjust
and unrepublican" for one generation to encumber the next.
Jefferson reasoned that the younger generation had no means to consent
to the decisions of their parents; nor did they necessarily benefit
from their forebears' debt-financed expenditures. Quite the opposite
— he believed they typically suffered the consequences of their
elders' follies. If, as the rebels at the Boston Tea Party had cried,
there could be "no taxation without representation," then
Jefferson added that logically there could be no representation
without gestation. Accordingly, the old should not encumber the
young, and the young bore no obligation to honour their parents'

Later in 1789,
Jefferson specified this principle. He suggested that the French,
who were mired in the throes of revolutionary violence, would be
wise "to declare, in the constitution they are forming, that
neither the legislature, nor the nation itself, can validly contract
more debt than they may pay within their own age, or within the
term of 19 years" — and that whatever portion of the debt that
should remain unpaid after that time should be cancelled. In
effect, Jefferson thought such a provision would, by raising government
bonds' risk premium and thereby lifting the cost of borrowing, restrain
the profligacy of governments and reduce the frequency of their
wars and severity of their bloodthirstiness. It "would
put the lenders and the borrowers also, on their guard. By
reducing too the faculty of borrowing within its natural limits,
it would bridle the spirit of war, to which too free a course has
been procured by the inattention of money-lenders to this law of
nature, that succeeding generations are not responsible for the

Madison did
not agree. The present generation, he believed, does indeed benefit
from the "productive labour, discoveries, capital improvements,
and defensive wars" of its parents. He believed that it was
just that they should help to pay for "improvements or endeavours"
whose expenses were too great to discharge within one generation. "The
improvements made by the dead," reasoned Madison, "form
a charge against the living who take the benefit of them." He
therefore concluded "debts may be incurred for purposes which
interest the unborn, as well as the living." Foremost in his
mind were "debts for repelling a conquest, the evils of which
descend through many generations." With the successful
but expensive rebellion against Britain clearly in mind, he added
"debts may even be incurred principally for the benefit of
posterity … which far exceeds any burdens which the present generation
could well [bear]."

Madison allowed
that he opposed "imposing unjust or unnecessary burdens"
upon succeeding generations. But his accommodating position, said
Jefferson, provided plenty of room through which reckless politicians
could drive profligacy, corruption, imperialism and war. What
government, he noted, can accurately foresee the effects of its
"improvements"? And what government has ever described
its extravagances and follies as anything other than just and necessary?

The Jeffersonian

Between 1789
and 1797, interest payments on debt accumulated during the rebellion
consumed more than half of the federal government's budget. Reflecting
the stalemate between Jefferson's and Hamilton's factions, George
Washington and his like-minded successor, John Adams, left the government
with roughly the same amount of debt ($80m) they had inherited.
After the "Revolution of 1800" and Jefferson's inauguration
as president in 1801, he immediately and resolutely began to reduce
the national debt. Within six years — and despite borrowing $11
million in order to finance the Louisiana Purchase (whose constitutionality
he knew was doubtful) — Jefferson's Administration repaid $25 million
of debt. In seven of its eight years, taxes were reduced, the government
spent less than it taxed and the resulting budgetary surplus was
used to retire debt.

successor, James Madison, reduced the debt further (to $45m) by
early 1812. Alas, a drastic spurt of borrowing to finance the
War of 1812 (denigrated as "Mr Madison's War" by his critics
in New England and dubbed "the greatest military and financial
debacle in American history" by James Savage in Balanced
Budgets and American Politic
Cornell University Press, 1990), coupled with the precipitous decline
in tariff revenue that accompanied the war, increased the debt to
$125m by 1816. 

In mid-1813,
a year after the recommencement of hostilities against England,
Jefferson wrote a remarkable letter to the chairman of the House
Ways and Means Committee. The ex-president recommended that if "America
were determined to make war" then a special and very visible
tax should be imposed in order to finance it. This tax should be
sufficient to pay the annual interest on the new war debt and also
to repay a portion of the principal, and should remain in force
until the entire debt was retired. Reaffirming his long-held
view, Jefferson also urged that the tax be high enough to repay
the principal within one generation (which he defined as 19 years). He
thought that stiff taxes should be imposed in order to make as clear
as possible to Americans the real financial cost of the War of 1812.
By reminding them that war means debt, debt means taxes and taxes
mean subjection, Jefferson that hoped that his countrymen would
think twice before they plunged again into war.

Further, and
equally importantly, a "redeeming tax" would act as "a
salutary warning" of the consequences that flow from the accumulation
of debt. It would establish "a salutary curb on the spirit
of war and indebtment [sic], which, since the modern theory of the
perpetuation of debt, has drenched the earth with blood, and crushed
its inhabitants under burthens [sic] ever accumulating." Jefferson
conjectured that if the principle that all public debts must be
retired within 19 years "been declared in the British bill
of rights [of 1689], England would have been placed under the happy
[inability] of waging eternal war, and of contracting her thousand
millions of public debt."

America's next
president (1817–25), James Monroe, another protégé
of Jefferson, reduced the debt to $85m, an amount equivalent to
10% of the country's GDP; and during his one term of office (1825–29),
John Quincy Adams reduced it further to $60m. Notice then,
that as a result of the second war with England, a conflict that
brought not a single benefit to the people of the United States
(unless one considers military and naval prestige, "national
honour," etc., to be worth the sacrifice of blood and treasure),
Americans paid taxes for 20 years just to return the national debt
to the level where it had stood when Jefferson left office in 1809. 

The Glorious

Andrew Jackson
brought the Jeffersonians' work to its logical conclusion. (No
man is perfect, and Jackson was certainly far from it. Even by the
standards of his day, he was extremely cruel to Native Americans.)
During his second administration, the last outstanding government
bond was retired and in 1835 the national debt stood at a paltry
$38,000. The U.S. remained virtually debt-free for one more
year; alas, it would never again enjoy this status. Even so, the
debt-to-GDP ratio hovered barely above 0%.

The debt was
$15m when James K. Polk took office in 1845. On the positive
side of the ledger, Polk was a hard-money and a low-tariff man;
alas, and like Jefferson and Jackson, he was also a continental
expansionist. He coveted California and Mexico's other northern
provinces; and to obtain them he resorted to war. The Mexican
War (1846–47) increased America's national debt four-fold (to $65m). The
next presidents, Taylor and Tyler, were Whigs; the Whigs were the
inheritors of Hamilton's mantle and the predecessors of the mercantilist
Republican Party; and as such, they were indifferent to debt. Under
their administration (Taylor died shortly after taking office),
debt rose to $80m by 1851. Fortunately, his successor was a
Jeffersonian Democrat — and therefore a resolute practitioner of
free trade, hard money and frugal government. The last of the
Jeffersonians, Franklin Pierce, retired two-thirds of the national
debt such that it fell to $30m (an amount less than 5% of GDP) when
he left office in 1857. Neither in absolute amount nor as a
percentage of GDP would the national debt ever again fall so low. 

Revenge: the Civil War and Its Disastrous Legacy

The War of
Northern Aggression was not only a humanitarian tragedy: Abraham
Lincoln's vast edifice of distortions and misrepresentations also
caused an explosion of borrowing that would have driven Thomas Jefferson
to despair — and perhaps secession and rebellion. Debt rose
from $75m in March 1861 to $28,000m (that is, $2.8 billion, an amount
equal to almost 65% of GDP) in August 1865. The debt, which
was $2 per capita in 1861, was now $75 per capita (and now considerably
fewer able-bodied people existed to service it). Such was the
human and financial cost of transforming what had hitherto been
a voluntary confederation joined by natural sentiment and natural
law into a centralised union cemented by bald lies and brute force
(see in particular John Denson, A
Century of War: Lincoln, Wilson and Roosevelt
, LVMI, 2006;
Thomas DiLorenzo, The
Real Lincoln: A New Look at Abraham Lincoln, His Agenda, and an
Unnecessary War
, Three Rivers Press, 2003; European
Views of the War To Prevent Southern Independence
and Jeffrey Rogers Hummel, Emancipating
Slaves, Enslaving Free Men: A History of the American Civil War
Open Court, 1996).

The federal
government, once bound by the Constitution, thus broke its chains
— but not completely or (yet) permanently. In 1869, the Supreme
Court ruled that the Legal Tender Acts of 1862 and 1863 — the financial
underpinnings of Evil Abe's military aggression — were unconstitutional. In
1872, the income tax expired and was not renewed (and for good measure,
in 1895 the Supreme Court ruled that it had been unconstitutional
all along). In 1879, Grover Cleveland restored America to the
gold standard (from which Lincoln had suspended it). As a consequence
of these salutary developments, for a generation after Lincoln's
fortuitous assassination the amount of America's national debt fell
significantly and then stabilised, and — thanks to capitalism and
entrepreneurship — the debt-to-GDP ratio fell without interruption.
By 1880, the debt stood at $2.1 billion (15% of GDP); by 1890, $1.1
billion (10%); and by 1900, $1.2 billion (8%). 

Rampant: Big Government, Total War and Astronomical Debt

As occurred
at the opening and middle of the 19th century, so too
at the beginning of the 20th: an utterly pointless and
ruinously expensive war, built upon an edifice of monstrous lies,
quickly negated the fruits of years of patient but cumulatively
significant debt reduction. President Woodrow Wilson — who,
next only to Lincoln, was America's worst — bamboozled, harangued
and deceived America into the Great War (see in particular Thomas
Fleming, The
Illusion of Victory: America in World War I
, Basic Books,
2003). As a result, in little more than two years its national debt
skyrocketed from $3 billion to $25 billion (25% of GDP). But
all was not yet lost: in a last gasp of rectitude, after the war
fiscally sane presidents (who were, by the way, the last to respect
the Constitution and therefore the most recent on the list of greats),
Warren Harding and Calvin Coolidge, reduced the debt to $15 billion
(18% of GDP) by mid-1930.

Alas, American
and British governments and central banks transformed the slump
that commenced in 1929 into the Great Depression. Worse, Herbert
Hoover was a typical Republican and thus no friend of frugality:
in just two years he increased the national debt from $15 billion
to $22 billion. Worst of all, Franklin Roosevelt (America's third-worst
president) was no Jeffersonian. Never mind that his platform of
1932 emphasised laissez-faire, the gold standard and retrenchment
of expenditure and debt: the New Deal accelerated Hoover's awful
policies. The Depression thus lengthened and deepened, and debt
increased more than three-fold (to $72 billion, 38% of GDP in 1940).

The culmination
of the damage FDR wrought were the deceptions that provoked the
country's entry into the Second World War (see in particular Thomas
Fleming, The
New Dealers' War: FDR and the War Within World War II
, Basic
Books, 2001; and Robert Stinnett, Day
of Deceit: The Truth About FDR and Pearl Harbor
, Free Press,
2000). The New Dealers' War caused the national debt to increase
3.6-fold (to $260 billion and 110% of GDP) by September 1945. And
all for naught: as Robert Higgs shows in Depression,
War and Cold War
(Oxford University Press, 2006), neither
the New Deal nor the Second World War vanquished the Great Depression.
What did? Read Higgs, and also chaps. 9 and 10 of Thomas DiLorenzo,
Capitalism Saved America: The Untold Story of Our Country, from
the Pilgrims to the Present
(Crown Forum, 2004).

The problem,
alas, was that virtually everybody thought that welfare and warfare
had rescued the country from the Depression. Hence regimentation,
war and profligacy replaced liberty, peace and frugality as the
hallmarks of life (see Robert Higgs, Crisis
and Leviathan
; and Figures 1 and 2 below). Abolished
was the venerable tradition of post-war retrenchment. The new
practice was a relentless increase of expenditure and piling of
debt upon debt. Apart from slight declines in 1947-48 and 1956-57,
America's national debt, like a NASA space probe, commenced an upward
trajectory into outer space. Fortunately, from 1945 to 1970 GDP
grew faster than the national debt, and so the debt-to-GDP ratio
fell modestly (to 95% of GDP in 1950 and 70% of GDP in 1960).

But not for
long. The removal in 1971 of the $US's last remaining (albeit tenuous)
link to gold freed Uncle Sam from any semblance of restraint. In
1970, the debt reached $390 billion and a post-war low of 28% of
GDP. In 1980 it was $930 billion and 30% of GDP. And then
came the deluge: under Ronald Reagan and a Republican Senate, debt
rose to $2,700 billion ($2.7 trillion); under George H. Bush,
Bill Clinton and a Republican House, it reached $5.7 trillion; and
under George W. Bush and a Republican Senate and House (until January
2007), it has risen to $8.7 trillion (as of 25 January 2007). 

According to
the U.S. National Debt
, since 26 September 2006 America's national debt has increased
by an average of $1.5 billion per day. (Recall that the national
debt refers to "on balance sheet" liabilities, as opposed
to the ca. $53 trillion of net on- and off-balance sheet liabilities.)
Any time an American politician, particularly a Republican, utters
words like "prudence," "responsibility" and
"conservatism," the appropriate response is uproarious
laughter and withering derision (see also Republican
by George Giles). Indeed, anytime anybody in Washington
except Ron Paul (see also
his articles)
says anything, the appropriate response is a deaf ear and a hard

1: Read It and Weep

In Crisis
and Leviathan, Robert Higgs summarised America's past half-century:

The mixed
economy that has prevailed in the United States since World War
II, a uniquely American form of participatory fascism, has lent
itself to a substantial expansion of the governmental authority
over economic decision-making. Given capitalist colour by the
form of private property rights, the system has denied the substance
of any such rights whenever governmental authorities have found
it expedient to do so. No individual economic right whatever,
not even the right to life, has been immune from official derogation
or disallowance; besides interfering in countless economic transactions,
the government has sent tens of thousands of men to their deaths
bound in involuntary servitude as conscripts in the military adventures
embarked upon by ruling elites. The potential for government to
set aside private rights has now been plenary for over [sixty]
years, even if governments have yet to exercise the potential
fully. Real reaction never materialised … and regardless of the
political swings the fixed point has remained a fundamental abrogation
of private economic rights … Whatever the so-called Reagan Revolution
may have done, it certainly did not bring about an ideological

Assuming that
the trends established during Reagan's presidency remain in place,
America's national debt will breach $10 trillion (and more than
60% of GDP) by 2010. According to the Congressional Budget Office,
whose projections The Wall Street Journal (19 January 2007)
has summarised, under present budgetary settings the debt-to-GDP
ratio will rise to 100% in 2030 and to 200% by 2040. On 18 January
Mr Bernanke commented that "a vicious cycle may develop in
which large deficits lead to rapid growth in debt and interest payments,
which in turn add to subsequent deficits." He added that similar
"debt spirals" in other countries have either provoked
or deepened financial emergencies. "Ultimately, this expansion
of debt would spark a fiscal crisis, which could be addressed only
by very sharp spending cuts or tax increases, or both." He
forgot to mention that sharply higher interest rates and a sharply
weaker $US might well accompany such a crisis.

2: Bloody Ronald Reagan: Read It and Shed CPI-Adjusted Tears

Investing in an Era of National Bankruptcy

What, then,
does this survey of America's national debt tell us? In order to
feed their egos, interventionist politicians wage war. To do so,
they must incur debt and receive the support (or at least the acquiescence)
of their subjects; and to obtain money and loyalty, time and again
they resort to deceptions and outright lies. Truly, war is an entitlement
program for neoconservatives; and in order to get a free hand to
wage war abroad, they happily concede New Dealers' demands to wage
war at home. Welcome
to Fascist America!
Neocons and socialists are the conjoined
twins of modern American statism. As Ludwig von Mises (Omnipotent
, Arlington House, 1969) put it:

peace is only possible under perfect capitalism, hitherto never
and nowhere completely tried or achieved. In such a Jeffersonian
world of the unhampered market economy, the scope of government
activities is limited to the protection of lives and property
of individuals against violence or fraudulent aggression … All
the oratory of the advocates of government omnipotence cannot
annul the fact there is but one system that makes for durable
peace: a free-market economy. Government control leads to economic
nationalism and thus results in conflict.

America's forgotten
heroes, the Jeffersonians, were right. The policies of that country's
evil quartet, Hamilton, Lincoln, Wilson and FDR — namely welfare,
warfare and debt-financed big government — have regimented thought
and life. They have created a zero-sum climate whereby politicians'
and bureaucrats' privileges wax, and individuals' autonomy wanes.
The pageantry of Imperial Government spawns a Leader (or should
that be "Decider"?) who much more closely resembles a
Caligula than a Cincinnatus. Within an empire, subjects exist in
order to serve the central state: in Lord Acton's apt phrase, passengers
exist for the sake of the ship and its hands. "When the people
fear their government," said Jefferson, "there is tyranny;
when the government fears the people, there is liberty." Today
in the U.S., Jefferson is barely a memory, people rightly fear their
rulers, and bureaucrats and politicians regard their subjects contemptuously.

Not just in
America but also in most Western countries, people fear their overlords
not because of what the latter already do to the former,
which is plenty, but because of the "services" and "benefits"
that rulers might withhold from their subjects! The good
news is that, around the developed world, state-run schemes of social
security face crises. The symptoms of problems include greater longevity,
declining ages of retirement and below-replacement fertility rates.
But symptoms are not causes. The welfare state's creators did not
anticipate the extent to which, and the manner by which, their interventions
would affect incentives to work, save and bear children. In this
way, social welfare schemes have sown the seeds of their own bankruptcy
(see, for example, Making
Kids Worthless: Social Security's Contribution to the Fertility
by Oskari Juurikkala). Happily, to the extent that the
welfare-warfare state disintegrates, individual liberties regrow.

Our survey
also tells us, in Henry Ford's words, that "history is bunk."
By this he meant that the received historical record and its conventional
interpretation are usually false. When analysed and interpreted
without statist lenses, however, history — bolstered with the laws
of economics — provides a rough but reliable guide with which to
navigate the future. If one studies the past in order to trace the
consequences of the ideas that people implemented (as opposed to
the desire to worship the state), then one can see for oneself what
these ideas and actions wrought, what worked and what didn't — and
what lessons we can draw in order to repeat the achievements and
avoid the mistakes of our forebears.

Armed with
these insights, let us return to the types of questions that Lawrence
Sloan posed in Every Man and His Common Stocks. Do the U.S.
and, more generally, Britain, France, Germany and Japan, face crises
of public finance? The answer, I believe, is "yes." Can
today's investors discern signs of trouble ahead of time? Yes —
albeit crudely. Can they take steps now that in the years to come
might evade the crises' (if that's what transpires) worst effects?
Can they, in other words, build portfolios whose streams of income
rise as inflation, CPI and interest rates rise, GDP and incomes
stagnate and the prices of many stocks and bonds fall? Can they
maintain the purchasing power of their capital, and perhaps even
augment it, in the face of these headwinds? Possibly. But the trouble
is that, during the boom, signs of bust are apparent only to investors
who seek them. Today, positive signs are numerous enough to persuade
investors with an optimistic and even neutral view of the world
that all is — and always will be — swell. A more sensible stance,
it seems to me, is to adopt a general attitude that is sceptical
and cautious, incorporate unfashionably dour assumptions into one's
analyses, and rejoice if bad things don't eventuate. As in the past,
so too today: mind the downside and the upside will mind itself.

13, 2007

Leithner [send him mail]
is a Director of Leithner & Company, a private investment company
in Brisbane, Australia.

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