Repudiating the National Debt

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In the spring of 1981, conservative Republicans in the House of Representatives cried. They cried because, in the first flush of the Reagan Revolution that was supposed to bring drastic cuts in taxes and government spending, as well as a balanced budget, they were being asked by the White House and their own leadership to vote for an increase in the statutory limit on the federal public debt, which was then scraping the legal ceiling of $1 trillion. They cried because all of their lives they had voted against an increase in public debt, and now they were being asked, by their own party and their own movement, to violate their lifelong principles. The White House and its leadership assured them that this breach in principle would be their last: that it was necessary for one last increase in the debt limit to give President Reagan a chance to bring about a balanced budget and to begin to reduce the debt. Many of these Republicans tearfully announced that they were taking this fateful step because they deeply trusted their president, who would not let them down.

Famous last
words. In a sense, the Reagan handlers were right: there were
no more tears, no more complaints, because the principles themselves
were quickly forgotten, swept into the dustbin of history. Deficits
and the public debt have piled up mountainously since then, and
few people care, least of all conservative Republicans. Every
few years, the legal limit is raised automatically. By the end
of the Reagan reign the federal debt was $2.6 trillion; now it
is $3.5 trillion and rising rapidly. And this is the rosy side
of the picture, because if you add in “off-budget” loan
guarantees and contingencies, the grand total federal debt is
$20 trillion.

Before the
Reagan era, conservatives were clear about how they felt about
deficits and the public debt: a balanced budget was good, and
deficits and the public debt were bad, piled up by free-spending
Keynesians and socialists, who absurdly proclaimed that there
was nothing wrong or onerous about the public debt. In the famous
words of the left-Keynesian apostle of “functional finance,”
Professor Abba Lernr, there is nothing wrong with the public debt
because “we owe it to ourselves.” In those days, at
least, conservatives were astute enough to realize that it made
an enormous amount of difference whether – slicing through
the obfuscatory collective nouns – one is a member of the
“we” (the burdened taxpayer) or of the “ourselves”
(those living off the proceeds of taxation).

Reagan, however, intellectual-political life has gone topsy-turvy.
Conservatives and allegedly “free-market” economists
have turned handsprings trying to find new reasons why “deficits
don’t matter,” why we should all relax and enjoy the process.
Perhaps the most absurd argument of Reaganomists was that we should
not worry about growing public debt because it is being matched
on the federal balance sheet by an expansion of public “assets.”
Here was a new twist on free-market macroeconomics: things are
going well because the value of government assets is rising! In
that case, why not have the government nationalize all assets
outright? Reaganomists, indeed, came up with every conceivable
argument for the public debt except the phrase of Abba Lerner,
and I am convinced that they did not recycle that phrase because
it would be difficult to sustain with a straight face at a time
when foreign ownership of the national debt is skyrocketing. Even
apart from foreign ownership, it is far more difficult to sustain
the Lerner thesis than before; in the late 1930s, when Lerner
enunciated his thesis, total federal interest payments on the
public debt were $1 billion; now they have zoomed to $200 billion,
the third-largest item in the federal budget, after the military
and Social Security: the “we” are looking ever shabbier
compared to the “ourselves.”

To think
sensibly about the public debt, we first have to go back to first
principles and consider debt in general. Put simply, a credit
transaction occurs when C, the creditor, transfers a sum of money
(say $1,000) to D, the debtor, in exchange for a promise that
D will repay C in a year’s time the principal plus interest. If
the agreed interest rate on the transaction is 10 percent, then
the debtor obligates himself to pay in a year’s time $1,100 to
the creditor. This repayment completes the transaction, which
in contrast to a regular sale, takes place over time.

So far, it
is clear that there is nothing “wrong” with private
debt. As with any private trade or exchange on the market, both
parties to the exchange benefit, and no one loses. But suppose
that the debtor is foolish, gets himself in over his head, and
then finds that he can’t repay the sum he had agreed on? This,
of course is a risk incurred by debt, and the debtor had better
keep his debts down to what he can surely repay. But this is not
a problem of debt alone. Any consumer may spend foolishly; a man
may blow his entire paycheck on an expensive trinket and then
find that he can’t feed his family. So consumer foolishness is
hardly a problem confined to debt alone. But there is one crucial
difference: if a man gets in over his head and he can’t pay, the
creditor suffers too, because the debtor has failed to return
the creditor’s property. In a profound sense, the debtor who fails
to repay the $1,100 owed to the creditor has stolen property that
belongs to the creditor; we have here not simply a civil debt,
but a tort, an aggression against another’s property.

In earlier
centuries, the insolvent debtor’s offense was considered grave,
and unless the creditor was willing to “forgive” the
debt out of charity, the debtor continued to owe the money plus
accumulating interest, plus penalty for continuing nonpayment.
Often, debtors were clapped into jail until they could pay –
a bit draconian perhaps, but at least in the proper spirit of
enforcing property rights and defending the sanctity of contracts.
The major practical problem was the difficulty for debtors in
prison to earn the money to repay the loan; perhaps it would have
been better to allow the debtor to be free, provided that his
continuing income went to paying the creditor his just due.

As early
as the 17th century, however, governments began sobbing about
the plight of the unfortunate debtors, ignoring the fact that
the insolvent debtors had gotten themselves into their own fix,
and they began to subvert their own proclaimed function of enforcing
contracts. Bankruptcy laws were passed which, increasingly, let
the debtors off the hook and prevented the creditors from obtaining
their own property. Theft was increasingly condoned, improvidence
was subsidized, and thrift was hobbled. In fact, with the modern
device of Chapter 11, instituted by the Bankruptcy Reform Act
of 1978, inefficient and improvident managers and stockholders
are not only let off the hook, but they often remain in positions
of power, debt-free and still running their firms, and plaguing
consumers and creditors with their inefficiencies. Modern utilitarian
neoclassical economists see nothing wrong with any of this; the
market, after all, “adjusts” to these changes in the
law. It is true that the market can adjust to almost anything,
but so what? Hobbling creditors means that interest rates rise
permanently, to the sober and honest as well as the improvident;
but why should the former be taxed to subsidize the latter? But
there are deeper problems with this utilitarian attitude. It is
the same amoral claim, from the same economists, that there is
nothing wrong with rising crime against residents or storekeepers
of the inner cities. The market, they assert, will adjust and
discount for such high crime rates, and therefore rents and housing
values will be lower in the inner-city areas. So everything will
be taken care of. But what sort of consolation is that? And what
sort of justification for aggression and crime?

In a just
society, then, only voluntary forgiveness by creditors would let
debtors off the hook; otherwise, bankruptcy laws are an unjust
invasion of the property rights of creditors.

One myth
about “debtors'” relief is that debtors are habitually
poor and creditors rich, so that intervening to save debtors is
merely a requirement of egalitarian “fairness.” But
this assumption was never true: in business, the wealthier the
businessman the more likely he is to be a large debtor. It is
the Donald Trumps and Robert Maxwells of this world whose debts
spectacularly exceed their assets. Intervention on behalf of debtors
has generally been lobbied for by large businesses with large
debts. In modern corporations, the effect of ever-tightening bankruptcy
laws has been to hobble the creditor-bondholders for the benefit
of the stockholders and the existing managers, who are usually
installed by, and allied with, a few dominant large stockholders.
The very fact that a corporation is insolvent demonstrates that
its managers have been inefficient, and they should be removed
promptly from the scene. Bankruptcy laws that keep prolonging
the rule of existing managers, then, not only invade the property
rights of the creditors; they also injure the consumers and the
entire economic system by preventing the market from purging the
inefficient and improvident managers and stockholders and from
shifting the ownership of industrial assets to the more efficient
creditors. Not only that; in a recent law review article, Bradley
and Rosenzweig have shown that the stockholders, too, as well
as the creditors, have lost a significant amount of assets due
to the installation of Chapter 11 in 1978. As they write, “if
bondholders and stockholders are both losers under Chapter 11,
then who are the winners?” The winners, remarkably but unsurprisingly,
turn out to be the existing, inefficient corporate managers, as
well as the assorted lawyers, accountants, and financial advisers
who earn huge fees from bankruptcy reorganizations.

In a free-market
economy that respects property rights, the volume of private debt
is self-policed by the necessity to repay the creditor, since
no Papa Government is letting you off the hook. In addition, the
interest rate a debtor must pay depends not only on the general
rate of time preference but on the degree of risk he as a debtor
poses to the creditor. A good credit risk will be a “prime
borrower,” who will pay relatively low interest; on the other
hand, an improvident person or a transient who has been bankrupt
before, will have to pay a much higher interest rate, commensurate
with the degree of risk on the loan.

Most people,
unfortunately, apply the same analysis to public debt as they
do to private. If sanctity of contracts should rule in the world
of private debt, shouldn’t they be equally as sacrosanct in public
debt? Shouldn’t public debt be governed by the same principles
as private? The answer is no, even though such an answer may shock
the sensibilities of most people. The reason is that the two forms
of debt-transaction are totally different. If I borrow money from
a mortgage bank, I have made a contract to transfer my money to
a creditor at a future date; in a deep sense, he is the true owner
of the money at that point, and if I don’t pay I am robbing him
of his just property. But when government borrows money, it does
not pledge its own money; its own resources are not liable. Government
commits not its own life, fortune, and sacred honor to repay the
debt, but ours. This is a horse, and a transaction, of a very
different color.

unlike the rest of us, government sells no productive good or
service and therefore earns nothing. It can only get money by
looting our resources through taxes, or through the hidden tax
of legalized counterfeiting known as “inflation.” There
are some exceptions, of course, such as when the government sells
stamps to collectors or carries our mail with gross inefficiency,
but the overwhelming bulk of government revenues is acquired through
taxation or its monetary equivalent. Actually, in the days of
monarchy, and especially in the medieval period before the rise
of the modern state, kings got the bulk of their income from their
private estates – such as forests and agricultural lands.
Their debt, in other words, was more private than public, and
as a result, their debt amounted to next to nothing compared to
the public debt that began with a flourish in the late 17th century.

The public
debt transaction, then, is very different from private debt. Instead
of a low-time-preference creditor exchanging money for an IOU
from a high-time-preference debtor, the government now receives
money from creditors, both parties realizing that the money will
be paid back not out of the pockets or the hides of the politicians
and bureaucrats, but out of the looted wallets and purses of the
hapless taxpayers, the subjects of the state. The government gets
the money by tax-coercion; and the public creditors, far from
being innocents, know full well that their proceeds will come
out of that selfsame coercion. In short, public creditors are
willing to hand over money to the government now in order to receive
a share of tax loot in the future. This is the opposite of a free
market, or a genuinely voluntary transaction. Both parties are
immorally contracting to participate in the violation of the property
rights of citizens in the future. Both parties, therefore, are
making agreements about other people’s property, and both deserve
the back of our hand. The public credit transaction is not a genuine
contract that need be considered sacrosanct, any more than robbers
parceling out their shares of loot in advance should be treated
as some sort of sanctified contract.

Any melding
of public debt into a private transaction must rest on the common
but absurd notion that taxation is really “voluntary,”
and that whenever the government does anything, “we”
are willingly doing it. This convenient myth was wittily and trenchantly
disposed of by the great economist Joseph Schumpeter: “The
theory which construes taxes on the analogy of club dues or of
the purchases of, say, a doctor only proves how far removed this
part of the social sciences is from scientific habits of mind.”
Morality and economic utility generally go hand in hand. Contrary
to Alexander Hamilton, who spoke for a small but powerful clique
of New York and Philadelphia public creditors, the national debt
is not a “national blessing.” The annual government
deficit, plus the annual interest payment that keeps rising as
the total debt accumulates, increasingly channels scarce and precious
private savings into wasteful government boondoggles, which “crowd
out” productive investments. Establishment economists, including
Reaganomists, cleverly fudge the issue by arbitrarily labeling
virtually all government spending as “investments,”
making it sound as if everything is fine and dandy because savings
are being productively “invested.” In reality, however,
government spending only qualifies as “investment” in
an Orwellian sense; government actually spends on behalf of the
“consumer goods” and desires of bureaucrats, politicians,
and their dependent client groups. Government spending, therefore,
rather than being “investment,” is consumer spending
of a peculiarly wasteful and unproductive sort, since it is indulged
not by producers but by a parasitic class that is living off,
and increasingly weakening, the productive private sector. Thus,
we see that statistics are not in the least “scientific”
or “value-free”; how data are classified – whether,
for example, government spending is “consumption” or
“investment” – depends upon the political philosophy
and insights of the classifier.

and a mounting debt, therefore, are a growing and intolerable
burden on the society and economy, both because they raise the
tax burden and increasingly drain resources from the productive
to the parasitic, counterproductive, “public” sector.
Moreover, whenever deficits are financed by expanding bank credit
– in other words, by creating new money – matters become
still worse, since credit inflation creates permanent and rising
price inflation as well as waves of boom-bust “business cycles.”

It is for
all these reasons that the Jeffersonians and Jacksonians (who,
contrary to the myths of historians, were extraordinarily knowledgeable
in economic and monetary theory) hated and reviled the public
debt. Indeed, the national debt was paid off twice in American
history, the first time by Thomas Jefferson and the second, and
undoubtedly the last time, by Andrew Jackson.

paying off a national debt that will soon reach $4 trillion would
quickly bankrupt the entire country. Think about the consequences
of imposing new taxes of $4 trillion in the United States next
year! Another way, and almost as devastating, a way to pay off
the public debt would be to print $4 trillion of new money –
either in paper dollars or by creating new bank credit. This method
would be extraordinarily inflationary, and prices would quickly
skyrocket, ruining all groups whose earnings did not increase
to the same extent, and destroying the value of the dollar. But
in essence this is what happens in countries that hyper-inflate,
as Germany did in 1923, and in countless countries since, particularly
the Third World. If a country inflates the currency to pay off
its debt, prices will rise so that the dollars or marks or pesos
the creditor receives are worth a lot less than the dollars or
pesos they originally lent out. When an American purchased a 10,000
mark German bond in 1914, it was worth several thousand dollars;
those 10,000 marks by late 1923 would not have been worth more
than a stick of bubble gum. Inflation, then, is an underhanded
and terribly destructive way of indirectly repudiating the “public
debt”; destructive because it ruins the currency unit, which
individuals and businesses depend upon for calculating all their
economic decisions.

I propose,
then, a seemingly drastic but actually far less destructive way
of paying off the public debt at a single blow: outright debt
repudiation. Consider this question: why should the poor, battered
citizens of Russia or Poland or the other ex-Communist countries
be bound by the debts contracted by their former Communist masters?
In the Communist situation, the injustice is clear: that citizens
struggling for freedom and for a free-market economy should be
taxed to pay for debts contracted by the monstrous former ruling
class. But this injustice only differs by degree from “normal”
public debt. For, conversely, why should the Communist government
of the Soviet Union have been bound by debts contracted by the
Czarist government they hated and overthrew? And why should we,
struggling American citizens of today, be bound by debts created
by a past ruling elite who contracted these debts at our expense?
One of the cogent arguments against paying blacks “reparations”
for past slavery is that we, the living, were not slaveholders.
Similarly, we the living did not contract for either the past
or the present debts incurred by the politicians and bureaucrats
in Washington.

largely forgotten by historians and by the public, repudiation
of public debt is a solid part of the American tradition. The
first wave of repudiation of state debt came during the 1840s,
after the panics of 1837 and 1839. Those panics were the consequence
of a massive inflationary boom fueled by the Whig-run Second Bank
of the United States. Riding the wave of inflationary credit,
numerous state governments, largely those run by the Whigs, floated
an enormous amount of debt, most of which went into wasteful public
works (euphemistically called “internal improvements”),
and into the creation of inflationary banks. Outstanding public
debt by state governments rose from $26 million to $170 million
during the decade of the 1830s. Most of these securities were
financed by British and Dutch investors.

During the
deflationary 1840s succeeding the panics, state governments faced
repayment of their debt in dollars that were now more valuable
than the ones they had borrowed. Many states, now largely in Democratic
hands, met the crisis by repudiating these debts, either totally
or partially by scaling down the amount in “readjustments.”
Specifically, of the 28 American states in the 1840s, 9 were in
the glorious position of having no public debt, and 1 (Missouri’s)
was negligible; of the 18 remaining, 9 paid the interest on their
public debt without interruption, while another 9 (Maryland, Pennsylvania,
Indiana, Illinois, Michigan, Arkansas, Louisiana, Mississippi,
and Florida) repudiated part or all of their liabilities. Of these
states, four defaulted for several years in their interest payments,
whereas the other five (Michigan, Mississippi, Arkansas, Louisiana,
and Florida) totally and permanently repudiated their entire outstanding
public debt. As in every debt repudiation, the result was to lift
a great burden from the backs of the taxpayers in the defaulting
and repudiating states.

Apart from
the moral, or sanctity-of-contract argument against repudiation
that we have already discussed, the standard economic argument
is that such repudiation is disastrous, because who, in his right
mind, would lend again to a repudiating government? But the effective
counterargument has rarely been considered: why should more private
capital be poured down government rat holes? It is precisely the
drying up of future public credit that constitutes one of the
main arguments for repudiation, for it means beneficially drying
up a major channel for the wasteful destruction of the savings
of the public. What we want is abundant savings and investment
in private enterprises, and a lean, austere, low-budget, minimal
government. The people and the economy can only wax fat and prosperous
when their government is starved and puny.

The next
great wave of state debt repudiation came in the South after the
blight of Northern occupation and Reconstruction had been lifted
from them. Eight Southern states (Alabama, Arkansas, Florida,
Louisiana, North Carolina, South Carolina, Tennessee, and Virginia)
proceeded, during the late 1870s and early 1880s under Democratic
regimes, to repudiate the debt foisted upon their taxpayers by
the corrupt and wasteful carpetbag Radical Republican governments
under Reconstruction.

So what can
be done now? The current federal debt is $3.5 trillion. Approximately
$1.4 trillion, or 40 percent, is owned by one or another agency
of the federal government. It is ridiculous for a citizen to be
taxed by one arm of the federal government (the IRS) to pay interest
and principal on debt owned by another agency of the federal government.
It would save the taxpayer a great deal of money, and spare savings
from further waste, to simply cancel that debt outright. The alleged
debt is simply an accounting fiction that provides a mask over
reality and furnishes a convenient means for mulcting the taxpayer.
Thus, most people think that the Social Security Administration
takes their premiums and accumulates it, perhaps by sound investment,
and then “pays back” the “insured” citizen
when he turns 65. Nothing could be further from the truth. There
is no insurance and there is no “fund,” as there indeed
must be in any system of private insurance. The federal government
simply takes the Social Security “premiums” (taxes)
of the young person, spends them in the general expenditures of
the Treasury, and then, when the person turns 65, taxes someone
else to pay the “insurance benefit.” Social Security,
perhaps the most revered institution in the American polity, is
also the greatest single racket. It’s simply a giant Ponzi scheme
controlled by the federal government. But this reality is masked
by the Social Security Administration’s purchase of government
bonds, the Treasury then spending these funds on whatever it wishes.
But the fact that the SSA has government bonds in its portfolio,
and collects interest and payment from the American taxpayer,
allows it to masquerade as a legitimate insurance business.

federal agency-held bonds, then, reduces the federal debt by 40
percent. I would advocate going on to repudiate the entire debt
outright, and let the chips fall where they may. The glorious
result would be an immediate drop of $200 billion in federal expenditures,
with at least the fighting chance of an equivalent cut in taxes.

But if this
scheme is considered too draconian, why not treat the federal
government as any private bankrupt is treated (forgetting about
Chapter 11)? The government is an organization, so why not liquidate
the assets of that organization and pay the creditors (the government
bondholders) a pro-rata share of those assets? This solution would
cost the taxpayer nothing, and, once again, relieve him of $200
billion in annual interest payments. The United States government
should be forced to disgorge its assets, sell them at auction,
and then pay off the creditors accordingly. What government assets?
There are a great deal of assets, from TVA to the national lands
to various structures such as the Post Office. The massive CIA
headquarters at Langley, Virginia, should raise a pretty penny
for enough condominium housing for the entire work force inside
the Beltway. Perhaps we could eject the United Nations from the
United States, reclaim the land and buildings, and sell them for
luxury housing for the East Side gliterati. Another serendipity
out of this process would be a massive privatization of the socialized
land of the western United States and of the rest of America as
well. This combination of repudiation and privatization would
go a long way to reducing the tax burden, establishing fiscal
soundness, and desocializing the United States.

In order
to go this route, however, we first have to rid ourselves of the
fallacious mindset that conflates public and private, and that
treats government debt as if it were a productive contract between
two legitimate property owners.

Day 16
of Robert
Wenzel’s 30-day reading list
that will lead you to become
a knowledgeable libertarian, this article first ran in the June
1992 issue of Chronicles
(pp. 49–52).

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