You Are Washington's Collateral
by Gary North: Permanent
would-be borrower approaches a lender for a loan, he must be prepared
to offer collateral, just in case he cannot repay the loan. If he
defaults, the lender wants to be able to gain possession of the
collateral, and obtain it quickly.
that uses bond sales to maintain its level of expenditures must
offer collateral. This collateral is its ability to extract sufficient
revenue from those people under its jurisdiction so that it can
make interest payments on the bonds.
In the South
of 1850, a planter could buy slaves on credit. He pledged the future
productivity of his slaves as collateral for the loan. He made sure
that he extracted sufficient wealth from the slaves to pay off his
loans. He lived well. They didn't.
Why did he
borrow? In order to buy more slaves. He used leverage. He built
his plantation with borrowed money and the heirs of kidnapped victims.
It was good business.
voter thinks of himself as a free man. After all, he has the right
to vote. He does not think of himself as a slave. While trade union
organizers – a truly hopeless career these days – still use the
phrase "wage slave," it never made any sense, either legally or
economically. A worker can legally walk away from his employer.
A slave cannot.
has borrowed more heavily than any planter ever dared to or could
do. Why so much debt? To get more leverage today. What is being
leveraged? Promises. Voters trade votes for government promises.
This system requires an ever-increasing supply of slaves in order
to pay the interest on the debt. Problem: the rate of population
growth is slowing. There will not be enough slaves to pay off the
not thought through the implications of government debt. They do
not perceive themselves as collateral for loans. But they are. This
is the meaning of the phrase, "the full faith and credit of the
United States government."
FAITH AND CREDIT"
hear the phrase, "the full faith and credit of the United States
government," an image should pop into your head: a slave overseer
in Alabama 1850, whip in hand, sitting on a horse at the edge of
a cotton field. The field is filled with slaves, bent down, fingers
scarred, dutifully picking cotton. You are not the overseer. You
would be lucky to be his horse.
buys government promises to pay future money in exchange for present
votes. The trouble is, the promises are backed by the full faith
and credit of the United States government. That means the overseer
will handle the payment system.
The U.S. government
is borrowed short and lent long. To understand this arrangement,
you must understand the currency. The Treasury borrows money on
average for about five years. (http://bit.ly/USdebtMaturity) It
spends this money to meet its obligations. These are political obligations.
The politicians bought past votes with promises of future payments.
Today's expenditures are these payments, which come due day by day.
The government must borrow about $1.3 trillion a year to make good
on past promises. This is in addition to $2.5 trillion in tax revenues.
for office continue to make new promises to voters. The benefits
of votes accrue to the elected candidates when they take the oath
of office. The costs are postponed. The price of votes keeps rising.
The politicians promise to make even larger future payments.
government is borrowed medium-term in the credit markets: a five-year
rollover of the debt. It needs cash to pay off past promises. So,
it borrows long: promises to pay far more money over the next 75
years: Medicare and Social Security.
This is a Ponzi
Why do voters
consent to this? Because they, like the planter in Alabama in 1850,
think this system can go on forever. But there is this crucial difference.
The planter never worked in the fields. The voters do.
of themselves as buying the right to sit on the veranda and sip
mint juleps in their old age. Those who got into the Ponzi scheme
early did just this. Ida Fuller is the classic example: $24 paid
in, $23,000 pulled out. But most voters will spend most of their
days in the fields. There will be no mint juleps for them.
IT TO OURSELVES!"
This one became
popular in the New Deal in the mid-1930s. It was still popular in
the 1950s. We do not hear it as often these days, which is a good
We need a mental
image for this, too. There is a crowd in front of a large domed
building. There is a much larger crowd behind it. Members in the
crowd in front have gray hair, white hair, and no hair. They are
all sitting in battery-powered carts. There is a large sign in the
middle of the crowd: "Ourselves." The people lined up at the back
door also are marked by a large sign: "We." Everyone has his wallet
open. The people in front of the building have the money slots facing
up. The people at the rear have the money slots facing down. On
the domed building, there is a sign: "Promises R Us."
of the credit/debt relationship are not understood well by voters.
The system is based on differences in time. Voters see themselves
as spending their golden years in one of those battery-powered carts.
They believe that if they pay for a ticket to a cart through their
working years, they will get their carts. They lend long (working
years) in order to receive the fruits of their investment (retirement).
this, the federal government issues tens of millions of dated tickets:
"Good for a free cart and all that goes with it." But the ticket
refers the holder to a web page. There, in obtuse legal language,
we find a qualification: "Subject to revision by the issuer." This
means that the date on the ticket can be changed. A wheeled walker
can be substituted for a cart. A cane can be substituted for a walker.
Finally, a card that says "Think Vertically!" can be substituted
for a cane.
An IOU is a
promise to pay. The value of this IOU depends on four factors: (1)
the solvency of the borrower, (2) the expected future value of the
asset promised, (3) the length of time before the IOU comes due,
and (4) the current interest rate for a loan of that maturity. Through
competition, a price is set by the market.
IOU is different from a legal contract between private parties.
A debtor government is the enforcer of the loan. It can therefore
change the terms of the loan at any time. So, the public must have
great trust in the government. Voters must assume that the government's
word is law. They are correct: it is law. This is the problem. The
law can be changed at any time by a new crop of politicians.
to solvency, the U.S. government is assumed to be the most solvent
borrower on earth. The U.S. dollar is the world's reserve currency
for central banks. The U.S. Treasury today pays about one one-hundredth
of a percent for 90-day IOUs. There is nothing else like this anywhere.
There has been nothing like it ever since the Great Depression.
Yet the level
of federal debt is growing rapidly: by $1.3 trillion a year in the
on-budget world, and even faster with respect to unfunded Medicare
and Social Security debt. The vast majority of economists insist
that the United States can and will grow its way out of these obligations.
This means that the government's collateral – you and I – will increase
our productivity and also consent to have at least 25% of it removed
by federal taxes.
will not be maintained for another decade. The numbers point to
a default. But investors do not care. Every large nation's solvency
looks equally bad or worse. By comparison, the dollar is the one-eyed
man in the world of the blind.
The other national
governments are running huge deficits that are also unsustainable.
Because the politicians of every large nation sell promises for
votes, the international exchange rate of the dollar is holding
up. The liars in other nations indulge in the same exchange. Their
lies are no more believable than ours, and maybe less.
the market value of the asset designated by the IOUs? What about
the long-term purchasing power of the U.S. dollar? Today, price
inflation is low. Lenders assume that they can sell the government's
IOUs if this low rate starts up. This assumes that most investors
will sell their bonds in time. Sell to whom? At what price?
will fall in value because the Federal Reserve will inflate. But
this question confounds investors: lower compared to what? Gold,
euros, yen? Real estate? What? When? How fast? How soon?
The IOUs of
the world are based on digital currencies manipulated by central
banks. The dollar looks good in the future because of how bad the
other currencies look. The Federal Reserve is trusted by investors.
term the IOU, the more opportunities for default, inflation, and
new legislation to destroy investors' hopes. This is why 30-year
bonds are risky. But with the FED twisting – buying long-term bonds
and selling short-term bills – the low long rates on T-bonds can
be maintained for years. People say that there will soon be a popped
bubble in 30-year T-bonds. This threat always exists. If commercial
banks start lending to the public again, thereby converting the
FED's more than doubled monetary base into M1, the money multiplier
will increase. So will prices. But this has not happened. There
are few signs that it will happen in 2012. So, twisting keeps T-bond
rates low. Also low are Fannie/Freddie mortgage rates.
So, the U.S.
government's IOU-something still has a strong market. It owes U.S.
dollars, which are in high demand as the euro moves towards the
precipice. The Treasury is in the catbird seat. It can sell its
IOUs at historic low rates.
any nation are collateral for various government's loans. The politicians
have pledged a substantial portion of the taxpayers' future productivity.
But there is
a problem facing lenders: this collateral votes. Collateral for
all loans except loans to a government is inanimate. It can be collected
by the lender after the debtor's default. This is not true of human
beings. They cannot be transferred to the lenders after the bankruptcy.
This is why
it is not possible for a private lender to collect payment from
a civil government that decides it will not pay. The lender is left
with a dead IOU: "You should have read the fine print, dummy." The
fine print says that civil governments are sovereign. They pay their
debts at their discretion.
at long last recognize that the promises made by the government
have become too expensive to fulfill, voters will send this message
to Washington: "Stop payment." It will take several election cycles
to elect enough politicians who will be in a position to issue a
"stop payment" notice to the Treasury, but it can be done. More
than this: it will be done. The escalation of the debt is so rapid
as to make "Stop payment" inescapable.
battles after the election of 2016 will focus on which departments
will receive the "insufficient funds" memo. If the answer is "none,"
then the political question will be this: "How high a rate of price
inflation will the voters tolerate?"
At some point,
voters abandon a hyperinflationary currency. They refuse to offer
goods and services in exchange for the currency. The currency falls
to zero value. This is what Ludwig von Mises called the crack-up
boom. After it ends, a new currency is declared by the government.
have been few such crack-up booms in modern history. Most came after
the loss of a major war. Here is a crucial fact: the replacement
currencies were fiat currencies. No government ever since 1914 has
gone from a crack-up boom to a precious metal currency. Every government
has inflated again. The citizens have never insisted on a gold standard
of any kind, let alone a gold coin standard in which the government
shuts down both the mint and the central bank. Not even Andrew Jackson
This is political
reality. We hear of a supposed reform by some national government
to introduce some variety of fractionally reserved, non-redeemable
gold standard. I pay no attention to these rumors. First, central
bankers are not Austrian School economists. Second, without full
redeemability in gold coins, any gold standard is a promise-based
standard, a pseudo-gold standard. It is a counterfeit. It is just
one more political promise. Political promises have gotten us into
the present mess. They will not get us out.
is a free market-based gold coin standard and also the abolition
of the central bank, voters have not escaped from their status as
collateral. For as long as there is a market for government bonds,
taxpayers are still collateral. They reserve the right to unilaterally
remove themselves from full liability. When it comes to debt, a
government is a limited-liability organization. It can default on
all or a part of its debt. That is what the U.S. government will
do: declare a partial default. The longer the government runs $1.3
trillion annual deficits, the more extensive the default will be.
There is another
possibility, rarely discussed. The Federal Reserve can stop buying
Federal debt. If the FED ever decides, as it did under Paul Volcker's
early years, late 1979 to mid-1982, to cease buying Treasury debt,
that would be the equivalent of "Stop payment." Why? Because the
FED would cease to supply the money necessary to make the otherwise
unfunded payments. The Treasury would have to sell its debt to private
citizens or other central banks. That would mean rising interest
rates and broken promises.
All debt must
have some sort of collateral. If voters understood that they are
the collateral for the federal government's debt, they might rebel.
They might demand a total default. But I don't think this is likely.
The vast majority believe that they will be the folks sitting on
the veranda sipping mint juleps.
I would like
to think that Ron Paul is Moses, calling the slaves to resist. But
I recall their reaction.
And the officers
of the children of Israel did see that they were in evil case,
after it was said, Ye shall not [di]minish ought from your bricks
of your daily task. And they met Moses and Aaron, who stood in
the way, as they came forth from Pharaoh: And they said unto them,
The LORD look upon you, and judge; because ye have made our savour
to be abhorred in the eyes of Pharaoh, and in the eyes of his
servants, to put a sword in their hand to slay us (Exodus 5:19-21).
North [send him mail]
is the author of Mises
on Money. Visit http://www.garynorth.com.
He is also the author of a free 20-volume series, An
Economic Commentary on the Bible.
2011 Gary North
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