Ricochet is the best place on the internet to discuss the issues of the day, either through commenting on posts or writing your own for our active and dynamic community in a fully moderated environment. In addition, the Ricochet Audio Network offers over 50 original podcasts with new episodes released every day.
Full Faith and Credit?
Why is the United States Government today still considered the finest investment risk in the world? The answer traces to Alexander Hamilton:
In 1789, Alexander Hamilton, the first U.S. Treasury secretary, faced a dilemma still challenging Congress today. The new nation was deeply in debt, and there was a lack of consensus in Congress about how to pay for it. Of the $75 million total debt, everyone back then agreed that the U.S. had to pay in full the $10 million loans from France and other nations to finance the American Revolution. Otherwise, no nation would ever loan money to the U.S. in an emergency again. More than $44 million, however, was owed to American citizens who had purchased war bonds during the war. Many of the original purchasers of these bonds had died or sold them at a significant discount to wealthy speculators. They had lost confidence in the ability or willingness of the infant nation to pay.
More:
Some leaders, including James Madison, argued that the new government should pay the current or market value of the bonds, rather than the higher, original face value. Others argued that the government should attempt to discriminate between the original purchasers of the bonds who paid the higher price and the speculators who paid the lower market value.
Adding to the complexity of the issue was the fact that some states had incurred $20 million of debt fighting the Revolution. Other states, which had already paid off their war debts, argued that their citizens shouldn’t be forced to pay the debts of other states. Some even suggested that some of the state debts were the result of non-war spending.
Hamilton’s “Report on the National Credit of 1790” stunned everyone, including President George Washington. Hamilton advised paying off the entire national debt at full face value and assuming all existing state debt. To do otherwise, he argued, would cause citizens to lose faith in the credit and integrity of the struggling government and sabotage the new Constitution. The Revolution had been fought for the benefit of all states, and the unity of all states would be critical to the survival of the new nation.
We often fail to understand just how important belief is to financial investors. Even the mere suggestion that America might default on its debt could induce widespread panic, a loss of faith in the dollar, and much, much higher borrowing costs for the government. Rational investors will not give money to people who did not pay them back last time. Institutions geared to minimizing risks will avoid “bad” sovereign debt like the plague.
Now consider this:
One day after assuring Americans he is not running for president “to make things unstable for the country,” the presumptive Republican nominee, Donald J. Trump, said in a television interview Thursday that he might seek to reduce the national debt by persuading creditors to accept something less than full payment.
Asked whether the United States needed to pay its debts in full, or whether he could negotiate a partial repayment, Mr. Trump told the cable network CNBC, “I would borrow, knowing that if the economy crashed, you could make a deal.”
From my perspective, this might all end up (after enormous pain) to be a good thing.
The simple fact is that US Government debt needs to be handled. There are, as far as I know, only four ways to do this:
- Grow like crazy. This requires enormous regulatory and tax reform, which — sadly — is not happening. We are stagnated and regulations continue to grow.
- Cut entitlements. Also not happening.
- Hyperinflate by printing money, third-world style. Debts become worthless (though so do savings, of course). The government will openly seize assets to pay entitlements, as they have done in Japan, Venezuela, Greece, Cyprus, Portugal, Argentina, etc. But in the end, most entitlements will become worthless.
- Default/bankrupt. Offer debtors a haircut. Destroy faith in the United States as the default safehaven in the world.It also means, in the end, cutting pensions for most Americans, not just those who have worked for the federal government.
I think that the nation — lacking the will for either of the first two — will end up hyperinflating under Clinton or defaulting under Trump.
Either, I suppose, would make it easier to for states to secede and start a new America, one reconnected to limited government and maximum individual rights to life, liberty, and property.
Am I missing something?
Published in General
SO TRUE!
Someday this theme will probably come out in more detail in a post I hope to do on theology and epistemology.
The Latin fides is neat: It means “faith” and has a religious application; it also means “credit” and has an economic application. But it’s one word and has only one meaning.
There is another way. How do you define hyperinflation? At least a 90% drop, or does it have to be a couple orders of magnitude to count?
Because if you look at American [EDIT inflation] rates, particularly after wars, we’ve always solved this problem with what I would characterize as heavy inflation. In the late 1940s it ran 8-14%; when you compound that for a few years, you cut the cost by about 40%. We’ve done this sort of thing over and over. Yes, it’s sleazy and it hurts innocent people, but so do raising taxes and cutting expenses.
Nope. You’ve got it. It will be #3 because it’s the easiest politically. It won’t necessarily be hyperinflation but may become that if the Fed loses control of the situation.
This post dovetails into a post I was going to write. Hope I don’t derail yours but:
Given that we may very undergo a financial catastrophe within the next few years, who do you want in charge when the calamity happens: Trump or Hillary?
It really depends on what I want the outcome to be. Neither seems interested in addressing the underlying problems, or going to war with the bureaucracy that gums up the lives of Americans.
Trump’s history is always default and bankruptcy. That will hurt. Hillary is probably more likely to inspire rebellion and secession.
I am a secessionist, if we can achieve it. If you asked Texans today, I think they’d be more in favor of an independent Texas if Hillary were President than if Donald was in the Oval Office.
Agreed that there is no likely scenario by which the US pays its debts.
By either inflation or default, “full faith” is denied. We could offer a tiered system of repayment with costs applied for speed, so latest returns are full but investors may seek more immediate returns at reduced rates. But without a definite structure for such an agreement at the time the loan is made, it still abuses the original contract.
But what are we worrying about? Economists are always telling us that national budgets aren’t comparable to personal budgets. No foreign lender actually expects to be paid in full, right?
Some people call it belief, but I would simply call it trust. All free economic transactions are based on both parties being honest about what goods they are providing to the other. In the case of debt its one party saying that they will pay back the creditor and with the added value that the creditor discerns would have been had with that original money to begin with.
So trust is what is most important I would argue. If you cannot trust an organization, one that defaults or threatens such, then why would you lend to them.
The responsibility of member states to other states seems the most fraught with difficulty and danger. As Arahant described in my thread about WWI, the relationship betwwen the states was different before Lincoln. Today, the ties are stronger, but the reasons for anger are severe. Corruption and irresponsibility are rampant.
The point I made at the Nashville meetup becomes more significant the weaker the US becomes and the less necessary the US dollar to world finance. Essentially, the point is that governments are not typically as reliable and fair as US banks. A regime change, a war, economic difficulty, trade disputes, and suddenly the lender is pushing for a greater return and sooner than originally agreed.
If America’s enemies perceive weakness, they will push any advantages they might have.
I doubt it. Most of our enemies don’t want the economic fallout either. ISIS probably craves it, but economic warfare is not exactly their area of expertise.
This is precisely the issue. Threatening default achieves two things:
1: Makes it more likely that current creditors freak out.
2: Makes it more likely that future creditors demur, raising the cost of borrowing, thus accelerating the inevitable.
I certainly would not put money in US Treasuries. And while I understand why financial institutions that “paint by numbers” do, I know that they and their fiduciaries will end up suffering for it.
I have a “partial zero” emissions vehicle. “Full faith and credit,” then, can surely be massaged into partial faith…
The current Drudge lead headline: “Kerry Declares Borderless World.” Hmmm. If the world is borderless, the sovereignty of the united (sic) States is surely diminished into something like partial sovereignty. If that is indeed true, states may be willing and able to secede. The desire to secede may become much more fervent as bailouts of bankrupt pension funds – particularly for government employees with outrageously large pensions – will become increasingly-frequent events. This will require enormous tax increases, as the Treasury will not allow cuts to the pensions.
Some catchy slogans used to hold us together as a nation, like “full faith and credit.” How about “consent of the governed?” An elementary attribute of consent is the ability to withdraw it. Secession is simply effective withdrawal of consent to be governed.
Speaking of consent withdrawal, recall that the same federal government which denies the right to secede, is currently forcing colleges and universities to deny all due process rights to males accused of “sexual improprieties;” consent of females may be withdrawn at any time, the feds insist, and males are guilty until proven innocent. Since the feds insist female consent to sex may be withdrawn at any stage and turn the encounter into a rape, does this imply that the females of a state may secede?? Is denial of secession equivalent to rape? Would I qualify to secede if I become transgendered?
I forget the exact wording, but in Niall Ferguson’s book The Ascent of Money, he describes money as trust made tangible.
EDIT: I found the quote:
3 is the obvious and perceived painless choice.
Unfortunately debt:GDP has an inverse relationship to growth and demand creation.
We’ve borrowed so much that our national debt is a record and so is bank credit which just crossed $12T.
Our central bank has been extraordinarily accommodative, but our tax and regulatory schemes combined with our debt levels suppresses conventional demand creation.
Thus we are in the debt spiral where an ever increasing monetary base has no purchase inflation does not ensure. This will lead to even more extraordinary measures including the concept of helicopter money that will induce the hyper inflation, but only after deflation of which we are on the early cusp.
The ensuing hyperinflation will be destructive and render our currency worthless. Our debt will be repaid in full with worthless fiat federal reserve notes.
That has been my prediction for years, here on Ricochet. But Trump has opened up the default/bankruptcy alternative.
I still think we can get tax and regulatory reform and entitlement reform – but not in the United States.
We are already set up for all of the above. If we did the right things, deregulate radically and reform the tax code by replacing it with something simple and transparent, we’d grow, but if we grow without also cutting spending and entitlements drastically we will face run away inflation. We’ve increased the monetary base by 500%. If credit expansion sparked by entrepreneurial renewal turns that into it’s potential 5000% expansion of the money supply even before velocity kicks in, we’ll wipe out the debt but also the middle class. That didn’t work out so well in Germany. So we’ll continue to stagnate until the world decides to dump an appreciable amount of its dollar holdings, interest rates will spike, the debt service will become too much to pay and we’ll default in some form. So we have to cut drastically, end welfare as a Federal program, reform entitlements by making them part of a tax reform that privatizes them for anyone under 40 the way we did for Federal employees. This must be done quickly then we can put forth regulatory reform. Entitlements, or at least a big chunk of them and gradually all of them, will then turn into real savings. We could have elected Cruz who understands this stuff, instead we are going to nominate a person who will precipitate all of it unless we can capture him or a crook who will be consulting with Soros.
A major problem with secession is Mutual defense . A bunch of states would be overrun by our enemies.
Do you think Mexico would invade Texas and succeed?! Or Canada takes out Idaho?
Or Canada takes out Idaho?
they already tried to slip in their sleeper cell Cruz.
Faith, trust, belief, credit, pistis (Greek), fides (Latin): They all mean pretty much the same thing.
AKA counterparty risk.
No comment!
Varys: “I did what I did for the good of the realm.”
Littlefinger: “The realm? Do you know what the realm is? It’s the 1000 blades of Aegon’s enemies, the stories we agree to tell each other over, and over, until we forget that it’s a lie.”
Varys: “And what do we have left, once we abandon the lie? Chaos. A gaping pit waiting to swallow us all.”
Littlefinger: “Chaos isn’t a pit. Chaos is a ladder. Many who try to climb it fail and never get to try again. The fall breaks them. And some are given a chance to climb, but they refuse. They cling to the realm, or the gods, or love. Illusions. Only the ladder is real. The climb is all there is.”
Maybe George Soros is Petyr Baelish.
We’ve printed a massive amount of money but there doesn’t seem to be any inflation. (or there is very selective inflation) I’ve been told this is due to the fact that everyone in the world printed money at the same time and in fact we did less of it (on a GDP basis) than a lot of countries. That is why the dollar is still the strongest of the currencies.
However, I don’t see anyway that sooner or later we have to deal with the debt. I don’t see any good way to do it. Then again I think we’ve been in uncharted waters for 15 years or so and no one knows what the rules are or how this all ends up.
But, like the old Chinese curse, we are going to live in interesting times.
No , I said enemies, how about Russia or China or even Isis. As as country we already have the smallest Army since World War Two.
Recalls a phrase about where you put your heart & where your treasure is-
Do you seriously imagine an airborne or naval invasion from Russia or China into Texas? They have no significant force projection capability around the world.
Glad to see a post praising Hamilton, who was the genius among the Founders. It is my pleasure to point out to my conservative friends the implications of the government’s assumption of the war debt & of the states’ reluctance to keep faith: It’s a strong federal government or it’s nothing at all. America could not have kept faith by preserving state sovereignty even in the sense understood in the Articles of Confederacy–a more perfect union was necessary & that meant an executive with a legal claim on the property of Americans & the power to enforce that claim to pay the debt.
I also think there is a strong argument that if the federal government does not take its powers seriously, secession, which is un-Constitutional, becomes a serious business, as suggested by that dangerous ninth Amendment, which alludes to the bloody part of the teaching of the Declaration: People, being human & equal in their human nature, do have a right to revolution after all. A government of terrible incompetence or despotism has to be overthrown. Also, a tolerable government is the instrument of faith in the common good.
Rather it would happen as before. The smaller or weak powers would get swept up & eventually the trouble would reach American shores; eventually, even Texas.
We’ve had eight years with a president whom nobody believes anymore (red line anyone?). No one believes anything Hillary says. Everything Trump says, we now realize, is just an extreme position at the start of negotiations – or it’s whatever happened to pop into his head a moment ago.
We live in a world flooded by words, and they’re getting cheaper by the moment. Even these words you’re reading at this moment are just comments to a post on a blog.
Word inflation is not thought expansion.