Common Fallacies in the 2023 Debt-Ceiling Debates

Published in the Mises Institute’s Quarterly Journal of Austrian Economics.

Abstract: This article investigates the veracity of three claims made by current and former government officials in the context of the 2023 debt-ceiling debates: it would be unconstitutional to enforce the debt ceiling; the U.S. government has never defaulted; and there are no measures that could be taken to avoid a government default except raising the debt limit. None of these claims is true.

As Congress and the Biden administration carried out the combative negotiations that led to the passage of the Fiscal Responsibility Act of 2023 (H.R. 3746), the news media was replete with stories and opinion pieces about the debt-ceiling debates. Many of these repeated claims made by administration officials and surrogates were designed to promote a political narrative. Such claims included the following: it is unconstitutional for the United States to default on its debt (Blinder 2023); the U.S. has never defaulted on its debt (Biden 2023); there are no additional measures that can be taken to prevent default (Janet Yellen, quoted in Condon and Hordern 2023); and finally, the sole solution to averting a debt crisis is to raise the debt ceiling (Powell 2023). This article will analyze these claims and explain why they are exaggerations, if not demonstrably untrue.

Read the full paper here.

How much would debt default damage US? History offers clues.

Published in CS Monitor.

The U.S. has repudiated its financial obligations at other times too, says Alex J. Pollock, a senior fellow at the Mises Institute and author of “Finance and Philosophy – Why We’re Always Surprised.” In 1968, it refused to redeem silver certificate paper dollars for actual silver dollars, despite a written guarantee. Three years later, the U.S. went off the gold standard completely, despite its commitment in an international agreement to convert dollars to gold. The agreement, known as the Bretton Woods system, collapsed.The U.S. has repudiated its financial obligations at other times too, says Alex J. Pollock, a senior fellow at the Mises Institute and author of “Finance and Philosophy – Why We’re Always Surprised.” In 1968, it refused to redeem silver certificate paper dollars for actual silver dollars, despite a written guarantee. Three years later, the U.S. went off the gold standard completely, despite its commitment in an international agreement to convert dollars to gold. The agreement, known as the Bretton Woods system, collapsed.

…

“Eight thousand tonnes of gold is not a gimmick,” says Mr. Pollock of the Mises Institute. “Eight thousand tonnes of gold is reality.”

The debt ceiling debates are tainted by these common fallacies

Published in The Hill with Paul H. Kupiec.

After weeks of heated debate, the White House and GOP leadership have reportedly reached a deal to suspend the debt ceiling; the House Rules Committee is considering the deal this afternoon. 

The media is full of stories and opinion pieces about the debt ceiling, many of them repeating administration officials’ and their surrogates’ claims that: It is unconstitutional for the U.S. to default on its debt, the U.S. has never defaulted on its debt and there are no other measures to prevent default, so the only solution to averting an imminent debt crisis is to raise the debt ceiling without reducing deficits. 

These claims are misleading, if not demonstrably false.

The 14th Amendment to the Constitution, ratified in 1868, included language that asserted the validity of war debt incurred by the Union while forbidding repayment of any debts incurred by the states of the Confederacy. The amendment states in part:

“The validity of the public debt of the United States, authorized by law, including debts incurred for payment of pensions and bounties for services in suppressing insurrection or rebellion, shall not be questioned” and “Neither the United States nor any state shall assume or pay any debt or obligation incurred in aid of insurrection or rebellion against the United States.”

The Civil War context is clear.

In the midst of the 1995-1996 debt ceiling negotiations, President Bill Clinton said, if need be, he would use the 14th Amendment as justification for ignoring the debt ceiling “and force the courts to stop me.” In contrast, during the 2011 debt ceiling negotiations, the Treasury general counsel wrote that “the Constitution explicitly places the borrowing authority with Congress, not the President.” The latter is correct legal thought, the former mere political bravado. 

The 14th Amendment argument especially fails because it is obvious that the U.S. could easily pay all its debt by not making other expenditures, and moreover, because the United States has in fact defaulted on its debt multiple times since the amendment’s adoption, once explicitly upheld by the Supreme Court.

The U.S. government refused to redeem Treasury gold bonds for gold in 1933 as the bonds had unambiguously promised. In 1968, it refused to redeem its silver certificates for silver notwithstanding its explicit promise to pay “one silver dollar, payable to the bearer on demand.” In 1971, the U.S. government refused to redeem the dollar claims of foreign governments for gold, as promised in the Bretton Woods Agreement, approved by Congress in 1945. Reneging on its Bretton Woods commitments by the U.S. government in 1971 fundamentally changed the global monetary system, putting the whole world onto a pure fiat currency system — a significant default event by any measure.

The 1933 gold bond default is instructive since the government’s refusal to make the gold payments it had unquestionably promised was upheld by the Supreme Court in a 5-4 decision in 1935. The majority opinion found, “Contracts, however express, cannot fetter the constitutional authority of the Congress.” A concurring opinion wrote, “As much as I deplore this refusal to fulfill the solemn promise of bonds of the United States, I cannot escape the conclusion announced for the Court.”

Also, contrary to assertions by the secretary of the Treasury and the chairman of the Federal Reserve, there is a proven legal measure that could be used to materially postpone the day the U.S. Treasury runs out of cash without increasing the debt limit.

The Treasury owns 261.5 million ounces, or 8,000 tons, of gold that have a current market value of over $500 billion at the market price of just under $2,000 per ounce. However, for government accounting purposes, the value of the Treasury’s gold is set by the Par Value Modification Act of 1973, which “directed the Secretary of the Treasury … to establish a new par value of the dollar … of forty-two and two-ninths dollars per fine troy ounce of gold.“

Congress could allow the Treasury to raise cash and avoid a default by amending this law to value gold at or near its current market price. Such a revaluation would be consistent with the guidance in the Federal Accounting Standards Advisory Board’s Technical Bulletin 2011-1. This change would allow the Treasury to monetize more than $500 billion in new gold certificates with no additional Treasury debt issuance.

Updating the value of gold certificates to avoid default is not a hypothetical idea — it has been done before. In 1953, when the Eisenhower administration faced a debt ceiling standoff and needed more time to negotiate, it issued $500 million in new gold certificates to the Fed to raise cash and avoid a government default. The transaction worked as intended, as it would again.   

In contrast to what is often claimed in the current debt ceiling debate: The 14th Amendment does not allow an administration to ignore a congressional debt ceiling, the U.S. government has defaulted on its obligations multiple times and Congress and Treasury have a proven option they could use to produce large amounts of additional cash without raising the debt ceiling.

Paul H. Kupiec is a senior fellow at the American Enterprise Institute. Alex J. Pollock is a senior fellow at the Mises Institute and co-author of “Surprised Again!—The Covid Crisis and the New Market Bubble” (2022). After weeks of heated debate, the White House and GOP leadership have reportedly reached a deal to suspend the debt ceiling; the House Rules Committee is considering the deal this afternoon. 

A Frightening Solution to the Debt Ceiling Crunch

Published in Law & Liberty by Alex J. Pollock and Paul H. Kupiec.

Could the debt ceiling crunch be avoided by the Federal Reserve forgiving treasury debt? Let's hope not.

Much has been written about the Congressional debt-ceiling standoff. US Treasury and Federal Reserve Board officials have insisted that the only way to prevent a federal government default on its debt is for Congress to simply raise the debt ceiling without requiring any reduction in spending and deficits.

However, more imaginative measures could be taken to forestall a general federal government default without increasing the debt ceiling. For example, we have previously shown that legislation that increases the statutory price of the US Treasury’s gold holdings from its absurdly low price of $42.22 per ounce to something close to gold’s $2000 per ounce market value provides an efficient process—one historically used by the Eisenhower administration—to significantly increase the Treasury’s cash balances and avoid default while budgetary debate continues.

In this note, we explore, as a thought experiment, the possibility that the cancellation of up to $2.6 trillion of the $5.3 trillion in Treasury debt owned by the Federal Reserve System could be used to avert a federal government default without any increase in the debt ceiling. We suggest that, given the enforcement of current law, federal budget rules, and Federal Reserve practices, such an extraordinary measure not only would be permissible, but it could be used to entirely circumvent the Congressional debt ceiling.

The Federal Reserve System owns $5.3 trillion in US Treasury securities, or about 17% of the $31 trillion of Treasury debt outstanding. The Fed uses about $2.7 trillion of these securities in its reverse repurchase agreement operations, leaving the Fed with about $2.6 trillion of unencumbered US Treasury securities in its portfolio.

What would happen if the Fed “voluntarily” released the Treasury from its payment obligations on some of all of the unencumbered US Treasury securities held in the Fed’s portfolio, by forgiving the debt? We believe there is nothing in Constitution or the Federal Reserve Act that would prohibit the Fed from taking such an action. This would free up trillions in new deficit financing capacity for the US Treasury without creating any operating difficulties for the Federal Reserve.

There is a longstanding debate among legal scholars as to whether the Fourteenth Amendment to the Constitution makes it unconstitutional for the federal government to default on its debt. But voluntary debt forgiveness by the creditor on the securities owned by the Federal Reserve would not constitute a default and the arguments related to the Fourteenth Amendment would not be applicable.

The Federal Reserve System is an integral part of the federal government, which makes such debt forgiveness a transaction internal to the consolidated government. However, the stock of the twelve Federal Reserve district banks is owned by their member commercial banks. Would it create losses for the Fed’s stockholders if the Fed absolved the US Treasury of its responsibility to make all payments on the US Treasury securities held by the Fed? We don’t think so.

The Fed has already ignored explicit passages of the Federal Reserve Act that require member banks to share in the losses incurred by their district Federal Reserve banks. Under its current operating policies, the Fed would continue to pay member banks dividends and interest on member bank reserve balances even if the entire $2.6 trillion in unencumbered Treasury debt securities owned by the Federal Reserve System were written off. Such a write-off would make the true capital of the Federal Reserve System negative $2.6 trillion instead of the negative $8 billion it is as of April 20.

The Federal Reserve Act requires member banks to subscribe to shares in their Federal Reserve district bank, but member banks need only buy half the shares they have pledged to purchase. The Federal Reserve Act stipulates that the “remaining half of the subscription shall be subject to call by the Board.” At that point, the member banks would have to buy the other half. Presumably, the Fed’s founders believed that such a call would be forthcoming if a Federal Reserve Bank suffered large losses which eroded its capital.

In addition, Section 2 of the Act [12 USC 502] requires that member banks be assessed for district bank losses up to twice the par value of their Federal Reserve district bank stock subscription.

The shareholders of every Federal reserve bank shall be held individually responsible, equally and ratably, and not one for another, for all contracts, debts, and engagements of such bank to the extent of the amount subscriptions to such stock at the par value thereof in addition to the amount subscribed, whether such subscriptions have been paid up in whole or in part under the provisions of this Act. (bold italics added)

To summarize, Fed member banks are theoretically required to buy more stock in a losing Federal Reserve district bank and to be assessed to offset some of the Reserve Bank’s losses. However, these provisions of the Federal Reserve Act have never been exercised and are certainly not being exercised today, in spite of the fact that the Fed’s accumulated losses are now greater than its capital. Indeed, the Fed consistently asserts that it is no problem for it to run with negative capital however large that capital shortfall may become.

Historically, all Fed member banks were entitled to receive a 6 percent cumulative dividend on the par value of their paid-in shares. Subsequently, Congress reduced the dividend rate for large banks to the lesser of “the high yield of the 10-year Treasury note auctioned at the last auction” (currently 3.46%), but maintained the 6% for all others. The Fed is now posting large operating losses but is still paying dividends to all the member banks. We confidently predict it will continue to do so.

Unlike normal shareholders, member banks are not entitled to receive any of their Federal Reserve district bank’s profits beyond their statutory dividend payment. The legal requirements and Federal Reserve Board policies governing the distribution of any Federal Reserve System earnings in excess of its dividend and operating costs have changed many times since 1913, but today, the Fed is required by law to remit basically all positive operating earnings after dividends to the US Treasury—but now there aren’t any operating earnings to remit.

Beginning in mid-September 2022, the Federal Reserve started posting cash losses. Through April 20, 2023, the Fed has accumulated an unprecedented $50 billion in operating losses. In the first 3 months of 2023, the Fed’s monthly cash losses averaged $8.7 billion. Notwithstanding these losses, the Fed continues to operate as though it has positive operating earnings with two important differences—it borrows to cover its operating costs, and it has stopped making any remittances to the US Treasury.

The Fed funds its operating loss cash shortfall by: (1) printing paper Federal Reserve Notes; or (2) by borrowing reserves from banks and other financial institutions through its deposits and reverse repurchase program. The Fed’s ability to print paper currency to cover its losses is limited by the public’s demand for Federal Reserve Notes. The Fed borrows most of the funds it needs by paying an interest rate 4.90 percent on deposit balances and 4.80 percent on the balances borrowed using reverse repurchase agreements. These rates far exceed the yield on the Fed’s investments.

In spite of its losses, the Fed continues to pay member banks both dividends on their shares and interest on their reserve deposits. The Fed has not exercised its power to call the second half of member banks’ stock subscriptions nor has it required member banks to share in the Fed’s operating losses.

Instead of assessing its member banks to raise new capital, the Fed uses nonstandard, “creative” accounting to obscure the fact that it’s accumulating operating losses that have rendered it technically insolvent.

Under current Fed accounting policies, its operating losses accumulate in a so-called “deferred asset” account on its balance sheet, instead of being shown as what they really are: negative retained earnings that reduce dollar-for-dollar the Fed’s capital. The Fed books its losses as an intangible “asset” and continues to show it has $42 billion in capital. While this treatment of Federal Reserve System losses is clearly inconsistent with generally accepted accounting standards, and seemingly inconsistent with the Federal Reserve Act’s treatment of Federal Reserve losses, Congress has done nothing to stop the Fed from utilizing these accounting hijinks, which the Fed could also use to cancel the Treasury’s debt.

Under these Fed operating policies, if all of the unencumbered Treasury securities owned by the Fed were forgiven and written off, the Fed would immediately lose $2.6 trillion. It would add that amount to its “deferred asset” account. Because the Fed would no longer receive interest on $2.6 trillion in Treasury securities, its monthly operating losses would balloon from $8.7 billion to about $13 billion, for an annual loss of about $156 billion. Those losses would also go to the “deferred asset” account. Treasury debt forgiveness would delay by decades the date on which the Fed would resume making any remittances to the US Treasury, but by creating $2.6 trillion in de facto negative capital, the Fed would allow the Treasury to issue $2.6 trillion in new debt securities to keep on funding federal budget deficits.

Under the federal budgetary accounting rules, the Fed’s deferred asset account balances and its operating losses do not count as expenditures in federal budget deficit calculations, nor do the Fed’s borrowings to fund its operations count against the Congressionally imposed debt ceiling. So in short, the Fed offers a way to evade the debt ceiling.

In reality, of course, the debt of the consolidated government would not be reduced by the Fed’s forgiveness of Treasury debt. This is because the $2.6 trillion the Fed borrowed (in the form of bank reserves and reverse repurchase agreement loans) to buy the Treasury securities it forgives would continue to be liabilities of the Federal Reserve System it must pay. The Fed would have $2.6 trillion more liabilities than tangible assets, and these Fed liabilities are real debt of the consolidated federal government. But in accounting, the Fed’s liabilities are uncounted on the Treasury’s books. Under current rules, there appears to be no limit to the possibility of using the Fed to expand government debt past the debt ceiling.

In other words, the Fed’s write-off of Treasury securities and its ongoing losses could accumulate into a massive amount of uncounted federal government debt to finance deficit spending. A potential loophole of trillions of dollars around the Congressional debt limit is an astonishing thought, even by the standards of our current federal government. Let’s hope Congress closes this potentially massive budgetary loophole while the idea of the Fed’s forgiving Treasury debt remains just a thought experiment.

Alex J. Pollock is a Senior Fellow at the Mises Institute and was the principal deputy director of the office of financial research of the U.S. Treasury Department, 2019-21. He is author of Finance and Philosophy—Why We’re Always Surprised and co-author of Surprised Again!—The COVID Crisis and the New Market Bubble.

Paul H. Kupiec is a senior fellow at the American Enterprise Institute, where he studies systemic risk and the management and regulations of banks and financial markets. Before joining AEI, Kupiec was an associate director of the Division of Insurance and Research within the Center for Financial Research at the Federal Deposit Insurance Corporation (FDIC) and director of the Center for Financial Research at the FDIC and chairman of the Research Task Force of the Basel Committee on Banking Supervision. He has previously worked at the International Monetary Fund (IMF), Freddie Mac, J.P. Morgan, and for the Division of Research and Statistics at the Board of Governors of the Federal Reserve System.

Could the Treasury selectively default on the Fed’s debt?

Published in The Hill with Paul H. Kupiec.

A reporter from this publication recently asked how a debt ceiling standoff might impact the banking system. One obvious answer is that if the Treasury ran out of cash and defaulted on the payments owed on its debt securities, the banking system would suffer since it collectively owns, per our calculations, about $1.3 trillion in Treasury securities that have always been treated as “risk-free.”

U.S. Treasury securities do not have cross-default clauses, so the Treasury could choose to default on only a specific set of selected securities sparing banks and others. This gives rise to a provocative question:

Could the U.S. Treasury save cash by selectively defaulting just on securities owned by the Federal Reserve System? How would this impact the Fed? How much cash would be freed up to pay other Treasury bills?

The Federal Reserve owns about $5.3 trillion in U.S. Treasury securities. The Fed’s 2022 audited financial statements show that $721 billion of these securities mature between April 1 and Dec. 31 and that the Fed received almost $116 billion in interest payments from the Treasury last year, or about $9.6 billion a month. Between now and Dec. 31, the Fed is scheduled to receive about $800 billion in interest and maturing principal payments from the Treasury, cash Treasury could use to pay its other bills if it stopped paying the Fed.

How would the Fed cope with a selective Treasury default? The same way it is managing what we’ve calculated is an ongoing $8.6 billion in operating losses per month — by borrowing the additional money it needs to operate and thus creating more debt for the consolidated government and ultimately a taxpayer liability.

If the Treasury suspended all payments due on its securities held by the Federal Reserve System, presumably by agreement with the Federal Reserve, the Fed would be short the cash it previously received. It would increase its borrowing to fund its operations, but the impact on the Fed’s reported operating loss would depend on the details of the suspension agreement and the accounting treatment adopted by the Fed.

Once Congress lifts the debt ceiling, we presume that the Treasury would pay the Fed its balances in arrears. Would the Treasury also pay accrued interest on the suspended amounts it owes the Fed? If so, at what rate?

The suspension of interest payments would clearly reduce the Fed’s cash interest received but it would not immediately increase the reported Federal Reserve operating losses. The Fed would likely account for suspended interest payments as non-cash interest income earned and create a new asset category, “interest income receivable from Treasury,” on its balance sheet.

The non-payment of interest would increase, dollar-for-dollar, the amount the Fed needs to borrow to pay its bills. Going forward, the Fed would have to continue borrowing to fund suspended Treasury balances. If these balances accrued interest at the Fed’s borrowing cost, there would be no future impact on the Fed’s reported operating income. If the Treasury agreed to a lower interest accrual rate or no interest accrual, the Fed’s reported operating losses would increase.

If the suspended maturing principal payments are merely delayed until Congress increases the debt ceiling, the Fed would likely record these as deferred balances due from the U.S. Treasury and would not create a reserve for a credit loss. The suspension would disrupt the Fed’s quantitative tightening plans as its Treasury security balances would not run off as planned.

With the suspension of interest payments on the Fed’s portfolio of U.S. Treasury securities, the Fed would increase its borrowing to cover not only its ongoing operating losses, now about $8.6 billion per month, but also the additional cash shortfall created by the suspension, about $9.6 billion a month, for a total new borrowing of $18.2 billion a month.

The Fed would fund its cash shortfall by (1) printing paper Federal Reserve Notes or (2) borrowing reserves from banks and other financial institutions through its reverse repurchase program. Because the Fed’s ability to fund its losses by printing paper currency is limited by the public’s demand for Federal Reserve Notes, the Fed will have to borrow most of the funds paying an interest rate of 4.90 percent on borrowed reserve balances and 4.80 percent on the balances borrowed using reverse repurchase agreements.

Loans to the Federal Reserve System, whether from reserve balances or repurchase agreements, are backed by Treasury securities owned by the Fed, or by the full faith credit of the U.S. federal government, since the Fed is the fiscal agent of the U.S. Treasury. However, unlike securities issued by the Treasury, when the Federal Reserve borrows, its loans are not counted in the federal government debt that is limited by the statutory debt ceiling. Indeed, Federal Reserve system cash operating losses are not counted as expenditures in federal budget calculations. Because of these budgetary loopholes, Fed operating losses are excluded from any federal budget deficit cap and its borrowings circumvent the statutory federal debt ceiling.

Could the U.S. Treasury take the extraordinary step of selectively halting interest and principal payments on the Treasury securities owned by the Federal Reserve System? We do not recommend such an action but see nothing in law or current Federal Reserve accounting and operating practices that would preclude it should the Treasury need to take emergency measures to avoid a wider federal government default.

If extraordinary measures are needed, a better alternative is free up funds by updating the Congressionally legislated price of the Treasury’s 8,000 tons of gold to ensure prompt payments on all the Treasury’s debt and maintain the credit performance of the United States government.

WRAL: Fact check: Has the U.S. ever defaulted on its debt?

From WRAL:

Possible precedents for defaults

In a 2021 op-ed in The Hill, a political news outlet, Alex J. Pollock, a former Treasury Department official, argued that there are four precedents for U.S. defaults. Pollock cited cases of the U.S. Treasury: Resorting to paper money largely not supported by gold during the Civil War in 1862; Redeeming gold bonds with paper money rather than gold coins during the Great Depression in 1933; Not honoring silver certificates with an exchange of silver dollars in 1968; and Abandoning the Bretton Woods Agreement in 1971, which included a commitment to redeem dollars held by foreign governments for gold. Also, a 2016 analysis by the nonpartisan Congressional Research Service noted that in 1979, the Treasury failed to make on-time payments to some small investors because of technical glitches. Most were paid within days or a week. The research service concluded that although the temporary payment delays "inconvenienced many investors, the stability of the wider market in Treasury securities was never at risk." But multiple economic specialists agree that although these were notable episodes, they do not mirror the type of default to which Jeffries was referring.

The Government Debt Ceiling: What Did Eisenhower Do?

July 27, 2011

Published with Anne C. Canfield in AEIdeas.

“Nothing is ever new, it is just history repeating itself”—at least in finance. In his A History of the Federal Reserve,¹ Allan Meltzer describes what happened during the Eisenhower administration when the Treasury ran out of debt authorization and Congress did not raise the debt ceiling. This was in 1953.

In order to keep making payments, the Treasury increased its gold certificate deposits at the Federal Reserve, which it could do from its dollar “profits” because the price of gold in dollars had risen. The Fed then credited the Treasury’s account with them, thereby increasing the Treasury’s cash balance. Treasury then spent the money without exceeding the debt limit.

By the spring of 1954, Congress had raised the debt ceiling from $275 to $280 billion (2 percent or so of today’s limit), so ordinary debt issuance could continue.

The Secretary of the Treasury still is authorized to issue gold certificates to the Federal Reserve Banks, which will then credit the Treasury’s cash account.² This is correctly characterized as monetizing the Treasury’s gold, of which it owns more than 8,000 tons. An old law says this gold is worth 42 and 2/9 dollars per ounce, but we know the actual market value is about 38 times that, at more than $1,600 per ounce.

Should we follow Eisenhower’s example?

Alex J. Pollock is a resident fellow at the American Enterprise Institute.  Anne Canfield is president of Canfield & Associates, Washington, D.C.

1. Allan Meltzer, A History of the Federal Reserve, Volume 2, Book 1, pp. 110 and 168.

2. Federal Reserve Bank of New York, 2010 Annual Report, p. 39.

Empire Salon | Alex Pollock & Howard Adler

Hosted by Committee for the Republic. Full video here.

The Committee for the Republic seeks to restore Congress as the exclusive custodian of the war power under the U.S. Constitution. Since the Korean War, American foreign policy has operated extra-constitutionally featuring presidential usurpation and congressional abdication. The price has been staggering—not only in the squandering of trillions of dollars and lives lost but in the annihilation of liberty and the rule law. Committee salons also explore the funding necessary to finance the wars that earmark an imperial presidency. The Federal Reserve is the rich uncle of war finance.

Central banking is a cornerstone of government power under any monetary standard. But it is a lead actor in our pure fiat currency system. The first step was taken in 1933 when President Franklin Roosevelt by executive order prohibited Americans from owning gold. The culminating step was taken in 1971 by President Nixon's severing of the last tie of the dollar to gold -- putting the world on an "elastic" paper money standard.

Alex Pollock and Howard Adler will address their new book, Surprised Again!--The Covid Crisis and the New Market Bubble. It dissects the 2020 financial panic, the massive government interventions to finance it, and the ensuing Everything Bubble and high inflation. With fiat currency in unlimited supply, the Fed was essential to financing these expansions of government. Its balance sheet ballooned by over $4 trillion in printing the dollars needed to "lend freely" into the financial crisis and to cover the staggering government deficits which ensued. The Fed performed the real first mission of every central bank: financing the government of which it is a part.

The salon will also explore the wider implications of the role of the Fed as paymaster of the American empire and enabler of our multi-trillion-dollar military-industrial-security complex. Since the Bank of England was formed in 1694 to finance King William's wars, the link of central banking to war finance has continued. The Constitution entrusts to Congress financing government operations, but Congress has surrendered responsibility to the executive branch and the central bank. The dollar as a reserve currency enables the Fed to fund the empire with foreign dollar holdings.

Opening remarks:

Have we lost an independent central bank?

In post-WW1 Germany, who caused inflation?

Explain if we are really surprised by massive financial events or not.

What are the implications long-term of manipulating interest rates?

How expensive would wars be if we weren't the reserve currency?

Broad question about the role of the Fed.

Question about the broad role of the Fed and its political involvement as well as the value of currency boards.

Letter: A piece that displayed that iron law of finance

Published in the Financial Times:

Martin Wolf’s timely opinion piece “We must tackle crisis of global debt” (January 18) displays once again an iron law of finance that “loans which cannot be paid will not be paid” — which applies to sovereign debtors as well as all others who have borrowed beyond their means.

Once we realise that this is the situation we have got ourselves into, the only question is how to divide up the losses among the parties. “Who gets to eat how much loss?” is the simple statement of what all the discussions of “debt restructuring” are about.

How to pay all of the Treasury’s bills without raising the debt limit

Published in The Hill with Paul H. Kupiec is a senior fellow at the American Enterprise Institute.

The news is filled with dire warnings of what will happen if Congress does not lift the debt ceiling and the U.S. Treasury defaults on its debt. 

Conservative House Republicans in the new Congress have promised to block any increase in the debt ceiling without an agreement to make cuts in the government’s massive deficit spending. President Biden has vowed not to negotiate and says Congress must pass a clean bill that only increases the debt ceiling. 

Unless Congress raises the debt limit, Treasury Secretary Janet Yellen estimates that the Treasury will run out of cash and be unable to pay all its bills sometime in June, triggering a default on the U.S. Treasury’s outstanding debt.

It would be ridiculous, wouldn’t it, for the Treasury to default on its debt when it owns more than half a trillion dollars worth of the most classic monetary asset there is: gold. If there is a way to convert the gold into cash in the Treasury’s bank account, then the government can pay its bills through the end of the fiscal year 2023 without an increase in the debt limit. There is a way, and it has been done multiple times in the past. All that is required is the passage of a bill that changes a few words in existing legislation — a bill that both Republicans and Democrats should support.

The Treasury owns a lot of gold: 261.5 million ounces of it, or more than 8,170 tons. The market price of gold is about $1,940 per ounce, so the Treasury’s gold is actually worth about $507 billion. Because of a law passed in 1973, the Gold Reserve Act requires the Treasury to value its gold at $42.22 per ounce — a number 50 years out of date and with no connection to reality. Gold is in fact a giant undervalued monetary asset of the Treasury. Unlike the phony idea of the Treasury issuing a trillion-dollar platinum coin, the gold owned by the U.S. Treasury is real; because of an outdated law, the Treasury just values it at an absurdly low price.

With the proposed change, the Treasury can simply issue gold certificates against the market value of its gold and deposit these certificates into its account with the Federal Reserve. The Fed will credit the Treasury’s account with an equivalent value in dollars, and the Treasury can spend the money as needed. The Treasury already has $11 billion in gold certificates deposited with the Fed. If the Treasury revalues its gold holding to current prices, we calculate that it can deposit $494 billion in new gold certificates at the Fed — creating $494 billion in spendable dollars without creating a penny of additional Treasury debt.

The Gold Reserve Act, as amended in 1973, provides that: “The Secretary [of the Treasury] may issue gold certificates against other gold held in the Treasury. The Secretary may prescribe the form and denominations of the certificates.” So the authorization to create gold certificates could not be clearer.

Then comes the words needing legislative change: “The amount of outstanding certificates may be not more than the value (for the purpose of issuing those certificates, of 42 and two-ninths dollars a fine troy ounce) of the gold held against the gold certificates.” New legislation is required to modify the Gold Reserve Act and strike “42 and two-ninths dollars” and replace it with “the current market value (as determined by the Secretary at the time of issuance).”Unless Congress raises the debt limit, Treasury Secretary Janet Yellen estimates that the Treasury will run out of cash and be unable to pay all its bills sometime in June, triggering a default on the U.S. Treasury’s outstanding debt.

It would be ridiculous, wouldn’t it, for the Treasury to default on its debt when it owns more than half a trillion dollars worth of the most classic monetary asset there is: gold. If there is a way to convert the gold into cash in the Treasury’s bank account, then the government can pay its bills through the end of the fiscal year 2023 without an increase in the debt limit. There is a way, and it has been done multiple times in the past. All that is required is the passage of a bill that changes a few words in existing legislation — a bill that both Republicans and Democrats should support.

The Treasury owns a lot of gold: 261.5 million ounces of it, or more than 8,170 tons. The market price of gold is about $1,940 per ounce, so the Treasury’s gold is actually worth about $507 billion. Because of a law passed in 1973, the Gold Reserve Act requires the Treasury to value its gold at $42.22 per ounce — a number 50 years out of date and with no connection to reality. Gold is in fact a giant undervalued monetary asset of the Treasury. Unlike the phony idea of the Treasury issuing a trillion-dollar platinum coin, the gold owned by the U.S. Treasury is real; because of an outdated law, the Treasury just values it at an absurdly low price.

With the proposed change, the Treasury can simply issue gold certificates against the market value of its gold and deposit these certificates into its account with the Federal Reserve. The Fed will credit the Treasury’s account with an equivalent value in dollars, and the Treasury can spend the money as needed. The Treasury already has $11 billion in gold certificates deposited with the Fed. If the Treasury revalues its gold holding to current prices, we calculate that it can deposit $494 billion in new gold certificates at the Fed — creating $494 billion in spendable dollars without creating a penny of additional Treasury debt.

The Gold Reserve Act, as amended in 1973, provides that: “The Secretary [of the Treasury] may issue gold certificates against other gold held in the Treasury. The Secretary may prescribe the form and denominations of the certificates.” So the authorization to create gold certificates could not be clearer.

Then comes the words needing legislative change: “The amount of outstanding certificates may be not more than the value (for the purpose of issuing those certificates, of 42 and two-ninths dollars a fine troy ounce) of the gold held against the gold certificates.” New legislation is required to modify the Gold Reserve Act and strike “42 and two-ninths dollars” and replace it with “the current market value (as determined by the Secretary at the time of issuance).”

Voila! The Treasury has $494 billion more in cash with no additional debt. The president’s budget proposed a deficit of $1.2 trillion for fiscal 2023, so the additional funds should carry the Treasury from the current June deadline to easily past the end of fiscal 2023, giving the new Republican House majority, and the Democratic Senate majority, time to negotiate, in regular order, and pass a 2024 fiscal year budget with spending cuts as well as pass a new appropriately-sized debt ceiling to facilitate government funding in fiscal 2024 and beyond.

By merely recognizing the true market value of the Treasury’s gold holdings, the intense embarrassment to the administration and Congress of a looming default by the Treasury can be completely avoided. It is indeed ironic that in a world of inflated fiat currency and massive deficit finance, simply recognizing the true value of the government’s gold holdings can keep the government solvent. There are no budgetary tricks involved. It’s been done before and can work again.

Alex J. Pollock is a senior fellow at the Mises Institute and the co-author of the new book, “Surprised Again!—The Covid Crisis and the New Market Bubble. ” Paul H. Kupiec is a senior fellow at the American Enterprise Institute.

A “default on our debt” would be unprecedented in American history?

Published in Politifact:

Possible precedents for defaults

In a 2021 op-ed in The Hill, a political news outlet, Alex J. Pollock, a former Treasury Department official, argued that there are four precedents for U.S. defaults.

Pollock cited cases of the U.S. Treasury:

• Resorting to paper money largely not supported by gold during the Civil War in 1862;

• Redeeming gold bonds with paper money rather than gold coins during the Great Depression in 1933; 

• Not honoring silver certificates with an exchange of silver dollars in 1968; and

• Abandoning the Bretton Woods Agreement in 1971, which included a commitment to redeem dollars held by foreign governments for gold. 

…

Our Sources

Hakeem Jeffries, interview with NBC’s "Meet the Press," Jan. 8, 2023

Congressional Research Service, "Has the U.S. Government Ever ‘Defaulted’?" Dec. 8, 2016

Alex J. Pollock, "The US has never defaulted on its debt — except the four times it did," Oct. 7, 2021

No, the United States Has Not Always Paid Its Debts

Published in Reason:

In 1934, Roosevelt officially devalued the dollar by increasing the price of gold from $20.67 to $35. Although contemporary press accounts characterized the government's actions as an abrogation (see the Wall Street Journal on May 4, 1933), Treasury securities issued in June and August 1933 were oversubscribed and a February 1935 Supreme Court decision upheld the government's actions. While these actions are generally portrayed today as an attempt to halt gold hoarding or end price deflation, they also appear to have had a fiscal motivation. In fiscal year 1933, the ratio of interest expense to federal revenues reached 33.15 percent, the only time this ratio has exceeded 30 percent since the post-Civil War era. The Roosevelt administration needed more funds to implement New Deal programs and wanted the flexibility to issue new Treasury securities unimpeded by gold convertibility.

No More Debt Ceiling Increases: Let the Federal Government Default

Published in Real Clear Markets:

In the meantime, the Democratic Party and the media will predictably continue to scream, “The United States has never defaulted on its debt!” As ‘The Hill’ recently pointed out, this isn’t true, but nonetheless we’ll be told that if Congress doesn’t raise the debt ceiling the world will end.

The US has never defaulted on its debt — except the four times it did

Published in The Hill.

Every time the U.S. government’s debt gets close to the debt ceiling, and people start worrying about a possible default, the Treasury Department, under either party, says the same thing: “The U.S. government has never defaulted on its debt!” Every time, this claim is false.

Now Treasury Secretary Yellen has joined the unfailing chorus, writing that “The U.S. has always paid its bills on time” and “The U.S. has never defaulted. Not once,” and telling the Senate Banking Committee that if Congress does not raise the debt ceiling, “America would default for the first time in history.”  

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This is all simply wrong. If the United States government did default now, it would be the fifth time, not the first. There have been four explicit defaults on its debt before. These were:

1. The default on the U.S. government’s demand notes in early 1862, caused by the Treasury’s financial difficulties trying to pay for the Civil War. In response, the U. S. government took to printing pure paper money, or “greenbacks,” which during the war fell to significant discounts against gold, depending particularly on the military fortunes of the Union armies.

2. The overt default by the U.S. government on its gold bonds in 1933. The United States had in clear and entirely unambiguous terms promised the bondholders to redeem these bonds in gold coin. Then it refused to do so, offering depreciated paper currency instead. The case went ultimately to the Supreme Court, which on a 5-4 vote, upheld the sovereign power of the government to default if it chose to. “As much as I deplore this refusal to fulfill the solemn promise of bonds of the United States,” wrote Justice Harlan Stone, a member of the majority, “the government, through exercise of its sovereign power…has rendered itself immune from liability,” demonstrating the classic risk of lending to a sovereign. In “American Default,” his highly interesting political history of this event, Sebastian Edwards concludes that it was an “excusable default,” but clearly a default.

3. Then the U.S. government defaulted in 1968 by refusing to honor its explicit promise to redeem its silver certificate paper dollars for silver dollars. The silver certificates stated and still state on their face in language no one could misunderstand, “This certifies that there has been deposited in the Treasury of the United States of America one silver dollar, payable to the bearer on demand.” It would be hard to have a clearer promise than that. But when an embarrassingly large number of bearers of these certificates demanded the promised silver dollars, the U.S. government simply decided not to pay. For those who believed the certification which was and is printed on the face of the silver certificates: Tough luck.

4. The fourth default was the 1971 breaking of the U.S. government’s commitment to redeem dollars held by foreign governments for gold under the Bretton Woods Agreement. Since that commitment was the lynchpin of the entire Bretton Woods system, reneging on it was the end of the system. President Nixon announced this act as temporary: “I have directed [Treasury] Secretary Connally to suspend temporarily the convertibility of the dollar into gold.” The suspension of course became permanent, allowing the unlimited printing of dollars by the Federal Reserve today. Connally notoriously told his upset international counterparts, “The dollar is our currency but it’s your problem.”

To paraphrase Daniel Patrick Moynihan, you are entitled to your own opinion about the debt ceiling, but not to your own facts about the history of U.S. government defaults.

The Many Faces of Government Default

Published in Law & Liberty.

Although government debt is a favored investment class all over the world, it has a colorful history of over 200 defaults in the last two centuries, which continue right up to the present time.

This record reflects a perpetual political temptation, memorably described by the sardonic observer of sovereign defaults, Max Winkler in 1933. Of “the politicians in the borrowing countries,” he wrote, “from Abyssinia to Zanzibar”—which we may update to Argentina to Zambia, both governments having defaulted again in 2020—“Tomorrow they may be swept out of office. Today they can live only by yielding to the multiple undertaking of expenditures . . . and exchange favors by the misuse of the public treasury. In order to enjoy the present, they cheerfully mortgage the future.” Of course, we can’t read this without thinking of the Biden $1.9 trillion project to spend, borrow, and print.

Often enough, historically speaking, booming government debt has resulted in “national bankruptcy and default” around the world. Winkler chronicled the long list of government defaults up to the 1930s. He predicted that future investors would again be “gazing sadly” on unpaid government promises to pay. He was so right. Since then, the list of sovereign defaults has grown much longer.

A Short Quiz: Here are six sets of years. What do they represent?

1. 1827, 1890, 1951, 1956, 1982, 1989, 2001, 2014, 2020

2. 1828, 1898, 1902, 1914, 1931, 1937, 1961, 1964, 1983, 1986, 1990

3. 1826, 1843, 1860, 1894, 1932, 2012

4. 1876, 1915, 1931, 1940, 1959, 1965, 1978, 1982

5. 1826, 1848, 1860, 1865, 1892, 1898, 1982, 1990, 1995, 1998, 2004, 2017

6. 1862, 1933, 1968, 1971

All these are years of defaults by a sample of governments. They are, respectively, the governments of:

1. Argentina

2. Brazil

3. Greece

4. Turkey

5. Venezuela

6. The United States.

In the case of the United States, the defaults consisted of the refusal to redeem demand notes for gold or silver, as promised, in 1862; the refusal to redeem gold bonds for gold, as promised, in 1933; the refusal to redeem silver certificates for silver, as promised, in 1968; and the refusal to redeem the dollar claims of foreign governments for gold, as promised, in 1971.

With the onset of the Civil War in 1861, the war effort proved vastly more costly than previously imagined. To pay expenses, Congress authorized a circulating currency in the form of “demand notes,” which were redeemable in precious metal coins on the bearer’s demand and promised so on their face. Secretary of the Treasury Salmon Chase declared that “being at all times convertible into coin at the option of the holder . . . they must always be equivalent to gold.” But soon after, by the beginning of 1862, the U.S. government was no longer able to honor such redemptions, so stopped doing so. To support the use of the notes anyway, Congress declared them to be legal tender which had to be accepted in payment of debts. About issuing pure paper money, President Lincoln quoted the Bible: “Silver and gold have I none.”

In 1933, outstanding U.S. Treasury bonds included “gold bonds,” which unambiguously promised that the investor could choose to be paid in gold coin. However, President Roosevelt and Congress decided that paying as promised was “against public policy” and refused. Bondholders sued and got to the Supreme Court, which held 5-4 that the government can exercise its sovereign power in this fashion. Shortly before, when running for office in 1932, Roosevelt had said, “no responsible government would have sold to the country securities payable in gold if it knew that the promise—yes, the covenant—embodied in these securities was . . . dubious.” A recent history of this failure to pay as agreed concludes it was an “excusable default.”

In the 1960s, the U.S. still had coins made out of real silver and dollar bills which were “silver certificates.” These dollars promised on their face that they could be redeemed from the U.S. Treasury for one silver dollar on demand. But when inflation and the increasing value of silver induced people to ask for redemptions as promised, the government decided to stop honoring them. If today you have a silver certificate still bearing the government’s unambiguous promise, this promise will not be kept—no silver dollar for you. The silver in that unpaid silver dollar is currently worth about $20 in paper money.

An underlying idea in the 1944 Bretton Woods international monetary agreement was that “the United States dollar and gold are synonymous,” but in 1971 the U.S. reneged on its Bretton Woods agreement to redeem dollars held by foreign governments for gold. This historic default moved the world to the pure fiat money regime which continues today, although it has experienced numerous financial and currency crises, as well as endemic inflation. Since 1971, the U.S. government has stopped promising to redeem its money for anything else, and the U.S. Treasury has stopped promising to pay its debt with anything except the government’s own fiat currency. This prevents explicit defaults in nominal terms, but does not prevent creating high inflation and depreciation of both the currency and the government debt, which are implicit defaults.

Winkler related a pointed story to give us an archetype of government debt from ancient Greek times. Dionysius, the tyrant of Syracuse, was hard up and couldn’t pay his debts to his subjects, the tale goes. So he issued a decree requiring that all silver coins had to be turned in to the government, on pain of death. When he had the coins, reminted them, “Stamping at two drachmae each one-drachma coin.” Brilliant! With these, he paid off his nominal debt, becoming, Winkler said, “the Father of Currency Devaluation” and thereby expropriating real wealth from his subjects.

Observe that Dionysius’s stratagem was, in essence, the same as that of the United States in its defaults of 1862, 1933, 1968, and 1971. In all cases, like Dionysius, the U.S. government broke a promise, depreciated its currency, and reduced its obligations at the expense of its creditors. Default can have many faces.

So convenient it is to be a sovereign when you can’t pay as promised.

Actually, Sovereigns Do Go Broke

Published in Law & Liberty.

The ballooning debt of the United States government is an especially large and interesting case of sovereign debt. One chronicler of sovereign debt’s long, global, colorful history, Max Winkler, concluded that “The history of government loans is really a history of government defaults.” More moderately, we may say that at least defaults figure prominently in that history.

In a vivid recent example, the government of Greece, in its 2012 debt restructuring, paid private holders of its defaulted debt 25 cents on the dollar, so these creditors suffered a 75 percent loss from par value. Greek government debt was at the vortex of Europe’s 21st century sovereign debt crisis. Various governments of Greece have defaulted seven times on their debt, which has been in default approximately half the time since the 1820s.

With such a record, how soon would the lenders be back this time?

Pretty soon, as usual. Defaults were the past; new loans proclaim a belief in the future. Thus in July, the print edition of the Financial Times informed us, “Greek debt snapped up as investors seek higher yields”! That’s a headline that would not have been predicted a few years ago—except by students of financial history who have observed the repeating cycles of sovereign borrowing, default, and new borrowing.

“Greece has seen vigorous demand for its latest bond sale,” read the Financial Times article. “The Mediterranean country received orders of more than €13 billion for the seven-year bonds, well above the €2.5 billion on offer.” And the “higher yield”? A not very impressive 1.9 percent. The recently again-defaulting Greek government has succeeded in borrowing at the same interest rate as the United States government was at the same time for the same tenor. Of course the currencies are different, but this is nonetheless remarkable.

Note the common but inaccurate figure of speech used in the article. It talks about the country borrowing, when it is in fact the government of the country that borrows. That these two are not the same is an important credit consideration. Governments can be overthrown and disappear, while the country goes on. Governments can and do default on their debt with historical regularity.

Breaking the Faith

Notorious in this respect is the government of Argentina, which has “broken good faith with its creditors on eight occasions since it declared independence from Spain in 1816,” as James Grant reminds us. That is a default on average about once every 25 years. Obviously the lenders reappeared each time—in 2017, they bought Argentine government bonds with a maturity of 100 years. That is long enough on average to cover four defaults. In August 2019, the Argentine government announced it would seek to restructure its debt once again, and its 100-year bonds at the end of the month were quoted at 41 cents on the dollar.

In contrast to this, an optimistic columnist for Barron’s pronounced in that same August that sovereign bonds “have minimal to no credit risk because they are backstopped by their governments.” This financially uneducated statement is reminiscent of the notorious Walter Wriston line that “countries don’t go bankrupt.” Wriston, then prominent in banking as the innovative chairman of Citicorp, was defending the credit expansion that would shortly lead to the disastrous sovereign debt collapse of the 1980s. While sovereign governments indeed do not go into bankruptcy proceedings, they nevertheless do often default on their debt.

The great philosopher, economist and historian, David Hume, famously argued two and a half centuries ago, “Contracting debt will almost infallibly be abused, in every government.”

Max Winkler shared a realistic appreciation of the risk involved, as he was writing during the sovereign debt collapse of the 1930s. His instructive and entertaining book, Foreign Bonds: An Autopsy (1933), provides a simple but convincing explanation for the recurring defaults. Considering “politicians in the borrowing countries, from Abyssinia to Zanzibar,” Winkler memorably observed:

The position they occupy or the office they hold is ephemeral. Their philosophy of life is carpe diem. . . . Tomorrow they may be swept out of office. Today they can live only by yielding to the multiple undertaking of expenditures, proposed by themselves and their temporary adherents. . . . In order to enjoy the present they cheerfully mortgage the future, and in order to win the favor of the voter they . . . exceed the taxable possibilities of the country.

This sounds familiar indeed. We only need to update Winkler’s A to Z country names—we could make it “from Argentina to Zimbabwe.” Otherwise, the logic of the politicians’ behavior he describes is perpetual. It applies not only to national governments but to the governments of their component states, cities, and territories, like over-indebted Illinois and Chicago; New York City, which went broke in 1975; and Puerto Rico, now in the midst of a giant debt restructuring, among many others.

The observation fits the governments of advanced, as well as emerging, economies. This political pattern includes the expanding debt of the United States government, although it has not defaulted since 1971. In that year, it reneged on its Bretton Woods agreement to pay in gold. The U.S. government also defaulted on its gold bonds in 1933. Then Congress declared that paying these bonds as their terms explicitly provided had become “against public policy.”

The always insightful Chris DeMuth, writing in The American Interest and pondering the long-term trend of rising U.S. government debt, proposes that we have seen “the emergence of a new budget norm.” This is “the borrowed benefits norm.” “Voters and public officials,” he writes, have forged “a new political compact: for the government to pay out benefits considerably in excess of what it collects in taxes, and to borrow the difference.” He points out that the benefits “are mainly present consumption and are not going to generate returns to pay off the borrowed funds. Borrowing for consumption leads to immoderation now, immiseration down the road.”

This scholarly language captures the same behavior Winkler described in more popular terms in 1933.

A Habit of Default that Few Seem to Have Noticed

How frequent are defaults on sovereign debt? In their modern financial classic, This Time Is Different (2009), Carmen Reinhart and Kenneth Rogoff counted 250 government defaults on their external debt between 1800 and 2006, or 12 sovereign defaults per decade on average (of course, there have been more since 2006). In addition, they found 70 defaults on domestic public debt over that period.

A study by the Bank of Canada finds that, since 1960, 145 governments “have defaulted on their obligations—well over half the current universe of 214 sovereigns.” That is on average 24 defaulting governments per decade.

The study considers “a long-held view among some market participants . . . that governments rarely default on local currency sovereign debt [since] governments can service such obligations by printing money.” It points out that “high inflation can be a form of de facto default on local currency debt.” Holders of U.S. Treasury bonds found that out in the Great Inflation of the 1970s, when the bonds became called “certificates of confiscation.” But not counting the inflation argument, the Bank of Canada still finds 31 sovereigns with local currency defaults between 1960 and 2017. “Sovereign defaults on local currency debt are more common than is sometimes supposed,” it concludes.

The Wikipedia “List of sovereign debt crises,” relying heavily on Reinhart and Rogoff, shows 298 sovereign defaults by the governments of 88 countries between 1557 and 2015.

“The regularity of default by countries on their sovereign debt” is how Richard Brown and Timothy Bulman begin their study of the Paris Club and the London Club. These are organizations of governmental and private creditors, respectively, to negotiate with over-indebted governments. The first Paris Club debt rescheduling was in 1956 for Argentina; the London Club’s first was in 1976 for Zaire. (A to Z again.) The clubs have been busy since then. “Reschedulings increased dramatically from 1978 onwards,” Brown and Bulman observed in 2006. The current webpage of the Paris Club reports that in total it has made 433 debt agreements with the governments of 90 debtor countries.

The cycle of sovereign borrowing, default, and new borrowing has a long and continuing history. “Defaults will not be eliminated,” Winkler wrote in 1933. He further predicted that “debts will be scaled down and nations will start anew,” and that “all will at last be forgotten. New loans will once again be offered, and bought as eagerly as ever.” He was entirely right about that, and now we observe once again “Greek debt snapped up.”

How far back in time do government defaults go? Over 2,300 years in Greece. As Sidney Homer, in A History of Interest Rates, tells us: “In 377-373 B.C., thirteen [Greek] states borrowed from the temple at Delos, and only two proved completely faithful; in all, four-fifths of the money was never repaid.”

Shall we expect the fundamental behavior of politicians and governments to change?

Government Debt: A Quiz

Published by the R Street Institute.

Government debt is a favored investment class all over the world, but it has a colorful history full of financial adventures. Often enough, historically speaking, it has resulted in investors gazing sadly on unpaid sovereign promises to pay, to paraphrase Max Winkler’s “Foreign Bonds: An Autopsy,” his chronicle of the long list of government defaults up to his day in the 1930s. The list has grown much longer since.

Here are six sets of years.  What do they represent?

1. 1827, 1890, 1951, 1956, 1982, 1989, 2001, 2014

2. 1828, 1898, 1902, 1914, 1931, 1937, 1961, 1964, 1983, 1986, 1990

3. 1826, 1843, 1860, 1894, 1932, 2012

4. 1876, 1915, 1931, 1940, 1959, 1965, 1978, 1982

5. 1826, 1848, 1860, 1865, 1892, 1898, 1982, 1990, 1995, 1998, 2004, 2017

6. 1862, 1933, 1968, 1971

All these are years of defaults by a sample of governments. For the first five of them, see Carmen Reinhart’s “This Time Is Different Chartbook: Country Histories.” They are, respectively, the governments of:

1. Argentina

2. Brazil

3. Greece

4. Turkey

5. Venezuela

And No. 6 is the United States.

In the case of the United States, the defaults were: The refusal to redeem greenbacks for gold or silver, as promised, in 1862. The refusal to redeem gold bonds for gold, as promised, in 1933. The refusal to redeem silver certificates for silver, as promised, in 1968. The refusal to redeem the dollar claims of foreign governments for gold, as promised, in 1971.

The U.S. government has since stopped promising to redeem money for anything else, making it a pure fiat currency, and stopped promising to redeem its bonds for anything except its own currency.  This prevents future defaults, but not future depreciation of both the currency and government debt.

Winkler related a great story to give us an archetype of government debt from ancient Greek times.  Dionysius, the tyrant of Syracuse, was hard up and couldn’t pay his debt to his subjects, the tale goes.  So he issued a decree requiring that all silver coins had to be turned in to the government, on pain of death. When he had the coins, he had them reminted, “stamping at two drachmae each one-drachma coin.” Brilliant!  With these, he paid off his debt, becoming, Winkler says, “the Father of Currency Devaluation.”

Observe that Dionysius’s stratagem was in essence the same as that of the United States in its defaults of 1862, 1933, 1968 and 1971.

So advantageous it is to be a sovereign when you are making promises.

Efforts to close the ‘doom loop’ are destined to fail

Published in the Financial Times.

Thomas Huertas (“Bank holdings of sovereign debt need scrutiny,” September 7) makes very reasonable proposals of how to control the “doom loop” of government debt making the banking system more risky, while the banks make the government’s finances more risky. But the sensible reforms he recommends won’t happen and can’t happen. This is for a simple and powerful reason: the financial regulators who would have to take the actions are employees of the government which wants to expand its debt. A top priority of all governments is to be able to increase their debt as needed. The regulators will not act against this fundamental interest of their employer.

An egregious example of this problem in the U.S. context is that as the bubble inflated the banking regulators did, and still do, allow the banks to hold unlimited amounts of the debt of Fannie Mae and Freddie Mac, the government-backed mortgage firms, long since failed and in conservatorship. Moreover, the regulators allowed (and indeed promoted, through low risk-based capital requirements) banks to own and finance with deposits the preferred equity of Fannie and Freddie. These were distinctly bad ideas. But what were the poor regulators to do? Their employer, the US government, wanted to expand housing debt and leverage through Fannie and Freddie, and they went along.

Confiscation of gold by the federal government: A lesson

Published in Real Clear Markets.

Historically as well as now, people in America tried to protect themselves against the government’s devaluation of their dollars by holding gold; and formerly, by buying Treasury bonds which promised to pay in gold.  The fundamental thought was and is the same that many holders of Bitcoin and other “cryptocurrencies” have now: hold something that the government cannot devalue the way it can its official currency.

Unfortunately for such an otherwise logical strategy, governments, even democratic governments, when pushing comes to shoving, may use force to control and even take away what you thought you had.  The year 1933 and the new Franklin Roosevelt presidency provide vividly memorable, though little remembered, examples.  First the U.S. Treasury defaulted on its promises to pay gold bonds in gold; then under notable executive orders, the U.S. government confiscated the gold of American citizens and threatened them with prison if they didn’t turn it in.  It moreover prohibited the future holding of any gold by Americans, an outrageous prohibition which lasted four decades, until 1974.

All this may seem unimaginable to many people today, perhaps including Bitcoin enthusiasts, but in fact happened.  Said Roosevelt in explanation, “The issuance and control of the medium of exchange which we call ‘money’ is a high prerogative of government.”

President Hoover had warned in 1932 that the U.S. was close to having to go off the gold standard.  Running for President, Roosevelt called this “a libel on the credit of the United States.”  He furthermore pronounced that “no responsible government would have sold to the country securities payable in gold if it knew that the promise—yes, the covenant—embodied in those securities was…dubious.”  The next year, during Roosevelt’s own administration, this “covenant” was tossed overboard.  Congress and the President “abrogated”—i.e. repudiated—the obligation of the government to pay as promised.  One can argue that this was required by the desperate economic and financial times, but about the fact of the default there can be no argument.

Roosevelt’s Executive Order 6102, “Requiring Gold Coin, Gold Bullion and Gold Certificates to Be Delivered to the Government,” of April 5, 1933 marks an instructive moment in both American monetary and political history.  To modern eyes, it looks autocratic, or perhaps could fairly be described as despotic.

The order begins, “By virtue of the authority vested in me by Section 5(b) of the Act of October 6, 1917,” without naming what act that is.  Why not?  Well, that was the Trading with the Enemy Act which was used to confiscate German property during the First World War.

The order states:

-“All persons are hereby required to deliver on or before May 1, 1933…all gold coin, gold bullion and gold certificates now owned by them or coming into their ownership.”

-“Until otherwise ordered any person becoming the owner of any gold coin, gold bullion or gold certificates shall, within three days after receipt thereof, deliver the same.”

-“The Federal Reserve Bank or member bank will pay therefore an equivalent amount of any other form of coin or currency”—in other words, we will give you some nice paper money in exchange.

Lastly, the threat:

-“Whoever willfully violates any provision of this Executive Order or of these regulations or of any rule, regulation or license issued hereunder may be fined not more than $10,000, or, if a natural person, may be imprisoned for not more than ten years, or both.”

Ten thousand 1933 dollars was a punitive fine—equivalent to about $190,000 today.  But the real punishment for trying to protect your assets was “We’ll put you in jail for ten years!”

A few months later the order was revised and tightened up by Roosevelt’s Executive Order 6260, “On Hoarding and Exporting Gold” of August 28, 1933.  It specifies that “no person shall hold in his possession or retain any interest, legal or equitable, in any gold,” and adds a reporting requirement: “Every person in possession of and every person owning gold…shall make under oath and file…a return to the Secretary of the Treasury containing true and complete information” about any gold holdings, “to be filed with the Collector of Internal Revenue.”  So the IRS was brought in as an enforcer, too.  The threat of fines and prison continued as before.

It’s a prudent idea to protect yourself against the government’s perpetual urge to depreciate its currency. But if pushing comes to shoving, how do you protect yourself against the government’s confiscating the assets you so prudently acquired—and its being willing to put you in prison if you try to keep them?  What governments, even democratic ones, are willing to do when under sufficient pressure, is a lesson Bitcoin holders and everybody else can usefully consider.

Sovereign debt has a pretty poor record

Published in the Financial Times.

Sir, “Nations have historically been the world’s best credits,” says your report “Supranational debt issuance on a high” (Aug. 10). This sanguine view is contradicted by Lex in the same issue: “the ‘doom loop’ between sovereign bonds and banks … remains intact” (“Sovereign debt/banks: risk, waiting”). One of these statements must be wrong, and the wrong one is the former.

In fact, the history of sovereign debt is pretty poor. Carmen Reinhart and Kenneth Rogoff, in This Time is Different, count over the past two centuries 250 defaults on external sovereign debt, which have of course continued up to the present. Sovereign debt created a financial crisis in Europe in this century; in Russia, Asia and Mexico in the 1990s; and a global debt crisis in the 1980s. There were vast sovereign defaults in the 1930s.

Max Winkler, in his Foreign Bonds: An Autopsy, summed up the history as follows: “The history of government loans is really a history of government defaults.