Government Bonds and Bondage
Tea Party Economist
by Gary North: Political
Climate Change: Ron Paul on the College Campus Circuit
"his word is his bond" is not heard as much these days as it was
in my youth, back when Eisenhower was President. The phrase relied
on a concept of "bond" that meant reliability. This reliability
was based on predictability.
The other use
of the word refers to bondage. The person who is in bonds is tied
up. That also relates to the ides of a bond. A person is restricted
by whatever it was that he promised to do. He is therefore predictable.
The essence of "bond" is predictability.
issue bonds. They have been doing this in the West for three centuries.
They have been defaulting on these bonds ever since, just as they
have been doing on all other forms of debt since at least the fourth
century B.C. The rate of defaults has escalated over the last two
In an academic
paper on these defaults, we learn this. "Most fiscal crises of European
antiquity, however, seem to have been resolved through currency
debasement' namely, inflations or devaluations rather
than debt restructurings."
This is a tip-off.
The politicians have sought to preserve the illusion of trust
"their word is their bond" only to cheat the debtors by inflating
the currencies. They repay the debts with money of reduced value.
They pay the amount of money they owe, but the money will not buy
as much. As the prophet Isaiah told Judah in the mid-eighth century
B.C., "Thy silver has become dross" (Isa. 1:22a). This deception
has been going on for a long time.
defaults began in the sixteenth century. They accelerated in
the seventeenth. "France and Spain remained the leading defaulters,
with a total of eight defaults and six defaults, respectively, between
the sixteenth and the end of the eighteenth centuries." Then the
ball really got rolling. "Only in the nineteenth century, however,
did debt crises, defaults, and debt restructurings defined
as changes in the originally envisaged debt service payments, either
after a default or under the threat of default explode in
terms of both numbers and geographical incidence."
era has been the great era of defaulting governments. Government
bonds have often been viewed as risk-free. This is an illusion.
This illusion led northern European bankers after the formation
of the euro in 1999 to lend to the PIIGS's governments at low interest
rates suitable for low-risk Germany. That idiocy has blown up in
their faces. Now the bankers demand that German taxpayers bail out
the PIIGS, and the European Central Bank inflate in order to lend
money to PIIGS banks, which in turn buy more bonds from the PIIGS's
governments. So far, their demands have been met.
me to a consideration of the economics of government bonds. It can
be summarized in one sentence: "Politicians' words are their bond,
and they are liars."
OFF PRODUCTIVE CAPITAL
dollar that goes into government debt is not going into the private
sector. This is a major problem today. The U.S. government is borrowing
and wasting an additional $1.2 trillion a year in on-budget (admitted)
debt. Meanwhile, it must roll over existing debt as it matures.
most important economic factor in strengthening the growth of the
modern state has been the development of government bonds. Governments
have been able to sustain their growth because they have promised
investors to pay interest on money lent to the government.
guarantees the payment of a specific rate of interest over a specific
period of time. Investors, looking for safety, and looking also
for a steady stream of income that is not subject to the risks of
the free market, hand over their money to the government on the
basis of their trust that the government will not default in any
way on its obligations.
a major way that governments default is accomplished through mass
inflation, or even hyperinflation. When governments, meaning central
banks, increase the money supply, this has an effect on prices.
Prices will begin to rise. Investors realize that the money that
they will get back over the period of the loan will be worth less
than today. So, they demand that the government promise to pay a
higher rate of interest.
who accepted the government's promise when the rate of inflation
was lower now suffer capital losses. They hold IOUs from the government
to pay a particular rate of interest, and now the government is
paying new investors a higher rate of interest. So, new investors
are not going to buy bonds from the older investors at the old selling
price, because those bonds pay a lower rate of interest than newer
ones. They are going to demand that existing sellers of bonds take
a lower price than the sellers paid when they bought the bonds from
of the government to extract wealth from rich people through taxation
has always been limited. Rich people know how to hide their money.
They know how to get it out of the country, and they know how to
get it into markets that are less easily taxed.
learned half a millennium ago to get their hands on rich people's
money before rich people started hiding their money. They did this
by promising to pay a rate of interest on the money. Government
bonds are ways of extracting money in advance, especially from rich
people, which politicians would have preferred to tax directly,
but which they did not tax directly because they knew that rich
people would hide the money.
The whole point
of the bond market is to enable the government to expand its operations
beyond what would be possible by collecting taxes today. Politicians
are able to get more money to expand operations today, because they
promise to repay lenders a specific rate of interest. But, of course,
this does not promise that the government will not repay with debased
When the international
gold standard operated, 1815 to 1914, governments found it very
difficult to cheat lenders over the long run. The gold standard
was the means by which buyers of government bonds protected their
investment against the indirect and insidious default involved in
monetary inflation. The gold standard put pressure on governments
not to inflate, because if they did inflate, there would be a run
on the government's treasury. People would bring in the government's
inflated money, and they would demand payment in gold. So, the governments
dared not inflate their currencies.
Once the international
gold standard ended at the outbreak of World War I, government bonds
became the great means of extracting wealth from the rich population.
The governments could then inflate to pay off those bonds with deeply
depreciated money. They all did this. There is no government that
did not extract wealth from bond purchasers by means of monetary
inflation after 1914.
keep turning their money over to governments to buy bonds, always
hoping that the government will stabilize the money supply, and
that they would be repaid with fair market value.
Nixon unilaterally took this country off the gold standard in August
of 1971, this was an announcement that there would be another wave
of expropriation of bond investors. That expropriation began in
1940, and it continued until 1982. At that point, the Federal Reserve
made clear that it would not inflate much, and long-term interest
rates began to decline. Along with that decline came a rise in the
stock market. We can date this: August 16, 1982. From that point
on, there was sufficient fiat money to keep the system going, but
it was obvious that mass inflation was not going to come, and so
long-term interest rates began to fall. That was the basis of the
rising stock market until the year 2000.
the government. Rich people trust the government. Rich people turn
over their money in advance to government, on the promise of the
government to repay that money at a fixed rate.
interest rates are probably at the lowest that we are going to see.
Long-term interest rates I believe are very close to the bottom.
From this point on, the recovering economy will begin to push long-term
interest rates back up. People who have bought long-term bonds will
begin to suffer capital losses.
BONDS AS SPECULATIONS
The case for
government bonds vs. corporate bonds is simple. Governments do not
repay bond holders when rates fall. Corporations do.
fall, bond prices rise. Corporations that are saddled with expensive
bonds issue more bonds at a lower rate and pay off existing bond
holders. "Heads, you lose." But if rates rise, the bond holders
are stuck with a declining asset. "Tails, you lose." If a bond can
be recalled (paid off early), it's not a good long-term investment.
The same is
true of mortgages. The debtor will re-finance.
bonds can be a temporary port in the storm. That is, they can be
a speculation. But the idea that you can buy them and hold them
to maturity is a myth. Eventually, governments default.
"NO" ON MUNICIPAL BONDS
to general political principle, no one should ever vote for the
issuing of new bonds. This is always an attempt by local politicians
to increase the amount of money they have to spend, spend, spend
on boondoggles and good old boy deals. There is no aspect of local
government that is more corrupt than the issuing of bonds for general
obligations or even specific obligations. This is the way that local
politicians pay off their constituents who have real money, and
who contribute to campaigns. One group of investors, meaning distant
bond investors, are expropriated over the long term, while other
constituents, meaning the local good old boy network, profits as
a result of this expropriation.
are then put on the hook to repay the bonds. The higher the bond
indebtedness, the more that local taxpayers must repay the original
investors. If inflation does not wipe out the obligation, then taxpayers
are going to see taxes rise on their property, or see local sales
taxes are the basis of county government, people cannot hide the
taxable asset. The government knows who owns the property, and the
government can extract payments from the voters until such time
as there is a voter rebellion. Because voters pay very little attention
to county government, they do not understand that the constant issuing
of new bond indebtedness is the basis of their loss of liberty at
the local level.
This is why
any conservative political movement should have as its number-one
goal, locally, the blocking of every bond authorization election.
They must do whatever is necessary to alert voters to the costs
of paying off those bonds, and the power of the voters to stop the
expansion of local government and stop the expansion of rising property
taxes by means of politics.
should focus on strangling local government expenditures. The best
way to do this is to make certain that every bond authorization
that comes before the voters is defeated. If the good old boys locally
cannot raise money by means of bond sales, they will have to do
it by direct taxation, and this creates political resistance.
here is conservative activist Paul
Dorr. He trains people in the techniques of defeating municipal
bond elections. Let us hope that others adopt his techniques and
sell their services.
so convinced that long-term debt is a good idea that they find it
difficult to organize politically against bond issues locally. They
vote for the bonds, because they think it is essentially free money.
They are present-oriented, and they do not factor in the effects
of increased bond indebtedness on local property values and local
This is the
heart of the matter. The voters, who legally control the issuing
of bonds, are present-oriented, which means that they discount sharply
the costs of paying off the bonds in the future. On the other hand,
investors in bonds are future-oriented, and they see the advantage
of getting a future stream of income without any risk on their part,
or so they think. They assume that the risk is minimal, because
they assume there will be no mass inflation, and they assume that
there will be no taxpayer revolt. They assume that the pension obligations
of the cities and counties will not force either the bankruptcy
of these jurisdictions or else force a default on the bonds. It
is much less risky politically to default on bonds owned by distant
investors than it is to raise taxes on local taxpayers.
There is going
to come a day when the defaults begin, and people who have turned
their money over to the government will rue the day they ever trusted
the government. The politicians know that bond investors have short
memories, and that they will come right back with their money to
do it again. We have learned that repeatedly over the past 400 years.
Investors in Latin American bonds have learned this every generation
for over two centuries. Slow learners wind up big losers.
resort to inflation to stimulate the economy, they ultimately undermine
the hopes and dreams of bond investors. But there are not many bond
investors, so governments really do not worry very much about undermining
I hope this
cycle can be broken. If the great default is great enough, maybe
it will be.
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.
2012 Gary North
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