X. The Burden of the National Debt

diluting if it were not for the debt and its recur rent monetization? How would we overcome de pressions (in the midst of booms), maintain full 98 THE BURDEN OF THE NATIONAL DEBT employment, and spend ourselves into ever greater richness? He who believes in inflation as a panacea for curing social ills, or even as a necessary evil, must justify the existence and growth of the overextended national debt. But the principle of "one pocket owes it to the other" applies to a communistic society only. When everything belongs to the state, all liabili ties are a matter of mere bookkeeping. Conversely, he who denies that the debt is more than a book keeping item, wittingly or unwittingly, negates the system of private property. Under that system, the "pockets" of creditors are distinctly separate from those of debtors. A gain of the one is no compenscftion for a loss to the other. Yet, the "two-pockets" principle asserts that, in contrast to private debts, servicing the public debt merely means a transfer of income from one group to the other. Real resources are not affected. "The fact that the government owes its citizens certain sums is not really a burden on the natIon as a whole," asserted The Economist (London) of November 21, 1959. That would be true if a 100 per cent tax were levied on income derived from federal securities. Of course, no one would buy the bonds, except the Federal Reserve that de livers to the Treasury practically all earnings on its huge portfolio.

Presently, the American taxpayer is burdened with $9 billion a year for interest on the $290 99 AN INFLATION PRIMER billion debt, nearly twelve cents of every dollar of federal revenue. Are we to believe that we would be no better off if federal taxes were 12 per cent lower, even though the bondholders would receive that much less? (Could they not have invested in other securities?) By the same token, no tax ever is a burden, provided the money taken from a domestic Peter is "transferred" to a domestic Paul, which is what usually happens. Note how neatly the argument for the public debt's alleged economic innocence fits into the not-so-innocent frame of mind of the demagogues who plead for wealth redistribution. Why not in dulge in such "transfers" by which the loss of one side is compensated, supposedly, by profits of the other? By promoting the something-for-nothing illusion, debt-making serves not only as the motor of inflation, but also as an intellectual vehicle of collectivism.

THE ECONOMICS OF THE DEBT The interest charge on the national debt is a strategic element in the federal budget. Without the $9 billion-minus $3 billion, maybe, allowing for the bondholder's income tax, etc.-among the "overhead" costs of government, the budget could be held in balance and the debt reduced by a notch, still leaving some funds available for tax cuts. The national debt burdens the economy in 100 THE BURDEN OF THE NATIONAL DEBT more than one way. New money the government borrows is taken out of the nation's "pool" of savings: $7 billion in 1958, $5 billion in !959. That much less is left to other borrowers-busi ness, consumers, local authorities, home builders. A shortage of capital is engendered and interest rates mount, raising production costs and living cost~ in addition to the government's own costs of operation. For another thing, what did the government do with the money? Little, i~ any, has been invested in a productive fashion. Wherever it went, almost none flows back. Its interest charges are not covered by forthcoming earnings, as in the case of reproductive (self-liquidating) investment. In stead, the charges have to be paid out of taxes, which are paid largely by lower-middle-class peo ple engaged in production, and a disincentive is fostered.

Some of the borrowing was necessary, to be sure. It is scarcely possible for current revenues to cover all war expenditures. But even during wars, the abandon with which the responsible politicians plunge into irresponsible borrowing-of the most dangerous short-term variety, preferably-is some thing to behold. What justification is there in this prosperous postwar era for not reducing the debt, nay, for raising it further? Of course, it is much easier to win support for public spending out of future generations' income 101 AN INFLATION PRIMER than at the living, and voting, taxpayers' expense. The latter resent higher taxation, especially when the burden is very heavy already, while the former cannot talk back. By recourse to borrowing, a singular hurdle to foolhardy projects (with popular appeal) is eliminated. And something else is elimi nated: the rational control over the use of the borrowed funds. As Adam Smith wrote nearly 200 years ago, speaking of the difference between private and public debt: A creditor of the public, considered merely as such, has no interest in the good condition of any particular por tion of land, or in the good management of any particular portion of capital stock. As a creditor of the public he has no knowledge of any such particular portion. He has no inspection of it. He can have no care about it. Its ruin may in some cases be unknown to him, and cannot directly affect him.

Budgetary controls are a highly unsatisfactory sub stitute for the lender's "inspection" of individual credit risks, least satisfactory on the postwar scene, when the Congress cannot even figure ou~t the exact state of fiscal commitments, or the govern ment its own operational condition. The federal budget is in a hopeless confusion, perpetuated by the demagogues' disposition to take credit for cur rent welfare spending and leave the debit to their successors. The sheer size of the American national debt should provide food for thought. Instead, it pro102 THE BURDEN OF THE NATIONAL DEBT vides the inflationists with a hollow argument. Why, the "bankers" were hollering about national bankruptcy if the debt should pass $50 billion. Now, we are close to $300 billion, and the shout ing has subsided. What matters is not the actual size of the debt but its proportion to the national income, ignoring the fact that the two rise to gether: IIlore debt means more paper income. If the debt rises faster, that is no problem either.

One simply declares that the new proportion is the right one. The richer the nation, the greater its ability to pay and the more it can borrow, a reason ing which at least recognizes that the debt is a burden. But it does not recognize the fact that in the process of accumulating the debt, prices had been inflated, the credit structure distorted, the savers shortchanged, the nation's financial stand ards corrupted, and the foundations of the free enterprise system impaired. Misgivings of sane minds were due to the foresight that unsavory practices would have to be used in "selling" a blown-up volume of obligations, with a chain re action of sickening repercussions to be expected. FISCAL LEGERDEMAINS Our national debt is equal to three-fifths of the annual gross national product, nearly double the public debts of all non-Soviet countries combined. How can the American capital market carry such a load of parasitical claims and still function? It 103 AN INFLATION PRIMER does so by a number of financial tricks and decep tive devices, all contrary to the 0perational rules of the free market, some even to the criteria of the criminal code.

Let us consider the distribution of the debt by major categories of holders, starting with the some $50 billion in the Treasury's trust funds, largely the social security, the railroad pension, and the veterans' life insurance accounts. These funds represent the excess of special payroll taxes over and above the amounts disbursed. The managers of an insurance or of a trust company would soon be out of. business if they invested in their own obligations the funds entrusted to them. But that is precisely what the government does. It diverts the earmarked revenues into general expenditures and puts its own IOU's in the respective accounts. It considers these well-Hplaced" obligations as owned by itself: the Treasury's one pocket owes it to the Treasury's other pocket. The sovereign cannot be put in his own penitentiary. In contrast, continental social-insurance systems, notably the German, are autonomous bodies that invest their reserves traditionally in bonds of private (regu lated) mortgage-credit institutions-rather than in government obligations.

The interest on these well-placed bonds is "paid" in more IOU's. What if outgoing pay ments should exceed the contributions? Why, that is simple; the rate of the levy will be raised, 104 THE BURDEN OF THE NATIONAL DEBT or more people will be· forced to t~ke the "insur ance." A more ingenious piece of financial leger demain is hard to irlvent. Quite logically, the bureaucrats figure that, since agencies of Uncle Sam hold the obligations of UntIe Sam, the two sides of his ledger cancel out. Accordingly, $40 odd billion are deducted from the "gross" national debt. The "net" debt is reduced by that amount, thus adding a statistical legerdemain to the finan cialone. In any case, one-sixth of the debt is no headache to the Treasury (for the time being). FALSIFYING THE BANK BALANCE SHEETS There are several more dumping places for fed eral securities, namely, agencies that have no other choice in investing their funds, though they are not organs of the Treasury. Number one is the central bank. The Federal Reserve holds some $27 billion which, by and large, have to be "rolled over" from one maturity date to the next, depriv ing the Reserve System of its freedom of ma neuvering. It buys bonds but scarcely ever sells a major amount .

.Another revealing case in point is the Federal Deposit Insurance Corporation. This agency sinks the "insurance" premiums paid by the banks into long-term government bonds, accumulating so far about $2~-billion worth, as a guaranty fund for some $140 billion of "insured" bank deposits. The FDIC itself brought out in its report for 1957 105 AN INFLATION PRIMER that, in effect, deposit insurance is relevant only in a bank crisis~in which case the FDIC would not be helpful at all. Its funds might be exhausted if a single one among the eight biggest banks would get into trouble, to say nothing of a widespread run. (The public's impression is that the deposits are guaranteed by the government, which is not the case.) On top of that, to cover even a small frac tion of the "insured" deposits, the FDIC would have to liquidate its own holdings and break the bond market. Not only is this a phony arrangement which misleads the public, but it also misleads the banks to reckless credit policies and to negligence in building up proper capital accounts for the protection of the deposits. The banks rely on the "insurance"-and on their own holdings of govern ment securities .

.That brings us to the some $65 billion of federal securities held by the banking fraternity, equal at the end of 1959 (on the books) to about 25 per cent of total deposits. Insurance companies and savings and loan associations were holding another $20 billion. The institutions are under no com pulsion to buy and are free to sell-legally. De facto" they have a limited choice only. They are cajoled (and bamboozled) into buying and retain ing these securities, mostly of longer than one-year maturity, in violation of economic common sense, business ethics, and governmental responsibility. A corporation publishing faked balance sheets 106 THE BURDEN OF THE NATIONAL DEBT would be barred from every stock exchange. It may face .criminal prosecution. The objective is to protect the investor against fraud. The same fraudulen t practice, however, is legalized so far as commercial and savings banks are concerned.

They can carry government bonds on their books at par value. A $1,000 bond may be quoted on the market at $800 or less; the balance sheet of your bank still may show it at $1,000. No need to write off such losses out of current' profits. The banks may even pay dividends-out of losses. The purpose of this perverted regulation, adopted by all federal and state supervisory agen cies and by the SEC, is to give those bonds a sacrosanct status, guaranteed against book losses. Thereby, they are promoted to absolutely safe and "liquid" investments. The bank examiners count the federal bonds, whatever their maturity and actual price, as prime liquid assets, just like cash. The more bonds in the portfolio, the more liquid is the bank, by the examiners' standards, and never mind the losses. (The more loans, the less liquid is the bank, and never mind the quality or the maturity of the loans!) Small wonder that the banks purchase risk loaded long-term federal obligations, thereby creating a market for them. (They are easily "persuaded" .to buy short-terms: the Treasury sweetens the deals by throwing deposits on tax and-loan-accounts into the bargain.) With rising 107 AN INFLATION PRIMER interest rates and declining values of medium-and long-term securities, as in 1958-59, the much too modest capital accounts, or reserves against losses, were impaired in most banks! In a number of banks, the entire capital and surplus had been lost.

In some, even a part of the deposits was wiped out. The public knows nothing about this sad situation. No newspaper dares to discuss it, or the preposterous methods of the government at the root of it. The "silence of the sea" covers them up. Those persons on the inside (and with insight) hope and pray that a recession will reduce the pressure on the capital market, raise bond prices, and wipe out the losses. Very likely it will; but what about the next cycle? For how long, or how many times, will the depositors and savers permit themselves to be fooled? Sooner or later every legerdemain, subtle as it may be, is exposed and backfires. As it is, the bond portfolios tend to "freeze in" time and again. By selling them, the banks dis close their losses, which would skyrocket if major amounts were liquidated. While the boom and high interest rates prevail, the "prime liquidity" turns into prime iI-liquidity-unless the bonds are monetized by, and the losses shifted to, the Federal Reserve. The central bank may, perhaps, be re lied on to resist the "telnptation" to absorb either or both temptations, but it could be overruled by the Congress.

108 THE BURDEN OF THE NATIONAL DEBT History may not teach anything (to those who do not wish to learn), but it certainly shO'\vs what happens to every public debt that has become burdensome. Sooner or later, it is liquidated. There are two kinds of illegitimate liquidation, in addition to the legitimate kind. State bankruptcy" the partial or total repudiation of capital or inter est, or both, is one technique, a favorite pastime of totalitarian states. The other kind consists in a gradual depreciation of the currency, wiping out the real value. (the burden!) of the obligations. This is what modern democracies, including ours, have been practicing for some time. 109 XI THE CURSE OF THE DEBT THE "RATIONALE" OF INFLATION Does it matter how large the national debt is? Not really, quoting a widely used college text book: "There is no sign that a high debt exhaus~s the credit of the government ... and since as a last resort 'it can borrow from itself,' there need be no fear on this accoun t."