Sic Semper Tyrannis

As I was growing up, I remember occasionally seeing nostalgia posters from the WWI and WWII eras for "war bonds." Part of their kitschy cuteness was that these posters would pull out all the propaganda stops to try to get citizens to buy them; invoking patriotism, crude demonization of the enemy, or exhorting you to "think of the children". In my time, however, no such thing as "war bonds" existed, despite no shortage of wars (as major ones go, Iraq I and II, so far). As a result I never really understood war bonds, nor why we didn't seem to have them anymore. My vague working assumption was simply that we had found "a better way", and war bonds were an relic of a more barbaric past.

Recently while reading Soddy's "Wealth, Virtual Wealth, and Debt" (which I have been working through for a few months), I came to an interesting discussion on War Bonds. Soddy was looking at Britain's experience with bonds in World War I (his book was written between WWI and WWII). This got me thinking about war bonds in general, and the US's contemporary situation. Here are some reflections.

Follow up:

The general point of bonds is to quickly raise money so the state can fund a particular thing it wants to fund, without resorting to the slow and economically-painful process of taxation. For war bonds, the thing to be funded is of course war.

Why not simply print the money, then?

A central question, in fact. By raising money through the device of bonds, the state is supposed to be avoiding this: bonds are supposed to be committing purchasers (who become the state's creditors) to voluntarily and temporarily part with some of their wealth, during which time they obviously cannot spend it. Thus the money supply stays roughly constant, save a gradual interest factor that grows over a long period of years until the bonds are paid off. It is also worth noting, as Soddy does, that by temporarily reducing their own wealth, citizens are taking themselves out of competition for goods and services, which prevents them from pushing the price up of same for the state (this is really just another way of thinking of the need for money supply stasis). As a result, inflation should largely be avoided, and the country should be able to have it's cake (war) and eat it too (little or no inflation).

At least, that is the theory.

The whole reason Soddy raised the point with the example of Britain in the Great War is that this didn't work out so well in practice; while the country made extensive use of war bonds, it's money supply increased at a 15% annualized rate between 1914 and 1920 anyway, rising from about 1.2 bln to 2.7 bln pounds.

Soddy has a keen observation about why this happened: the ability to securitize the loans and their general financial fungibility was to blame.

You see, the whole "austerity" function of war bonds is lost if you can simply transfer them to third parties, "cashing them out" again for immediate spending. In WWI England, this became a staple of the banking system, and no one really had to "hold" a war bond to get their money back. And why wait when you had already done your duty and lent the government some money, and wanted to get back to consuming? The banking system simply became the financial intermediary between the government and the people (the war bond creditors), holding their bonds and skimming off a percentage.

The resulting situation was one where there was no austerity and inflation was got anyway -- obviously the money supply didn't decrease. In fact, it likely increased even more than it would with just plain cash inflation, because the bond securities themselves (being backed by the government) became fungible, zero-risk "money" of their own right in the financial economy. Certainly the profits skimmed off the bonds by the banks were a totally unnecessary national expenditure (as compared to plain currency inflation).

And again, without the people forgoing a meaningful amount of consumption, prices the state paid for goods likely had rise higher than they would otherwise.

Soddy concludes that this whole system is pointless, in fact making everyone worse off than they would have been with simple currency-based inflation, and should therefore be done away with. And this appears to be what happened.

But is it?

In the United States we no longer have "war bonds", per se. But we do have bonds, or more generally US Treasury Securities (bills, notes, and bonds, distinguished largely by maturity). These are sold essentially all the time, with the Treasury going to market to raise specific amounts of money to cover the spending deficit on a regular basis, and a similar situation with respect to foreign buyers buying official US securities (at their option) as an ongoing result of a significant trade deficit.

So we don't just raise bonds to fund the government and it's wars "from time to time": we're doing it continuously.

If my history is correct, this modern American system really got its start in 1971, when Nixon cut the gold tie to the dollar and ended the last vestiges of the Bretton-Woods international financial system. Now foreign countries couldn't settle their capital surpluses with the US (resulting from trade) by demanding gold; they had to accept US Treasury securities or nothing. Perhaps through an implicit need to keep the anti-Soviet economic bloc together, buy US securities they did.

Reagan soon went whole-hog into using this system as if it were a part of the fiscal budgeting apparatus, cutting taxes and paying for his military buildup with debt (despite a long history of railing against the same). He even made a show of "funding social security" by putting a trillion dollars of Treasury securities into the social security "trust fund" as a nest egg -- a transparently foolish maneuver, considering the government cannot spend the bonds without monetizing them (that is, printing the corresponding money), and spends the interest as part of the general fund anyway.

And of course, as you all surely know, Bush II has utilized this always-on debt facility to an unprecedented extent, doubling the public debt in the past four years (to over $8 trillion) while running his own Reagan-esque defense buildup, a Vietnam-like elective war in Iraq, and the most severe trade deficit this country (and likely the world) has ever seen.

So we don't have "war bonds" anymore; we have "everything bonds".

What has this system wrought? Have we somehow managed to avoid all the ills of the old war bonds tradition, while gaining all of the advantages? For the lack of critique on the whole apparatus, you sure would think so.

But I think not. And after reflecting on the old system and the reasons for it's downfall, it's clear to me that the new system is just a scaled-up, surreptitious version of the same, snuck in through the back door by political expedience, happily embraced by the banking system (just like the old war bonds), and kept publicly quiet to a fantastic extent (while there are periodically complaints about the size of the National Debt, no one criticizes the system itself).

Let's take a catalog of the ills of this system:

• Inflation has hardly been avoided. The money supply has clearly increased, and a 5.5% annual real rate of inflation would make a reasonable, very conservative lower-bound estimate of the effect since the early 1980s.
• You wouldn't know it for the lack of mentioning, but we have reached the approximate level of $400 bln a year in interest payments on the Federal debt, making it the third largest non-entitlement spending category. This is a tremendous amount of interest to pay on the debt, money which is basically wasted. To make matters worse, it has of yet mostly been paid for with more bonds as opposed to higher taxation. But this makes the scheme one of the ponzi variety; and such schemes always end badly.
• Particularly since 2000, a good chunk (at least half) of the buying of US bonds has come from foreigners -- especially China. This foreign financing has a few quite unsavory consequences. Apart from the generally-bad problem of dependence, once again we have subverted the "austerity" function of bonds, as the domestic populace isn't even acting as a creditor (and regular folks certainly aren't) to the extent foreigners are buying. So the locals keep on consuming -- which perhaps isn't unintentional as consumers are now 75% of the domestic economy. Making matters worse, government spending on defense is largely domestic, so not only do people keep their money, but the government spends even more (none of which it really has), stoking the flames of inflation even higher.

Where are US official securities really consumed, domestically speaking? That would be in the financial economy, by traders, speculators, and institutional players. Just like with British banks in WWI, official US bonds have migrated into the financial sphere and left the real economy far behind. But now we've taken the system to an extreme: US Treasury securities are ubiquitous, if not infrastructural. You can use them as collateral in brokerage accounts for example, which quite clearly makes them de facto money. The market interest rate on US bonds and notes is considered the bellweather of the financial economy and assumed to have nearly supernatural properties for divining the health of the bond market, providing a sound pricing basis for other sorts of bonds, inferring inflation expectations, and a host of other core functions. The 10-year note, importantly, is used to construct mortgages.

And what happens when you create all this "money" in the financial economy? Bubbles happen. So I would submit that our increasingly bond-based government has been a major factor in inflating the financial bubbles of recent years, especially (and obviously) the recent housing bubble. But the influence could have even been large in the late-90s stock market bubble. Perhaps not coincidentally, the Treasury modernized its securities sales system in 94-95, making the whole process much more "efficient". Apparently no one at the time thought to ask if this was really "wise" or "ethical"; I don't believe the matter was even raised for debate. But a modernized, always-on, everything-bonds system is what we got, and it's what we're living with today.

I can say this with certainty: Soddy would have disapproved.