The Wealth of Nations—written by Adam Smith and published in A.D. 1776—is generally regarded as the first book to not only explore, but to lay the foundation for, the study of economics.
Given my fixation on the size, “unpayablity” and adverse consequences of our massive national debt, I decided to review Smith’s chapter on “Public Debts”. The text, being almost 250 years old, is a little hard to read. Even so, Smith offers amazing insights into the “sovereign debt” problems we face today.
As it turns out, the problems of national debt—and the solutions thereto—have been virtually identical for thousands of years. These similarities are important because they indicate that today’s national or “sovereign” debt problems are not exceptional or unprecedented (except, perhaps, in terms of magnitude) and the solutions to these problems will be virtually identical to the solutions practices for centuries: default.
Smith implies that today’s debt-ridden governments have knowingly advocated the same self-serving and self-destructive financial policies that debt-addicted governments have advocated for centuries.
We’re not facing an economic collapse due to unforeseen circumstances. We’re facing the same sort of economic calamity that’s plagued scores of nations for centuries. Why? Because all governments ultimately prefer to be popular rather than responsible. Governments habitually buy the public’s approval with “free” benefits paid for by (secretly) going deeper and deeper into debt. Eventually, even the interest on the debt becomes too great to be repaid. Then, governments always default and thereby rob and defraud their creditors. According to Smith, that’s been true for centuries. It seems still true today.
According to Smith:
• “The want of parsimony in time of peace imposes the necessity of contracting debt in time of war. When war comes, there is no money in the treasury but what is necessary for carrying on the ordinary expence of the peace establishment. In war an establishment of three of four times that expence becomes necessary for the defence of the state, and consequently a revenue three or four times greater than the peace revenue.”
In other words, virtually all governments are too irresponsible during peace time to save enough money for future emergencies like war. If money comes in during times of peace, government spends it quickly to maintain public support. Result? When war comes, governments are broke, won’t raise taxes and alienate their people, and therefore have no choice but to borrow money to finance their war.
From this phenomenon, we can infer that bankers, eager to lend to “risk-free” governments and generate interest, have a vested interest in fomenting wars.
More, Smith’s observations concerning ancient governments’ reluctance to save during the good times, parallels a fundamental and practical flaw in today’s Keynesian economics. Keynes sought to balance out the highs and lows of the business cycle by raising taxes and saving revenue during the good years and spending those saving to mitigate or overcome the bad years. Unfortunately, politicians who love the Keynesian theory also hate raising taxes or savings during the good years. Therefore, governments must borrow to “stimulate” the economy during the bad years. Politicians who want to be “big spenders” during the good years are inevitably broke and compelled to borrow “big time” during inevitable emergencies. Therefore, in practical application, Keynesian theory—which depends on taxing and saving in the good years—fails.
• “A country abounding with merchants and manufacturers necessarily abounds with a set of people through whose hands not only their own capitals, but the capitals of all those who either lend them money, or trust them with goods, pass as frequently, or more frequently, than the revenue of a private man, who, without trade or business, lives upon his income, passes through his hands. . . . A country abounding with merchants and manufacturers, therefore, necessarily abounds with a set of people who have it at all times in their power to advance, if they choose to do so, a very large sum of money to government.”
I.e., governments can’t borrow from people who don’t save. Ordinary working people live hand-to-mouth and tend not to have savings. The only people the government can historically borrow from are merchants and manufacturers who understand that savings (“capital”) are the key to prosperity.
Thus, governments historically have had a vested interest in increasing the number of merchants and manufacturers in order to create a larger class of potential lenders. More, governments normally had a vested interest in embracing the merchants’ and manufacturers’ values. So long as the government must rely on merchants and manufacturers, it must also be as responsible as merchants and manufacturers in its handling of money.
I.e., merchants and manufactures necessary know the value of a “dollar” (that would be a gold or silver dollar). They won’t generally lend to a government that doesn’t also know the value of a dollar and behave in a way that financially responsible.
But, Smith’s observations imply that if a government could implement a fiat currency that could be “spun out of thin air,” it might be possible to “borrow” that fiat currency directly from an irresponsible central bank rather than rely on the responsible “merchants and manufacturers”. Once governments found a new class of creditors, government would no longer need to increase the “merchant-manufacturer” class, nor would government be compelled to embrace financially responsible values. Thus, Insofar as a central bank and fiat currency freed government from borrowing from merchants-manufacturers, government could allow that class to wither or even disappear.
For example, a government that depended on fiat currency rather than borrowing real money (gold/silver) from its merchants and manufacturers could allow the export if its nation’s industries to foreign countries. The loss of such industries and their jobs might be important to the people of the nation, but would no longer be significant to a government deriving credit from sources other than its people.
Smith’s fundamental lesson seems obvious and ancient. The borrower is servant (some say, slave) to the lender. Government will serve the interests of its creditors. Insofar as those creditors are other than the people of the nation a government purports to rule, the government will be predisposed to betray the people’s best interests and even commit treason.
• “The progress of the enormous debts which at present oppress, and will in the long-run probably ruin, all the great nations of Europe has been pretty uniform.”
In A.D. 1776, virtually every great nation was subject to self-destruction as a consequence of great debt. The same is true today.
And yet, knowing that great debt is at least “oppressive” and almost certainly conducive to national destruction, since WWII, our government has reduced The United States of America from the richest nation on earth to the world’s greatest debtor nation.
More, our government has even implemented a “debt-based monetary system” wherein “debt” (a mere “promise to pay”) is deemed to be form of wealth as tangible as a gold coin in hand. Anyone who believes that a debt can be a reliable form of wealth is foolish. Debt instruments are not wealth. They are merely paper promises of wealth in a world where most promises (especially by government) can’t be kept.
Our government’s fundamental economic posture is insane and even suicidal.
But this isn’t news.
Adam Smith clearly understood the dangers of excessive public debt over two centuries ago. So, why has our current government ignored or refused to understand these fundamental principles? Is it simply a matter political irresponsibility? Are our politicians universally stupid and ignorant? Or are the upper echelons of our government intentionally seeking to destroy our nation with excessive debt?
• Smith distinguished between two fundamental kinds of governmental debts: 1) those based on “anticipation”; and 2) “perpetuities”.
The “anticipation” debts were short term and based on the expectation (“anticipation”) that tax revenues would accrue over the next few years that would be sufficient to repay both the principal and interest on the “anticipation” debt. We borrow $1 million today because our anticipated tax revenues will allow us to repay principal and interest in, say, 3 years.
Smith described those debts that were intended to last forever as “perpetuities”. These debts did not “anticipate” ever being repaid in full. Instead, the principal would never be repaid, and each year the government would simply pay the interest on the “perpetuity”.
I don’t know that today’s government has expressly designated any of our national debt as “perpetual”–but that’s what most of our national debt has become. Government currently claims our national debt to be about $16 trillion. Others claim the national debt is really $80 to $200 trillion. It’s unlikely that all or even most of our $16 trillion national debt will ever be repaid. It’s certain that most of an $80 trillion (or $200 trillion) national debt can’t and won’t ever be repaid.
Insofar as our national debt has effectively become a “perpetuity,” there’s no intent of ever repaying the principal on a “perpetuity”. However, so long as the gov-co can still repay the interest, the debt (“perpetuity”) will be deemed valid and valuable. But if we reach a time when even the interest can’t be paid, the perpetuity will be deemed worthless and the debt repudiated. Those holding such “perpetuities” as a form of wealth will be ruined, as will anyone holding virtually any other form of US debt.
What is the annual interest due on the national debt? It depends. What’s the true size of the national debt? $16 trillion? $80 trillion? $200 trillion?
How much longer can we afford to pay (or conceal) the interest on the national debt? I don’t know. But, the absolute, outside limit on the life-expectancy of the current economic system is the moment when we can’t or won’t pay the interest on the national debt.
• “To relieve the present exigency is always the object which principally interests those immediately concerned in the administration of public affairs. The future liberation of the public revenue they leave to the care of posterity.”
Nothing new under the sun. Governments then and now are happy to solve “present exigencies” by borrowing money to appease today’s taxpayers by laying off the debt on future taxpayers.
But what happens if future taxpayes can’t or won’t repay the debt? The government will be exposed as bankrupt, and its debt instruments will be deemed worthless to its creditors.
• “When national debts have once been accumulated to a certain degree, there is scarce, I believe, a single instance of their having been fairly and completely paid. The liberation of the public revenue, if it has ever been brought about by bankruptcy; sometimes by an avowed one, but always by a real one, though frequently by a pretended payment.”
Mr. Smith is saying that once the national/sovereign debt of a government reaches a “certain degree,” government debtors always default on its debt. Smith doesn’t specify what that “certain degree” may be. But, insofar as the US is now the biggest debtor nation in the world, it seems likely that the US has exceed that “certain degree”.
If so, those who keep their wealth in the “risk free” bonds of the US government be dumb. Unless our government is nigh unto the first in recorded history to do so, our government will not repay its national debt. It will default.
More, government will not be forced to default by unforeseen circumstance. Default was always government’s ultimate intent.
People in positions of power and influence in the federal government and the Federal Reserve have known all along that whenever the national debt gets too big, they’ll simply default. Debt repudiation is their fall-back position; their “plan B”. Governments have routinely defaulted on their debts since the time of Caesar. They’ll continue to default and defraud their creditors until hell freezes. It’s what government do.
So, while you may be able to safely hold US bonds today and tomorrow and next year, the day is absolutely coming when those debt-instruments will be substantially or completely repudiated. Bet on it.
According to Smith, over the centuries, defaults have taken two forms: 1) overt declaration of bankruptcy; and 2) “pretended payment”.
Smith recognized the adulteration or inflation of the coin of the realm as a “pretended payment”. Today, we have another: fiat currency. In both instances, debtors repay their debts with “cheaper dollars” and thereby rob their creditors—and destroy capital.
“The raising of the denomination of the coin has been the most usual expedient by which a real public bankruptcy has been disguised under the appearance of a pretended payment. If a sixpence, for example, should either by Act of Parliament or Royal Proclamation be raised to the denomination of a shilling, . . . the person who under the old denomination had borrowed twenty shillings, or near four ounces of silver, would, under the new, pay with twenty sixpences, or with something less than two ounces. A national debt of about a hundred and twenty-eight millions, nearly the capital of the funded and unfunded debt of Great Britain, might in this manner be paid with about sixty-four millions of our present money. It would indeed be a pretended payment only, and the creditors of the public would really be defrauded of ten shillings in the pound of what was due to them.”
Note that Smith recognized a real “payment” as denominated in ounces of gold or silver. Smith’s “pretended payments” were somehow less than the number of ounces of gold or silver originally borrowed and thus constituted fraud.
Today, thanks to fiat currency the monetary fraud of “pretended payment” with paper dollars has been institutionalized.
“The calamity, too, would extend much further than to the creditors of the public . . . every private person would suffer a proportionable loss . . . . A pretended payment . . . aggravates . . . the loss of the creditors of the public, and . . . extends the calamity to a great number of other innocent people. It occasions a . . . subversion of the fortunes of private people, enriching in most cases the idle and profuse debtor at the expence of the industrious and frugal creditor, and transporting a great part of the national capital from the hands which were likely to increase and improve it to those which are likely to dissipate and destroy it.”
Smith recognized “capital” as crucial to increasing economic prosperity. Smith therefore contended that capital is destroyed by means of pretended payments of the sort we see with currency manipulation and inflation.
If Smith is right, what can we suppose about a government that claims to be “capitalist” while simultaneously embracing a fiat currency and inflation that destroy “capital”?
Can a nation that routinely engages in “pretended payments” (inflation and fiat currency) truly be “capitalist”? Is inflation’s attack on our nation’s capital is an accident, or evidence of governmental intent to destroy “capitalism”?
• It takes a little effort to read The Wealth of Nations. But that book offers so much commonsense insight into economics, that the effort is absolutely worthwhile.