The Gist: Turn bondholders into loan sharks.
A partial review of 10% Less Democracy by Garett Jones.
How do you get the government to be responsible with your money?
The conventional answer is a constitutional amendment that requires a balanced budget, forcing politicians to spend no more than they collect in taxes in any given year. As early as 1798, Thomas Jefferson wanted to constitutionally prohibit debt – but soon thereafter discovered its merits when Louisiana went on sale. As recently as 1995, the Senate came just one vote short (a Republican vote, no less) of sending a balanced budget amendment to the states for ratification.
Presumably the states would have ratified: 49 claim to have a balanced budget amendment, though they vary in strength. Some amendments are more suggestive than mandatory and quite a few permit “casual” deficits which is a perfect term for our present attitude toward debt. A surprising number permit debt for such necessities as repelling invasion which, based on some states’ balance sheets, appears to be a regular occurrence. Colorado and Oregon have features that not only discourage debt but also surpluses: excess collections are redistributed back to taxpayers. But Alabama should inspire the nation: one provision of its constitution calls for the imprisonment and personal fining of officials who spend more than is available.
Figure 1. Texas probably just needs a little nudge to make unbalanced budgets a capital offense. But if we really want fiscal responsibility, that’s not enough: balanced budgets could be an annual precondition of state universities’ participation in football.
While few officials actually want to run a deficit, fewer still are willing to give up something they like to reduce it. One man’s waste and inefficiency is another’s vital project for the security and prosperity of the nation – and vice versa. The two end up coming to a perfect compromise at the favor factory: keep both projects, borrow money to buy votes for re-election, worry about the problems later (maybe they’ll even be retired by then!)
Figure 2. Forget party sponsorship, fees, and voter signatures. Ballot access should be limited to those who pass the marshmallow test.
Though some states have thus made extravagant expenditures (and profligate pension promises), their debts and obligations are all in United States dollars, the value of which is beyond their control. Who does control the dollar’s value is of course the federal government, which has a significant debt burden of its own. Other nations, finding themselves drowning in debt, might suddenly make the 27 trillion pesos they owe just enough to buy a Big Mac.
Figure 3. Before you judge, know that, despite experiencing hyperinflation, the Confederate dollar has actually held its value better than the United States dollar since 1865.
Economist Garrett Jones proposes an intriguing but politically challenging alternative that answers a basic question: in whose incentive is fiscal responsibility?
His answer is bondholders – that is, owners of government debt that fear not being paid back if states recklessly spend beyond their means into default or if governments inflate away their debt by overprinting money. Though all citizens should worry about their government’s debt, a majority too often can be bribed with immediate goodies. Bondholders are the only ones with a disproportionate and direct financial stake in ensuring that the government is responsible.
Figure 4. “Bond, James Bond. I take my risks on baccarat, not government debt. I am here to give you a dose of Scottish frugality in between martinis, shaken, not stirred. From now on, your monetary policy will be determined by Goldfinger and you’ll need to submit your budgets to Dr. No. With your risks, I expect much more than 0.07% yield!”
Bondholders presently exercise their substantial power over governments only when they buy their bond. Jones illustrates how:
If you had lent (to give approximate figures) $100 to the United States in 1972 for ten years, you got back enough money when you were repaid a decade later to buy just $82 worth of goods. Yes, you would have been repaid “one hundred dollars” in 1982 plus interest, but since prices had nearly doubled over the decade, that sum of money bought 18% less than it did in 1972. The bondholders of the 1970s paid for the privilege of lending to the U.S. government, and that experience made investors cautious about lending to the U.S. government ever again… By the late 1970s, after it became clear that U.S. government bondholders might get burned by high inflation, investors insisted on higher yields, higher interest rates, and so they paid lower prices for U.S. government debt. Those low prices were expensive for the government and its taxpayers. The government didn’t have to just repay the money it borrowed; it had to repay investors enough to make up for the fear, the risk, that high inflation could happen again. This pattern continued through the 1980s and 1990s. Even in 1988, six years after inflation had dramatically (and, so far, persistently) fallen, investors were (effectively) paying $100 in 1988 and getting repaid $190 in inflation-adjusted buying power in 1998. The global pool of money that chose to invest in America during the late 1980s and 1990s received a massive return on what turned out to be a safe, fairly low-inflation investment, in large part because the United States had burned its reputation in the high-inflation 1970s. It’s expensive to rebuild a burned reputation.
Once you’ve bought your bond, however, the government is almost indifferent to you. The most you can do is sell your bond on the secondary market at a discount, which might influence future bond buyers to demand higher yields. And while this pressure has resulted in downward pressure on U.S. inflation, it has had little impact on spending (or the related size of debt taken on). Perhaps this is because at the center of modern finance is a convenient but perhaps fictional foundation that literally insists that U.S. bonds are “riskless” assets when it comes to credit – in fact, all other debt instruments on the globe are compared to it. During times of international crisis, even if it originates in the United States, even if the U.S. government might be responsible, there’s a “flight to quality” as investors abandon risky stocks and alternative debts to buy “safe” U.S. bonds. But with no ending to spending in sight, can the fantasy last?
What if, Jones proposes, the balance of power was altered? What if bondholders were no longer an impotent mass of individuals and institutions but were instead collectively organized into a group that could actually pressure their government debtors into the right behavior, like a bank might a credit card borrower? What if bondholders were given a veto over government spending?
Figure 5. Expect income tax garnishments, liens on national parks, repo men going after aircraft carriers – and, if that’s not enough, politicians’ kneecaps might be at stake!
Though Jones does not mention Antonin Scalia, this kind of proposal goes to the heart of what Scalia always thought was the most important part of the United States Constitution. Other countries, such as the Soviet Union, had long lists of guaranteed and wonderful rights but they never got enforced because what actually matters is how power is arranged and divided. James Madison hoped that our government would feature ambition clashing against ambition that would ultimately limit the federal government’s largesse. It hasn’t quite turned out that way – politicians bought off each others’ ambitions with other people’s money – but might the answer lie with properly-incented bondholders?
Jones offers a variety of proposals that range from the toothless to the unconstitutional (at least, until an amendment or an activist judge decides otherwise). The United States could hold “formal annual shareholder-style meetings between elected bondholder representatives and elected government officials” but, of course, the government wouldn’t be required to hold the meeting and we’d see if it resulted in sufficient political pressure. Jones’ most dramatic proposal would add U.S. Senators elected by long-term bondholders, the number to increase “for every 10% in the debt-to-income ratio” that the government enjoyed. Were it debt to GDP, bondholders might have to elect 98% of Senators, though they might be restricted to voting on fiscal issues.
Figure 6. In the new shareholder meetings of that malfunctioning corporation called the USA, “Prudence is preferred” will be the new “greed is good”
Of course, you might be worried about a particular problem associated with empowering bondholders: who owns U.S. debt? The answer might surprise: the U.S. government is actually the largest owner of its own debt – more than a third – another strange aspect of American accounting. For outside pressure to reign and fiscal responsibility to follow, this debt would have to be devoid of voting rights. Instead, we’d want to empower the famously risk-averse, disproportionately curmudgeon individual American investors and institutions that own about a third of our debt.
The final less than a third is owned by foreigners. While China has frequently been the biggest individual foreign national owner in recent years, Japan has been as often on top or right behind. And, for context, China owns only about 6x as much debt as tiny Luxembourg and only about 1/20th of total U.S. debt. Jones is not especially concerned about foreign-debt holders improperly exercising their voting rights – even to the degree China wanted to dramatically cut our military spending, Japan may want us to increase it. Jones cites the positive examples of international lenders demanding free market economic reforms – and a bit more fiscal pressure from Switzerland (a top 10 foreign holder of U.S. debt) might be welcome. But, to the degree we have any fear at all, we could limit the power of foreign debtholders – we’d just have to be on guard that the U.S. government didn’t suddenly only sell foreign debt and continue its spendthrift ways.
Figure 7. Just wait for the policy changes when the Vatican starts buying our debt!
Of course, the Founders designed the Senate to be a bastion of states’ rights and Senators failed miserably to protect them. Perhaps bondholders would be terribly represented by their newly empowered representatives – or there may be unpredictable perverse incentives where bondholders demand the US take on debt merely for the sake of creating an income stream for its owners and not for any especially useful national project. Giving bondholders genuine power would probably require a constitutional amendment and if a fairly popular balanced budget amendment can’t get passed, then the exotic empowerment of bondholders might face much more trouble. Within our present system, we might give bondholders more power over the constitutionally ambiguous Federal Reserve but, as we’ve seen, the bond market has already successfully put downward pressure on inflation with no visible success on spending. Perhaps there might be additional, positive pressure – debt might be limited only to inflation-protected securities so that bond-holders would be focused entirely on credit risk – but bondholders might also go too far, not content to contain inflation, they may push personally profitable but nationally questionable deflation.
Relatedly, neither empowering bondholders nor a balanced budget amendment necessarily decreases government spending – either move might instead increase taxes (to pay the bondholders and/or balance the budget’s heavy spending). To the degree you think that’s a problem (as I do), it’s worth considering how to increase the number of people or points at which spending could be cut, such as giving the President a direct line-item veto. Or, for that matter, a bondholder-elected National Comptroller whose only power is to veto spending. Back during the 2011 debt ceiling crisis , I worked for the U.S. Senate Steering Committee, which tried to push something called Cut, Cap, and Balance – cut the budget now, cap it forever at a percentage of GDP, and balance the budget henceforth. It’s a fine idea, but the devil’s in the details – legislators were demanding exemptions, GDP and projections can be fiddled around with by bureaucrats. In the meanwhile, the President ought to reassert his impoundment power and we all ought to give serious thought to how properly aligned incentives and clashing ambitions might result in a responsible government.
Figure 8. Despite the focus of this email, empowering bondholders is actually just one chapter of the reviewed book: 10% Less Democracy by Garett Jones. I am not confident all of his proposals would lead to desirable results – in some, I am confident of the opposite – but they are at least interesting to think about. His fundamental point is that in rich democracies around the globe, some insulation from total democracy (a republic, perhaps?) might result in better economic policies leading citizens to enjoy a multiple of their current income. Jones quips that Singapore – ruled by a single free-market-oriented political party for decades – has thrived with 50% less democracy. Among his suggestions:
- Enact longer terms to get braver politicians – but what if “bravery” means banning fossil fuels, seizing the means of production, packing the Supreme Court, etc?
- Elect fewer officeholders, i.e. why elect a dog-catcher or coroner? But, to the degree those are irrelevant, it may not change much. The real question is whether fiscal authorities should be elected and, if not, how should they come to power.
- Especially, don’t elect judges. He claims that, around the world, this is correlated with freer economic systems but my experience in the United States is that the type of system he recommends results in lawyers’ guilds choosing judges who aren’t faithful textualists.
- Maintain or strengthen central bank independence. He again finds that central bank independence is correlated with low inflation and strong economic growth and insists that this is due to isolating conservative technocrats from whimsical politicians who want to juice the currency ahead of an election. But what if the independent central banker discovers magical monetary theory?
- Tighten voter eligibility. He argues that voters who have more education are more likely to support free markets and directly challenges William Buckley’s quip that he’d rather be ruled by the first 2,000 names in the Boston telephone directory than the faculty of Harvard. Jones has a variety of proposals: increase the voting age to 40, disenfranchise criminals, weight people’s votes based on their education and military service. He cites the incredible example of Ireland, which reserves 10% of the seats in its senate to be elected by alumni of its top universities, which sounds like a pretty bad idea in the U.S.
- Embrace national (or supranational) regulators whose goal is to reduce local regulations, a la the Great Reversal.
- Vigorously use earmarks: “The practical way to cement a spending cut deal would be to hand out a few dozen well-targeted earmarks to the most pro-spending members of Congress in exchange for a pro-spending-cut vote. (Even if the earmarks add up, they won’t add up to much; at their peak, earmarks were no more than 1% of total U.S. federal spending)”
For more and more detail, check out the book!
Thanks for reading! If you enjoyed this review, please sign up for my email in the box below and forward it to a friend: know anyone passionate about restraining government or its debt? How about any holders of U.S. bonds? Or perhaps lawyers ready to restructure our government?
I read over 100 non-fiction books a year (history, business, self-management) and share a review (and terrible cartoons) every couple weeks with my friends. Really, it’s all about how to be a better American and how America can be better. Look forward to having you on board!