Coupon-clipping demystified

Weary of reading play-by-play stories about  the Treasury Department’s efforts to manage in light of the hold-up by right-wing Republicans over reaching the federal debt ceiling – impoundment decisions, discharge petitions, and various accounting maneuvers – I took down my copy of Barry Eichengreen’s In Defense of Public Debt (Oxford, 2021) to remind me of what, at bottom, the fracas is all about.

Eichengreen, an economic historian at the University of California at Berkeley, is still not yet a household word in homes wherein economics is dinner-tables conversation, though earlier this month he was named (with four others) a distinguished fellow of the American Economic Association, the profession’s highest honor.

He was recognized chiefly for having written  Golden Fetters: The Gold Standard and the Great Depression 1919-1939 (Oxford, 1992), which has become the standard account of how the Great Depression was so globally damaging – the role the gold standard played in transmitting around the world its origins in the United States.

But it was sheer  good citizenship that led Eichengreen and three other experts – Asmaa El-Ganainy, Rui Esteves, and Kris James Mitchener – to write what their publisher describes as “a dive into the origins, management, and uses and misuses of sovereign debt through the ages.”  Their Defense turns out. too, to be useful in looking ahead to what is said to be a looming crisis of global debt. .

Their book begins with another dramatic moment of American civic life: Sen, Rand Paul (R-Ky) inveighing in December 2020, against government borrowing earlier that year on news of the outbreak of the global Covid pandemic:

How bad is our fiscal situation? Well, the federal government brought in $3.3 trillion in revenue last year and spent $6.6 trillion, for a record-setting $3.3 trillion deficit.  If you are looking for more Covid bailout money, we don’t have any. The coffers are bare. We have no rainy day fund. We have no savings account.  Congress has spent all of the money.

Paul’s alarm was based on a fundamental insight, Eichengreen and his co-authors write, namely that governments are responsible for their nation’s’ finances. If they borrow frivolously, or excessively, bad consequences usually follow, On the other hand, if national governments fail to borrow in a genuine emergency – to fight a war deemed necessary; to staunch a financial panic; to facilitate a domestic political pivot – even worse damages might ensue.  The sword is two-sided: public debt has its legitimate uses, after all. .

A market for sovereign debt existed for millennia.  Kings and war-lords borrowed, most often to wage war. They paid exorbitant interest rates because they often defaulted.  It was only in the seventeenth centuries, as modern nation began to emerge, that viable institutions of public debt were established, first in England and the Netherlands.

Constitutional governments, with legislatures and parliaments, made it possible for would-be lenders to participate in decisions to borrow, to engineer realistic hopes of getting their money back, as they turned in the coupons they clipped from their government bonds in exchange for semi-annual payments of interest.  Advice and consent became part of the game.

From the beginning, there was ambivalence.  In The Wealth of Nations, Adam Smith himself warned that it would be all to easy for nations to borrow profligately against the promise of future tax revenues, Eichengreen noted. Smith made an exception mainly for war.  As it turned out, the stabilization of British government debt markets organized by Robert Walpole after the disastrous South Sea Bubble became the original military industrial complex.  Many scholars credit superior borrowing capacity for Britain’s eventual victory in the Napoleonic Wars.

Government borrowing expanded to other purposes in the nineteenth century, Eichengreen writes, especially for investments in canals and railroads intended to foster geographic integration and growth. Central banks learned how to halt financial panics by serving as lenders of last resort.

In the twentieth century, he says, the emphasis shifted again, this time to social services and transfer payments.  Government borrowing financed the creation of the modern welfare state. And, of course, governments continue to shoulder the responsibility to maintain overall financial stability.

Today, the argument is between “conservative” radicals who hope to disassemble the welfare state, and radical “progressives,” who seek to expand it with little concern for the dangers of borrowing too much. In the center are a large corps of sensible citizens, such as Eichengreen, who seek to harness the existing system of taxing and borrowing and spending to allow it to work in a sensible and less expensive manner.

The market for government debt has survived, Eichengreen notes, “indeed thrived, for the better part of five hundred years.” It is an indispensable part of the world’s fiscal plumbing. Tinkering with it is fine; holding it hostage makes no sense at all.  In Defense of Public Debt is an excellent primer on all these issues. I haven’t done it justice, but I started too late, and have run out of time.

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