How To Control Your Friends and Enemies with Debt

In this essay I address the issuance of debt denominated in fiat currency by sovereigns who control that currency. I break down the history of fiat debt issuance into two main periods 1910–1970 and 1970–2020 and compare them. I discuss how the US government has deeply embedded itself in private institutions like banks, pensions, insurance companies, and universities through debt issuance. Further, I explain how the US has solidified control over its allies and enemies through the issuance of debt. Finally, I elucidate how the US uses debt to control its own citizenry by either loaning to them or borrowing from them at different stages of their lives.

For most of history when sovereigns, the old fashioned kind like actual kings, issued debt it was always denominated in gold or gold backed currencies. The very concept of a fiat currency was so heterodox there is no large scale examples of fiat bond issuance until the first world war. This was much to the chagrin of the sovereigns. When God grants you divine right you naturally want to use it to bilk your creditors to the utmost. The inherent constraints of a fixed money supply protected medieval creditors in terms of real returns. Hard money makes inflating away one’s debt impossible. Even if the nominal rates of interest on these loans weren’t high gold maintained its value so creditors always did okay assuming they got their principal back. This helped wealthy Dutch creditors to sleep easily at night regardless of what insane conquest Napoleon was now embarking upon. The idea of a government issuing debt in a currency it has absolute control over is a modern one, especially in peacetime.

It is baffling to me that anyone would buy debt denominated in a fiat currency. Everything about this arrangement is seemingly stacked against the lender and in favor of the borrower. The borrower has absolute control over the currency the debt is denominated in. They can sell you debt and then they can print the money with which to pay it off, which devalues your debt. They can sell you debt and then raise interest rates sharply which will then devalue the lower interest rate debt that you previously purchased. You have no control over any of this. Your counter party, which has absolute control, is a group of politicians who will do anything necessary to please a majority of their constituents. There is a million different levers for them to pull and any one of them can screw you over. You are playing against the house. You know who’s going to win.

In buying sovereign fiat debt you are putting a tiny group of individuals in control of your future purchasing power. This is your life blood, your means to acquire food and shelter, and to conduct your life in a respectable manner. When you buy stocks, real estate, commodities, gold, bitcoin, art, or any other asset, you are buying something who’s supply is not controlled absolutely by a central organization. This is only not true of bonds.

No sovereign bond holders worry about nominal default. This is reasonable but they should worry about being defaulted on in real terms. The government could eliminate the national debt tomorrow by printing $24 trillion. They cannot prepay these debts. But they can buy up this debt on the open market, as they are doing right now via the fed to the tune of trillions of dollars, and pay the interest to themselves. This will only continue to drive rates down and actually makes any additional borrowing even cheaper. Believe me, there will be additional borrowing.

An even simpler, and more politically palatable, method is to just print a couple trillion and give it out to the people. This helicopter money will spike inflation the couple of percent that governments need to burn off the massive debt load they have previously issued at low rates. As you read this, rates across the entire curve are already negative for all wealthy industrialized nations in real terms. Furthermore, a great many governments in Europe along with Japan are right now being paid to borrow in nominal as well as real terms. What do you think the next step will be after this historic glut of issuance with interest rates at all time lows?

Let’s get some historical context. Most of the fiat denominated bonds issued from WW1 up to nearly the 1970s had negative or close to negative real returns. A great many bonds were defaulted upon in nominal terms by the Central and then Axis powers, having lost both world wars. I mean if you are going to default losing a world war seems like a valid reason. But the allies defaulted as well, in real terms. Those poor souls in the US buying war bonds to support our boys at the front did not make their money back if you account for inflation. U.S. WW2 war bonds were issued with maturities of between six and fourteen years with interest rates ranging from 1.5% for short-term bonds and 3% for long-term bonds. Inflation averaged 5% in the 1940s as stated by the bureaucrats, but we know they love to understate inflation. It’s practically a tradition that during wartime countries ditch the gold standard and then lecture the citizenry on patriotism. They do this while force feeding them war bonds with negative real yields, caused by the higher than normal inflation that comes with war.

The first 60 years of large fiat denominated debt issuance (from 1910–1970) was sparked by two disruptive world wars. These wars were so total that countries had to go off the gold standard to pay for them. This wasn’t unusual. The unusual part was that these wars were so devastating to these countries balance sheets and their tax base so permanently impaired that they were unable to return to the gold standard afterwards. Things got so out of control that the idea of returning to a gold standard seemed so far fetched that no modern central banks were seriously considering it. They had too much debt they needed to burn off. Maintaining a perpetual fiat standard was the only remedy to the situation. So for the first 50 years of fiat denominated debt issuance bondholders did not have a good time.

When we hit a high in interest rates in the 1970s something changed. It was the very beginning of the first time in history when you could make great real returns from the riskiest of all propositions, buying debt denominated in fiat currency. Bondholders only wanted to lend to governments at high rates because they had been burned for the past 60 years. It was logical to assume that another war would eventually come and ravage the world and again spike inflation. This in addition to the inflation caused by staggering world population growth. World population began to parabolically rise starting in the early 20th century. Rising from 2 Billion in 1927 to 4 billion in 1974. This in addition to the OPEC oil crisis which aided inflation as well. Energy costs are a force multiplier when it comes to inflationary pressures.

All of this led bondholders to be judicious about the rates of return they required for lending out capital. Then all of these trends reversed. Population growth began to slow markedly going into the 21st century, energy prices collapsed as new supply was found and brought online, and all major conflict between the great powers was miraculously avoided. In addition to this technology and globalization have changed everything about how products are made business is conducted. This potent deflationary cocktail is the world we have now been inhabiting for 50 years. This second epoch (1970–2020) has therefore been a time of marvelous returns for these bondholders.

It created an outlier period where buying a traditionally risky asset, sovereign debt, generated great returns. Risky in the sense that these instruments are sensitive to moves in interest rates and inflation, even more so for the the long duration stuff. (20 and 30 year bonds) Buying the long end of the curve has nearly outperformed the stock market and with much lower levels of volatility since the 1970s. This should have been a suckers trade. But for the reasons we discussed above regarding energy prices, war, and population growth it has been a golden age for the sovereign lender.

I think there is good reason to suppose this second epoch has ended. Interest rates are at zero globally, nominally negative in some jurisdictions, and central banks are not exactly exercising restraint with the size of their balance sheets. It’s time for a return to the conditions of the initial period of fiat debt issuance (1910–1970). It’s time for sovereigns to return to the practice of sticking anyone who is dumb enough to buy their debt with negative real yields.

I have addressed the financial implications of such debt arrangements now I shall go into the social ones. Governments issuing debt in a currency they control is an insidious way for them to exert control over society. It gives them de facto control over large private entities like banks and pension funds. Entities that in the past on a gold standard were far more independent. It allows the government to dictate who gets to be a bank. You only get to be a bank if you check these boxes and hold certain “safe” assets in sufficient quantities. The government then declares that only US government debt qualifies as a a safe asset. US banks today hold roughly two trillion worth of U.S. treasuries. A banking relationship should be between only a customer and a banker. I don’t want a government dictating what my bank is able to do and what assets it is permitted to hold. I want to choose the bank that is right for me. The government tells both parties it is regulating for their benefit but really it is only to benefit itself.

The government does the same with massive pension funds. They agree to back stop pension funds only if they hold “safe” assets. Again, those safe assets just happen to include only government debt. This seems like a bit of a conflict of interest. I’ll back stop your pension as I’m a sovereign who can print money and your employees will then trust your pension’s solvency and continue to work diligently for you for decades. While they work diligently for decades their money is allocated into 80% US government debt which is now yielding less than 1% per year. This is not doing right by the employees but increases the power of both the company and the government. The government also back stops many insurance companies in a similar manner. Forcing them to hold a large amount of US treasuries in exchange for Uncle Sam’s stamp of approval that the insurer is managing risk properly. As if Uncle Sam knows anything about managing financial risk. These agreements, like those for the pensions, state that the government will ride to the rescue with a bailout if (when) needed.

The PBGC is a government organization that insures private pensions. If you have worked for a company for 40 years and in the year you retire they go bankrupt you might not get a dime if their pension was holding insufficient assets. This was commonplace for many hundreds of years and it left many seniors destitute. This 4 letter government bureaucracy was created to make sure pension payments kept coming even if companies fell on hard times or mismanaged their assets. While it is noble to want to protect the common working man’s quality of life it has led to many disastrous consequences.

It has transferred a lot of risk to the taxpayer. I don’t want my taxes going to Bill’s pension payouts just because GE didn’t set aside enough assets for him. Also as above, in exchange for this guarantee the government can dictate terms to the pension. They can decide mandatory contribution rates for employees and what assets the pension has to hold. I’ll give you a hint, it needs to be “safe” assets. Good old U.S. treasuries yielding 1% or less. The PBGC has a mandate to hold at least 65% fixed income assets and at most 30% equities. It currently holds over 80% fixed income assets and most of these are US treasuries. 1% or lower returns when you have far more people retiring than you have new workers coming into the workforce to support them is not a sustainable situation. People wonder why pensions are underfunded.

Both benefits and contributions are indexed to official inflation targets which massively undershoot reality. This is the single biggest saving grace for these companies, at least it could be if they were able to purchase inflation indexed assets like equities. They could make equity like returns but pay out bond like premiums. However, since the bonds that make up most of their portfolio are yielding less than inflation this does not help their situation in which payouts are literally indexed to inflation. For inflation here I am referring to government quoted inflation or CPI which I think massively undershoots reality. A pension should be an arrangement between an employer and employee, we don’t need a government mucking about in the middle. Making promises that its presence benefits both employers and employees when it really only benefits itself.

Social security, the largest pension fund in the world, is required to only hold U.S. treasuries. Trillions of dollars are sitting in an account yielding less than inflation. The majority of state government pension funds have similar asset allocation mandates. This is a tragedy of underperformance for these assets owned by the common man. Sadly, this state of affairs must go on to keep the sovereign funded.

Government’s have also used debt to gain control over the universities. Since the vast majority of students take out loans to attend college and the vast majority of that debt is supplied by the government, as they can provide cheaper rates, because if defaulted upon they can print money. The government is indirectly the largest revenue source for the schools. This means the government can indirectly dictate terms to them. Such as what curriculums may contain, how campus life should be managed, and what school organization’s should be allowed exist. Education should be an agreement between a student and a school. We don’t need a government in the middle dictating his will on both just because he has the ability to print money. The ability to print money does not make you good or wise. In fact it turns you mad.

This is specifically for secondary education. For primary education our government has even more time and opportunity to dictate how we educate our children. For in this domain the government is the direct source of revenue for public schools, whereas for university it is at least indirect. 90% of all U.S. children attend public school primary education. Parents are in a tough spot. They are forced to pay for two educations if they send their children to private school and this is out of reach for most parents. 26% of students choose private universities over public universities. This tells you what the market would be closer to without the coercive forced taxation required for primary school. More parents would choose to send their kids to private schools for primary education if they had a choice. I concede that public universities are a better value most of the time for STEM degrees but again much of this is due to favorable subsidies heaped upon public universities by the government. Prices for public university have gone up but have gone up far less than for private university, again due to subsidy.

The U.S. government uses debt as a way to strengthen its grip on society. To wrap its tentacles of overreach ever tighter. To make us more dependent and needy on their perceived benevolence. To ensure we can never stand on our own again. They do this domestically quite ingeniously as I have described above. But they also shine on the international frontier when it comes to debt-based control.

China has taken their yearly multi-hundred billion dollar trade surplus with the US and used them to purchase US treasuries, currently they own around $1.1 trillion worth. The king of Saudi Arabia has used decades of multi-billion dollar surpluses from selling us oil to buy both both U.S. treasuries and U.S. made weapons. The Saudis currently own $170 Billion worth of U.S. debt. Saudi Arabia needs us for both financial and military security. We can disable their fighter jets and defensive interceptor missiles, like THAAD and PAC3, at a moments notice. We can also disable the interest payments they now so badly need, as they are now running large deficits with oil at $40 a barrel. These are just two obvious examples, the Japanese also own over a $1 trillion worth of U.S. debt.

All of these government’s fortunes are now directly linked to the future of the US, they not only need the US to make on time interest payments but they benefit if the U.S. outgrows the rest of the world so they will be repaid in higher valued dollars. This gives them a greater real return when they liquidate these dollars upon repayment of the loans. Having your subjects buy debt which you pay interest on is analogous to the king giving out periodic gifts to his vassals to assure their loyalty whenever he should call upon them. It showcases the leaders beneficence while keeping his nobles in line.

There is an old saying in banking: if you owe the bank a little money the bank owns you. But if you owe the bank a lot of money, trillions of dollars in this case, you own the bank. Or at least have great control over the bank, as it is so dependent on your survival and repayment. This applies to the above example, the US is the borrower and our international creditors are the bank.

As you can see the US government has mastered both international and domestic control. It has been a brilliant method for governments to infect every part of our lives, to further their continual effort of encroachment into our private spaces and thoughts.

Most people envy government employees who are due to receive a cushy government pension at age 55 or 60. Many public officials in Greece are given 100% of their salary as pension starting at age 45. I used to envy people who secured such sinecures. Now I see that their future subsistence and very dignity is tied to the government entity who employs them and will then dispense their pension checks. The retired teachers and military officers in Weimar Germany were the first to go hungry. Their pay being denominated in prehyper-inflationary marks. Their checks kept coming in each month but were not enough to purchase a single loaf of bread. I shall instead choose to invest for myself. To look out for my own future. Not have a bureaucrat do it for me.

When a government has the ability to set tax policy, issue large amounts of debt in its own currency, monetize that debt via an alternative arm of the government known as the central bank you are creating a monstrosity so powerful it will be incredibly difficult to ever destroy. Further it teaches us what to believe from ages 3–18. Our mothers used to stay home and teach us but the money printing induced inflation has compelled them to go into the workforce. Upon graduation from high school the state saddles us with tens of thousands of dollars in debt and 4 more years of schooling required just to get a respectable job. This is debt that can never be discharged, not even in bankruptcy. We don’t pay off this debt until we are 45 on average. By this time we have bought a home with the help of a government subsidized mortgage. Being a homeowner makes us feel like we have a stake in the country.

Our low interest rate home loan comes at the loss of every pensioner and person on a fixed income. When a loan is generated money is created out of thin air due to fractional reserve banking. This creates inflation. But we don’t care. We have finally joined the haves and left the have-nots. We now have assets at risk in the event of riots or invasion. This causes us to be loyal to the government and back it at all times, even when it does questionable things. But really we don’t own our house, the same way we don’t own our education until it is paid for. If we buy our house at 30 which is considered a miracle for the average millennial today then our 30 year Fannie Mae subsidized mortgage doesn’t terminate until we are 60. At this point when we are finally debt free, the government comes in and starts showering us with a monthly social security check. At this point all of our idealism and vigor are gone. We only have energy left to walk to the mailbox and grab our check.

The average American life consists of 15 years of indoctrination by the state for the state, followed by 4 more years of hyper-indoctrination by the state for the state, then 18 years of student loan payments to the government, in concert with 30 years of home loan payments to the state, and then finally 20 years of direct cash payments from the state to keep you docile and quiet. While this is occurring at the individual level all of the private institutions we depend on, banks, pensions, insurance companies, and schools are all directly or indirectly funded by the government which dictates terms to them. In concert with both of these, our allies and enemies don’t want to upset the state of affairs as they have loaned so much money to the government they need to protect their investment.

In some of the mentioned instances the US government is the debtor in others it is the creditor. In either case when you enter into a debt arrangement it compels both parties to maintain the status quo. This crushes the dynamism that has made humanity so innovative. Our current debt based system is an American nightmare, a situation so complex and deeply embedded in our institutions, traditions, and subconscious it will be difficult to ever unravel. The US is too big to fail. But is it big enough to bail itself out?