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Bernie’s White Lie

In this piece, Senator Bernie Sanders tells us:

“It’s an IOU that is backed by Treasury bonds and the faith and credit of the United States government,” said Sen. Bernie Sanders, I-Vt. “It is the same faith and credit that enables us to borrow from rich people and from China and from other countries. As you well know, in the history of this country, the United States has never defaulted on one penny owed to a creditor.”

Not exactly Bernie. There are three ways the government can “default” on its obligations to its creditors. And Bernie reminds us that we have never committed two of the three, but boy is that a far cry from three for three.

  1. When the U.S. owes someone money, it can “default” by being late on a promised payment. To the best of my knowledge, “we” have never done this.
  2. When the U.S. owes someone money, it can “default” by giving back less than $1 to its creditor for every $1 it promised. To the best of my knowledge, “we” have never done this either.
  3. When the U.S. owes someone money, it can “default” by paying back dollars that are worth less than the dollars it promised.

To the best of my knowledge, we have had an orgy of defaults (certainly until TIPS) due to the third possibility. The political economy of why mild inflation is more palatable (and sensible for the government) than not fulfilling the letter of the contract promises is pretty clear. But don’t for a second Mr. Sanders go around telling people that the U.S. government has always paid its obligations in full. The only reason we can get away with it is because every other sovereign nation does the same thing.

5 Responses to “Bernie’s White Lie”

  1. Speedmaster says:

    I am always amused when I see Bernie Sanders listed or described as an “independent.” He is better described as a turbo-Democrat.

  2. Harry says:

    Speedmaster, you nailed it.

    Your comment opens up our friends’ blog to all sorts of comments.

    To all: do you think Bernie’s understanding of money and inflation is right? Would you wish him to be your investment advisor, and how would direct him with your own money? Would you ask him about Wintercow’s graph, and how it may have applied to Vermont farmers during his long tenure as a government employee?

    Back during or before wintercow was returning kicks from liberal punters from Trinity, the Federal Reserve was playing games, encouraged by government, to inflate the currency.

    My take is that interests rates will rise, faster than you think.

    The federal reserve is poised to do QE2, which means that Ben and his colleagues think they can buy 500 Billion worth of bonds without anyone watching.

    I wish Milton Friedman were alive today to supply all of these folks with a dose of humility. He even may have spit at the Princeton academics who hate freedom and liberty, which it is all about, right?

  3. jb says:

    Wintercow: I sympathize entirely regarding unchecked governement spending, and I have made your argument to others many times. But upon recent consideration I now do not think it is quite right.

    Buyer of conventional Treasury Bonds are not in fact “sheep to be shorn” who passively accept that their dollars invested will be eroded. They know the score and insist upon a return that has some expectation of price inflation built in. Sometimes the actual inflation rate over the period until the bond matures will exceed that premium the investor receives, in which case you would be correct; the goverment paid the investor in real terms less than what was promised. However, when price inflation is less than that premium, the investor wins in real terms. Think of all the people who bought long term treasuries at 14% in 1982. If they held their bonds to maturity they made a killing in real terms because actual price inflation came in far below expectations over the next couple of decades.

    What the government HAS done, however, is turn what could otherwise have been a virtually risk free asset into a risky asset. Inflation creates uncertainty (risk) investors insist on compensation for bearing that risk. Who pays for it? Taxpayers, of course.

    As an aside, TIPS in theory remove the possbility of UNEXPECTED inflation, because their coupons and face value adjust to the actual (CPI) rate of inflation. Over time we should therfore expect conventional Treasuries to provide a higher return vs. TIPS because, unlike TIPS, investors will insist on a premium to cover the risk of unexpected inflation.

    I really hope someone weighs in on this; is there a flaw in my logic?

  4. wintercow20 says:

    Nothing wrong at all with your logic. In fact, I should have made your point more explicit in the post. I’ll address it in a future post where I want to discuss optimal monetary and stimulus policy. The only way inflation as a stimulus can work is if it is unexpected. In other words, we have to rely, as policymakers, on tricking our citizens. Do we really like the idea that we have to rely on tricking people for policy to work?

  5. jb says:

    OK, so if the govt can trick investors into financing a stimulus by paying them back with negative real returns, I guess it can work but how long can they get away with that? Not only is it wrong to trick investors, but it seems to me you can go to the well only so many times; I would expect the inflation premium to rise over time the more they play this game. so ultimately it can’t “work”.

    The other thing I ponder as I consider TIPS: their returns are explicitly tied to the CPI, which is driven by government spending, and government spending in turn includes inflation adjusted interest payments on TIPS. There is something circular here that troubles me (alas I am merely an investor). My instinct tells me that this arrangment might have troubled the founders. What would Ben Franklin think? Common Sense indeed.

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