Public Debt, Inequality, and Power: The Making of a Modern Debt State

Front matter

SANDY BRIAN HAGER

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The publisher gratefully acknowledges the generous support of the Anne G. Lipow Endowment Fund for Social Justice and Human Rights of the University of California Press Foundation, which was established by Stephen M. Silberstein.

Contents

List of Illustrations vii Preface ix

1. Introduction: Public Debt, Inequality, and Power 1 2. The Spectacle of a Highly Centralized Public Debt 14 3. The Bondholding Class Resurgent 34 4. Fiscal Conflict: Past and Present 55 5. Bonding Domestic and Foreign Owners 70 6. Who Rules the Debt State? 83 7. Conclusion: Informing Democratic Debate 96 Appendix: Accounting for the Public Debt 105 Notes 123

Bibliography 143 Index 153

Preface

This book began life as my PhD dissertation, which I successfully defended in September 2013. I had started the doctoral program in political science at York University in Toronto six years earlier, just before the world was plunged into the worst financial crisis since the Great Depression of the 1930s. Looking back on my journey through the PhD program, it is difficult to envision a more remarkable set of circumstances in which to study political economy. Historians of thought have a knack for demonstrating how the ideas of a given age were shaped by their historical context. My case is really no different: the research path that I chose to pursue during my time at York was undoubtedly influenced by the spectacular upheaval in the global political economy that I saw unfolding.

One thing that the global financial crisis made plain was the indispensable role of public debt within contemporary capitalism. As governments across the advanced capitalist world sought to combat the crisis, a process of private deleveraging was met by large-scale public borrowing, the likes of which had not been seen since World War II. The global financial system was, in large part, saved from the brink of collapse by the explosive rise in public indebtedness. I became especially fascinated with the US case, not only because of the country’s position at the center of global capitalism, but also because the massive growth in its public debt seemed to defy its reputation as a liberal bastion of small government and free markets.

And so I started to read into the history of the public debt to understand its origins and how it had evolved over time. I quickly discovered that the developments during the crisis were not as novel as I had originally thought. As the historical record shows, the public debt has been central to capitalist states from the very beginning, even if its function within them has changed considerably. The public debt initially served to bolster the war-making prowess of states in the eighteenth and early nineteenth centuries. In the latter half of the nineteenth century, governments borrowed to develop massive public works projects, including railways and canals. It was only in the twentieth century that the public debt was “discovered” as a key tool of macroeconomic policy and crisis management.

What most piqued my interest in this historical reading were the colorful debates concerning ownership of public debt, the power of government bondholders, and the redistributive effects of government borrowing on class relations in Western Europe and the United States during the eighteenth and nineteenth centuries. On one side of this debate, tales were told of the capitalists who effectively controlled governments thanks to their power as dominant owners of the public debt. Dissenting accounts, which have become more and more prevalent from the late nineteenth century onward, claimed that the public debt was, in fact, a democratizing force because it was mainly those of modest means, including widows and orphans, who owned it.

These unresolved historical debates resonated with me because of another development that the crisis had laid bare: the growing wealth and income inequality and the percolating “class warfare” in the liberal market heartland of the United States, Canada, and the United Kingdom. It was during the early years of my PhD program that the research of Thomas Piketty, Emmanuel Saez, and others on the stunning increases in inequality within these countries was just starting to be noticed. Later on, in 2011, awareness of issues of inequality and corporate power was increased thanks to the occupy movement, which began in Zuccotti Park near Wall Street and which quickly spread to become a global protest movement against crisis-era capitalism.

This, in essence, was the historical milieu in which I operated, and my intuitive response was to put two and two together. On the one hand, there was the public debt, which had long played a central role in capitalist societies, a role that had been further solidified during the crisis. On the other hand, there were the growing inequities in the distribution of wealth and income that had intensified as a result of the crisis.

As far as I could tell, the academic literature on the contemporary US political economy had not yet managed to link issues of public debt and inequality, at least not in any systematic way. In other words, rich accounts of the class conflict at the heart of the public debt, such as those found in the historical literature, were simply absent from more contemporary research.

X «¢ PREFACE

What I did find was that most of the contemporary research suffers from an aggregate fixation with the macroeconomic consequences of government borrowing. Disaggregate studies of the public debt focus on generations, not classes, as their primary units of analysis. And the abstract, even esoteric, assumptions that inform the generational debates to me seemed, to put it mildly, otherworldly. I found the sparse contemporary accounts that do draw attention to the class underpinnings of the public debt unsatisfying, mainly because they offer little in the way of empirical evidence to substantiate their claims.

So it was out of these twin interests in the public debt and in inequality that my PhD research project emerged. I started the research process with a simple question that contemporary accounts had failed to address: namely, who exactly are the major domestic owners of the US public debt? A long and painful process of empirical inquiry yielded quite shocking results. My research findings showed that, since the 1980s, domestic ownership of the public debt had rapidly become concentrated in favor of the now-infamous top 1 percent of US households and the top 2,500 US corporations. What stunned me most was the finding that ownership of the public debt had become even more heavily concentrated during the crisis.

Almost immediately after it was first posted online, my research caused a stir not normally associated with PhD dissertations. And I was unexpectedly thrust into the spotlight when, in November 2013, Gillian Tett, one of the world’s most astute financial journalists, published a full-length article on my findings in the Financial Times. While most of the responses to the Tett article were decidedly positive, some were less charitable. In a small minority of cases, I was the subject of ad hominem attacks, the intensity of which was likely fueled by Tett’s mentioning of the “leftwing political bent” of my analysis. This small minority dismissed the research findings outright as fudged numbers compiled by a radical student with a revolutionary axe to grind.

Others offered more constructive and thoughtful criticism. They wondered whether the concentration in ownership that I covered was of any significance now that widely held money manager funds, including pension and mutual funds, own a substantial portion of the public debt. They asked about the political consequences of my findings and the effect that concentrated ownership of the public debt might have on government policy. They wanted to know why foreign ownership of the public debt, which now stands at roughly so percent, was excluded from the analysis and how it might relate to the domestic pattern of ownership I uncovered in my research. They also

PREFACE œ xi wondered what political solutions might be necessary to address the growing inequalities that characterize ownership of the public debt.

The buzz generated by the dissertation was one of my main motivations for transforming it into a book. And over the past two years, I updated and expanded the empirical findings, incorporated the constructive criticisms, and, more generally, tried to push the limits of what we can know about ownership of the public debt and its underlying consequences. The result is this book, a document that is very different from the one that I defended as a doctoral candidate.

During this undertaking, much of my effort has been aided by studies that were published after my PhD defense. The most famous of these is Thomas Piketty’s Capital in the Twenty-First Century. Justifiably renowned for its contribution to our historical and cross-national understanding of wealth and income distribution, I found Piketty’s work indispensable in its tackling of the methodological and conceptual issues associated with the measurement of ownership concentration.

Wolfgang Streeck’s Buying Time: The Delayed Crisis of Democratic Capitalism came as a revelation and helped to refine my thinking on the redistributive and political consequences of the public debt in a world plagued by wealth and income inequality. As the reader will see, I leaned on Streeck’s work and, in recognition of his influence, I reference his concept of the debt state in the subtitle of the book.

Finally, Eswar Prasad’s The Dollar Trap: How the U.S. Dollar Tightened Its Grip on Global Finance informed what turned out to be one of the more challenging aspects of writing this book: incorporating foreign ownership of the US public debt into the analysis. I had always found the debates concerning foreign ownership of the public debt to be lacking because of their overt aggregate bias. In examining the consequences of foreign ownership for US power and influence in the global arena, these debates had overlooked the interplay between domestic politics and global financial processes, especially the role that the former plays in shaping and reinforcing the latter. Prasad makes what is, to my knowledge, the only sustained effort to go beyond this aggregate bias. And a critical engagement with his work has guided my own story about the linkages between domestic and foreign ownership of the US public debt.

This project has been a long time in the making and much of that time has been spent writing in isolation. But every so often, the loneliness of the xii + PREFACE research process was interrupted by welcome interactions with people, who, in various ways, provided the support that propelled me in my efforts to complete this manuscript.

It has been a pleasure to work with Niels Hooper, Bradley Depew, and Ryan Furtkamp at the University of California Press. Whether they were responding to my emails, arranging reviewers for the manuscript, designing a book cover, or coordinating marketing and promotional materials, all three have been professional and friendly. The process of completing my first (single-authored) book was made a little less daunting thanks to their efforts.

Anyone who has conducted exploratory research using disparate data sources has had plenty of questions. And one of the most refreshing aspects of conducting the research for this book has been witnessing the enthusiasm with which staff at various statistical agencies responded to my queries. Kurt Schuler at the US Department of the Treasury; Marty Harris, Ruth Schwartz and Nuria McGrath at the Internal Revenue Service; and Richard Wind, Alice Henriques, and Gerhard Fries at the Federal Reserve clearly outlined the possibilities and limitations of the data sources they manage, and, in some cases, verified my calculations when the results seemed too shocking to be true.

A number of people deserve thanks for giving feedback, challenging me with pointed questions, providing boosts of morale at opportune moments, and discussing my research findings in private or in public. In this regard, I am thankful to Joseph Baines, Jordan Brennan, Katerina Dalacoura, Tim Di Muzio, Jeff Frieden, Eric George, Randall Germain, Julian Germann, Jeremy Green, Peo Hansen, Paddy Ireland, Izabella Kaminska, Jongchul Kim, Covadonga Meseguer, Mark Peacock, Jesse Schreger, Herman Schwartz, Engelbert Stockhammer, Gillian Tett, and Robert Wade. I am especially grateful for the support and guidance I have received from Jonathan Nitzan, whose teaching, as well as his research with Shimshon Bichler, first inspired me to conduct independent research.

To my family, especially to my parents, Graham and Sue, thanks for love and encouragement. To Natasha, thanks for your beautiful soul and your sharp mind . We met near the tail end of this project, but I can’t help but see your imprint on every word that is written here.

Finally, I would like to acknowledge the generous financial assistance I received to conduct this research. Doctoral and postdoctoral funding from the Social Sciences and Humanities Research Council of Canada

PREFACE © xiii relieved some of the financial stresses that come with pursuing a PhD

and allowed me considerable breathing room in making the perilous

transition to an academic career. Research funds from the Department of

International Relations at the London School of Economics also provided crucial support.

Sandy Brian Hager

Cambridge, MA xiv + PREFACE

Introduction

Every man and woman who owned a Government Bond, we believed, would serve as a bulwark against the constant threats to Uncle Sam’s pocketbook from pressure blocs and special-interest groups. In short, we wanted the ownership of America to be in the hands of the American people

HENRY MORGENTHAU JR.

IN THE BEGINNING

IN THE EARLY YEARS OF nationhood, the political economy of the United States would be shaped in crucial ways by its public debt.’ Revolutionary forces accumulated debts of $54 million during the War of Independence (1775-83). A difficult task for the first secretary of the Treasury, Alexander Hamilton, was to devise a plan to manage this debt burden. Should the debts be repaid in full? And if so, by what means should the federal government honor its commitments to creditors?» The answers to these questions would go along way in determining the nature of the US system of public finance, a crucial lynchpin of the power and cohesiveness of nation states.

Defaulting on foreign debts was out of the question. Revolutionary forces borrowed heavily from the French and the Dutch to finance the war, and estimates suggest that nearly one-quarter of wartime debt was in foreign hands.3 The United States did not want to alienate itself from allies that had assisted its drive for independence. In these formative years of nationhood, the federal government’s unquestioned commitment to its foreign creditors was widely accepted as a means of breaking the shackles of British dominance, establishing creditworthiness on global capital markets, solidifying geostrategic alliances, and, later on, fueling highly lucrative territorial expansion.*

The federal government was also hesitant to renege on its commitments to domestic bondholders. Most of the debt had been purchased by a small group of wealthy elites, with Robert Livingston’s estimate suggesting that, at the time of independence, only 0.025 percent of the US population owned government bonds.’ Furthermore, among the tiny elite that owned the debt were the chief architects of the country’s nascent political system. In his classic study An Economic Interpretation of the Constitution of the United States, Charles Beard noted that forty of the fifty-five men who drew up the constitution had lent money to the government.®

These men would provide a powerful force against repudiation and would rally against any attempt to default on a debt in which they and their class peers had a significant interest. The writers of the Constitution also had an interest in creating a system of taxation that would ensure reliable revenue streams to service the public debt. This system would prove especially advantageous if the burden of taxation were to fall on someone else: that someone else being the vast majority of Americans who did not own government bonds.

Hamilton decided that the debts were to be paid in full. And in order to raise the revenue needed to honor these commitments, the US Congress approved Hamilton’s recommendation to levy a highly regressive excise tax on distilled spirits. Small-scale farmers saw the new tax as a threat to their livelihood and would eventually vent their frustrations through violent attacks against tax collectors in western Pennsylvania.

For Hamilton, the Whiskey Rebellion of 1794 served as a grave menace to the power and legitimacy of the fragile federal government. So concerned was Hamilton with the unrest that he personally accompanied General George Washington, and the thirteen thousand troops he commanded, to put down the rebellion. One critic, William Findley, seized on the events, suggesting they were proof that Hamilton’s system of public debt had created a “new monied interest” that wanted nothing other than “oppressive taxes.””

THE DEBATE CONTINUES (WITHOUT DATA) Early critics treated Hamilton’s plan with suspicion. They saw the public debt, and the broader system of public finance of which it was a part, as a culprit of worsening inequality and social instability. Well over two centuries later, the public debt remains a source of great controversy. Over this time, an intense debate has raged over the unequal power relations that underpin the public debt.

Some continue to insist, in the critical spirit of the likes of Livingston and Findley, that the public debt is heavily concentrated in the hands of the rich and powerful. According to this argument, the public debt serves as a vector of regressive redistribution, transferring income from low- and middle-income taxpayers to a small group of elites. The wealthy are said to use their ownership of the public debt as a powerful lever to influence government policy and decision-making.

Others suggest that the public debt is, in fact, widely owned by broad swathes of the US population. Government bonds, so the argument goes, provide a safe investment opportunity for vulnerable elements of society, including widows and orphans. The development of savings bonds and the rise in pension and mutual funds are said to have made ownership of the public debt even more diffuse. Proponents of this view argue that, thanks to the development of a progressive tax system over the course of the twentieth century, the public debt redistributes income from the rich to the Americans of modest means who own the bulk of the public debt. The public debt, in this way, has played a key role in democratizing the public finances. In the words of former secretary of the Treasury Henry Morgenthau Jr., quoted at the beginning of this chapter, a widely owned public debt would put ownership of the United States in the hands of the American people.

The rapid increase in foreign ownership of the US public debt since the early 1970s has provided a further source of controversy. Early on in US history, reliance on foreign financing was seen as a necessary part of nation-building. And this sentiment is often echoed today. Some suggest that the fact that foreigners now own roughly half of the US public debt is merely proof of the attractiveness of the United States for global investors. According to this view, foreign ownership of the public debt is a clear sign of US strength; it frees up domestic capital for private investment and it allows the federal government to finance its large budget deficits on the cheap.

Others argue precisely the opposite. They claim that foreign owners of the public debt hold the United States hostage, exacting tribute in the form of interest payments and using their significant holdings of government bonds to influence policy. That about 20 percent of the US public debt is now owned by the central bank of a geostrategic rival, China, is often invoked as proof of the dangers of foreign indebtedness.

What explains this lack of consensus on ownership of the US public debt? The answer, I contend, is quite simple: we do not know the basic facts. Despite centuries of speculation and heated debate, only a handful of studies have attempted to map empirically the ownership pattern of the US public debt, and even fewer have tried to theorize and analyze the broader consequences of this pattern as it evolves over time. To make matters worse, analysts tend to keep domestic ownership of the public debt strictly separate from foreign ownership, precluding any possibility of understanding the potential interlinkages between the two.

Thus participants in the existing debates are engaged in what we might call, borrowing from Thomas Piketty, a “debate without data”—a protracted and seemingly endless dispute that is based on “an abundance of prejudice and paucity of fact.”’ Without recourse to the basic facts, we have no way of knowing which of the competing views is correct. The lack of systematic data leaves us with no way of identifying the winners and losers of the public debt. As a result, we are not able to identify, let alone develop solutions to, the potential conflicts and injustices that surround this vital component of public policy.

A TIMELY INTERVENTION

The purpose of this book is to address shortcomings in the existing debates by offering the first comprehensive study of the ownership structure of the US public debt as it has evolved over time. In particular, the book addresses the following questions: Who are the dominant owners of the public debt? Are government bonds heavily concentrated in the hands of a specific class or social group or are they widely held? Does the public debt redistribute income from taxpayers to bondholders? Does the public debt exacerbate or mitigate wealth and income inequality? In what ways, ifany, does ownership of the public debt give bondholders power over the government and society? Is it of any significance that foreigners have increased their share of the public debt from 3 percent in the postwar period to about 50 percent today? What are we to make of the fact that a geostrategic rival, China, owns roughly 20 percent of this foreign share of the public debt?

Finding answers to these questions is imperative given the growing centrality of the public debt to contemporary capitalism. Representing $18 trillion as of this writing (autumn 2015), the US Treasury market is one of the largest and most liquid financial markets in the world. Save for a period of budget surpluses in the late 1990s, the US public debt has been growing rapidly since the early 1980s and has exploded since the onset of the global financial crisis of 2007-8. In 2013, the public debt breached the 100 percent mark of gross domestic product (GDP) for the first time, excluding World War II, and continues to hover above this mark today.

With the collapse of tax revenues and with the increases in government spending that accompany a crisis of this magnitude and duration, the public debt plays an indispensable role in the federal government’s macroeconomic strategy. And even with signs of recovery on the horizon, a large public debt is likely to persist. In fact, projections from the Congressional Budget Office (CBO) suggest that public debt levels will remain stubbornly high for at least the next decade.?

What is more, increasing levels of public indebtedness over the past three-and-a-half decades have coincided with an unprecedented bull market for US Treasury securities. Figure 1 plots the “real” total return for 10-year US Treasury bonds from 1790 to 2015.° This total return index measures the performance of the US Treasury market by adding together the price changes (capital gain or loss) on 10-year Treasury bonds with interest payments (for the purposes of constructing the index, all interest payments are assumed to be reinvested in 10-year Treasury bonds).™ Over the long haul, the most recent increase in the total return for 10-year Treasury securities is both stunning and unprecedented. From 1980 to 2015, the average annual return has been 5.5 percent. Contrast this with the previous thirty-five-year period (1944-79), when investors in 10-year Treasury securities faced average annual losses of 1 percent.

In this era of rampant wealth and income inequality, it is crucial. perhaps now more than ever, to investigate who exactly has purchased this ever-growing pile of public debt and who is profiting from this unprecedented bull market for US Treasury securities.

FINDINGS AND ARGUMENTS

The remainder of this introductory chapter summarizes the book’s main findings and arguments. Chapter 3 presents this book’s key finding: since the early 1980s and especially since the onset of the global financial crisis, there has been a rapid concentration in ownership of the public debt. Specifically, the stunning increases in ownership concentration over this period have

1790 1810 1830 1850 1870 1890 1910 1930 1950 1970 1990 2010 FIGURE 1. The “real” total return index for 10-year US Treasury bonds, 1790-2015. The index was calculated by combining bond prices and bond interest payments (which are assumed to be reinvested in 10-year Treasury bonds). The series is deflated by the consumer price index. (From Global Financial Data. Series mnemonic for US Treasury bonds: TRUSG10M; series mnemonic for consumer price index: CPUSAM.)

taken place in favor of the top 1 percent of US households and the top 2,500 US corporations.

What the research also shows is that the distribution of the public debt is tightly correlated with the distribution of wealth more generally. In other words, when the share of wealth owned by wealthy households and large corporations increases or decreases, so, too, does their share of the public debt. Thus there is an intimate relationship between growing inequality, on the one hand, and a rising public debt, on the other. On the basis of these findings, I argue that the spectacular increases in public indebtedness over the past three-and-a-half decades have served the interests of the dominant owners at the apex of the wealth and income hierarchy.

To explain this rapid concentration in ownership of the public debt, I make use of Wolfgang Streeck’s concept of the debt state." As we will see in chapter 4, under the debt state, the primary driver of the recent increases in the public debt has been stagnating federal tax revenues, which in themselves are the result ofa successful tax revolt by powerful elites since the 1980s.” Not only do tax revenues constitute a dwindling portion of national income, but wealthy households and large corporations are also paying less and less in taxes as a percentage of their total income. Thus, declining tax progressivity means greater inequality and increased savings for those at the top of the wealth and income hierarchy. Asa result of changes in the tax system, these elites have more money to invest in the growing stock of US Treasury securities, which, thanks to their “risk-free” status, become particularly attractive in times of crisis.

In essence, what the debt state means is that the US federal government has come to rely on borrowing from elites instead of taxing them. Significant changes to the system of public finance over the past century mean that the public debt no longer redistributes income upward from the laboring masses of taxpayers to the dominant owners of the public debt. Yet at the same time, these dominant owners do not finance their own interest payments either. Instead, the interest income paid out on government bonds is met by further increases in government borrowing. And, I argue, that in choosing to furnish elites with risk free assets instead of levying taxes on their incomes, the debt state comes to reinforce the existing pattern of wealth and income inequality.

The debt state is anything but stable, and since the crisis, concerns about ever-increasing public indebtedness have come to the fore. Assessing the situation from the top down, the dominant owners of the public debt fear that consistent deficit spending will eventually bring into question the creditworthiness of the federal government. In order to at least prevent further substantial increases to the public debt, the interests of wealthy households and large corporations are best served by an austerity program of social spending cuts. Austerity, therefore, would seem to be the ideal strategy for the dominant owners of the public debt because it would serve to keep public debt levels in check and bolster the value of their existing investments in US Treasury securities.’+ But in a climate of growing inequality, austerity is also risky and socially destabilizing.

Thus I argue that the dominant owners of the public debt are conflicted: though they do not want further substantial increases in the public debt, they are also likely to resist significant decreases in the supply of risk-free US Treasury securities, at least until there are clearer signs of a sustained global recovery. In this sense, the interests of the dominant owners of the public debt are, at present, best served by maintaining the status quo of the debt state.

Assessing the situation from the bottom up provides us with a different view of the stability of the debt state. Progressive groups have bought into fears about growing public debt and the need to enhance the creditworthiness of the federal government. But these groups strongly oppose austerity and argue that responsibility for debt repayment should fall on the wealthy households and large corporations, which have seen their tax burdens decrease in step with a rising public debt.

The legitimacy of the debt state has thus been called into question. Despite its fragility, I argue, the debt state is likely to persist for the foreseeable future. The reason, explained in chapter 5, has to do in large part with the role that foreign ownership of the public debt plays in reinforcing the unequal power relations that underpin the debt state.

The seemingly insatiable foreign appetite for US Treasury securities puts downward pressure on interest rates, providing US households and corporations, as well as the US government, with an abundant source of cheap credit. This has two main effects. First, cheap credit for the federal government relieves pressures for socially disruptive spending cuts, as well as increased taxation, which would fall more heavily on the incomes of the dominant domestic owners of the public debt. Second, access to cheap credit allows low- and middle-income Americans to maintain consumption habits in the face of decades-long wage stagnation." In this way, the flow of cheap credit from abroad deflects challenges to the dominant position of the domestic owners of the public debt within the wealth and income hierarchy.