(New Thinking in Political Economy Series) Richard M. Salsman - The Political Economy of Public Debt - Three Centuries of Theory and Evidence-Edward Elgar Pub (2017) PDF

The Political Economy of Public Debt
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The Political Economy of Public Debt
Three Centuries of Theory and Evidence
Richard M. Salsman
The Political Economy
of Public Debt
Three Centuries of Theory and Evidence
Richard M. Salsman
Assistant Professor, Program in Philosophy, Politics &
Economics, Department of Political Science, Duke University,
USA
NEW THINKING IN POLITICAL ECONOMY
Cheltenham, UK • Northampton, MA, USA

© Richard M. Salsman 2017
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Contents
List of figuresvi
List of tablesvii
Acknowledgmentsviii
Introduction1
1 A brief history of public debt 12
2 Classical theories of public debt 30
3 Keynesian theories of public debt 94
4 Public choice and public debt 153
5 The limits of public debt 217
Conclusion258
Appendix263
References264
Index303
v
Figures
1.1 Public debt of the United Kingdom as a percentage of GDP,
1700–201518
1.2 Public interest expense of the United Kingdom as a percentage
of GDP, 1700–2015 18
1.3 Public spending of the United Kingdom as a percentage of
GDP, 1700–2015 19
1.4 Public debt of the United States as a percentage of GDP,
1800–201520
1.5 Public interest expense of the United States as a percentage of
GDP, 1800–2015 21
1.6 Public spending of the United States as a percentage of GDP,
1800–201522
1.7 Public debt of 22 OECD nations as a percentage of GDP,
1900–201122
1.8 Three projections of the US debt/GDP ratio (leverage),
2010–4028
vi
Tables
1.1 Gross public debt as a percentage of GDP, 15 OECD nations,
1910–201023
1.2 Public spending as a percentage of GDP, 15 OECD nations,
1910–201024
1.3 The paradox of profligacy: higher public debt leverage, yet
lower borrowing rates, G-7 nations, 1980–2015 25
A.1 Public debt theorists classified as realists, pessimists, and
optimists263
vii
Acknowledgments
The author acknowledges Michael Munger for being an invaluable mentor
and the model of a collegial, productive scholar, the late John David Lewis
for blazing a path I’ve since happily traversed, and Lisa Lynn Principe for
her loving and loyal support. My sincerest appreciation extends also to
John Allison, Carl Barney, and Yaron Brook for their invaluable support
of me professionally. Additionally, I am very grateful to Geoffrey Brennan,
William Keech, John Aldrich, Thomas Spragens, Richard Wagner, Peter
Boettke, and Richard Sylla for their valuable input and counsel on this
project. Finally, I thank Alan Sturmer, Karissa Venne, and Sarah Brown at
Edward Elgar Publishing for their terrific skill and utmost professionalism.
I’m proud of what I’ve accomplished here, yet I’m also solely responsible
for any errors or oddities that might still remain.
viii
Introduction
This work examines three centuries of the most prominent political-
economic theories of public debt, to help illuminate various causes and
consequences of the unprecedented expansion of such debt over the
past decade and – as is probable – for decades to come. I consult and
interrogate not only specialists in public debt but also the most influential
minds of political economy in modern history, from Hume and Smith in
the eighteenth century to Ricardo and Marx in the nineteenth century, to
Keynes and Buchanan in the twentieth century.
That public debt has undergone “unprecedented expansion” of late
reflects two facts. First, until recently, public debts were typically incurred
during wartime, not in peacetime. Second, unlike today, large debt
burdens in the past were usually felt most by less developed nations,
not advanced or industrialized nations. Evidence is abundant that these
new patterns are attributable largely to the spread of ever-more demo-
cratic, fiscally profligate welfare states that expand social insurance and
pension schemes without overtaxing voting majorities,1 and also to
state guarantees of fragile financial sectors,2 which promote excessive
risk-taking (“moral hazard”) while necessitating periodic public absorp-
tions of defaulted private debts.3 Equally unprecedented (and reckless)
is the recent adoption of zero or negative interest rate policies by major
central banks, which help highly leveraged sovereigns borrow at artificially
low rates, and enable still more public borrowing and ever-rising rates of
public leverage.
The great American statesman and finance minister Alexander Hamilton
(1795) was the first to identify the relationship between unrestrained
democracy (with purely “popular” instead of constitutional government)
and unmitigated growth in public debt:
[There is a] danger to every Government from the progressive accumulation of

Debt. A tendency to it is perhaps the natural disease of all Governments and
it is not easy to conceive anything more likely than this to lead to great and
convulsive revolutions of Empire. . . There is a general propensity in those who
administer the affairs of a government, founded in the Constitution of man, to
shift off the burden from the present to a future day; a propensity which may be
expected to be strong in proportion as the form of the State is popular.
1
2 The political economy of public debt
Four decades later, writing in Democracy in America, Alexis de

Tocqueville (1835, p. 196) noted that when “the people is invested with the
supreme authority, the perpetual sense of their own miseries impels the
rulers of society to seek for perpetual ameliorations,” and “those changes
which are accompanied with considerable expense are more especially
advocated, since the object is to render the condition of the poor more
tolerable, who cannot pay for themselves.” Moreover, “democratic com-
munities are agitated by an ill-defined excitement and by a kind of feverish
impatience, that engender a multitude of innovations, almost all of which
are attended with expense.” The populace soon “discovers a multitude
of wants to which it had not before been subject, and to satisfy these exi-
gencies recourse must be had to the coffers of the State.” Ultimately, for
Tocqueville, the cause “which frequently renders a democratic government
dearer than any other is, that a democracy does not always succeed in
moderating its expenditure, because it does not understand the art of being
economical. As the designs which it entertains are frequently changed, and
the agents of those designs are still more frequently removed, its undertak-
ings are often ill conducted or left unfinished” such that “the State spends
sums out of all proportion to the end which it proposes to accomplish,”
even as “the expense itself is unprofitable” (pp. 196–7).
Hamilton and Tocqueville, being equally suspicious of unrestrained
democracy, were also prescient about its deleterious fiscal effects. It’s become a
commonplace in modern (unrestrained) democracies in the past century that
governments have extracted and spent ever-higher shares of private income,
and while some political parties secure votes by promising higher public
spending without more taxing, others secure votes by promising lower taxing
without less spending. The result: an inherent bias in favor of chronic deficit
spending and public debt accumulation. According to Gersbach (2014):
Limiting the accumulation of public debt in democracies has always been

a problem but it has become a particularly pressing one in the last few
decades. . . [Democratic] political processes tend to push public debt to levels
that are likely to be socially undesirable. The reasons for this tendency are well
known and well explored: fragmented governments, political uncertainty, time-
inconsistent public debt policies, rent-seeking and increasing the advantages of
incumbency – to say nothing of shifting the burden of public debt onto future
generations – can all lead to excessive debt accumulation.
The past two decades entail an astonishing reversal of fortune in

the public debts of democracies. When this century began, most major
nations, including the United States, were enjoying consecutive years of
budget surpluses, debating about the likely duration of surpluses, and
about how much public debts might decline without harm to policymaking
Introduction 3
or markets. In 2000 the US Treasury submitted a draft chapter for the

Economic Report of the President, which analyzed the presumed dilemma
of a pending disappearance of US public debt; it was discarded when
surpluses began to vanish.4
Today, opposite concerns prevail. The United States and major nations
now run record budget deficits, and are likely to do so for decades to come,
amid rising public leverage ratios that now approach levels last seen in
World War II. Major central banks now monetize vast sums of public debt
and vow to keep short-term interest rates near zero indefinitely. Previously
unquestioned sovereign debtors, the United States included, have lost their
top debt ratings. The (seeming) paradox is that as public leverage ratios
have climbed in recent decades, public bonds yields have plunged, explica-
ble partly by the resumption of the autocratic wartime policy of “financial
repression.”5 Central bank “independence” from politics, once seen as
crucial to monetary integrity, has given way to the phenomenon of “fiscal
dominance” of central banks by highly leveraged sovereigns.6 Record
low public debt yields imply that sophisticated bondholders reject debt
pessimists’ fears of a looming financial disaster and inevitable economic
collapse; meanwhile, the debt optimists, who insist that deficit spend-
ing “stimulates” economies, can’t explain why those receiving the most
stimulus (Japan, United States) suffer persistent economic stagnation.
There’s no better time than now to re-examine public debt history, theory,
and practice. The main purpose of this work is to convey and critique the
rich history of political-economic theorizing on public debt across three
distinct schools of thought: classical, Keynesian, and public choice. Each
school seeks to explain the evolution of public debt, its political-economic
causes and effects, the meaning of sustainability in debt burdens, and the
conditions under which governments are likely to monetize or repudiate
their debts. For empirical context, I begin with three centuries of data on
public debt for major nations, relative to national income, and govern-
ment bond yield data for more recent decades. Throughout, I also examine
various methods for assessing fiscal capacity, debt sustainability, and the
outer limits of government borrowing. The empirics provide a concrete
basis for assessing the validity of public debt theories.
Clarity of exposition is enhanced, I believe, by a tripartite classifica-
tion of the major theorists of public debt since the early 1700s. Beyond
the usual “schools” of thought on public debt, I classify debt theorists
as pessimists, optimists, and realists. For reader convenience I provide an
Appendix, which aptly groups the major thinkers.
Public debt pessimists typically argue that government provides no truly
productive services; that taxing and public borrowing detract from the
private economy, while unfairly burdening future generations; that high
and rising public leverage ratios are unsustainable and will likely bring
national insolvency and perpetual economic stagnation. When public
debts become excessive or unpayable, pessimists advise explicit default
or repudiation. They also tend to view financiers in general and public
bondholders in particular as unproductive. Pessimists also usually endorse
smaller-sized governments and free markets. With few exceptions, most
public debt pessimists appear in the classical or public choice schools
of thought; the most representative are David Hume, Adam Smith, and
James Buchanan.
Public debt optimists believe that government provides not only produc-
tive services, such as infrastructure and social insurance, but also means
of mitigating and correcting supposed “market failures,” such as savings
gluts, economic depressions, inflation, and secular stagnation. Optimists
contend that deficit spending and public debt accumulation can stimulate
or sustain economy activity and ensure full employment, without burden-
ing either present or future generations. To the extent that public debts
become excessive, optimists tend to recommend default, whether explicitly
or implicitly (by an inflationary debasement of the currency). Like pes-
simists, the optimists view financiers and bondholders as essentially
unproductive, but unlike pessimists they defend a larger economic role
for the state. Almost without exception, optimists reside in the Keynesian
school of political-economic thought. Among the leading optimists, the
most representative are Alvin Hansen and Abba Lerner.
Public debt realists contend that government can and should provide
certain productive services, mainly national defense, police protection,
courts of justice, and basic infrastructure, but that social and redistributive
schemes tend to undermine national prosperity. Realists say public debt
should fund only services and projects that help a free economy maximize
its potential, and that analysis must be contextualized – that is, related to
a nation’s credit capacity, productivity, and taxable capacity. According to
realists, public leverage is neither inevitably harmful, as pessimists say, nor
infinite, as optimists say. Realists view financiers as productive and insist
that sovereigns redeem their public debts in full, on time, and in sound
money. Realists favor constitutionally limited yet energetic governments
that help promote robust markets. They appear mainly in the classical era
of political-economic thought. The most representative and renowned of
the public debt realists are Sir James Steuart and Alexander Hamilton.
Public debt pessimists and optimists differ from realists primarily in the
way that they omit crucial context; whereas pessimists focus on the down-
side of public debt and de-emphasize its upside, optimists focus on the
upside of it while de-emphasizing its downside. Realists, in contrast, tend
to consult the wider, most relevant context.
Introduction 5
A main thesis of this work is that the public debt realists provide the
most persuasive theories and plausible interpretations of the long, fasci-
nating history of public debt. Moreover, certain puzzles and paradoxes in
contemporary public debt experience – including the recent, multi-decade
trend of a simultaneous rise in public leverage ratios and decline in public
debt yields, among developed nations – is explicable mainly in realist terms.
In contrast, pessimists and optimists alike offer unbalanced, inadequate
accounts of the public debt record: whereas pessimists are confused or
mistaken in foreseeing an alleged “inevitable” ruin from public debt, opti-
mists are confused and mistaken about the alleged economic “stimulus”
attainable by large-scale deficit spending and debt build-ups. Looking to
the future, the realist perspective will likely provide better interpretations
of public debt policies and trends.
Credit is the most relevant context for debt. The limit of public debt
(see Chapter 5) is circumscribed by public credit, or a sovereign’s capac-
ity to borrow. The greater is public credit relative to public debt, the safer
and cheaper is the borrowing, and the greater the possibility of further
borrowing at affordable rates. A sovereign may have too much debt relative
to its credit, but its credit alone can never be excessive. As Hamilton (1795)
put it, public credit is the power “to borrow at pleasure considerable sums
on moderate terms, the art of distributing over a succession of years the
extraordinary efforts found indispensable in one, a means of accelerating
the prompt employment of all the abilities of a nation.” As such, “there
can be no time, no state of things, in which Credit is not essential to a
Nation.” Moreover, national credit must rest “on grounds which cannot
be disturbed” and fiscal affairs managed so as “to prevent that progressive
accumulation of debt which must ultimately endanger all government.”
Prior to exploring the theory of public credit and debt in the works of
the leading thinkers of the classical (Chapter 2), Keynesian (Chapter 3),
and public choice (Chapter 4) schools, I present the three-century empiri-
cal record of public debt (Chapter 1). The schools aren’t homogeneous on
public debt theory; pessimists, optimists, and realists can be found in each,
although pessimists tend to congregate in the classical and public choice
schools, while optimists reside in the Keynesian school and realists in the
classical school. Having identified distinct strains of pessimism, optimism,
and realism, and having learned that the realist approach is more persua-
sive and consistent with history, I apply this perspective to current debate
on the limits of public debt (Chapter 5). Each approach has its proponents
in the contemporary debate, but Chapter 5 conveys realism’s distinctive
analytic advantage.
In examining the three schools of thought, I seek answers to questions
on three levels: nature, causes, and consequences:
●● questions as to the nature of public credit and debt, including: the

ways of characterizing public credit and public debt, and whether
the two key concepts are distinguished; the view of private debt
versus public debt, and whether or not they are analogous; external
(foreign-held) debt versus internal (domestically held) debt, and
whether the notion that “we owe it to ourselves” is valid; gross debt
versus net debt, and whether a lower net debt entails less of a burden;
national debt versus public debt (the sum of national plus state and
local debt) and the implications of debt federalism; explicit debt
versus implicit debt (or “off-balance-sheet” debt, reflecting longer-
term obligations tied to public entitlements); whether it is sensible or
possible to quantify limits to public debt, or its sustainability relative
to national income, taxable capacity, or interest rates;
●● questions as to the causes of public credit and debt, including: the
extent to which the roots of public debt are ethical-cultural, political-
legal, and/or economic-demographic; whether some regime types
(autocracy, democracy, intermediate types) are more or less prone to
accumulate excessive public debts; why debts are incurred in wartime
versus peacetime; whether deficit spending and public debts are
temporary or permanent; whether public debt is incurred to fund
transfers and outlays from an operating budget (consumption) or for
capital and infrastructure projects (investment); why a state might
treat minority groups (the rich) or posterity as “fiscal commons”;
●● questions as to the consequences (or incidence) of public credit
and debt, including: effects on national income, the business cycle,
savings, investment, inflation, interest rates and employment;
whether deficit spending and public debt “ stimulate” output or job
creation, or instead “crowd out” private-sector activity; the effects
of public debt on the size, scope, and spending capacity of govern-
ment; its effects on the dependency of a government’s central bank;
and whether, or to what extent the policies buttressing a burgeoning
public debt entail “financial repression.”7
Ideology and political regime types also influence public debt policies.
Normatively, they reflect public preferences about the proper purpose,
size, and scope of government, and how public goods should be funded.
Positively, they reflect fiscal-monetary institutions, which in turn influence
saving, investment, production, interest rates, and prices. Whether public
debt is deemed harmful, beneficial, or innocuous, at root it’s a fiscal deriva-
tive of deeper factors; its value ultimately reflects citizens’ demands for
public goods relative to their willingness and ability to pay for them through
taxes, and investors’ willingness and capacity to buy and hold public bonds.
Introduction 7
Although fiscal institutions, interacting with voter preferences, shape

fiscal outcomes, the ethical-ideological norms that determine the size and
scope of government, thus its resort to deficit spending, also tend to guide
preferences for fiscal-monetary institutions. A democratic citizenry that
demands (and is provided) more public goods than it is willing (or able)
to pay for in taxes will likely oppose institutions designed specifically to
constrain a government’s capacity to borrow or default on its debts. Such
restraints as a balanced- budget amendment or mandatory monetary
rules (in place of central bank discretion) will lack popular support. An
electorate that truly opposes deficit spending and large public debts can
simply vote against them, in which case no constitutional-institutional
fiscal-monetary restraints would be necessary; in contrast, an electorate
that condones deficit spending and large public debts will vote for them,
in which case no constitutional-institutional restraints could be effective.
Despite distinct fiscal preferences, democratic political regimes unavoid-
ably render fiscal rules either unnecessary or ineffective. Regardless, it’s not
finance, economics, laws, or budgetary metrics that rule the fiscal world
of unrestrained democracy, but instead the deeper, wider (more popular)
preferences of the prevailing majority. Most political economists take
public preferences as given, yet ideology ultimately determines preferences
and political institutions, for good or ill (Hinich and Munger, 1994). For
this reason, perhaps, public choice scholars, who are more interdisciplinary
than rivals, have usually been more active in public debt debates.
Political ideology has strongly influenced public debt theory. The
theories of the classical political economists embodied the classical-liberal
(Lockean) conceptions of property rights and limited government that
prevailed in the eighteenth (and much of the nineteenth) century. The
Keynesian theory of public debt evolved in the wake of progressives hope
for an ever-expanding state, which prevailed so tragically in the twentieth
century. Public choice, while reviving some classical conceptions of public
debt, also recognizes the crucial contemporary influences of unrestrained
democracy.
In the two centuries prior to 1930 it wasn’t necessary to say much more
about the cause of large public debts than “war.” One might ask why war,
but it wasn’t necessary to ask “Why so much public debt amid war?” It was
no mystery. Only in the last century, with the expansion of unrestrained
democracy, welfare states, and social insurance schemes, have public debt
theorists been obliged to incorporate in their work the powers inherent in
both the warfare state and welfare state. Until 1930 the peacetime “norm”
had been to restore pre-war budget balance and if possible generate budget
surpluses to permit debt reduction; since 1930, with chronic deficit spending
in wartime and peacetime alike, the norm has been perpetual public debt
accumulation. The radical transformation of public finance over the past

century deserves explanation beyond the merely economistic-positivistic; it
both caused and reflected the vast increase in the size, scope, and power of
the state and its root cause is arguably moral-ideological-political.8
No school – whether classical, Keynesian, or public choice – has
eclipsed rivals, at least on public debt theory, which is now broadly
eclectic or narrowly technical. Modern political theory and practice
alike have given the world enlarged state spending relative to GDP,
whether financed by taxes or (increasingly) by debt. Upon reflection
I’ve come to sympathize with public choice theorists, not because they
tend to be debt pessimists, but because they rightly attribute excessive
public debt to unconstrained democracy, noting (uncontroversially) that
political elites’ electoral incentive is to maximize spending, minimize
taxation, and borrow or print money to plug the gap, while treating
wealthy minority groups and future generations as fiscal commons worth
exploiting.9
By now it should be obvious that governments borrow most when they
are least willing or able to tax citizens presently and to the full extent
needed to fund outlays. Beyond this, states unwilling or unable to constrain
public spending, yet precluded from borrowing further, on affordable
terms, tend to repudiate their debts, whether explicitly (by non-payment
of principal and interest), or implicitly (by a deliberate inflation). When
governments borrow to ensure their survival (in war), to effect a near-term
economic recovery (from depression), or to foster longer-term prosperity
(through infrastructure), their brief resort to deficit spending need not
persist, nor must debt burdens mount. In contrast, chronic deficit spend-
ing may reflect a diminution in the assent of taxpayers to fully support
rising public outlays, even as the resulting accumulation of debt diminishes
public creditors’ expectations of repayment.
Public credit and debt also suffer from a problematic conflict of inter-
est that makes it prone to being abused in unlimited democracies. In any
society governed by a constitutionally limited state, the creditor-debtor
nexus is free and legally secure; to the extent such a state borrows, it obeys
the same norms and rules as market participants. Yet conflict arises when a
less constrained government both adjudicates private creditor-debtor rela-
tions and itself becomes a dominant and burdensome debtor in markets.
The unrestrained state is more likely to co-opt the banking system while
enacting laws and conducting fiscal-monetary policies that favor its own
interests at others’ expense.
Whether the causality runs from unconstrained majority rule to impru-
dent public finance, or the other way around, is less important than their
coincidence and hostility to individual liberty, private property, and
Introduction 9
economic prosperity. Direct democracy breeds public profligacy – and the

reverse. They are mutually corroboratory.
At certain times in history, of course, realism demands a candidly nega-
tive assessment of political-economic trends, an interpretation that other-
wise seems akin to latent pessimism. The evidence is ample that we’re living
in such a time now, as states globally become more interventionist only a
few decades after the dissolution of the Keynesian consensus and utter
collapse of socialism in Eastern Europe.10 More than 70 years ago, E.C.
Griffith (1945) foresaw the fundamentally anti-capitalist nature of interven-
tionist states, with their chronic deficit spending and public debt build-ups:
The philosophy of deficit financing is but one part of a program that creates
basic changes in the reactions of people that, per se, are sufficient to destroy the
system of Capitalism, [which] rests upon the institution of private property, is
motivated by the profit motive, and directed by a price mechanism function-
ing through the media of the market place. . . Planned economies – of which
a cardinal feature is the policy of deficit financing – are directly opposed to
the continuation of the milieu required for the preservation of the capitalist
system. . . The presence of a national debt created and enlarged for the purpose
of eradicating unemployment will produce an environment that is not condu-
cive to the preservation of the capitalist system. If this proposition is true, then
either the program of deficit financing or the capitalistic system must be aban-
doned. But when, in a democratic society, this condition becomes apparent, it
will be impossible to abandon deficit financing and, hence, the alternative must
be the abandonment of the capitalistic system.
To be clear, Griffith doesn’t contend that deficit spending by itself destroys

capitalism. The claim would be absurd. He stresses how it’s one part of a
broad anti-capitalist program: deficit-spending facilitates the evolution of
a larger, more powerful, more invasive, and more redistributive state – all
of which is inimical to private property rights.
A year after Griffith’s essay, Ruml (1946) applauds enlarged state power;
he’s encouraged to see how more powerful central banks, an abandonment
of the restrictive gold standard, and a greater reliance on public borrow-
ing are all making tax revenues “obsolete.” He interprets the same facts
differently, because he opposes capitalism while Griffith favors it. Ideology
influences assessments of public finance. The anti-capitalist Keynes (1920)
also favors fiat money, for as its real value “fluctuates wildly,” the
“permanent relations between debtors and creditors, which form the

ultimate foundation of capitalism, become so utterly disordered as to be
almost meaningless,” and “wealth-getting degenerates into a gamble and a
lottery.” Later, Keynes (1936) also demands “the euthanasia of the rentier”
class (bondholders) by means of low or zero interest rates. Krugman
(2014), Piketty (2014, 2015) and others today advise likewise.
The public debt realists that I examine in this work tend to be more
attentive to moral-political-legal issues than their pessimistic and optimis-
tic counterparts. The realist is able to acknowledge genuinely bad times but
also to find a way out. At the end of its Revolutionary War, America was
effectively bankrupt. Incorporating a realist perspective in a 1781 letter
to Robert Morris (then Superintendent of Finance for the Continental
Congress), a young Alexander Hamilton advised against extreme assess-
ments of public credit, and against the notion that public debt is either an
unalloyed benefit or latent harm. “No wise statesman will reject the good
from an apprehension of the ill,” he wrote:
The truth is, in human affairs, there is no good, pure and unmixed. Every
advantage has two sides, and wisdom consists in availing ourselves of the good
and guarding as much as possible against the bad. . . A national debt, if it is
not excessive, will be to us a national blessing. It will be powerful cement of our
union. It will also create a necessity for keeping up taxation to such a degree
which, without being oppressive, will be a spur to industry.11
In place of pessimism or optimism, Hamilton offered a balanced, realistic

perspective, which best explains the full history of public debt – to which
we now turn.
NOTES
1. On the burgeoning welfare state, see Browning (2008). On “democracy in deficit” see
Buchanan and Wagner (1977 [1999]), Crain and Ekelund (1978), Balkan and Greene
(1990), Plumper and Martin (2003), Gillette (2004, 2008), Ferguson (2006), Eusepi
and Giuriato (2008), Bruner (2009), Arezki and Brückner (2010), Kane (2012), McKee
and Roche (2012), Motha (2012), Wagner (2012a, 2012b, 2012c), and Catrina (2014).
Addressing recent public debt crises, Bragues (2011) believes “the fault ultimately lies
with democracy. Among the many lessons the current crisis is enjoining us to learn,
the most important is how the political incentives embedded in the architecture of
democracy conduce to the inordinate buildup of public debt. Chronic deficits have
usually been at the root of monetary-policy failures in the past when central bankers
came under heavy pressure to print money as a politically convenient way to repay the
huge public debt. The deeply held belief that democracy is the best regime keeps us from
noticing all its imperfections.”
2. Calomiris and Haber (2014) attribute financial sector fragility to populist political pres-
sures. In earlier studies Salsman (1990, 2013a, 2013b) attributed the fragility to modern
central banks devoted more to enabling democratic overseers and underwriting profli-
gate sovereigns than to ensuring sound money or safe banking.
3. Ciumas et al. (2012) find “strong empirical evidence for the hypothesis that imbal-
ances built up in the private sector would eventually spill over to the public sector
under the form of government deficit and increased public debt.” See also Breton et
al. (2012, p. 57): “In financial crises, private debts typically turn into public debt” and
“sovereign debt may balloon out of control because of actions taken to prevent the
collapse of banking systems.” See also Per Tiwari et al. (2015, p. 2): “banking sector
Introduction 11
expansions” “can create significant risks for the sovereign”; “When banking sector
vulnerabilities unravel in banking crises, the risks to the sovereign are further exacer-
bated by the high fiscal cost of related crisis management policies, particularly bank
bailouts [which are more likely] in countries with larger and more leveraged banking
sectors.”
4. US Department of the Treasury (2000). See also Reinhart and Sack (2000) and
Kestenbaum (2011).
5. Reinhart (2012) and Brenner and Fridson (2013).
6. Turner (2011), Blommestein and Turner (2012a), and Moessner et al. (2012).
7. On public debt incidence and burdens, see Matsushita (1929), Wright (1940), Smith
(1941), Ratchford (1942), Domar (1944), Reinhardt (1945), Cohen (1951), Meade
(1958), Bowen et al. (1960), Lerner (1961), Modigliani (1961), Neisser (1961), Mishan
(1963), Buchanan (1964a, 1967a), Tullock (1964), Daly (1969), West (1975), Cavaco-
Silva (1977), Barro (1980), Backhaus et al. (1987), Buchanan and Roback (1987), Stern
(1987), Toshihiro (1988), Blanchard and Missale (1994), Gale and Orszag (2003), Michl
(2006), Yarrow (2008), Laubach (2009), Reinhart and Rogoff (2010), Krugman (2011d),
and Otaki (2015).
8. On ideology in politics see Hinich and Munger (1994). On the political economy of
public debt see Musgrave (1959), Roubini and Sachs (1989), Verbon and Van Winden
(1993), Brubaker (1997), Neck and Getzner (2001), Winer and Shibata (2002), Bruner
and Abdelal (2005), Brennan (2012), Wagner (2012c), and Theocarakis (2014).
9. Buchanan (1964b) and Wagner (2012a).
10. See Time (1965), Hicks (1975), Feldstein (1981), and Palmer (1990). More recently, see
Giles et al. (2008), Meacham (2009), and Skidelsky (2009).
11. Hamilton (1781 [1961]).
1. A brief history of public debt
A concise history of public debt is a prerequisite to understanding its
causes and consequences. Historical context helps corroborate or confute
alternative theories and analytical methods. The good news is that hard
data on public debt and its history have become more comprehensive,
more accurate, and more readily available in recent years.1 Unfortunately,
much contemporary analysis is overly formal, non-empirical, or focused
myopically on a narrow subset of public debt history that’s not representa-
tive of its timeless and valid principles. By one selective reading public debt
may appear sinful, wasteful, and burdensome – by another, moral, produc-
tive, and beneficial – and by another still, neither harmful nor beneficial
but merely innocuous.
1.1 FINANCE IN ANCIENT AND MEDIEVAL TIMES
Governments in ancient and medieval times required funding, as do

modern states, but they didn’t borrow “publically” in the sense of drawing
funds from a wide populace and making it ultimately responsible for
servicing the debt (paying principal and interest), as a form of deferred
taxes. Homer and Sylla (1991) show that private borrowing existed since
recorded history and preceded the development of public borrowing by
many centuries. Eventually, public borrowing became common, but ini-
tially involved loans in kind (commodities) instead of in money, for shorter
rather than longer periods, and for war or idiosyncratic purposes rather
than as a permanent funding source. In ancient and medieval times no debt
instruments existed in the forms so familiar to us today – namely, tangible
securities traded in secondary, liquid markets with prices and yields visible
on public exchanges. This form of sovereign obligation emerged in the late
seventeenth century, when the rule of law, sanctity of contract, and parlia-
mentary checks on monarchical power took hold, after Britain’s Glorious
Revolution in 1688.2
In the pre-commercial feudal era, princes, landlords, and clerics owned
estates or sanctuaries that generated income, not unlike a personal busi-
ness, but by command-and-control operations, with tribute paid by tenant
12
A brief history of public debt 13
farmers or serfs, in return for military protection.3 Government funds in

the feudal era also derived from the spoils of conquest and war, from the
sale of offices, titles, and indulgences, or by debasing coins at the mint.
Prior to the Renaissance, whenever monarchs, princes, and popes bor-
rowed they did so on their own account, pledging personal income and
estates as security. They often reneged on their debts. Creditors, initially
lured by the prospect of large financial gains, given their privileged prox-
imity to political power, more often than not were mistreated, whether by
defaults, interest reductions, confiscations, or bodily harm.4
In an early account of sovereign debt in ancient times, Bullock (1930)
describes how in the fourth century BC, Dionysus of Syracuse borrowed
from citizens but “repaid” the loan only by debasing the coinage. Today
this is called an implicit (or indirect) default, in contrast to an explicit
or direct one; principal and interest are still paid, but not in the initially
promised medium of exchange. Governments still resort to this ruse today,
as all now issue fiat paper money. In recent decades a few have issued
inflation-
indexed public bonds (the United Kingdom since 1982, the
United States since 1997), mainly for information purposes or as policy
guides; they are not a major part of total issuance. The old-fashioned
term “debasement” has been out of favor for at least a century; today the
tactic is known as “inflationary finance” and the only remaining analytical
controversy is whether public creditors offset its effects by requiring higher
yields.
Even though credit–debtor relations developed in ancient times, they
stagnated and reversed in the dark ages and medieval period, due to a
persistent animosity not only to money-making and commerce but also to
usury (Munro, 2003). Originally usury meant lending money at an interest
rate, not merely at a high rate.5 Aristotle had declared money “barren,” or
unproductive, so interest was an exploitation or theft (Meikle, 1994), but
the ancients were not nearly as hostile to it as their religious successors
subsequent to the fall of the Roman Empire. For a millennium all major
religions condemned, forbade, and punished money-making and lending
at interest.
Eventually Aquinas provided a qualified defense of lending, which
coincided with the origin and growth of modern, private banking and
lending, starting in Italy and spreading quickly to Spain and Holland.
With the Protestant Reformation came an unlikely defense of usury, by
Martin Luther (1524 [1897]). In the Enlightenment of the eighteenth
century, after commerce and lending at interest emerged and flourished
for nearly two centuries, usury received a robust, unqualified defense
by Bentham (1787), which the classical economists – from Smith to
Ricardo and Say and Mill – heartily endorsed. Without a more favorable
attitude toward lending at interest, there would not have been so great
an increase in debt of any kind, including public debt. The more favora-
ble philosophical-cultural attitude toward economic activity and capital
accumulation in general that was so characteristic of the Renaissance and
Enlightenment also made available more lendable funds. Yet the latent
and age-old (ancient-medieval) animosity toward bankers and lenders has
never totally dissipated; it was revived in the mid-nineteenth century by
Karl Marx, with his prejudice against “rentiers” as parasites who induce a
late, crisis-ridden phase of capitalism, “finance capitalism.”6 Antagonism
towards creditors made it easier (and morally obligatory) for overextended
borrowers, mainly sovereigns, to renege on debts or demand forgiveness.7
In contrast, under the classical gold standard era (1870–1913) sovereigns
were better behaved, more credible, and more creditworthy.8
Prior to the seventeenth-century Renaissance and eighteenth-century
Enlightenment in Europe, lending to governments meant lending
personally to rulers, usually monarchs or popes (Cahill, 2010). But these
were largely the personal debts of the rulers, incurred mainly to wage war,
repel invasion, or fund infrastructure projects; technically they were not
“public” debts, in the sense of being based on the paying capacity of the
general public. These were state debts, repayable from the spoils of war or
by the crown’s tax revenues or wealth transfers. Instead of relying on the
precarious practice of borrowing funds under emergency settings like war,
monarchs, princes, and popes preferred instead to amass riches and armies
in advance.
Indeed, mercantilism as a system not only of protectionism and
regulation but also of public finance, precisely favored policies that built
up, ex ante, the cash holdings of the king and his nation-state, if necessary
at the expense of citizens or other nations. The aim of a “favorable balance
of trade,” or net exports of goods in excess of their importation, was a
net importation of money (or specie). In this way a monarch amassed a
“war chest” and didn’t have to borrow. In France, mercantilism was per-
sonified in finance minister Colbert (1619–83). The German counterpart
to mercantilism was Cameralism, or the art and science of efficiently
administering royal finances.
1.2 THE FINANCIAL REVOLUTION AND THE

ENLIGHTENMENT
The origin and development of today’s modern system of public finance

was made possible by the rise of constitutionally limited, representa-
tive government, especially in the wake of Britain’s Glorious Revolution
in 1688 and America’s Revolution in 1776 (Fisk, 1920). Each was a

revolt not of peasants or serfs but of the rich and elites (taxpayers and
rentiers) who were fed up with incessant royal land grabs, arbitrary exac-
tions, cavalier loan defaults, and opportunistic debasements of official
coinage. Parliamentary restraint on the arbitrary powers of royals shifted
the focal point of public finance from the personal finances of mon-
archs to the financial capacity of the populace and economy at large.
Thereafter, government spending, taxing, and borrowing would be under-
taken on behalf of the public; instead of bending to royal edicts or caprice,
public finance practices thereafter would hew to regular and predictable
commercial customs.
The financial revolution of the seventeenth and eighteenth centuries,
which preceded and made possible the Industrial Revolution of the
eighteenth and nineteenth centuries, entailed greater reliance on rule-
based systems and procedures among creditors and debtors, a greater
standardization of debt instruments and securities, and secondary markets
where such securities could be traded, rendered more liquid as collateral
for further borrowing.9 As debt securities became publicly traded and
more visible, so also did their prices and yields; a transparent window
was opened on the reputation and credibility (or lack thereof) of debtors
generally, and sovereign debtors in particular recognized that they could,
by credible commitment and demonstrated creditworthiness, borrow more
easily and regularly at lower interest rates relative to rivals, and that
borrowing power could be enormously advantageous in wartime, when
debt finance was politically preferable to higher taxes. No longer was it
necessary to accumulate royal riches in advance. After 1650 public borrow-
ing began in earnest in the Italian republics of Genoa and Venice, next in
the United Provinces (Netherlands), and soon thereafter (especially after
1688) in England and France (Fritschy, 2003; Carlos and Neal, 2011).
History makes clear that during the multi-century, post-medieval shift
from absolute monarchies to today’s virtually unrestrained democracies,
there existed, in the eighteenth and nineteenth centuries, a third and better
way: constitutionally limited commercial republics (the United States
included) where rights were respected most and economies performed
best (MacDonald, 2003). There public credit was sound because the
state itself was restrained. Suffrage was limited and representatives were
“natural” aristocrats (manufacturers, merchants, bankers) not the lawyers
or political careerists drawn from all too common pools. The “Republic of
Rentiers” (my own nomenclature) properly and profitably eschewed the
capriciousness and chaos common to autocracy and democracy alike.
The transition from arbitrary rule by whim and by men to rule by
pre-established legal precedent fostered a vast expansion of credit–debtor
relations, including those between government (as debtor) and private

creditors. Whereas most public debt scholars have argued that more
representative forms of constitutional government encouraged responsible
public debt issuance, some argue a reverse causation – that burgeoning
public debt itself expanded democracy and freedom (ibid.). But the past
century has seen not merely a vast extension in suffrage and more direct
forms of democracy, but also the spread of public fiscal imprudence.10
In the eighteenth and nineteenth centuries, public debt expanded mainly
during wartime, then contracted in peacetime, relative to national income,
but in the more democratic past century, deficit spending and high public
debt ratios have become the norm, despite cyclicality and wars, and rise
even in peacetime.
Of great importance to the historical development of public debt, during
the Renaissance, private banks shifted from providing mere w arehouse
services for clients’ specie into fractional- reserve institutions that lent
a portion of deposits at interest, with assets now a mixture of precious
metals and loans – what Carroll (1855–79 [1964]) called the “organization
of debt into currency.” Instead of currency backed by specie only, it was
backed by specie plus debts owed to banks by borrowers. Initially currency
was still redeemable at a fixed weight of specie, and not as yet monopolized
by government or issued by states without backing (as we have today). This
manner of backing currency partly with debt was eventually and gradually
adopted by money-issuing central banks.
During the first two centuries of public debt issuance (the eighteenth and
nineteenth centuries) coupon rates were low relative to prior experience,
typically 3–6 percent (Homer and Sylla, 1991), because most sovereigns
were fiscally prudent. They issued large sums of debt amid war, but
otherwise eschewed chronic budget deficits. In peacetime they also used
various pre-commitment devices – sinking funds, annuities, and the gold
standard – to assure creditors of timely repayment in money that would
hold its value over time.11
For much of US history the federal government employed sinking funds
to enhance the credibility of its commitment to service its debts. Annual
budget appropriations would include a set-aside of sums to accumulate
in an escrow-type fund to be used to repay the principal of public debt
at maturity. The fund was also used to periodically purchase undervalued
public bonds; the Treasury could selectively redeem those of its bonds that
were trading below par, which boosted bond prices and investor confi-
dence. Public bond prices were less volatile, thus more attractive to hold.
Public annuities were also used; instead of paying interest only during the
life of a public bond, then a single, large principal payment at maturity,
an annuity paid both interest and a steady portion of the principal
semi-annually, eliminating the burden of repaying a huge lump sum of

principal at maturity. Like sinking funds, annuities were a credible means
of prudent public borrowing, which permitted sovereigns to borrow more
at lower rates, without either financial repression or unorthodox central
bank policies.
The sinking fund method had been used in England and was inaugurated
by new US Treasury Secretary Alexander Hamilton in 1790 to enhance
the trustworthiness of an erstwhile bankrupt government. Britain ceased
resorting to sinking funds in the late 1800s, while the United States
discontinued their use (along with the classical gold standard) in the 1930s.
In time, sinking funds became prone to political abuse and manipulation;
accumulated sums initially earmarked for repayment of principal, years
hence, proved tempting to populist politicians wishing to spend the money
sooner than later, and on more democratic purposes than a return of
capital to bondholders. With sinking funds depleted, public bonds became
“unfunded,” as are public contingent liabilities today.
1.3 VISUALIZING THE HISTORY OF PUBLIC DEBT
Visual depictions of the history of public debt provide perspective on

what has occurred in the West over the past three centuries – and why. The
longest-term data are available for the United Kingdom and United States,
but data for other major countries are available since 1870.
For the United Kingdom since the Glorious Revolution in 1688,
Figure 1.1 illustrates the long-term trend in the public debt/GDP ratio.
Today’s ratio of 50 percent is well below the all-time high of 255 percent
recorded at the end of the Napoleonic Wars (1815), and also below the
ratio recorded immediately after World War II (230 percent). Britain’s
public debt ratio climbed steadily and precipitously amid repeated and
costly wars between 1700 and 1815, but then declined just as precipitously
during the relatively peaceful and prosperous century that lasted from 1815
to 1914. Today’s debt ratio, at 50 percent, is roughly where it was before the
large run up in public debt associated with World War I and World War II.
Certainly the British government has engaged in chronic deficit spending
in recent decades, but Figure 1.1 makes clear that it has not done so in
excess of growth in national income.
Figure 1.2 illustrates the interest expense that has been incurred by
the British government on its public debt since 1700, also measured as
a percentage of national income. The pattern is similar to that seen in
Figure 1.1: public interest expense has been high when the public debt ratio
has been high, and low when the debt ratio has been low. Today Britain’s
Source: www.ukpublicspending.com.
Figure 1.1 Public debt of the United Kingdom as a percentage of GDP,

1700–2015
Figure 1.2 Public interest expense of the United Kingdom as a percentage

of GDP, 1700–2015
Figure 1.3 Public spending of the United Kingdom as a percentage of

GDP, 1700–2015
public interest expense is a mere 2.2 percent of its annual GDP, or less than
a quarter of the 9.5 percent burden felt at the end of World War II and the
still higher burden of 10 percent recorded at the end of the Napoleonic
Wars in 1815. Indeed, today’s ratio of 2.2 percent is lower than the ratio
of 2.5 percent seen prior to the multi-year expansion of public debt that
began a century ago on the eve of World War I.
Figure 1.3 plots the long-term ratio of annual government spending
in the United Kingdom, also as a percentage of annual national income
(GDP). We see a saw-toothed but upward climb in the relative size of the
British government between 1700 and 1815, but then a long-term decline
from roughly 33 percent of the economy in 1815 to less than 10 percent
between 1850 and 1900. The spending share reaches the astounding heights
of 57 percent amid World War I and 70 percent amid World War II, but
today’s share, at 41 percent, is almost half the level of the previous record
high and, despite increases in the role and scope of the British welfare
state, the spending share has generally declined from 48 percent in 1981.
Figure 1.4 shows the long-term trend in the public debt/GDP ratio of the
United States soon after its founding in 1790. Today’s ratio is 100 percent,
nearly triple the recent low of 35 percent in 1982, but also below the all-time
high of nearly 120 percent set in World War II. Wars have been the main
cause of spikes in the US debt ratio – up to 18 percent at the end of the war
of 1812, to 34 percent by the end of the Civil War, 37 percent at the end of
Source: www.usgovernmentspending.com.
Figure 1.4 Public debt of the United States as a percentage of GDP,

1800–2015
World War I, and 125 percent after the end of World War II. The latest rise
in the US debt ratio might also be attributed to war, to the “war on terror-
ism,” which has been more expensive (inflation-adjusted) than all prior US
wars except World War II. The secular rise in the debt ratio since 1975 also
reflects entitlement spending.
The more recent, dramatic rise in the US debt ratio is due to the large
revenue loss and deficit spending associated with the financial crisis and
Great Recession (2008–09) and thus more resembles the period of banking
failures and Great Depression of the 1930s, when the US debt ratio doubled
from 18 percent to 36 percent. Thereafter, due to the deficit spending
associated with World War II, it tripled from 36 percent to 125 percent.
Figure 1.5 plots US public interest expense as a portion of GDP since
1800. Despite a high debt ratio lately (Figure 1.4), the interest-expense
ratio remains relatively low, at 1.4 percent, because the average interest rate
on US public debt has been very low compared to prior decades (1980s
and 1990s). The record ratio occurred in the late 1980s, when the US debt
ratio was only 68 percent but interest rates were much higher. From 1985 to
1990 the US ten-year Treasury bond yield averaged 8.75 percent, but over
the past five years, even under a much higher debt ratio, it has averaged a
mere 3.25 percent.
Figure 1.5 Public interest expense of the United States as a percentage of

GDP, 1800–2015
Figure 1.6 shows that US federal spending is now 20 percent of GDP,

versus a 41 percent share in Britain, but the US share is up sharply from
17 percent a decade ago. Nevertheless, the all-time high spending share was
48 percent, amid World War II.
The United Kingdom and United States, although the biggest and
steadiest public borrowers, in absolute terms, over the past few centuries,
aren’t the only public borrowers. Figure 1.7 depicts the debt ratios of
22 advanced OECD nations since 1900. As in the UK and US figures,
spikes in public leverage ratios accompany World War I (1914–18), the
Great Depression (1930s), and World War II (1940–45), but also the recent
peacetime period. The ratio at present is 90 percent, up from a low of
23 percent in the mid-1970s and nearly double the 52 percent share in 2007,
prior to the onset of the Great Recession.
Table 1.1 provides more historical context on public debt, depicting
trends in public debt/GDP ratios for 15 developed nations over the
past century. The highest ratio is that of Japan, nearly 226 percent in
2010, up from 68.0 percent when its stock market and economy peaked
in 1990, and versus 8.5 percent in 1970. The second largest ratio in
2010 is Italy’s, at 117.5 percent, up steadily from 96.3 percent in 1990
and 30.9 percent in 1970. Australia now has the lowest debt ratio – at
Figure 1.6 Public spending of the United States as a percentage of GDP,

1800–2015
Source: Reinhart (2012, Figure 1).
Figure 1.7 Public debt of 22 OECD nations as a percentage of GDP,

1900–2011
Table 1.1 Gross public debt as a percentage of GDP, 15 OECD nations, 1910–2010
Nation 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 2010
Australia 38.8 61.2 70.3 67.7 109.8 48.3 35.0 18.7 10.0 10.8 11.3
Austria 67.1 38.4 19.3 44.3 22.1 13.6 10.6 25.2 46.0 58.2 61.4
Belgium 49.6 102.7 57.5 73.7 73.7 69.7 48.3 53.6 106.6 99.6 98.2
Canada 28.2 41.6 55.4 48.4 111.0 61.7 42.7 34.1 66.1 66.3 54.3
France 79.6 185.5 142.9 – 27.4 22.1 12.4 20.9 35.2 57.3 78.5
Germany 46.6 – – – 17.5 18.8 17.4 30.0 41.0 59.7 78.8
Italy 76.2 142.3 111.4 93.3 32.3 32.8 30.9 53.5 96.3 105.9 117.5
23
Japan 70.1 25.3 47.3 78.5 41.3 8.4 8.5 51.4 68.0 142.0 225.9
Netherlands 70.0 59.6 75.6 119.8 141.0 78.7 49.6 45.4 75.8 53.8 67.4
Norway 26.9 15.1 35.8 23.3 43.9 41.8 32.9 47.3 28.9 34.2 54.3
Spain 89.7 44.4 58.9 71.8 46.2 30.0 18.0 14.7 42.6 59.3 63.5
Sweden 16.6 11.6 17.3 24.6 36.5 27.8 26.8 39.3 41.2 53.2 41.7
Switzerland 32.9 – 22.7 42.1 39.6 15.9 5.9 13.2 32.2 51.8 39.5
United Kingdom 31.7 130.7 161.6 110.0 194.2 106.8 64.2 41.3 27.4 33.3 72.0
United States 7.9 29.4 17.7 42.4 87.6 54.4 35.7 32.6 55.7 57.0 89.9
Averages 48.8 68.3 42.1 29.3 34.7 51.5 62.8 76.9
Sources: www.carmenreinhart.com/data, and Reinhart and Rogoff (2011b).

Table 1.2 Public spending as a percentage of GDP, 15 OECD nations,

1910–2010
Nation 1910 1920 1940 1960 1980 1990 2000 2010

Australia 16.5 19.3 14.8 21.2 34.1 34.9 34.8 36.3
Austria 17.0 14.7 20.6 35.7 48.1 38.6 52.2 53.0
Belgium 13.8 22.1 21.8 30.3 58.6 54.8 49.1 53.0
Canada 15.1 16.7 25.0 28.6 38.8 46.0 41.1 43.8
France 17.0 27.6 29.0 34.6 46.1 49.8 51.6 56.2
Germany 14.8 25.0 34.1 32.4 47.9 45.1 45.1 46.7
Italy 17.1 30.1 31.1 30.1 42.1 53.4 46.1 50.6
Japan 8.3 14.8 25.4 17.5 32.0 31.3 39.0 40.7
Netherlands 9.0 13.5 19.0 33.7 55.8 54.1 44.2 51.2
Norway 9.3 16.0 11.8 29.9 43.8 54.9 42.3 46.0
Spain 11.0 8.3 13.2 18.8 32.2 42.0 39.1 45.0
Sweden 10.4 10.9 16.5 31.0 60.1 59.1 55.1 53.1
Switzerland 14.0 17.0 24.1 17.2 32.8 33.5 35.1 33.7
United Kingdom 12.7 26.2 30.0 32.2 43.0 39.9 36.6 53.1
United States* 7.5 12.1 19.7 27.0 31.4 33.3 33.9 42.3
Averages 12.9 18.3 22.4 28.0 43.1 44.7 43.0 47.0
Note: * Includes federal, state, and local government spending for comparability.
Sources: 1910–80: Tanzi and Schuknecht (2000); thereafter, OECD Factbooks.
11.3 percent, compared to the 15-nation average of 76.9 percent, more

than double its level in 1970 (29.3 percent), yet not much above its level
in 1950 (68.3 percent).
The main cause of rising public leverage can be found in Table 1.2,
which shows public spending (as a percentage of GDP) by the same
15 nations over the same past century. The trend is clearly upward.
On average, only 12.9 percent of GDP was spent a century ago; in
2010 the proportion was 47.0 percent. Today’s highest spender is
France (56.2 percent), while the lowest is Switzerland (33.7 percent).
Bucking the trend, four nations since 1980 have reduced spending as
a share of GDP: Belgium, Germany, Netherlands, and Sweden. The
biggest increases since 1980 have occurred in Spain (+12.8 percentage
points, to 45.0 percent), the United States (+10.9 percentage points, to
42.3 percent), France (+10.1 percentage points, to 56.2 percent), and the
United Kingdom (+10.1 percentage points, to 53.1 percent). Japan has a
relatively low spending share (40.7 percent), but that’s more than double
the level of 1960; that Japan’s public leverage today is the highest among
Table 1.3 The paradox of profligacy: higher public debt leverage, yet lower
borrowing rates, G-7 nations, 1980–2015
Nation Gross Public Debt as a % Ten-year Sovereign

of GDP Bond Yields
1980 1990 2000 2010 2015 1980 1990 2000 2010 2015
Japan 51.4 68.0 142.0 225.9 249.7 9.2 7.4 1.8 1.3 0.4
Italy 53.5 96.3 105.9 117.5 122.3 15.3 13.5 5.6 4.0 1.7
USA 32.6 55.7 57.0 89.9 105.1 11.5 8.6 6.0 3.5 2.1
UK 41.3 27.4 33.3 72.0 92.2 13.8 11.1 5.2 3.9 1.9
France 20.9 35.2 57.3 78.5 89.6 13.0 9.9 5.5 3.3 0.9
Canada 34.1 66.1 66.3 54.3 78.8 12.1 10.8 5.9 3.5 1.5
Germany 30.0 41.0 59.7 78.8 74.4 8.5 8.9 5.2 2.9 0.5
Averages 37.7 55.7 74.5 102.4 116.0 11.9 10.0 5.0 3.2 1.3
Sources: OECD, IMF, and www.carmenreinhart.com/data.
advanced nations (250 percent, per Table 1.3) is due partly to relatively
faster spending but also to slower revenue growth since its economy
effectively peaked in 1989.
Despite abundant evidence of sharp increases in public spending shares
of GDP in recent decades, with a concomitant expansion in deficit spend-
ing and public leverage, Table 1.3 reveals how this has not translated into
higher public borrowing costs. In the private sector, all else equal, greater
leverage entails a greater risk of debt default, which in turn induces credi-
tors to demand compensation in the form of higher yields. Yet Table 1.3
makes clear that even though public debt ratios for the G-7 nations have
increased steadily in recent decades – from an average of 37.7 percent in
1980 to 74.5 percent in 2000 and 116.0 percent in 2015 – their average
benchmark (ten-year) Treasury yields have decreased – from an average of
11.9 percent to 5.0 percent in 2000 and just 1.3 percent in 2015. I designate
this odd phenomenon the “paradox of profligacy,” and seek to explain
it later in the book (Chapter 5). It could be argued that inordinately low
bond yields reflect a rational market’s view that no profligacy exists in fact,
or instead that profligacy prevails but yields have moved lower due to a
multi-decade disinflation and, more recently, to financial repression and
central banks’ zero interest rate policies.
No history of public debt can exclude the increasing role of central
banks, which issue a government’s monopolized money and underwrite
its bonds. Once deemed “lenders of last resort” to private banks, they now
also act as lenders of last resort to profligate governments. The power
and reach of central banking expands virtually without limit with each
new decade, especially amid the crises it instigates. Public debt analysts
now routinely consolidate the balance sheets of central banks and their
needy sovereigns, treating them as one. Central bank “independence” from
politics and finance ministries, once considered the sine qua non of proper
policymaking, is now a mere shibboleth.
To many economists and historians, the spread of central banking and
fiat paper money systems in the past century was a “fix” for a “market
failure” in free banking and the gold standard. Yet the origins and evolu-
tion of central banking suggest otherwise. Most central banks originated
in a sovereign’s desperate need to secure funds that it couldn’t otherwise
obtain by taxes or voluntarily loans. Some began as private banks com-
pelled to lend to deadbeat sovereigns; upon becoming insolvent due to
defaults on public loans, they were conveniently nationalized and trans-
formed into government-privileged central banks with monopoly control
over fiat currencies that eventually displaced gold and silver in private
bank reserves and as circulating media. This was the pattern by which most
modern central banks were established, including the first two, in the late
seventeenth century: the Swedish Riksbank, established in 1688 upon the
takeover of a private bank initially founded in 1656 but which failed, and
Britain’s Bank of England, established in 1694 as a means of financing yet
another war with France.
Britain’s modern public debt was launched when William III arranged
for the sale of public debt through a syndicate of London merchants;
in time this syndicate was formed into the Bank of England. In similar
ways and for the same purpose – financial support for the state – central
banks were established in Denmark (1773), France (1800), Austria (1816),
Norway (1816), Belgium (1850), Netherlands (1864), Germany (1875),
Japan (1882), Italy (1893), Switzerland (1905), the United States (1913)
and Canada (1933).12
Until the 1930s major central banks issued currency redeemable into a
fixed weight of gold, and governments in industrially advanced nations
pledged to redeem their bonds in gold-convertible money. But since central
banks were established mainly to assist governments in funding,13 they
also purchased large sums of public debt – especially in wartime – and
used that asset as a basis for money creation. In this way the classical gold
coin standard (1870–1913) was abandoned, amid World War I, in favor of
the more centralized gold bullion standard, which in turn was abandoned
in 1933 amid the Great Depression. That was followed by a paper-based
gold exchange standard (the Bretton Woods system), whereby the US
dollar was the worldwide reserve currency and the only one redeemable
in gold (albeit solely for other central banks). Since the abandonment of
the Bretton Woods system in 1971 no central bank resumed issuance of

any currency redeemable in gold, for anyone; all such banks have issued
only fiat paper money. Initially, in the 1970s, the severing of currencies
from gold caused higher inflation expectations and fast-rising public bond
yields, but over the past four decades yields on advanced nation sovereign
bonds, with exceptions, have steadily declined.
Today’s global monetary system, which is less integrated than it was a
century ago, due to the international gold standard, entails no effective
limit on central banks’ power and willingness to create fiat money, which
permits public debt and leverage to reach heights unseen historically. In
the past decade major central banks have purchased vast new sums of
public debt by creating reserves or currency – a method once described
as “debt monetization” and “inflationary finance,” but lately referred to
as “quantitative easing.” So far the procedure hasn’t boosted inflation or
public bond yields, because central banks (in Japan, the United States,
Europe, and elsewhere) have also brought down short-term policy rates to
near zero percent or even negative, purportedly to stimulate economies,
but more probably, to ensure low yields on public debt and thereby forestall
the budgetary pressure associated with fast-rising interest expense.
1.4 QUESTIONS OF SUSTAINABILITY
Much attention and analytical effort has been devoted in recent decades to
the drama associated with explicit defaults on public debts, but as scholars
have shown, such defaults are nothing new. 14 More unexpected perhaps is
the fact that more highly leveraged sovereigns have been able to borrow so
cheaply in recent years; given that they can, still larger increases in public
leverage are likely over the coming decades.
The US government has recorded budget deficits totaling $7.6 trillion
in the past decade (2006–15); nearly 25 percent of total spending in this
time has been financed by loans instead of tax revenues, nearly quadruple
the 6 percent share of spending that was borrowed in the post-World War
II decades through 2005. For comparison, 35 percent of US spending was
borrowed during the Great Depression (1930–39), and 51 percent during
its involvement in World War II (1941–45). Looking ahead, budget ana-
lysts project that US federal deficits, despite having narrowed somewhat
in recent years, will resume widening over the coming decade, such that
total US public debt will continue increasing, both in absolute amount and
relative to GDP (Figure 1.8).
Fast-rising public debts will remain a potential problem and thus a
crucial issue in the coming decades. Welfare states will continue to face
Notes: * Includes only federal debt held by the public, which is less than gross debt.
CBO Congressional Budget Office.
Source: National Commission on Fiscal Responsibility (2010, p. 10).
Figure 1.8 Three projections of the US debt*/GDP ratio (leverage),

2010–40
slow-growing tax revenues due to stagnant (because overtaxed and over-

regulated) economies, while spending still larger sums on dependent
and aging populations. Public debts will continue to mount so long as
democratic welfare states keep growing with no effective constitutional
limit. Until then, public finance scholars can only try to best gauge the
outer limits of public credit – that is, public debt capacity. In Chapter 5, I
examine some initial efforts along these lines. But in the next three chapters
I first assess classical, Keynesian, and public choice conceptions of public
debt.
NOTES
1. See the public debt databases of the IMF, World Bank, OECD, and BIS plus Tomz
(2007), Abbas et al. (2011), Jaimovich and Panizza (2010), Das et al. (2012), Enderlein
et al. (2012), Janus et al. (2013), Beers and Nadeau (2015), Bloch and Fall (2015),
Dembiermont et al. (2015), and Bova et al. (2016).
2. North and Weingast (1989), Weingast (1997), and MacDonald (2003).
3. Bastable (1903), Birck (1927), Brewer (1989), Brantlinger (1996), Mueller (1997),
Bonney (1999), Botticini (2000), Bordo and Cortes-Conde (2001), Schofield and
Mayhew (2002), Stasavage (2002, 2003, 2007, 2011, 2015), Cahill (2010), Cardoso and
Lains (2010), Graeber (2011), and Strangio (2013).
4. Webber and Wildavsky (1986), Shatzmiller (1989), Homer and Sylla (1991), Glaeser and
Scheinkman (1998), Armstrong (2003), and Dyson (2014).
5. Nelson (1949), Jones (1990), Shatzmiller (1989), Glaeser and Scheinkman (1998), Reed
and Bekar (2003), Brook (2007), and Cahill (2010).
6. The prejudice persists today: Pollin (1996), Hudson (2010), Krugman (2011a, 2014),
Konczal (2013), and Baiman (2014).
7. Suter (1992), Coleman (1999), Skeel (2003), and Mann (2009).
8. Bordo and Rockoff (1996) and Esteves (2013).
9. R. Hamilton (1816), E.J. Hamilton (1947), North and Weingast (1989), Root (1989,
1994), Dickson (1993), Brewer (1989), Homer and Sylla (1991), Neal (1993), Bonney
(1999), Hoffman and Norberg (2002), Stasavage (2003, 2007, 2011), Johnson (2006),
Dincecco (2009), and Carey and Finlay (2011).
10. Boltho and Glyn (2006), Altman and Haass (2010), and Dincecco (2010).
11. Ross (1892), Bordo and Rockoff (1996), Sylla and Wilson (1999), Selgin and White
(2005), Dove (2012), and Murphy (2013).
12. Timberlake (1978, 2012), Goodhart (1988), Toniolo (1988), Volcker (1990), Vaubel
(1997), and Fry (1997).
13. Selgin and White (1999), Wood (2012), and Salsman (2013a, 2013b).
14. Eichengreen and Portes (1986), Suter (1992), English (1996), Sturzenegger and
Zettelmeyer (2006), Kohlscheen (2007), Reinhart and Rogoff (2009), Oosterlinck
(2013), Rampell (2013), Tomz and Wright (2013), Beers and Nadeau (2015), Altamura
and Zendejas (2016), and Reinhart et al. (2016).
2. Classical theories of public debt
Classical theories of public debt in the eighteenth century were developed
during the Enlightenment, a period dominated by respect for reason,
science, and liberal ideas, a greater appreciation (relative to the medieval
times) for the virtues of self- interest, the benefits of commerce and
finance, and the need for constitutionally limited and rights-respecting
government. This political-legal context proved crucial to the development
of public credit and debt and theories about each.1
2.1 PUBLIC DEBT AND CONSTITUTIONALISM
Britain’s Glorious Revolution of 1688 revolutionized and institutional-

ized modern creditor-debtor relations, as it did usury, which was less
denounced as exploitative and increasingly defended as savings lent to
borrowers who gained by it and thus obliged to compensate lenders. The
spread of a capitalist spirit was also crucial to diversification beyond
agriculture – to commerce, finance, and manufacturing. Private capital
markets expanded with the growth of foreign trade, banking, and public
finance (taxing and borrowing). The “financial revolution,” whereby debt
and equity became liquid securities tradable on organized exchanges, both
caused and reflected growth in prosperity.
Without exception, but with some variation, the leading classical
economists – David Hume, Adam Smith, David Ricardo, Jean-Baptiste
Say, and John Stuart Mill – believed government should live within its
means and that its means should be limited. Taxes should be light and the
sovereign’s tasks restricted to military defense, law and order, and security
of life, liberty, property, and contract. Beyond this government might
provide public schooling and infrastructure (roads, bridges, canals), but
little more.
For the classical economists governments must be as prudent as house-
holds; they must balance budgets and refrain from burdensome debt
accumulations. Borrowing should be reserved for war, or for p roductive
infrastructure, not ordinary outlays – and then repaid as soon as p ossible.
The classical theory denied that deficit spending added anything to
30
Classical theories of public debt 31
roduction; indeed, it only diverted private savings from productive pur-

p
poses. The theory held that overindebted states courted national economic
ruin. Britain was the more prudent fiscal role model, due partly to its polit-
ical system being aristocratic-oligarchic rather than monarchic or demo-
cratic. France, in contrast, was monarchical until 1789, then anarchical,
then Napoleonic-dictatorial (1797–1815), then monarchical again under
the Bourbon Restoration (1815–30), and thereafter more democratic and
socialist. A third and arguably superior model was the United Provinces
(Netherlands); it was scrupulous fiscally and a global creditor without
being militaristic.
The prudent public debtors in this period made credible commit-
ments, fiscally and monetarily. They followed a balanced budget norm,
at least in peacetime, and established sinking funds to ensure repayment
of distant principal obligations. They abided by the rules of the classical
gold standard (in Britain’s case, from 1717 to 1821), which ensured sound,
stable, and non-politicized money. Montesquieu, who influenced America’s
founders in framing a new federal government in 1787–88, and Alexis de
Tocqueville, who observed the spread of democracy during America in its
first few decades, opposed excessive use of public debt. This was also the
view of David Hume, Adam Smith, David Ricardo, and Jean-Baptiste Say.
In what would become a famous thought experiment, Ricardo posited
that the real burden of government was its spending, regardless of whether
tax financed or debt financed; in either case resources were drawn from
the private sector and diminished prosperity. He further imagined that
people would treat new public debt as deferred taxation; they’d save more
and bequeath more wealth to posterity, so it could service the larger future
debts. Dubbed the “Ricardian equivalence” theorem in the 1970s, it was
used to reject Keynesian claims that chronic deficit spending could boost
aggregate output; yet others doubted the implication that posterity could
be freed of debt burdens.
In Democracy in America (1835–40) Tocqueville posited that the more
a nation became democratic, with less constitutional protections of
property, the more likely its finances would deteriorate. J.R. McCulloch,
John Stuart Mill, and Karl Marx also wrote on public debt, the latter
advocating a “centralization of credit in the hands of the state” and
opposing the idea of repaying creditors; financiers in general were exploit-
ers, like capitalists, imposing “debt slavery.” From such views came the
later notion of “odious debt” – that any new state, whether established by
conquest or revolution, could justifiably repudiate the debts incurred by its
enemy predecessor.
Despite grim interpretations by influential writers in this period,
public debt expanded safely without much distress. Consequently,
some authors offered sanguine views, arguing that public debt was
preferable to oppressive taxation or monetary debasement, and could
prove beneficial for the state and economy alike, if managed prudently
(with a plan for e xtinguishment via sinking funds). Notable in this group
are Charles Davenant, Jean-François Melon, George Berkeley, Isaac de
Pinto, Sir James Steuart, Alexander Hamilton, and Thomas Malthus.
Some scholars interpret these “optimists” as precursors of the Keynesian
view that prevailed in the twentieth century, but in truth they lie between
overpessimistic classical views and overoptimistic Keynesian views.
In the United States during the classical period, Hamiltonian financial
principles drew more upon optimistic views of public debt, while
Jeffersonian financial principles embodied the pessimism of more widely
read classical thinkers. Alexander Hamilton and Thomas Jefferson differed
pointedly over whether government should borrow at all, whether it should
fully pay its debts (even when trading at a discount), whether the currency
in which debts were to be repaid should be gold backed and of uniform
consistency nationally, whether public obligations should extend to future
generations or instead be cancelled, and whether private banking was
legitimate. On all such questions Hamilton answered in the affirmative,
Jefferson in the negative.2
As with modern public debt theorists, most classical theorists devote
more attention to the incidence of public debt than to its causes and
most believe public debt is detrimental to a nation’s long-term survival,
even while acknowledging that such debt is most contracted in war,
when national survival is most at stake. Governments were reluctant to
test wartime patriotism with punitive taxation. If war was a temporary
emergency, borrowing could be a temporary expediency. Budget surpluses
and debt reductions would occur in peacetime. No deeper theory of public
debt causation seemed necessary; at most one asked why some nations
were war prone or why some waged longer wars. Ricardo thought easy
public borrowing, compared to the lesser pain of undertaxed citizens,
made states wage war more often and for longer than necessary.
Classical political economy lasted a century after Adam Smith’s Inquiry
Into the Nature and Causes of the Wealth of Nations (1776 [1937]), but
the classical economists had precursors and after 1870 their value theory
was recast in neoclassical form, away from cost-of-production theories
towards utility-based theories. Classical public debt theory reflected clas-
sical value theory – leading to suspicions of public debt as inherently
unproductive. The “marginal revolution” of Carl Menger, Stanley Jevons,
and Leon Walras in the 1870s emphasized utility theory and rejected the
labor theory of value that was so unique to the classical system (excepting
J.B. Say). Yet neoclassical public debt theory revived classical school
themes and retrieved them from the Marxian detour. The political trend
reflected in Bismarck’s German welfare state (1880s) and in America’s sub-
sequent populist-progressive era was away from laissez-faire and towards
interventionism. By 1920 the United States had a graduated federal income
tax (91 percent being the highest rate), a central bank (Federal Reserve),
and high public leverage (debt at 35 percent of GDP, due to World War I,
versus only 8 percent in 1900). There followed a century-long expansion
in the size and scope of most governments and public debts, even in
peacetime, which animated Keynesian theory amid rejections of classical
themes; national thrift was deemed dangerous and deficit spending seen as
a crucial economic stimulant.
Next I convey and assess classical views on the nature, history, moral-
political-economic causes, consequences, and sustainability of public debt.
2.2 EARLY THEORIES: DAVENANT, MELON,

BERKELEY, AND MONTESQUIEU
The first major work comes from Englishman Charles Davenant (1656–
1714), two decades after Britain’s Glorious Revolution (1688), when the
government began borrowing as a sovereign on the credit of the public
at large, represented by king and Parliament jointly, and not alone on the
king’s personal credit. Davenant, a pre-Revolution Tory MP who had lost
substantial capital in unpaid loans to Charles II, became an a uthority
on British public debt in the 1690s. According to Sir James Steuart, in
1767, “no person” besides Davenant “appears to have so thoroughly
understood” public debt at the time. In 1695 Davenant issues the Ways
and Means of Supplying the War, advising that Britain’s war versus the
Dutch be funded exclusively by excise taxes. The subtitle of his Essay Upon
the National Credit of England (1710) conveys his aim: “To Render the
Public Credit Highly Beneficial to the Government, Trade and People of
this Kingdom.” No critic of public debt, Davenant merely tries to place
it on sounder footing. British officials had been in constant conflict with
creditors, sometimes addressing their self-interest, but other times punish-
ing them for charging high interest. Davenant says public debts should be
of short maturity, to ensure their liquidity; he warns against long-term
bonds as volatile, illiquid, and prone to political abuse (default).
In the quarter-century following Davenant’s 1695 book, Britain’s public
debt nearly tripled, from £17 million to £47 million. As some writers
worried about the rising burden, Jean-François Melon (1675–1738), a
French mercantilist, declared, in A Political Essay Upon Commerce (1738),
that worry was unjustified, because “the debts of the state are debts owed
by the right hand to the left, by which the body will be in no way weakened
if it has the nourishment and is able to distribute it.” Thus Melon is the first
to argue, in effect, that regarding public debt “we owe it to ourselves” – that
the more a nation owes, the more it also owns. A bond is a debtor’s liability
yet also a creditor’s asset. New public debt entails no new net burden but
also no net wealth. Melon’s qualifiers are crucial: a state borrows safely
if it “has the nourishment” (tax revenues) to service its debt and if it “is
able to distribute” its debt (it has the credibility to attract buyers). Melon
also implies that public debt can become excessive if tax revenues are defi-
cient or bond buyers scarce (or demand high rates). “Countries of great
productions, and free from the dread of [the] revolutions which overturn
states, will always be, whether in peace or in war, wealthy and powerful
when the credits and the circulations are proportioned to their wants.”
Melon rejects claims that “an unlimited quantity of debt is advantageous”
to a nation, for that is “running into extremes.” He suggests that a limit
exists at which public debt is unsafe, but doesn’t specify. He denies that
some regime types are inherently more creditworthy. “Debts contracted
by republics are no better secured than others,” he writes, although “it is
to this credit that the republics owe their wealth and their power.” At root,
“the basis of credit is a security in the public contracts.” Melon is best clas-
sified as a realist on public debt, not as an optimist, as some might suggest.
Soon after Melon’s book appeared in 1734 he found support for his views
from philosopher George (Bishop) Berkeley (1685–1753), who touches
on the topic briefly in The Querist (third volume, 1737). Unlike Melon,
Berkeley is an optimist who sees no downside. “That which increases the
stock [public debt] of a nation,” he writes, is “a means of increasing its
trade,” and “the credit of the public funds” entails not only “a mine of
gold to England” but “the principal advantage that England has over
France [and] every other country in Europe.” Moreover, the “ruinous
effects of absurd schemes and credit mismanaged” isn’t attributable to
state-sponsored national banks, as long as they promote industry instead
of speculation. Soon thereafter, Nicolas Dutot (1684–1741) tries to refute
Berkeley’s sanguine view, in Reflexions Politiques sur les Finances et le
Commerce (1738). Dutot had worked at John Law’s French bank before
its collapse in the wake of the South Sea “bubble” (1720–23). Law, armed
with royal charters and a scheme to aid an underfunded French monarch,
tried to boost demand for French bonds with a fraudulent paper-money
bank; after a boom it busted, as did royal bonds. Dutot became a harsh
critic of public debt, as did Montesquieu (1689–1755).
In his Spirit of Laws (1752 [1777]) Montesquieu notes how “some have
imagined that it was for the advantage of the state to be indebted to itself:
they thought that multiplied riches by increasing the circulation.” But
“those who are of this opinion have confounded a circulating paper which
represents money, or a circulating paper which is the sign of the profits that
a company has, or will make by commerce, with a paper which represents
a debt. The two first are extremely advantageous to the state: the last can
never be so: and all that we can expect from it is, that individuals have a
good security from the government for their money” (Book XXII, Chapter
XVII, “Of Public Debts”). He questions the mercantilists’ aim of maximiz-
ing the domestic money supply (gold and silver); they believed sovereign
bonds induced people to hoard less money, freed them to pay more in taxes,
and served as a readier, more liquid asset source for the state. Montesquieu
rejects these claims and stresses the “inconveniencies” of public debt. First,
“if foreigners possess much paper which represent a debt, they annually
draw out of the nation a considerable sum for interest.” That would con-
found the mercantilist aim of having money flowing in rather than out of
a nation. Second, “a nation that is thus perpetually in debt, ought to have
the exchange very low.” Third, “the taxes raised for the payment of the
interest of the debt are a hurt to the manufactures, by raising the price of
the artificer’s labor.” Fourth, public debt “takes the true revenue of the state
from those who have activity and industry, to convey it to the indolent; that
is, it gives the benefits for laboring to those who do not labor, and clogs
with difficulties the industrious artist.” All told, he c oncludes, “I know of
no advantages.” Clearly, Montesquieu is a public debt pessimist. It creates
no new wealth. It’s a liability exchanged for an asset (money) given by a
lender, and it may even diminish wealth to the degree it raises business
costs, rewards indolence, and saps incentives to produce. He surmises
that “people are thrown perhaps into this error” because they believe “the
paper which represents the debt of a nation is the sign of riches.” They are
deluded: seeing no decline in the value of public debt they think “it is a
proof that the state has other riches besides,” because it seems “none but
a rich state can support such paper.” People are contradictory when they
claim that public debt “is not an evil because there are resources against it”
yet also “an advantage, since these resources surpass the evil.”
Elsewhere in the Spirit of Laws, Montesquieu addresses debt repay-
ment (Book XXII, Chapter XVIII, “Of the Payment of Public Debt”).
“There should be a proportion between the state as creditor and the state
as debtor,” he contends, for “the state may be a creditor to infinity, but it
can only be a debtor to a certain degree, and when it surpasses that degree,
the title of creditor vanishes.” Here he wonders about a state’s maximum
borrowing capacity. It’s already well known that sovereigns default, but it
isn’t yet clear what principles should govern limits. Credibility is crucial:
“If the credit of the state has never received the least blemish, it may do
what has been so happily practiced in one of the kingdoms of Europe
[England]; that is, it may acquire a great quantity of specie, and offer to
reimburse every individual, at least if they will not reduce their interest.”
But this is best achieved by a sinking fund (where the state must “pay every
year a part of the capital”); this boosts creditors’ confidence that bonds
will be repaid. It also fosters a lower borrowing rate.
Sinking funds certainly weren’t a failsafe way to assure wary bondholders.
British finance minister Robert Walpole created the first fund in England
in 1717, but in 1731 it was raided by Parliament to fund n on-debt spend-
ing. Still, Montesquieu saw England as exceptional: a public debtor that
kept its promises, while others (like France) were frequently irresponsible
about credit. Deadbeats could especially benefit by a sinking fund, accord-
ing to Montesquieu, for “when the credit of the state is not entire, there
is a new reason for endeavoring to form a sinking fund, because this fund
being once established, will soon procure the public confidence.” Here
he backtracks a bit on his pessimism and acknowledges cases when risky
public debt is made safe.
On regime types, Montesquieu believes republics better maintain their
credit than monarchies, and constitutionally-limited monarchies better
than absolutist monarchies. Regimes that follow a rule of law earn the
confidence of the law- abiding and wealthy, who lend most; unfaith-
ful sovereigns are capricious and risky. A republic “in its own nature”
is “consistent with its entering into projects of a long duration” and so
needn’t place as much capital in a sinking fund; a monarchy, in contrast,
is less trusted and so must set aside more in its sinking fund, or else pay a
higher interest rate.
As for securing stable tax revenues to service debt, Montesquieu advises
reliance on a wide tax base; if only the rich are taxed, they’re made to pay
for their own interest income, but it’s risky. “The regulations ought to be
so ordered, that all the subjects of the state may support the weight of the
establishment of these funds,” he writes, “because they have all the weight
of the establishment of the debt.” Montesquieu identifies four classes
who service public debts: land proprietors, trade merchants, laborers-
artificers, and annuitants. The last class, typically the richest, should be
taxed relatively more (they “ought least to be spared” taxes) because they
are “entirely passive, while the state is supported by the active vigor of the
other three.” Montesquieu endorses the false and prejudicial anti-rentier
premise held by most classical theorists: that financiers are not astute
judges of productive ability and rational allocators of remunerative capital
but instead unproductive and parasitical. At least he opposes overtaxing
them, for they “cannot be higher taxed without destroying the public con-
fidence, of which the state in general, and these three classes in particular,
have the utmost need.” The paradox is plain: the “passive,” supposedly
superfluous creditor is also crucial to prosperity and indispensable to a

sovereign’s sustenance. A state might be within its “rights” to breach its
credit, but onlookers may react badly. “As a breach in the public faith
cannot be made on a certain number of subjects without seeming to be
made on all,” Montesquieu warns, and “as the class of creditors is always
the most exposed to the projects of ministers,” “the state is obliged to give
them a singular protection, that the part which is indebted may never have
the least advantage over that which is the creditor.”
2.3 DEBATE DEEPENS: HUME, STEUART, AND

SMITH
In his essay, “Of Public Credit” (1752 [1987], Part II, Essay IX), David
Hume (1711–76) insists that sovereign borrowing breeds “poverty,”
national “impotence,” and “subjection to foreign powers.” It is, he warns,
“a practice which appears ruinous, beyond all controversy.” Hume is a debt
pessimist. Indeed, he predicts that Britain will be insolvent in under a half-
century – that is, by 1800. “Either the nation must destroy public credit,
or public credit will destroy the nation,” he contends, and adds that he’d
prefer the destruction of public credit, because creditors are outnumbered
by citizens unfairly harmed by the burdensome taxes needed to service
large debts. Hume doesn’t explain why public debt defaults or repudiations
won’t also inflict harm on a nation.
In the half-century before Hume wrote “Of Public Credit,” Britain’s
public debt more than quintupled, from £14 million (1700) to £77 million
(1750). By the time of Hume’s death in 1776 the debt had risen to
£127 million; had he seen it climb to £427 million by 1800 he would have
felt his forecast vindicated. Yet Britain’s public debt peaked at £819 million
in 1819, after the Napoleonic Wars (1803–15), and declined steadily
thereafter to just £569 million by 1900. Far from being “ruined,” the
nineteenth century was the heyday of Britain’s empire; peace reigned and
output boomed. Of course, GDP data weren’t available in Hume’s time;
yet he and most classical theorists rarely cited any statistics that did exist
and might have provided context. Thus, few were debt realists. They’d cite
absolute levels of public debt but not relate them to a sovereign’s capacity
to generate the tax revenues necessary for debt service. Data now in hand,
we now know that Britain’s public debt increased from just 22 percent
of GDP in 1700 to 105 percent in 1750 before peaking at 255 percent in
1819; thereafter, public leverage (public debt/GDP) declined to 100 percent
(1876) and a low of 25 percent before World War I (see Chapter 1,
Figure 1.1). While Hume correctly foresaw a rise in Britain’s debt level,
he overestimated its relative magnitude and burden; given his pessimism,

he could never predict the steady, multi-decade decline in Britain’s public
leverage after 1819.
The state of Britain’s debt had bothered Hume as early as 1741, in
his essay “Of Civil Liberty” (1741 [1987] Part I, Essay XII). There he
suggests that no honorable nation becomes beholden to “financiers,”

those he derides as “a race of men rather odious to the nobility and the
whole kingdom.” Popular states, Hume argues, are more prone than other
types to depend slavishly on money-lenders (presumably, the “masters”).
He concedes that “monarchical governments have approached nearer to
popular ones, in gentleness and stability,” but “they are still inferior” to
republics, except in respect to public debt. In monarchy “there is a source
of improvement, and in popular governments a source of degeneracy,”
and in the latter “the source of degeneracy, which may be remarked in free
governments, consists in the practice of contracting debt, and m ortgaging
the public revenues, by which taxes may, in time, become altogether
intolerable, and all the property of the state be brought into the hands of
the public.” Hume recounts how “among the moderns, the Dutch first
introduced the practice of borrowing great sums at low interest, and have
well-nigh ruined themselves by it.” He notes that absolute monarchs (as in
France) have mishandled debt, but “as an absolute prince may make a
bankruptcy when he pleases, his people can never be oppressed by his
debts.” In “popular governments,” in contrast, “the people, and chiefly
those who have the highest offices, being commonly the public creditors,
it is difficult for the state to make use of this remedy, which, however it
may sometimes be necessary, is always cruel and barbarous. This, therefore
seems to be an inconvenience, which nearly threatens all free governments;
especially our own, at the present juncture of affairs.” For Hume, debt
repudiation is a viable “remedy,” although “cruel and barbarous” in more
popular states than absolutist ones, for there public bonds are more widely
held, so more suffer.
It’s worth exploring further Hume’s claim that public debt differs under
different political regimes. “If the prince has become absolute,” he writes,
“it is so easy for him to increase his exactions upon the annuitants, which
amount only to the retaining money in his own hands,” for “the whole
income of every individual in the state must lie entirely at the mercy of the
sovereign.” On the contrary, in a popular state reliant on the acquiescence
of taxpayers, when “the consent of the annuitants be requisite for every
taxation, they will never be persuaded to contribute sufficiently even to
the support of government” because “the diminution of their revenue
must in that case be very sensible” and “would not be shared by any other
order of the state, who are already supposed to be taxed to the utmost.”
Republics usually impose light tax burdens, so can’t easily service public
debts; in contrast, “where a government has mortgaged all its revenues,”
it “necessarily sinks into a state of languor, inactivity, and impotence.”
Popular states are more secure electorally, yet more precarious fiscally.
In “Of Public Credit” (Part II, Essay IX) Hume says he prefers ancient
to modern methods of public finance. In ancient times states accumu-
lated treasure in advance of emergencies (mainly war) because they were
unable or unwilling to borrow when trouble arrived. He notes how public
borrowing is a more recent (seventeenth-century) phenomenon, but insists
it burdens future generations (“posterity”) and that “ancient maxims are,
in this respect, more prudent than the modern” ones. He doesn’t explain
why, in the absence of debt, no equivalent burden is felt by current gen-
erations who must pay the taxes necessary to meet emergencies; instead
he assails “our modern expedient, which has become very general. . .to
mortgage the public revenues, and to trust that posterity will pay off
the encumbrances contracted by their ancestors.” It’s “a practice which
appears ruinous, beyond all controversy.” For Hume, fiscal maxims in the
political realm should mirror those in a household, “for why should the
case be so different between the public and an individual, as to make us
establish different maxims of conduct for each? If the funds of the former
be greater, its expenses are also proportionately larger” and although
“its resources be more numerous, they are not infinite.” Yes, “abuses of
[accumulated] treasures can be dangerous, either by engaging the state
in rash enterprises, or making it neglect military discipline, in confi-
dence of its riches,” but “the abuses of mortgaging are more certain and
inevitable: poverty, impotence, and subjection to foreign powers.” Hume
prefers that public funding rely on ex ante treasure, not ex post borrowing.
Reiterating the theme of his 1741 essay (“Of Civil Liberty”), that popular
governments are more prone to “mortgaging posterity,” in his 1752 essay,
“Of Public Credit,” Hume posits a motive: “It is very tempting to a
[finance] minister to employ such an expedient, as enables him to make a
great figure during his administration, without overburdening the people
with taxes, or exciting any immediate clamors against himself. The prac-
tice, therefore, of contracting debt will almost infallibly be abused, in every
government. It would scarcely be more imprudent to give a prodigal son
a credit in every banker’s shop in London, than to empower a statesman
to draw bills, in this manner, upon posterity.” Hume believes “every
government” is tempted to spend on current citizens with funds extracted
from yet-born future citizens, but the temptation is greater in popular than
in autocratic states. He adopts what’s now called the “public choice” view
(see Chapter 4). Although he doesn’t ignore the benefits of public debt, he
believes they’re eclipsed by its hazards and “degeneracy.” Public securities,
being safe and liquid, serve as near money, can be pledged as collateral
for private loans, and are a means to hold interest-earning capital. Since
“national debts furnish merchants with a species of money that is con-
tinually multiplying in their hands, and produces sure gain, besides the
profits of their commerce,” they “enable them to trade upon less profit,”
which “renders the commodity cheaper,” “causes a greater consumption,”
“quickens the labor of the common people,” and “helps to spread arts and
industry throughout the whole society.” Here Hume seems to be a realist.
He concedes that “more men, with large stocks and incomes, may naturally
be supposed to continue in trade, where there are public debts,” and “this
is of some advantage to commerce,” by “promoting circulation” and
“encouraging industry.” This should increase national income and lighten
public leverage, but Hume misses the implication; despite conceding that
public debt might encourage industry, he never relates debt to income. He
is a debt pessimist, not a realist.
Hume’s hostility towards financiers only intensifies his opposition to
public debt. Instead of despising investors for holding public rather than
private bonds, he despises public bonds because of his prejudice that
their holders are unproductive rentiers. For Hume these “are men who
have no connections with the state,” unlike landlords, because they are
left free to “enjoy their revenue in any part of the globe in which they
choose to reside,” and tend to “live anonymously,” and to “naturally
bury themselves in the capital or in great cities,” where they “sink into
the lethargy of a stupid and pampered luxury, without spirit, ambition,
or enjoyment.” He disdains the financier’s lifestyle as a sin against “all
ideas of nobility, gentry, and family.” He’s bothered that liquid securities
“can be transferred in an instant, and being in such a fluctuating state,
will seldom be transmitted during three generations from father to son,”
and that this form of wealth will “convey no hereditary authority or credit
to the possessor.” If so, society’s static hierarchy will erode, until “the
several ranks of men, which form a kind of independent magistracy in
a state” “are entirely lost.” In consequence, “the middle power between
king and people” ( landholders) will disappear and “a grievous despotism
must infallibly prevail.” Destitute landholders will be “unable to make any
opposition” to the growing power of the rentiers. Honest government will
be sacrificed to the financial class, with elections “swayed by bribery and
corruption alone.” Absent a c onservative hierarchy, “no expedient remains
for preventing or suppressing insurrections” or “resisting tyranny.” Hume
never proves that financial liberty breeds political tyranny, but his theme is
echoed decades later by Marx, Keynes, and Piketty.
For Hume the hazards of public debt far outweigh the benefits, yet
none of the five hazards he names can possibly diminish the level or
growth rate of national income. First, he warns, “national debts cause a

mighty confluence of people and riches to the capital, by the great sums,
levied in the provinces to pay the interest.” That “so many privileges
should be conferred on London, which has already arrived at such an
enormous size, and seems still increasing,” is against the public interest.
Metaphorically, “the head is undoubtedly too large for the body.” Yet
Hume praises London as a “great city,” “happily situated,” and believes
“its excessive bulk causes less inconvenience” than many smaller capitals.
It’s an odd claim. Hume’s main complaint is that public debt concen-
trates citizens and wealth in cities; he thinks it problematic that London
is becoming the world’s financial capital. Second, although public bonds
are liquid near monies, they tend to “banish gold and silver from the most
considerable commerce of the state,” to “reduce them to common circula-
tion,” and raise the cost of living. Third, with new public debt comes new
taxes “levied to pay the interest of these debts,” which raises labor costs
while oppressing “the poorer sort.” Fourth is the danger that “foreigners
possess a great share of our national funds,” which may, eventually, entail
a “transport of our people and our industry” out of Britain. Fifth, Hume
worries that public bonds reside “in the hands of idle people, who live
on their revenue,” and that if the bond supply expands, so will idleness.
Public debts will give “great encouragement to a useless and inactive life.”
The last objection reflects his disdain for the financial class and his doubt
that any p roductive activity fostered by public debt will prove sufficient to
service it. An accumulation of debt can spur industry and prosperity, but
also sloth and idleness. Pessimistically, Hume contends the latter outbal-
ances the former, over time. Today this is called “financialization,” the
thesis that as capitalism matures its finance sector crowds out others and
causes systemic, system-crushing imbalances.
Hume’s third objection, that new public debt implies an extra future
tax burden with deleterious effects on the economy, is the only one that
pertains to a nation’s prosperity and capacity to service debt. For Hume,
“it will scarcely be asserted that no bounds ought ever to be set to national
debts,” and it is false to believe that no tax burden could be too high, in
effect that “the public would be no weaker, were twelve or fifteen shil-
lings in the pound, land-tax, mortgaged, with all the present customs
and excises.” In Hume’s time, Britain’s pound consisted of 20 shillings, so
“twelve or fifteen shillings in the pound” meant a ratio of 12 to 20 and
15 to 20, respectively, or tax rates of 60 percent and 75 percent. These
weren’t actual British tax rates at the time, but Hume uses them to make
his dire prediction that public debt will prove ruinous. He asks readers to
“suppose the public once fairly brought to that condition, to which it is
hastening with such amazing rapidity,” with land taxed at “eighteen or
nineteen shillings in the pound” (90–95 percent), “for it can never bear the
whole twenty” (100 percent), and to further suppose that “all the excises
and customs to be screwed up to the utmost which the nation can bear,
without entirely losing its c ommerce and industry,” then further imagine
“all those funds are mortgaged to perpetuity,” to the point when no new
tax can serve “as the foundation of a new loan.” By such fiscally punitive
methods “the seeds of ruin are here scattered.” Blame debt, he says, not
taxes or outlays. He doubts that in Britain “any future ministry will be
possessed of such rigid and steady frugality, as to make a considerable
progress in the payment of our debts.”
Britain’s top tax rates in Hume’s time weren’t close to 60 percent,
let alone 95 percent, and only a few decades later (1798) it enacted an
income tax (discontinued in 1816), so revenue sources expanded. Defying
Hume’s skepticism, between 1750 and 1800 Britain’s debt jumped more
than five-fold, from £78 million to £427 million, but her tax revenues
increased seven-fold, from £7.4 million to £50.3 million, and the share of
public spending devoted to public debt service in 1800 was identical to the
share in 1750: 33 percent (Churchman, 2001, pp. 129–31). Hume falsely
presumed that a rising public debt necessitated rising tax rates that reached
confiscatory levels and destroyed incentives to produce, while depriving
government of the revenues needed to service debt.
Given Hume’s analytical ambiguities and dearth of statistics, he’s
reluctant to project national insolvency, although he’s certain it’ll come.
“Britain is visibly tending” toward the five “disadvantages” of public debt,
he warns, “not to mention the numberless inconveniencies, which cannot
be foreseen, and which must result from so monstrous a situation as that of
making the public the chief or sole proprietor of land” (1752 [1987], Part
II, Essay IX). Britain’s insolvency is a “not very remote” event; indeed, he
would “to assign to this event a very near period, such as half a century,”
or 1800. He notes that predecessors have wrongly forecasted national
insolvency, that he’d be more specific “had not our fathers’ prophecies of
this kind been already found fallacious, by the duration of our public credit
so much beyond all reasonable expectation.” He is “more cautious than to
assign any precise date” to a bankruptcy and is simply “pointing out the
event in general.” It’ll happen somehow, someday, but he can’t say how or
when. Eschewing any definitive metric, Hume nevertheless thinks “it may
not be difficult to guess at the consequences” of Britain’s debt, for “it must,
indeed, be one of these two events; either the nation must destroy public
credit, or public credit will destroy the nation.” For Hume “it is i mpossible
that they can both subsist, after the manner they have been hitherto
managed, in this, as well as in some other countries.” There’s an inherent
conflict between sovereign debt and political sovereignty, and since Hume
prefers that Britain survive as a nation, he prefers her credit be destroyed

before she is. Of two possible solutions, only one preserves sovereignty,
the “natural death” of public debt, a deliberate default or repudiation; the
other solution entails the “violent death” of public debt, when the nation,
rendered weak by its fiscal burdens, is conquered by a foreign rival that
summarily repudiates its victim’s odious debt as not its own to pay.
Might England be conquered if she doesn’t conquer her debt addiction?
Hume makes light of the consequences of public debt dying a “natural
death” – which in truth is a murderous plan, since deliberate (per Hume,
“voluntary” default). The result is that “the whole fabric [of credit],
already tottering, falls to the ground, and buries thousands in its ruins,” yet
in time the buried rise to lend again, for “so great dupes are the g enerality
of mankind, that, notwithstanding such a violent shock to public credit,
as a voluntary bankruptcy in England would occasion, it would not prob-
ably be long before credit would again revive in as flourishing a condition
as before.” It’s safest to lend to a sovereign after it has repudiated large
burdens; despite its diminished credibility, it soon finds “great dupes”
greedy enough to lend again. Yet Hume insists such creditors act rationally,
for “a prudent man, in reality, would rather lend to the public immediately
after we had taken a sponge to our debts, than at present,” just as much as
“an opulent knave, even though one could not force him to pay, is a prefer-
able debtor to an honest bankrupt.” The knave “may find it in his interest
to discharge his debts,” while honest bankrupts are willing but unable to
pay. “Men are commonly more governed by what they have seen, than
by what they foresee, with whatever certainty,” and “promises, protesta-
tions, fair appearances, with the allurements of present interest, have such
powerful influence as few are able to resist.” Creditors are like “mankind
are, in all ages, caught by the same baits, the same tricks, played over and
over again.”
Given excessive public indebtedness, Hume asks, “What then is to
become of us?” Will Britain’s debt suffer a natural or violent death? The
sovereign, he says, mustn’t await events but control them; he advises
something like a Biblical jubilee, a forgiving of debts, based on a view
of debts as “slavish” oppression. “Were we ever so good Christians, and
ever so resigned to Providence,” he writes, “this, methinks, were a curious
question, even considered as a speculative one,” and “it might not be
altogether impossible” to secure such a remedy. Excessive debt can be cured
by sacrificing the greedy few (public bondholders) for the sake of the many
(citizens), for the greater good of king and country. Compared to millions
of citizens burdened by taxes to service public debts, Hume estimates that
“all the creditors of the public” total just 17 000 people, and though a
default would render them “the lowest, as well as the most wretched of the
people” it would be worthwhile, to save the nation. Laursen and Coolidge

(1994) reveal that until death Hume never abandoned his view that public
debt entailed public “degeneracy” or that Britain would become insolvent.
Hont (1993), less critical of Hume’s views, traces them not to his distaste
for financiers but to his hatred of wars.
British jurist William Blackstone (1723–80) also addressed public debt,
when writing on royal revenues in his Commentaries on the Laws of England
(1753 [1765–69]). Blackstone influenced many of America’s founders,
especially Alexander Hamilton, who cited him most of all. A debt pes-
simist, Blackstone in Book I, Chapter VIII (“Of the King’s Revenue”)
attributes Britain’s debt to a large increase in spending on administration
and war after the Revolution of 1688, and to a reluctance to tax citizens.
For political leaders “it was not thought advisable to raise all the expenses
of any one year by taxes to be levied within that year, lest the unaccus-
tomed weight of them should create murmurs among the people.” Instead:
“the policy of the times [was] to anticipate the revenues of their posterity,
by borrowing immense sums for the current service of the state, and to
lay no more taxes upon the subject than would suffice to pay the annual
interest of the sums so borrowed: by this means converting the principal
debt into a new species of property, transferable from one man to another
at any time and in any quantity.”
Initially he finds a net benefit, for “by this means the quantity of property
in the kingdom is greatly increased in idea, compared with former times,”
but it’s a mere idea, for real property is “not at all increased in reality,” and
“we may boast of large fortunes, and quantities of money in the funds,”
but “where does this money exist?” In “public faith, in p arliamentary
security” only; in fact what’s been pledged to creditors is “the land, trade,
and personal industry of the subject,” which are “ diminished in their true
value just so much as they are pledged to answer.”
A nation is impoverished by public debt, according to Blackstone.
Any creditor’s property (a bond) is a demand on the debtor, and when
government is the debtor, the creditor’s property consists of “a certain
portion of the national taxes.” However much the creditor is enriched,
the nation, in paying the interest, is poorer; public debt doesn’t boost
national wealth. “The only advantage that can result to a nation from
public debts is the increase of circulation, by multiplying the cash of the
kingdom,” so “a certain proportion of debt seems therefore to be highly
useful to a trading people.” Yet “what that proportion is, it is not for me
to determine.” Blackstone is “indisputably certain” that public debt is a
net harm, “that the present magnitude of our national encumbrances very
far exceeds all calculations of commercial benefit, and is productive of the
greatest inconveniences.” This is so not only because of “the enormous
taxes that are raised upon the necessaries of life for the payment of the
interest of this debt,” which hurt the economy, but because more money
only debases money’s value and external debt causes exports of wealth, to
pay interest. Even domestically held public debt ruins the economy because
“the active and industrious subject” is taxed to pay interest to “the indolent
and idle creditor.” Last, a large public debt “weakens the internal strength
of a state, by anticipating those [tax] resources which should be reserved to
defend it in case of war.” He doesn’t believe “we owe it to ourselves.”
Hume and Blackstone are avowedly pessimistic about Britain’s debts,
but the pessimism intensifies in Malachy Postlethwayt (1707–67), who
pens Great-Britain’s True System (1757), with this subtitle: “Wherein is
Clearly Shown that an Increase of the Public Debts and Taxes Must, in a
Few Years, Prove the Ruin of the Moneyed, the Trading, and the Landed
Interests.” A young Alexander Hamilton is initially influenced by this
work, in writing his first essays in 1774–75, when he predicts a British
insolvency on the eve of war with America’s colonies, but in time he
becomes a debt realist and Postlethwayt’s work is interpreted mainly as a
warning not to accumulate excessive public debt.
What of the relation of mercantilism and public debt? Adam Smith
coined the term “mercantile system” to convey the idiosyncratic politi-
cal economy dominant in the two centuries before 1776. In contrast to a
laissez-faire approach, mercantilism commands sovereigns to intervene
to maximize net exports of goods and net imports of money (precious
metals), with the aim to enrich not merchants but the treasury. Contrary
to contemporary accounts,3 which presume mercantilism to have opti-
mistic views of public debt, in truth it has no necessary predilection to
optimism, pessimism or realism; it worries about public debt only to the
extent it entails a net outflow of cash. In wanting a perpetual trade surplus,
the mercantilist wants a perpetual capital deficit (a net inflow of foreign
capital), a condition that public debt issuance neither favors nor disfavors.
In 1767, the last of the most influential mercantilist theorists, James
Steuart (1713–80), provides a sophisticated, sanguine view of public debt,
in An Inquiry into the Principles of Political Economy (1767 [1966]). No
advocate of laissez-faire policy, nevertheless Steuart endorses a constitu-
tionally limited state. He rejects Hume’s claim that public debts necessarily
deduct from prosperity or that Britain courts insolvency. He also insists
sovereigns should pay their debts. As we’ll see, Steuart’s work was fol-
lowed by two optimistic accounts – by Isaac de Pinto (1774)4 and Thomas
Mortimer (1772) – but Steuart’s approach, being more contextualized, is
realistic. Mercantilism is mistaken on many principles of political economy,
but Steuart, qua mercantilist, isn’t much mistaken on public debt. Hamilton
later incorporates much of this realism in his own debt theory.
Steuart (1767 [1966]) believes “the principles which influence the doctrine
of public credit are so few, and so plain,” that it’s surprising they’re so fre-
quently “plunged” into “obscurity.” For “a limited and free government”
three requisites are “essential to the firm establishment of public credit”
(p. 656). First, citizens must realize that servicing public debt requires tax
payments, hence some diminution of income; second, the state should
borrow only for the public’s (general) benefit; third, the state must earn the
confidence of creditors, by making ex ante provision for debt service and
fulfilling its promises. As a mercantilist, Steuart favors policies to ensure
ample supplies of domestic cash, so he wants Britain to have a “positive”
trade balance; he ignores the fact that when all nations adopt such policies,
interests clash and trade wars ensue. Mercantilists like Steuart fear markets
will fail to create sufficient sums of money and credit, causing higher inter-
est rates, deflation, and depression. They also mistakenly believe interest
rates equilibrate the supply and demand for money, whereas in truth they
equilibrate the supply and demand for credit (“loanable funds”). They
believe that more money lowers interest rates and that lower interest rates
are better for the economy. For Steuart, a key benefit of public bonds is
their liquidity, or near-money status; they supplement the existing money
supply, and thereby keep interest rates below where they’d otherwise be.
Public debt has many advantages, he argues, not least that it minimizes
the scope of taxation, which is favorable to production. It also augments
a nation’s “permanent income” by luring investment demand from cash
hoards. Public debt counteracts commercial stagnation by circulating
funds (via interest payments). Steuart believes problems arise only with
public debt held abroad, for then cash must be exported to pay interest; yet
public debt needn’t be a national hazard, as long as the state avoids chronic
deficit spending and adopts prudent methods (like sinking funds) of debt
service.
What of public debt holders? Unlike Hume and almost all debt theo-
rists, who see degeneracy, idleness, and corruption in financiers, Steuart
respects them and sees them as prudent and frugal, making possible invest-
ment, productivity, and prosperity, whereas prodigals consume wealth
and retard prosperity. Steuart also endorses the spirit of finance. “We
may easily conceive,” he writes, “that a moneyed interest, of a long stand-
ing, may have influence enough to produce a change upon the spirit and
manners of the people,” and in Great Britain he is pleased to see that “the
spirit of that nation is totally bent upon the support of public credit,”
because “their commercial interest depends upon it” (pp. 636–7). One
of the many “contingent consequences” of public debt is its power to
promote commerce, “to influence the spirit of the people, and make them
adopt the sentiments of the moneyed interest” (p. 639). He wants this
interest to succeed because “the prosperity of the state stands upon a pre-
carious footing” whenever “any one interest becomes too predominant.”
Fortunately, “the firm establishment of public credit” fosters “reciprocal
sentiments of good-will among the two great classes of people,” which
tends to “preserve a balance between them” (ibid.). He might have added
that sentiments of class warfare often arise from the age-old prejudice
against financers.
Like Hume, Steuart believes the state should be a nation’s sole sovereign,
and not sacrifice to any subclass of society, including public creditors;
unlike Hume, he believes sovereigns must never sacrifice or repudiate their
creditors. Steuart opposes defaults stemming not from “necessity” (when
a state is unable to repay) but from “expediency” (when a state is unwill-
ing to repay). Steuart (1767 [1966], p. 609) sees no latent conflict between
debtor and creditor; he extolls right principles to discover “the methods
for making them severally turn out to the best account not only for the
state, considered as a body politic by itself, but also for the individuals
which compose it.” He praises Britain’s handling of debt during the reign
of William III (1689–1702), because although its credit “was then in its
infancy,” it was “set upon the principle of a free and limited authority,
exercised by ministers of state, at all times responsible to Parliament at the
risk of their heads, in case of any open violation of the public faith.” The
constitutionally limited state “is the best of all securities against the bad
exercise of power” (p. 612) for “public faith stands upon the solid security
of an honest Parliament” (p. 615). In contrast, “when credit is in a languid
state, every expense of government must rise in proportion to the discredit
of the paper with which they pay” (p. 619). Despite Britain’s many wars in
the first half of the eighteenth century, and the vast rise in its public debts,
its credit remained unquestioned; it established sinking funds to protect
creditors and kept the pound as good as gold; as a result it also paid lower
interest rates (below 4 percent) than Continental sovereigns. Here Steuart
the realist brings context to public debt analysis: the extent of public credit,
pertaining to borrowing capacity. High public debts are serviceable if they
are within such capacity and well managed. “In one way or another,” he
writes, “all [public] debts contracted will disappear, either by being paid,
or by being abolished, because it is not to be expected that posterity will
groan under such a load any longer than convenient, and because in fact
we see no very old debts as yet outstanding, where interest has been regu-
larly paid out of a fund which has remained in the possession of the state”
(p. 636). If commerce remains vigorous, growth in tax revenues can keep
pace with higher debt service, and the creditworthy state can access new
loans at low rates, with proceeds used partly to repay old loans. This is a
realist position.
Steuart also explores the limits of public debt – including national

insolvency. “How far may debts extend?” “How far may taxes be
carried?” “What will be the consequence, supposing the one [taxes] and
the other [debt] are carried to the greatest height possible?” (p. 645).
These are his queries. Although debt pessimists perpetually predict
insolvency, the analytics behind it are usually the domain of realists.
First, public debt “may be increased to the full proportion of all that
can be raised for the payment of interest” (p. 646). If debt accumulates
but yields stay low, interest expense needn’t absorb a growing share of
tax revenues and debt may be safely increased. On the second question,
he notes that Britain’s property tax rate is four shillings in the pound,
or 4/20 (20 percent), and that Hume’s fear that it may reach 19 shillings
in the pound (95 percent) is alarmist. Britain’s current tax burden is
not great, nor will it become so; the nation could support higher debt.
Indeed, Britain’s public debt totaled £130 million in 1767, or 141 percent
of GDP; by 1800 it summed to £440 million, or 177 percent of GDP.
Yields remained low even as Britain’s leverage peaked at 259 percent in
1819; that high leverage preceded not national bankruptcy but a century-
long span of peace and prosperity, with budget surpluses and debt
redemptions that reduced leverage to 100 percent in 1860 and just 25
percent on the eve of World War I in 1914. Steuart knows it’s important
“to show where the constant mortgaging of a public revenue may end,”
but also believes he can “disprove the vulgar notion that by contracting
debts beyond a certain sum, a trading nation which has a great balance
in its favor must be involved in an unavoidable bankruptcy. To say that
a nation must become bankrupt to itself is a proposition which I think
implies a contradiction” (p. 647).
As a mercantilist eager to see exports exceeding imports, Steuart touts
the related cash inflow as a way to boost the economy and better service
public debt. It is “not necessary that public credit should ever fall, from
any augmentation of debts whatever, due to natives,” but surely “it must
fall as soon as the nation becomes totally unable either to export commodi-
ties equal to all her imports and foreign debts, or to pay off a proportional
part of the capital sufficient to turn the balance to the right side.” Thus
“the most important object in paying off debts, is to get quit of those
due strangers” (p. 654). Yet he also wants no default on bonds debts held
abroad, for “to break faith with strangers” and pursue a “glaring scheme
of treachery” will stop the circulation of money and credit and cause
“the ruin of industry” (p. 655). Domestically held debt he says we owe to
ourselves; it can’t bankrupt a nation, unlike externally owed debts. “The
idea of a nation’s becoming bankrupt to itself, I have always looked upon
as a contradiction; but that it may become bankrupt to the rest of the
world, is quite consistent with reason and common sense” (p. 653). In
1767 Steuart is “very far from supposing the present situation of England
to forebode the approach of any such disaster” (p. 654). Although he is a
realist, in this regard (external debt) he’s a pessimist, like so many other
classical theorists.
Steuart differs from Hume as well in opposing deliberate default: he
makes “no argument to prove that a scheme of a public bankruptcy is
either lawful, honorable, or expedient, if voluntarily gone into by a state,”
for that is “diametrically opposite to every principle of good government.”
If a government is unable to repay its debts, there’s a “proper method of
breaching faith,” and of “bringing credit decently to her grave when, after
being overstretched, it can no longer be supported” (p. 648). Sovereigns
should only default out of necessity, as a last resort, never deliberately, out
of expediency. Deliberate default harms not just creditors but also confi-
dence in sovereigns generally, which hurts many others. Creditors “would
lose all” but also “the trade of England would be undone” and “the multi-
tudes who live in consequence of the demand for their industry, from the
one and the other, would be reduced to misery.” Unlike Hume, Steuart
believes the multitude, mostly manual laborers, depend on financiers and
merchants; default harms employees because it harms their employers.
It’s naive to expect “that government shall find it expedient” to “use a
sponge for the public debts,” and “sacrifice the interest of all the creditors
in favor of the whole body,” “without hurting any interest in the state, that
of the creditors alone excepted” (p. 651). A policy of “total bankruptcy”
or an “abolition of taxes” would return Britain “to the situation it was
in before taxes and debts were known” – meaning: to a poverty-stricken
medieval era. The best way to service public debt is to make an ongoing
provision for it, by a sinking fund, or to borrow by the annuity method,
where interest and a portion of principal are repaid annually. This is
hardly an optimistic, proto-Keynesian position, as mercantilists are typi-
cally classed; it’s a realist position. Steuart specifies eight separate ways
to cut overindebtedness, what he calls “fair and honest expedients which
a state may employ to get rid of its debts, without any breach of public
faith, or without prescribing conditions of payments, which the creditors
are forced to accept against their will” (p. 663). For example, peacetime is
the best time to cut excessive debt, “a golden opportunity for diminishing
the public burden” (p. 667). For a state to accumulate debt in peacetime
is folly, and it risks a perpetual burden, since debt always rises most in
emergencies.5
Soon after Steuart’s 1767 book came one that claimed public debt
always enriches, a decidedly optimistic view. The book, by Isaac de Pinto
(1717–87), was An Essay on Circulation and Credit (1774):
I say that the national debt has enriched the nation. . . At every loan the gov-
ernment of England, by granting creditors the proceeds of certain taxes which
are pledged to pay the interest, creates a new, artificial capital, which did not
exist before and now becomes permanent, fixed, and solid. This capital, by the
agency of credit, circulates to the advantage of the public as if it were an actual
sum of money by which the state has been enriched. . . [Monies borrowed in
1760] were spent in great part within the nation itself. . .[and] only the subsidies
to other [foreign] states. . .were a pure loss. . . The enormous sum which com-
poses the national debt has never existed at one time; the magic of credit and of
the circulation of money has produced this mass of wealth by successive opera-
tions with the same coins. . . Public funds are the magnets which draw money. . .
Reflect then on these principles – the nature, the essence, and the effects of
public loans where properly made and employed. You will find that they effec-
tively enrich the state and do not impoverish it, that they double the moneyed
capitals, and consequently, the power of contracting more loans.
Pinto’s premise – that public borrowing and spending add to wealth – is

common among certain mercantilists, yet fallacious, because it forgets
that in the exchange two sums are drawn from the private sector while
only one is returned by state spending. There is a net loss, not a net gain,
for the private economy. Surely “the state has been enriched” by it, as
Pinto concedes, but the nation as a whole isn’t. First, a sum goes to the
state as a loan; second, the state spends the sum on goods and services;
third, goods and services are sold to the state. Thus two sums go to the
state while only one goes to the private sector; the latter surely retains an
asset, a sovereign bond, but its value depends on the sovereign’s ongoing
capacity to tax the private sector, which is but a deferred deduction from
national wealth. Pinto doesn’t claim that just any sum of debt suffices to
perform what he calls the “magic” of credit creation; he begs the question
and insists public loans enrich if they are “properly made and employed.”
Obviously, loans improperly employed don’t enrich. This is closer to the
realist approach.
As for public debt limits, Pinto (1774) concedes that a state might
“accumulate too great a debt,” but doesn’t specify a metric to gauge sus-
tainability. He agrees with Steuart that a state’s trustworthiness is best
sustained by a credible sinking fund, but denies that principal should be
repaid materially or entirely, even in peacetime, or even with a sinking
fund. Even if England could rid herself of all public debts she shouldn’t.
The curious advice reflects his optimistic view of public debt: since its issu-
ance creates net national wealth, extinguishing any part of it is a wealth
loss. In 1774 England owed £120 million and Pinto thought “it would
be very harmful to [England] not to preserve at least £60 million of its
artificial riches, the utility and necessity of which I have demonstrated.”
He isn’t troubled by his own resort to contradictory terms like “artificial
capital” or credit that circulates “as if it were an actual sum of money,” or

those that imply that newly issued public debt doesn’t really generate solid,
permanent wealth.
Thomas Mortimer (1730–1810), an Englishman who expands on Pinto’s
pro-debt themes, says it’s wrong to reduce public debts or establish sinking
funds, in his book The Elements of Commerce, Politics, and Finances
(1772). For Mortimer “public debt is a national good,” because “it raises us
fleets and armies more expeditiously than the mint could coin the precious
metals” (p. 365). Again we find praise for liquid public securities serving as
near-money animating the mercantilist notion that new money is crucial
to creating tangible wealth. Recounting Britain’s brief experience with
an “increase of paper credit,” Mortimer believes it promoted “a general
circulation of a new species of money, quickened industry and labor, and
augmented not only the value, but the demand, for the produce of every
art and manufacturer” (p. 380). Another advantage of debt finance in war
is avoidance of “tedious and oppressive modes [of fund-raising] formerly
practiced here, and still subsisting in France, such as heavy capitations, or
poll taxes, and monthly assessments on lands and personal property.” He
imagines debt finance displacing tax finance, which is possible only by a
perpetually rising debt, with new funds dedicated to repaying due funds.
He ignores the possible danger of debt growth beyond income growth. Can
public debt ruin a nation, as Hume (1752 [1987]) asserts? Mortimer denies
it: “This is the well-known postulate which has sounded the alarm to the
whole [British] kingdom, and has propagated a general apprehension con-
cerning the final consequence of the national debt.” He complains about
Hume’s ruinous influence:
Every speculative projector, every disappointed statesman, every pseudo-

patriot, every timid or hypocondraical [sic] adventurer in the public funds,
and all the ruined gamblers in Change Alley, have made [Hume’s essay, “Of
Public Credit”] their common text, and have filled our ears with tedious essays
and declamations on the approaching bankruptcy of the state, in times of war
adding to its horrors, and in the halcyon days of peace, disturbing its repose,
by their ill-judged intimations. But we shall easily silence the disciples, if we are
able to refute their master. (Mortimer, 1772, p. 368)
Leaning on Pinto, Mortimer tries to refute Hume’s debt pessimism, his

fears of national ruin, and his case for a default, noting how well British
public bonds have performed in the market, “notwithstanding all the
declamations” in Hume’s analysis. “Public credit has outlived the gloomy
prophecies of its bankruptcy,” he declares. It is now “in a more flourish-
ing condition at present than in any former time,” and in time it “will
support us triumphantly in twenty future wars against the united powers
of the house of Bourbon [France], securing to us, likewise, our unrivalled

commerce” (p. 366). In hindsight, we now know that Mortimer was correct:
Britain’s debt skyrocketed during the many subsequent wars it fought, to
the end of the Napoleonic Wars (1803–15), yet British bonds performed
well as yields stayed low. Echoing the pro-debt themes of Melon, Pinto,
and Mortimer, Robert Peel (1750–1830), whose son (of the same name)
later became Britain’s prime minister, issued The National Debt Productive
of National Prosperity (1780). Its theme was no longer novel but it
influenced the junior Pitt, and counted as the last optimistic account of
debt to appear for decades. Britain’s debt accumulated further during war
with the American colonies (1775–83), so observers still worried about the
burden and suspected Hume’s pessimism might still be warranted.
Adam Smith (1723–90), in The Wealth of Nations (1776 [1937]), rails
against public debt (“Of Public Debts,” Book V, Chapter III), mainly
on the grounds that it funds government spending, which he presumes
entails a non- productive dissipation of wealth (a premise shared by
later economists like Jean-Baptiste Say, David Ricardo, Robert Malthus,
J.R. McCulloch, and J.S. Mill). Malthus actually welcomed dissipation as a
way to absorb output “gluts.”
Only the last chapter of Smith’s 1000-page Wealth of Nations treats
public debt, so it receives less attention than his other theories (Nicholson,
1920 is an exception) and consequently plays a lesser role in today’s debate.
Yet Smith’s account is popularly held today, because it’s so pessimistic. His
memorable, oft-cited phrase is that public debt has “enfeebled” every state
that has tried it. He wants Britain’s debt extinguished entirely and at once,
if necessary by higher taxes, even if doing so splits or shrinks the empire.
On public debt Smith examines its origins, effects, servicing, and termi-
nation, in the last instance by sinking funds or default (whether explicit
or implicit, in the latter case by inflation, what he calls a “pretended
payment”). Although Smith is often cited for saying “what is prudence in
the conduct of every private family can scarce be folly in that of a great
kingdom,” in truth the phrase appears not in his analysis of public debt but
in Book IV, Chapter II of The Wealth of Nations, when he explains the ben-
efits of free trade (good bargains). Yet Smith certainly saw public finance
as analogous to household finance, a view later rejected by Keynesians but
revived by public choice theorists.
According to Smith, no specific regime type tends to borrow or borrow
excessively; monarchs and republics alike have done so. “The parsimony
which leads to accumulation has become almost as rare in republican as in
monarchical governments,” he says, noting how “the Italian republics and
United Provinces of the Netherlands are all in debt,” an exception being
the canton of Berne (Switzerland), but universally “the taste for some sort
of pageantry, for splendid buildings. . .prevails as much in the apparently

sober senate-house of a little republic, as in the dissipated court of the
greatest king” (Smith, 1776 [1937], p. 861). Smith contends that “the prac-
tice of funding has gradually enfeebled every state which has adopted it,”
starting in the Renaissance, with the Italian republics (Genoa and Venice),
and today they can only “pretend to an independent existence,” and “have
both been enfeebled by it.” Spain learned from Italian republics how to
borrow, and it too has been “enfeebled,” having been deeply indebted even
in the sixteenth century, long before England started borrowing. France
too “languishes under an oppressive load” of debt, despite her vast natural
resources; the Netherlands too is “enfeebled” by debt (p. 881). He makes
dire predictions based on the debts incurred by 1776, prior to the larger
ones to be incurred during the American Revolutionary War (1775–83) and
Napoleonic Wars (1803–15). “The progress of the enormous debts which at
present oppress, and will in the long-run probably ruin, all the great nations
of Europe,” Smith writes, “has been pretty uniform.” He worries that states
“have generally begun to borrow upon what may be called personal credit,
without assigning or mortgaging any particular fund for the payment of
the debt” (p. 863). States selectively dispense with sinking funds and other
vehicles designed (since 1716) to ensure that sums exist to repay principal
at maturity; public borrowing becomes more tenuous. Not only does Smith
believe public debts “enfeeble” states; they are even likely to “ruin” them.
Smith complains often that tax revenues aren’t sufficiently “liberated”
from the need to pay principal and interest, implying belief in some-
thing akin to “debt slavery,” as would later become part of Marxian debt
analysis. Smith doesn’t deny that public bonds are bought voluntarily, that
proceeds bestow benefits, or that solid public credit is an asset of better
administered states. “The security which [public debt] grants to the original
creditor, is made transferable to any other creditor,” he notes, “and from
the universal confidence in the justice of the state” it “sells in the market
for more than was originally paid for it,” so the financier who makes money
this way “increases his trading capital.” Creditors lend happily to credit-
worthy states, and such states happily borrow on easy terms, but given
“the facility of borrowing,” the state isn’t motivated to economize, save, or
reduce its debt. A commercial society is wealthier and saves more, but its
government is “very apt to repose itself upon this ability and willingness
of its subjects to lend it their money on extraordinary occasions” (p. 863).
Ironically, commercial (not martial) societies are best positioned to finance
wars and emerge victorious, but also to emerge more indebted.
Smith is chagrined that sovereigns in his time rarely record budget
surpluses in peacetime, for use in case of future war; instead, they borrow
for war (if possible) because spending spikes. The lack of peacetime
surpluses “imposes the necessity of contracting debt in time of war,” and

taxes won’t do the job in war, because they take too long to collect. The
nation at risk must act (finance itself) quickly. “An immediate and great
expense must be incurred in that moment of immediate danger, which will
not wait for the gradual and slow returns of the new taxes. In this exigency
government can have no other resource but in borrowing” (pp. 861–2). Of
course, states only reluctantly fund war by taxes: it rarely raises enough
funds and it risks patriotic disloyalty at a critical time. States borrow from
a “fear of offending the people, who by so great and so sudden an increase
of taxes, would soon be disgusted with the war,” and because “they are
enabled, with a very moderate increase of taxes, to raise, from year to year,
money sufficient for carrying on the war,” to raise “the largest possible
sum” with “the smallest possible increase of taxes.” In this way few feel a
financial (tax) pinch from war. “In great empires the people who live in the
capital, and in the provinces remote from the scene of action, feel scarce any
inconveniency from the war,” and even enjoy “the amusement of reading in
the newspapers [about] the exploits of their own fleets and armies,” ignor-
ing the likelihood that in peacetime their wealth will be “mortgaged for the
interest of the debt contracted in order to carry it on” (p. 872).
The economic effects of public debt are, for Smith, uniformly del-
eterious: it permits greater public spending, which he deems wasteful or
unproductive, and defers deferred taxes, which retard saving, capital accu-
mulation, and incomes. He rejects the claims of optimists like Pinto that
public debt adds to national wealth; it is not “the accumulation of a great
capital superadded to the other capital of the country,” nor “the means
of which its trade is extended, its manufactures multiplied, and its lands
cultivated and improved.” For Smith, the debt optimist “does not consider
that the capital which the first creditors of the public advanced to govern-
ment was, from the moment in which they advanced it, a certain portion of
the annual produce turned away from serving in the function of a capital,
to serve in that of a [tax] revenue,” and shifted “from maintaining produc-
tive laborers to maintain unproductive ones, and to be spent and wasted,”
“without even the hope of any future reproduction” (p. 877). A debt pes-
simist, Smith believes no public goods or services can be productive. He
concedes that no net loss arises when creditors trade their saving for a
public bond, but says the problem is that the funds go to an unproductive
(public) sector, whereas previously it was (or could have been) invested in a
productive (private) sector. Smith assumes that no private capital ever goes
unemployed; “all capitals” are devoted to “maintaining productive labor,”
so if creditors had “not advanced this capital to government, there would
have been in the country two capitals, two portions of the annual produce,
instead of one, employed in maintaining productive labor” (ibid.).
On fiscal incidence, Smith believes tax finance and debt finance alike
are disproportionately negative for savings, capital stock, and prosperity.
Whereas taxes reduce future levels of savings, and capital, debt destroys
existing savings and capital. “When the public expense is defrayed by
[debt] funding,” Smith writes, “it is defrayed by the annual destruction
of some capital which had before existed in the country,” by diverting
outlays from productive to unproductive labor. Some savings are pre-
served when borrowing lightens present tax burdens, and with public
borrowing “the frugality and industry of private people can more easily
repair the breaches which the waste and extravagance of government
may occasionally make in the general capital of the society,” but the
borrowing nonetheless “destroys old capital” (p. 878). Eventually “the
pernicious system of funding” grows so large that taxes also must rise
substantially, to repay principal and interest; the “multiplication of
taxes” only “impairs as much the ability of private people to accumulate
even in time of peace, as the other system would in time of war.” Smith
rejects the notion that “in the payment of the interest of the public debt”
“it is the right hand which pays the left,” and that “the money does not
go out of the country,” for “it is only a part of the revenue of one set
of the inhabitants which is transferred to another,” and “the nation is
not a farthing the poorer.” This he derides as mere “apology” derived
from “the sophistry of the mercantile system,” which assumes all public
debt is held domestically (it isn’t); even were all of it domestically held
“it would not upon that account be less pernicious” (p. 879). Ongoing
diversions of wealth by “the constant practice of [a state] borrowing of
its own factors and agents, and of paying interest for the use of its own
money,” are destructive, akin to the acts of “an improvident spendthrift,
whose pressing occasions will not allow him to wait for the regular
payment of his revenue” (p. 865). Genuine prosperity requires public
frugality.
The ultimate harm of public debt, for Smith, is that it facilitates the
“transfer from the owners of those two great sources of revenue, land
and capital stock, from the persons immediately interested in the good
condition of every particular portion of land, and in the good man-
agement of every particular portion of capital stock, to another set of
persons (the creditors of the public, who have no such particular inter-
est), the greater part of the revenue arising from either.” The “long-run”
result is “the neglect of land and the waste or removal of capital stock.”
Here he echoes Hume’s denigration of the bondholder. He worries that
although the public creditor has “a general interest in the prosperity of
the agriculture, manufactures, and commerce of the country,” he has “no
interest in the good condition of any particular portion of land, or in the
good management of any particular portion of capital stock,” and indeed

“no knowledge of any such particular portion,” “no inspection of it,” and
“no care about it,” so “its ruin may in some cases be unknown to him, and
cannot directly affect him” (p. 880). The public bondholder doesn’t care
to foster a sovereign’s creditworthiness; in contrast, privately held firms
are cared for, from self-interest. Private capital bolsters national p
rosperity
while public capital undermines it. This is a pessimistic view of public
debt.6
Although Smith believes public debt “enfeebles” and “ruins” states,
he provides no empiric, metric, algorithm or rule of thumb to discern
maximum debt capacity or public leverage. Instead he offers anecdotes
of defaults, the most relevant (for our time) being the implicit default
due to government-caused inflation, in which principal and interest are
repaid in money of lesser value than when borrowed.7 For Smith this is a
“treacherous fraud” that involves “injustice” and “violence” (p. 885). He
elaborates:
When national debts have once been accumulated to a certain degree, there is
scarce, I believe, a single instance of their having been fairly and completely
paid. The liberation of the public revenue, if it has ever been brought about at
all, has always been brought about by a bankruptcy; sometimes by an avowed
one, but always by a real one, though frequently by a pretended payment. The
raising of the denomination of the coin has been the most usual expedient by
which a real public bankruptcy has been disguised under the appearance of a
pretended payment. . . A national debt of about a hundred and twenty-eight
millions, nearly the capital of the funded and unfunded debt of Great Britain,
might in this manner be paid with about sixty-four millions of our present
money. It would indeed be a pretended payment only, and the creditors of the
public would really be defrauded of ten shillings in the pound of what was due
to them. The calamity too would extend much further than to the creditors of
the public, and those of every private person would suffer a proportionate loss;
and this without any advantage, but in most cases with a great additional loss,
to the creditors of the public. If the creditors of the public indeed were gener-
ally much in debt to other people, they might in some measure compensate
their loss by paying their creditors in the same coin in which the public had
paid them. But in most countries the creditors of the public are, the greater
part of them, wealthy people, who stand more in the relation of creditors
than in that of debtors towards the rest of their fellow-citizens. A pretended
payment of this kind, therefore, instead of alleviating, aggravates in most cases
the loss of the creditors of the public; and without any advantage to the public,
extends the calamity to a great number of other innocent people. (Smith, 1776
[1937], p. 883)
Smith especially detests the fact that a sovereign’s inflation-driven default

enriches the profligate public debtor (the sovereign itself) at a cost to the
prudent private creditor:
It occasions a general and most pernicious subversion of the fortunes of private

people; enriching in most cases the idle and profuse debtor at the expense of the
industrious and frugal creditor, and transporting a great part of the national
capital from the hands which were likely to increase and improve it, to those
which are likely to dissipate and destroy it. When it becomes necessary for a
state to declare itself bankrupt, in the same manner as when it becomes neces-
sary for an individual to do so, a fair, open, and avowed bankruptcy is always
the measure which is both least dishonorable to the debtor, and least hurtful to
the creditor. The honor of a state is surely very poorly provided for, when, in
order to cover the disgrace of a real bankruptcy, it has recourse to a juggling
trick of this kind, so easily seen through, and at the same time so extremely per-
nicious. Almost all states, however, ancient as well as modern, when reduced to
this necessity, have, upon some occasions, played this very juggling trick. (Ibid.)
Smith, despite a reputation for wanting limited state power, neverthe-

less believes Britain’s budget deficits are best reduced by tax hikes instead
of spending cuts, and higher taxes specifically on provinces and colonies
(pp. 887–99), even though, given non-representation in Parliament, “this
could scarce be done” “consistently with the principles of the British
Constitution” (p. 887). Smith hopes new taxes can defray “the general
expense of the empire” and go “towards paying the public debt,” that they
“might be augmented every year by the interest of the debt which had been
discharged the year before,” in a way “sufficient in a few years to discharge
the whole debt, and thus to restore completely the at present debilitated
and languishing vigor of the empire” (p. 890). He also advises higher
taxes on rebellious Americans, despite their anti-tax protests since 1765
and violence at Lexington-Concord in 1775. The policy is just, he says –
proper recompense for the £90 million the British government spent on the
Seven Years War (1756–63), which helped America by securing her borders
from repeated invasions of French and Indians (p. 899). Americans
had become “irregular and uncertain” in paying taxes, not because they
couldn’t pay but because they wouldn’t pay – because they were “too eager
to become excessively rich” (pp. 896–7). For Smith, “a total separation
from Great Britain” is “very likely” unless America is absorbed into the
empire and taxed accordingly. Smith’s tax plan, aimed at cutting Britain’s
debt, was imposed by the Parliament in the decade before 1776, which
instigated the break and all-out war, which only further boosted Britain’s
debt, from £136 million (1776) to £238 million (1783).
2.4 EARLY AMERICAN DEBATE: HAMILTON

VERSUS JEFFERSON
Early American debate on public debt was focused on the $77 million
in obligations incurred to help pay for America’s Revolutionary War
with Britain (1775–83) and animated by the distinct political economy
of Federalists, led by Alexander Hamilton, and of anti-Federalists, led
by Thomas Jefferson. Whereas Hamilton holds that all economic sectors
(agriculture, manufacturing, finance, and commerce) are productive and
interdependent, Jefferson, enamored by the French physiocrats, believes
that only agriculture produces a net product and that all other sectors
are parasitic on farming. Hamilton, like Steuart, views a credible public
bond as a close substitute for currency and believes it represents capital (as
savings), but denies it constitutes additional wealth, warns against its over-
accumulation, and advocates its eventual extinguishment. Overindebted
during his adult life, Jefferson declaimed against all debt, private and
public, in the latter case insisting that no generation should pass its debts
to future ones. Hamilton believes assets and debts alike can be validly and
morally bequeathed to posterity, so long as they entail a positive net worth.
Hamilton (1757–1804), the first US Treasury Secretary (1790–95) and
foremost theorist (and practitioner) of public debt in the eighteenth century,
read Postlethwayt (1757) as a youth and initially seconded his doubts
about the sustainability of Britain’s public debt:
As to [England’s] wealth, it is notorious that she is oppressed with a heavy

national debt, which it requires the utmost policy and economy ever to dis-
charge. Luxury has arrived to a great pitch; and it is a universal maxim, that
luxury indicates the declension of a state. Her subjects are loaded with the
most enormous taxes. All circumstances agree in declaring their distress. . .
The national debt [of England] is now about one hundred and forty millions
sterling – a debt unparalleled in the annals of any country besides. The surplus
of the annual revenues, after paying the interest of this debt, and the usual
expenses of the nation, is upon an average about one million and a quarter ster-
ling, so that with all their present resources they would not be able to discharge
the public debt in less than one hundred and twelve years, should the peace
continue all that time. It is well known that most of the necessaries of life are
at present heavily taxed in Great Britain and Ireland. The common people are
extremely impoverished [and] totally unable to bear any new impositions. . . [A]
war will take place in the course of a few years, if not immediately. . .and then,
through the negligence of her rules, Great Britain, already tottering under her
burdens, will be obliged to increase them till they become altogether insupport-
able, and she must sink under the weight of them. (Hamilton, 1774)8
Answering Congressional requests, Hamilton submitted influential

reports on the nation’s money, economy, and finances, the most important
being the Report on Public Credit (January 1790), Report on a National

Bank (December 1790), Report on the Establishment of a Mint (January
1791), Report on Manufactures (December 1791), and Report on a Plan
for Further Support of Public Credit (January 1795). The framers of the
US Constitution had given the federal government the power to “borrow
Money on the credit of the United States,” “coin Money” and “regulate
the Value thereof ” (Article I, Section 8), while also stipulating that “All
Debts contracted and Engagements entered into, before the Adoption
of this Constitution, shall be as valid against the United States under
this Constitution, as under the Confederation” (Article VI). To achieve
these ends, Hamilton argued for five main policies on public debt – all $77
million of it (41 percent of GDP), mostly in default. First, he insisted that
current bondholders be refinanced not at the lower market price but at full
face value (par), to comply with original contracts; on grounds of justice
and efficiency alike he rejected calls to discriminate between initial bond-
holders (by paying them less than the higher face value) and current ones
(by paying them more than the depressed market value). For Hamilton a
debt discrimination was “impolitic,” “highly injurious,” “ruinous to public
credit,” “a breach of contract inconsistent with justice,” and “in violation
of the rights of a fair purchaser” (Syrett and Cooke, 1961–87, Vol. VI,
p. 73). Second, Hamilton wished the federal government to assume all state
debts (one-third of the $77 million due), because they were incurred in the
common cause of independence and because the now constitutionally-
united states should begin on an equal fiscal footing. Assumption would
simplify public finances and deter destructive intergovernmental rivalry
over tax sources. Third, Hamilton proposed a privately controlled, nation-
ally branched bank to centralize tax collection, simplify debt service, and
issue uniform currency. Fourth, he wanted sinking funds, tariffs, and taxes
sufficient to repay all public debt by 1825. Finally, Hamilton advised
a bimetallic dollar convertible into fixed weights of gold and silver, to
replace innumerable and irredeemable paper currencies.
Each of these proposals became US policy or law in the early 1790s and
enormously improved US public finances, which enabled the economy to
be robust enough to repay all US public debt by 1835, the first (and last)
time a major nation in modern history accomplished such a feat. Hamilton
was a realist about public debt. He understood context. His policies also
reflected his well-grounded theory, to which I now turn.
Hamilton’s most comprehensive account of public credit and debt
appears in his last report to Congress (issued in January 1795), amid clear
indicators of success for his five-year-old plan – although he had also pre-
dicted that success. Here he summarizes the enormous moral and practical
benefits of a solid and stable public credit:
Credit, public and private, is of the greatest consequence to every country. Of

this it might emphatically be called the invigorating principle. No well-informed
man can cast a retrospective eye over the progress of the United States, from
their infancy to the present period, without being convinced that they owe, in a
great degree, to the fostering influence of credit, their present mature growth.
This credit has been of a mixed nature, mercantile, and public, foreign and
domestic [but each] nourished all the parts of domestic labor and industry.
Their united force, quickening the energies and bringing into action the capaci-
ties for improvement of a new country, was highly instrumental in accelerating
its growth. Credit, too, animated and supported by the general zeal, had a great
share in accomplishing, without such violent expedients as, generating universal
distress, would have endangered that result, that revolution, of which we are
justly proud, and to which we are so greatly indebted. Credit, likewise, may,
no doubt, claim a principal agency in that increase of national and individual
welfare since the establishment of the present government. . . There can be no
time, no state of things, in which credit is not essential to a nation, especially as
long as nations in general continue to use it as a resource in war. . . [Let others
contend that it would be] practicable at all to raise the necessary sum by taxes
within the year [that it would not exert a harmful degree of] distress and oppres-
sion [but none can conclude] that war, without credit, would be more than a
calamity – would be ruin. But credit is not only one of the main pillars of the
public safety; it is among the principal engines of useful enterprise and internal
improvement. (Hamilton, 1795, pp. 387–8)
As early as 1780, before the end of the Revolutionary War, Hamilton

had written to Continental Congressman James Duane (Syrett and Cooke,
1961–87, Vol. II) that in peacetime a convention should be held to establish
a federal government with powers to tax, service debt, establish a nation-
wide bank and coin sound money. During the war Congress had found it
near impossible to secure tax revenues from the states for ammunition and
provisions; instead it borrowed and printed worthless money. Hamilton
understood the dangers of debt and that taxation was never popular. The
“popular will” isn’t always fiscally responsible. “Free countries have ever
paid the heaviest taxes,” he wrote Duane, and “the obedience of a free
people to general laws however hard they bear is ever more perfect than
that of slaves to the arbitrary will of the prince.” A state in need of funds
must please “moneyed men” at least as much as any other group. “Our new
money is depreciating almost as fast as the old,” Hamilton wrote, and “the
moneyed men have not an immediate interest” to uphold public credit. The
solution is to “engage the moneyed interest immediately” in favor of sound
public finance, so they’ll “contribute the whole or part of the stock” of
savings and get “the whole of the profit.” Hamilton’s aim isn’t to privilege
public creditors but to cease their exploitation by a deadbeat state.
Hamilton held that “a national debt, if it is not excessive, will be to us
a national blessing; it will be a powerful cement to our union.” Written
two years before the end of the war, in an April 1781 letter to Philadelphia
banker Robert Morris (and Superintendent of Finance for the Continental

government), it proposes fixes for America’s finances once peace arrives
(Syrett and Cooke, 1961–87, Vol. II). Later critics truncate the line to
portray him as proto-Keynesian optimist and claim he felt “a national debt
is a blessing,” regardless of context. In truth Hamilton’s contextualized
approach makes him a realist. In certain circumstances (post-revolutionary
America) and with relevant qualifiers (“not excessive”) public debt is an
asset. To show the world the United States could and would pay its debts
conveyed strength and elicited the confidence of creditors. A heavy debt
resulting from a war of liberation, though not preferred, needn’t be a
demerit, per Hamilton; it could be shaped to good purpose. To Morris he
said the United States must “speedily restore the credit of the government
abroad and at home,” for it would “induce our allies to greater exertions
on our behalf ” and “inspire confidence in moneyed men in Europe as well
as in America to lend to us.” Hamilton’s 1781 letter included metrics for
calculating a nation’s money supply, taxable capacity, debt sustainability,
and their relevance in the United States. He sketched the basics of a finan-
cial reform that became his Treasury plan a decade later. Hamilton’s aim
was to:
[e]rect a mass of credit that will supply the defect of moneyed capitals and
answer all the purposes of cash, a plan which will offer adventurers immediate
advantages analogous to those they receive by employing their money in trade,
give them the greatest security the nature of the case will admit for what they
lend, and which will not only advance their own interest and secure the inde-
pendence of their country, but in its progress have the most beneficial influence
upon its future commerce and be a source of national strength and wealth.
(Syrett and Cooke, 1961–87, Vol. II)
Hamilton saw that a national (nationwide) bank, a national (uniform)

money, and fully serviced public debt were central to public fiscal integ-
rity. Debt service wasn’t sufficient; payments must be in valid money. To
Morris he insists that “the only cure to our public disorders is to fix the
value of the currency we now have” and “increase it to a proper standard
in a species that will have the requisite stability.” Sound public money and
public credit undergird the private financial sector, such that “industry
is increased, commodities are multiplied, agriculture and manufactures
flourish.” In this “consists the true wealth and prosperity of a state.” But
none of it is possible without respecting creditors’ rights. “No paper credit
can be substantial or durable,” Hamilton writes, “which has not [a sinking
fund] and which does not unite immediately the interest and influence of
the moneyed men in its establishment and preservation.” As a public debt
realist, he interprets pessimism and optimism as false alternatives:
Never did a nation unite more circumstances in its favor than we do; we have
nothing against us but our own misconduct. There are two classes of men
among us equally mistaken – one who, in spite of daily experience of accumu-
lated distress, persist in a narrow line of policy and amidst the most threatening
dangers fancy everything in perfect security; another, who judging too much
from the outside, alarmed by partial misfortunes, and the disordered state of
our finances, without estimating the real faculties of the parties, give themselves
up to an ignorant and ill-founded despondency. We want to appreciate our true
situation and that of the enemy. This would preserve us from a stupid insensibil-
ity to danger on the one hand, and inspire us with a reasonable and enlightened
confidence on the other. (Syrett and Cooke, 1961–87, Vol. II, p. 633)
Only from a realist perspective can one understand Hamilton’s state-

ment that “a national debt if it is not excessive will be to us a national
blessing.” He neither extols public debt as an elixir (as optimists contend),
nor fears it as an inexorable road to ruin (as pessimists contend). Facts and
context matter. The US debt is good in the sense that its proceeds paid the
warriors of independence; the alternative – taxation – was opposed even by
declarers of independence, who couldn’t now logically condemn the debt
as an unfair imposition by a “moneyed interest.” That interest was crucial
to the colonists’ victory. The national debt needn’t weigh down the nation;
if honorably recast and made serviceable, US credit could be solidly
established and bring long-term economic gains.
Hamilton’s realism on public debt is illuminated by a juxtaposition of
his first and last reports to Congress. In the first (January 1790) he stresses
the benefits of stabilizing a shaky debt structure; in the last (January 1795)
he warns against excessive debt and plots its elimination three decades
hence. In the 1790 report he reminds critics that his plan isn’t the cause of
the public debt, for “it was the price of liberty,” “the faith of America has
been repeatedly pledged for it, and with solemnities, that give peculiar force
to the obligation,” and given what was pledged on the debt in Article VI
of the Constitution, “a general belief, accordingly, prevails, that the credit
of the United States will quickly be established on the firm foundation of
an effectual provision for the existing debt” (Syrett and Cooke, 1961–87,
Vol. VI, p. 68). Writing to Washington in 1792, he argues that “the public
debt was produced by the late war” and “it is not the fault of the present
government that it exists; unless it can be proved, that public morality and
policy do not require of a government an honest provision for its debts.” In
paying its debts the United States will “preserve the public faith and integ-
rity” and “manifest due respect for property,” since the bonds publicly held
by creditors are “as much their property as their houses or their lands, their
hats or their coats.” Anticipating full repayment, he notes that “it is the
merit of the funding system to have reconciled three important points – the
restoration of public credit – a reduction of the rate of interest – and an

organization of the debt convenient for a speedy extinguishment” (ibid.,
Vol. XII, pp. 229, 235, 242). In the 1790 report (1970a) Hamilton also
stresses how “the maintenance of public credit” is achieved only “by good
faith, by a punctual performance of contracts,” for “states, like individu-
als, who observe their engagements, are respected and trusted,” while “the
reverse is the fate of those who pursue an opposite conduct. Every breach
of the public engagements, whether from choice or necessity, is in different
degrees hurtful to the public credit.” Enlightened policy appeals not to his
critics but to truly enlightened men.
Hamilton is also committed to a voluntary restructuring of US debt, to
secure a lower borrowing rate that nonetheless appeals to creditors because
full repayment is assured. He refuses to compel, exploit or rob creditors.
“Those who are most commonly creditors of a nation,” he writes, are
“enlightened men,” and “when a candid and fair appeal is made to them,
they will understand their true interest too well to refuse their concurrence
in such modifications of their claims as real necessity may demand” (ibid.,
Vol. VI, p. 68). The “fundamental principles of good faith,” he argues,
“dictate that every practicable exertion ought to be made, scrupulously to
fulfill the engagements of the government,” that “no change in the rights
of creditors ought to be attempted without their voluntary consent,” and
such consent “ought to be voluntary in fact as well as in name,” and “every
proposal of a change ought to be in the shape of an appeal to their reason
and to their interest,” “not to their necessities.” In any debt restructur-
ing, creditors must receive an uncoerced “fair equivalent” with no default
(p. 88). For risky debt paying 6 percent he substituted safe debt paying
4.5 percent.
For Hamilton, all “enlightened friends of good government” should
support credible public borrowing, and he names the “great and invalu-
able ends to be secured by a proper and adequate provision” for support
and repayment of the public debt, including that it would “justify and
secure the confidence” [of the friends of good government], “promote
the increasing respectability of the American name,” “answer the calls of
justice,” “restore landed property to its due value,” “furnish new resources
both to agriculture and commerce,” “cement more closely the union of the
states,” “add to their security against foreign attacks,” and “establish order
on the basis of an upright and liberal policy.” But funds must also be set
aside annually, preferably from budget surpluses, in a secure sinking fund,
to stabilize the market value of public bonds and ensure principal repay-
ment at maturity. “The good effects of a public debt are only to be looked
for when, by being well-funded, it has acquired an adequate and stable
value,” for without this, the debt has “a contrary tendency.” In contrast,
unfunded public debt, being precarious and volatile, invites wasteful

speculation and a weak economy; in that condition public debt will only
“destroy confidence” and cause a “pernicious drain of our cash from the
channels of productive industry” (pp. 70–71).
Hamilton’s public debt theory is misconstrued when characterized as
being overoptimistic, as if it is a mercantilist or proto-Keynesian theory.
For Hamilton it isn’t public debt in isolation that constitutes a “blessing”
but one that’s properly managed, doesn’t sap all credit (unused debt
capacity), and finances only those public goods necessary to preserving
life, liberty, and property. It’s a curse when its proceeds are wasted; instead
of being foundational to prosperity it becomes a quicksand that quickens
insolvency. Hamilton warns of this in his final (1795) report to Congress,
as he had in 1790, further revealing his opposition to unlimited public debt
at any cost:
Persuaded as the Secretary is that the proper funding of the present debt will
render it a national blessing, yet he is so far from acceding to the position, in
the latitude in which it is sometimes laid down, that “public debts are public
benefits,” a position inviting to prodigality, and liable to dangerous abuse,
that he ardently wishes to see it incorporated, as a fundamental maxim, in the
system of the public credit of the United States, that the creation of debt should
always be accompanied with the means of extinguishment. This he regards as
the true secret for rendering public credit immortal. [The sinking fund should be
applied to] the discharge of the public debt. . .until the whole of the debt shall
be discharged. (Hamilton, 1795, pp. 106–7)
Unlike Steuart and the mercantilists, Hamilton doesn’t see public debt
as a net addition to wealth, nor does he endorse Hume and Smith’s view
that it unavoidably destroys wealth by diverting capital to “unproductive”
uses. He’s more consistent as a realist than Steuart because he’s not a
mercantilist. The rights-respecting state isn’t unproductive but necessary:
it provides those services that are essential to wealth creation, including law
and order, security of property, contract enforcement, national defense,
and indispensable infrastructure (aka, internal improvements). As such,
a proper government may borrow in emergencies (wars) or in creating
productive infrastructure that passes to posterity.
Hamilton counteracts optimistic theories of public debt in his December
1791 report to Congress, although its main focus is “the Subject of
Manufactures” (Syrett and Cooke, 1961–87, Vol. X, pp. 277–82). “Though
a funded debt is not in the first instance an absolute increase of capital,
or an augmentation of real wealth,” he writes, “yet by serving as a new
power in the operation of industry, it has within certain bounds a tendency
to increase the wealth of the community.” Nevertheless, we must always
“estimate every object as it truly is” and “appreciate how far the good in
any measure is compensated by the ill, or the ill by the good,” for “either of
them is seldom unmixed.” This is a realist approach. Hamilton again warns
against excessive public debt:
Neither will it follow, that an accumulation of debt is desirable, because a

certain degree of it operates as capital. There may be a plethora in the political,
as in the natural body; there may be a state of things in which any such artificial
capital is unnecessary. The debt too may be swelled to such a size, as that the
greatest part of it may cease to be useful as capital, serving only to pamper the
dissipation of idle and dissolute individuals; as that the sums required to pay
the interest may become oppressive, and beyond the means, which a govern-
ment can employ, consistently with its tranquility, to raise them; as that the
resources of taxation, to face the debt, may have been strained too far to admit
of extensions adequate to exigencies, which regard the public safety. Where
this critical point is, cannot be pronounced, but it is improbable to believe that
there is not such a point. And as the vicissitudes of Nations beget a perpetual
tendency to the accumulation of debt, there ought to be in every government
a perpetual, anxious and unceasing effort to reduce that, which at any time
exists, as fast as shall be practicable consistently with integrity and good faith.
(Hamilton, 1795, p. 282)
Hamilton’s caution about public debt is now lost to the world after
decades of misrepresentation. Whereas minimal-state critics claim he’s an
apologist for public debt and denier of its allegedly latent harm, maximal-
state fans claim he’s a champion of public debt and booster of its sup-
posedly miraculous effects. In truth Hamilton acknowledges a “critical
point” when public debt becomes excessive and its servicing dependent
on a burdensome, unjust tax system that harms production. The cure is to
restrain public spending and generate surpluses sufficient to reduce debt
to manageable proportions – preferably to extinguish it. For Hamilton
public debt isn’t a prerequisite of prosperity, for extinguishing it would
end prosperity and Hamilton prizes prosperity. In his 1792 report to
Congress on means for securing the Western borders, Hamilton writes
that “nothing can more interest the national credit and prosperity than
a constant and systematic attention to husband all the means previously
possessed for extinguishing the present debt, and to avoid, as much as pos-
sible, the incurring of any new debt.” Conceding that “great emergencies
indeed might exist in which loans would be indispensable,” nevertheless,
they mustn’t be pretended emergencies. Since “taxes are never welcome to
a community,” there’s often “too strong a propensity, in the government
of nations, to anticipate and mortgage the resources of posterity, rather
than encounter the inconveniences of a present increase of taxes.” More
debt is but deferred taxes, imposed on posterity; it is policy of “the worst
kind,” for “its obvious tendency is, by enhancing the permanent burdens of
the people, to produce lasting distress, and its natural issue is in National
Bankruptcy” (Syrett and Cooke, 1961–87, Vol. XI, p. 141).
Under the Federalists, US public debt had increased slightly, from
$77.2 million in 1790 to $80.8 million in 1794, but declined from 41 percent
to just 26 percent of GDP. Whereas interest expense on the debt had been
more than twice federal revenues in 1790, by 1794 it was just 64 percent
of revenues. Hamilton nevertheless wanted slower spending growth and
less public debt. Federal revenues had tripled from 1790 to 1794, totaling
$17 million in those five years, but spending grew more quickly and totaled
nearly $21 million. In 1795 Hamilton proposed “a definite plan for the
redemption of the public debt” and for “consummation of whatsoever
may remain unfinished of our system of public credit, in order to place
that credit, as far as may be practicable, on grounds which cannot be dis-
turbed, and to prevent that progressive accumulation of debt which must
ultimately endanger all government” (Hamilton, 1795, p. 345). He pleads
with Congress to maintain the sinking fund that had been established in
1792; he worries it might be raided to avoid spending cuts or tax hikes. He
reminds Congress that it’s “desirable, by all just and proper means, to effect
a reduction of the public debt, and that the application of the surplus
revenue to that object will not only contribute to this desirable end, but
will be beneficial to the creditors of the United States, by raising the price
of their securities, and be productive of considerable saving to the United
States” (p. 353). He insists that any new public debt be accompanied by
both means and measures to service and redeem it. To that end, “the
inviolable application of an adequate sinking fund is the only practicable
security against an excessive accumulation of debt, and the essential basis
of a permanent national credit” (p. 375). If the fund works as designed, US
debt can be fully repaid by 1825.
Hamilton was doubtful Congress would service US debt, let alone fully
repay it as quickly as he wished. By the mid-1790s the United States was
fiscally sound, thanks to Hamilton, but then the Congress became fiscally
lazy and insensible to what Hamilton called “the danger to every govern-
ment from the progressive accumulation of debt” which is “the natural
disease of all governments,” especially popular ones:
There is a general propensity in those who administer the affairs of government,

founded in the constitution of man, to shift off the burden from the present to
a future day – a propensity which may be expected to be strong in proportion as
the form of the state is popular. To extinguish a debt which exists, and to avoid
the contracting more, are ideas always favored by the public feeling and opinion;
but to pay taxes for the one or the other purpose, which are the only means of
avoiding the evil, is always more or less unpopular. These contradictions are in
human nature; and happy, indeed, would be the lot of a country that should
ever want men ready to turn them to the account of their own popularity, or
to some other sinister account. Hence it is not an uncommon spectacle to see
the same men clamoring for occasions of expense, when they happen to be in
unison with the present humor of the community, whether well or ill-directed,
declaiming against a public debt, and for the reduction of it, as an abstract
thesis; yet vehement against every plan of taxation which is proposed to dis-
charge old debts, or to avoid new, by defraying the expenses of exigencies as
they emerge. . . The consequence is that the public debt swells till its magnitude
becomes enormous, and the burdens of the people gradually increase till their
weight becomes intolerable. Of such a state of things great disorders in the
whole of political economy – convulsions and revolutions of government – are
a natural offspring. (Hamilton, 1795, pp. 372–3)
In 1795 Hamilton tells Congress “there can be no more sacred obligation”

of a statesmen “than to guard with provident foresight and inflexible
perseverance against so mischievous a result” as a revolution due to fiscal
disorder. With America now at peace and prosperous, it’s a perfect time for
“improving efficaciously the very favorable situation in which they stand
for extinguishing, with reasonable celerity, the actual debt of the country,
and for laying the foundation of a system which may shield posterity from
the consequences of the usual improvidence and selfishness of its ances-
tors, and which, if possible, may give immortality to public credit” (p. 373).
Tragically, popularly elected politicians are more prone to borrow than to
tax or cut spending, and to impose unchosen burdens (public debts) on
future generations. Hamilton hopes the propensity can be resisted or at
least precluded constitutionally. Only wise and courageous statesmen – not
myopic and reckless politicians – prevent abuses of public credit:
It is wisdom, in every case, to cherish whatever is useful, and guard against its
abuse. It will be the truest policy of the United States to give all possible energy
to public credit, by a firm adherence to its strictest maxims, and yet to avoid
the ills of an excessive employment of it by true economy and system in the
public expenditures, by steadily cultivating peace, and by using sincere, efficient
and persevering endeavors to diminish present debts, prevent the accumulation
of new ones, and secure the discharge, within a reasonable period, of such as
it may be, at any time, a matter of necessity to contract. It will be wise to cul-
tivate and foster private credit, by an exemplary observance of the principles
of public credit, and to guard against the misuse of the former by a speedy
and vigorous administration of justice, and by taking away every temptation
to run in debt, founded in the hope of evading the just claims of creditors.
(Hamilton, 1795, p. 389)
Hamilton seeks neither to champion public debt for its own (or the
sovereign’s) sake nor declare public creditors evil precipitators of national
ruin. Despite his wariness of excessive public debt, by the time of his death
in 1804 the United States still owes $82 million, slightly less than in 1795,
but only 16 percent of GDP compared to 22 percent in 1795, and interest
expense now absorbs only 36 percent of federal revenues, versus 52 percent
in 1795. In 1835, only a decade later than he predicted in 1795, US public
debt was zero.
Hamilton is a public debt realist and certainly no statist, although
in modern times he’s typically mischaracterized by Jeffersonian lib-
ertarians as a proto- Keynesian.9 Beyond misconstruing Hamilton’s
public debt theory, critics then and now also misconstrue his banking
theory. Contrary to conventional interpretation, Hamilton was no fan
of fiat paper money or central banking but instead advocated (and
implemented) specie-redeemable money and a “national” (nationwide)
bank. He recognized the value of a truly independent monetary author-
ity (the Bank of the United States, or “BUS”) modeled on the Bank of
England, which was not itself a monopolist but an issuer of gold (and
silver)-convertible currency (the pound), which otherwise left private
banks free to form and grow. Similarly, Hamilton’s BUS, approved by
Congress for a limited-life charter (1791–1811), issued a gold-convertible
currency (the dollar) that competed with other redeemable currencies
(and private banks). The BUS was formed to “promote commerce” by
furnishing “a more extensive valuable medium” in place of a depreciated
and volatile currency; public creditors would be spared public robbery.
The BUS was privately owned and operated with only 20 percent of
its capital contributed by government (in the form of existing public
bonds); BUS reserves were gold and silver (25 percent of capital) and
its leverage (liabilities as a percent of capital) was capped at 1:1. Some
BUS proponents wanted it owned and operated by government for
“public” benefit. Hamilton opposed this. Unlike today’s central banks,
the BUS wouldn’t be political, nor empowered to issue monopoly paper
money, nor permitted to monetize public debts. For enemies of the plan,
“considerations of public advantage” entailed a “wish” that the BUS be
established “on principles that would cause the profits of it to redound
to the immediate benefit of the State.” Hamilton opposed that wish. His
Report on a National Bank stressed the benefits of the BUS so long as it
wasn’t politicized:
The following are among the principal advantages of a Bank. First. The augmen-
tation of the active or productive capital of a country. Gold and Silver. . .when
deposited in Banks, to become the basis of a paper circulation. . .can
acquire. . .an active and productive quality. . . Secondly. Greater facility to the
Government in obtaining pecuniary aids, especially in sudden emergencies. . .
Thirdly. The facilitating of the payment of taxes. . . Considerations of public
advantage suggest a further wish, which is – that the bank could be established
upon principles that would cause the profits of it to redound to the immediate
benefit of the State. This is contemplated by many who speak of a national
bank, but the idea seems liable to insuperable objections. To attach full confi-
dence to an institution of this nature, it appears to be an essential ingredient in
its structure, that it shall be under a private not a public direction – under the
guidance of individual interest, not of public policy; which would be supposed
to be, and, in certain emergencies, under a feeble or too sanguine administra-
tion, would really be, liable to being too much influenced by public necessity.
The suspicion of this would, most probably, be a canker that would continually
corrode the vitals of the credit of the bank, and would be most likely to prove
fatal in those situations in which the public good would require that they should
be most sound and vigorous. It would, indeed, be little less than a miracle,
should the credit of the bank be at the disposal of the government, if, in a long
series of time, there was not experienced a calamitous abuse of it. It is true, that
it would be the real interest of the government not to abuse it; its genuine policy
to husband and cherish it with the most guarded circumspection, as an inesti-
mable treasure. But what government ever uniformly consulted its true interests
in opposition to the temptations of momentary exigencies? What nation was
ever blessed with a constant succession of upright and wise administrators?
(Hamilton, 1790b)
That Hamilton was no fan of irredeemable paper money is clear

from his Report on a National Bank (1790b) and from his Report on
the Establishment of a Mint (1791a). Fiat paper money had been wide-
spread in the states during and after the Revolutionary War and that
monetary medium has become an essential element of contemporary
central banking, but Hamilton wanted no part of it; he advocated (and
implemented) an objective, non-
political, commerce-
centric monetary
standard based on silver and gold:
The emitting of paper money by the authority of the government is wisely

prohibited to the individual States by the National Constitution; and the spirit
of that prohibition ought not to be disregarded by the Government of the
United States. Though paper emissions, under a general authority, might have
some advantages not applicable, and be free from some disadvantages which
are applicable, to the like emissions by the States, separately, yet they are of
a nature so liable to abuse – and, it may even be affirmed, so certain of being
abused, – that the wisdom of the government will be shown in never trusting
itself with the use of so seducing and dangerous an expedient. In times of tran-
quility it might have no ill consequence, – it might even perhaps be managed
in a way to be productive of good; but in great and trying emergencies there is
almost a moral certainty of its becoming mischievous. The stamping of paper is
an operation so much easier than the laying of taxes, that a government in the
practice of paper emissions would rarely fail, in any such emergency, to indulge
itself too far in the employment of that resource, to avoid, as much as possible,
one less auspicious to present popularity. If it should not even be carried so far
as to be rendered an absolute bubble, it would at least be likely to be extended
to a degree which would occasion an inflated and artificial state of things,

incompatible with the regular and prosperous course of the political economy.
(Hamilton, 1790b)
Hamilton wanted citizens to have full confidence in the new US finan-

cial system, including the BUS, so it had to be “under a private not a
public direction,” and motivated not by “public policy” but “the guidance
of individual interest” and profit. A politicized financial system would
“corrode the vitals” of public credit. The BUS must not be “at the disposal
of the government,” for if it were, it would suffer a “calamitous abuse” at
its hands. Hamilton makes the case not for an “independent central bank,”
which today is, in fact, a fiscally abused institution, but for a truly inde-
pendent monetary authority not beholden to the state and not capable of
undermining the safety and soundness of private banking.
Thomas Jefferson (1743–1826) – Hamilton’s political nemesis, US
Secretary of State (1790–93), and US president (1801–09) – abhorred
all debt, private and public, ironically, as a type of slavery. He and other
agrarian critics of Hamilton’s system also preferred state- dominated
banks and inconvertible paper currencies, so as to boost land (plantation)
values and commodity prices while favoring debtors over creditors. This
anti-capitalistic approach to money and banking, dominant in the United
States before 1790, has also dominated since the early 1970s.
Some scholars (Sloan, 2001) attribute Jefferson’s hostility towards
debt to the fact he was overindebted most of his life and by 1826, despite
owning Monticello and more than a hundred slaves, died insolvent – all
while the federal government he so distrusted was becoming debt free
(by 1835). But attributing his disdain for debt to his personal experience
is trite; a similar disdain made others limit their use of debt. Born into
landed gentry, yes, but Jefferson by choice is a Francophile and physiocrat;
for ideological reasons he despises debt, banks, finance, Wall Street,
“moneyed interests,” and cities. As a physiocrat he believes wealth derives
solely from the soil; he also believes only agrarian life preserves virtue,
that “those who labor in the Earth are the chosen people of God.” If non-
agriculturalists (merchants, manufacturers, financiers) accumulate wealth,
he assumes they extorted it from the truly productive and moral. Debt is
slavish dependence; predatory lenders are masters in the c reditor-debtor
nexus. Jefferson’s interpretation fuels what’s now called “class warfare.”
Jefferson, famed for favoring America’s revolt against Britain and
drafting the Declaration of Independence (1776), nonetheless opposed
levying the taxes necessary to fund and fight the Revolutionary War and
later opposed fully servicing the public debt that actually funded the war
effort. He applauded subsequent debtor revolts (Shay’s Rebellion, 1786),
opposed the founding of a federal government in 1787–88, and rejected

every key aspect of Hamilton’s plan to satisfy the new Constitution’s
requirement (in Article VI) to service war debts. Jefferson’s view of public
debt is also influenced by his favorite political economist, Count Destutt
Tracy (1754–1836), a French aristocrat who in his Treatise on Political
Economy (1817) holds that public debt is inherently “evil” and that “in
no case is it good to be in debt” of any kind. Yet Tracy, like Hamilton,
denies that “the loans of government are a cause of prosperity,” that “a
public debt is new wealth created in the bosom of society,” and that living
generations have “a right thus to burden men not yet in existence and
compel them in future times its present expenses.” Unlike Hamilton, Tracy
wants serial repudiations, on the grounds that antecedent public debt can’t
legitimately oblige new-born generations; states must “modify, change and
annul” public debt, so “this evil would be destroyed at the root.” Money-
lenders, “having no longer any guarantee” of repayment, “would no longer
lend,” and consequently “many misfortunes would be prevented.” For
Tracy the problem isn’t excessive public debt but public debt per se. “The
evil is not in the abuse of loans,” he writes, but “in the use itself of loans,”
for “the abuse and the use are one in the same thing.” Indeed, “every time
a government borrows it takes a step towards its ruin.” For Jefferson and
Tracy the private sector borrows legitimately, to produce, but a sovereign
only consumes wealth.
A self- described “enemy” of public debt, in a 1788 letter to the
Commissioners of the Treasury, Jefferson nevertheless concedes it is crucial
to national defense. “Though much an enemy to the system of borrowing,
yet I feel strongly the necessity of preserving the power to borrow,” because
“without this, we might be overwhelmed by another nation, merely by the
force of its credit” (Jefferson, 1904, Vol. 6, p. 423). In 1788 he also writes
General Washington about feeling “anxious about everything which may
affect our credit,” expresses hope America might “possess it in the highest
degree” (but “use it little”), and admits that “were we without credit, we
might be crushed by a nation of much inferior resources, but possessing
higher credit” (ibid., p. 453).
Despite Jefferson’s grudging recognition of the value of public debt
in 1788, in a letter to Madison sent from Paris in September 1789, soon
after the French Revolution, he argues for repudiation of public debts,
echoing Tracy. He now says that no public debt should ever persist in
maturity beyond the life of the generation that incurs it (which he defines
as comprising 19 years); just as political constitutions should expire every
few decades, so also should public debts. True sovereignty and express
consent require a “popular will” to decide anew, each generation, which
constitutions, debts or property relations shall be valid; otherwise living
generations would have to abide by arrangements imposed by deceased

ancestors. “The earth belongs to the living,” he declaims, and “no man can
by natural right oblige the lands he occupied, or the persons who succeed
him in that occupation, to the payment of debts contracted by him,” for
“what is true of every member of the society individually, is true of them
all collectively, since the rights of the whole can be no more than the sum
of the rights of the individuals” (Jefferson, 1984, pp. 959–60):
The question, whether one generation of men has a right to bind another [is] of
such consequences as not only to merit decision, but to place also among the
fundamental principles of every government. . . [T]hat no such obligation can
be transmitted, I think very capable of proof. I set out on this ground, which
I suppose to be self-evident, that the earth belongs in usufruct to the living;
that the dead have neither powers nor rights over it. The portion occupied by
any individual ceases to be his when himself ceases to be, and reverts to the
society. . . [Bequeathed estates transfer] not by natural right, but by a law of
the society [and] no man can, by natural right, oblige the lands he occupied, or
the persons who succeed him in that occupation, to the payment of debts con-
tracted by him. For if he could, he might during his own life, eat up the usufruct
of the lands for several generations to come; and then the lands would belong
to the dead, and not to the living, which is the reverse of our principle. . . [The
earth belongs to each [successive generation] during its course, fully and in its
own right. . .clear of the debts and encumbrances of [earlier generations]. . .
The conclusion then, is, that neither the representatives of a nation, nor the
whole nation itself assembled, can validly engage debts beyond what they may
pay in their own time. . . [T]he received opinion, that the public debts of one
generation devolve on the next, has been suggested by our seeing, habitually,
in private life, that he who succeeds to lands is required to pay the debts of his
predecessor; without considering that this requisition is municipal only, not
moral, flowing from the will of the society, which has found it convenient to
appropriate the lands of a decedent on the condition of a payment of his debts;
but that between society and society, or generation and generation, there is no
municipal obligation, no umpire but the law of nature. . . On similar ground
it may be proved, that no society can make a perpetual constitution, or even a
perpetual law. (Jefferson, 1984, pp. 959–64)
Presuming an analogy between intergenerational bequest norms for fami-

lies and transfers among generations of a nation (as with public debts and
public infrastructure), Jefferson elides the fact that in common law no
individual heir is obliged to assume solely an ancestor’s debts or a nega-
tive net worth. With nations, succeeding generations may assume public
debts but also receive public assets from predecessors, and unless a nation’s
living standards are in decline, posterity is bequeathed positive net worth.
Jefferson insists that only assets be inherited, though not even by right.
He further ignores that public debts are assets (bonds) to holders. Even
were his principle to be accepted today, it would be inapplicable because
few public bonds have maturities beyond 20 years; the average duration of
public bonds is five years, a mere fraction of any generation’s duration. No
posterity can be truly “burdened” by a five-year public debt.
Moving further from his 1788 concessions, in 1798 Jefferson informs
John Taylor that if it “were possible to obtain a single amendment to our
Constitution” he’d prohibit public debt entirely – “taking from the Federal
Government the power of borrowing” – that he’d “be willing to depend
on that [amendment] alone for the reduction of the administration of our
government.” The states but not the federal government could still borrow.
Wars too should be funded wholly by taxes: “I know that to pay all proper
expenses within the year would, in case of war, be hard on us,” he admits,
“but not so hard as ten wars instead of one. For wars could be reduced in
that proportion; besides that the State governments would be free to lend
their credit in borrowing quotas” (Jefferson, 1904, Vol. 10, p. 64). Jefferson
again wrote to Taylor on public debt in 1816, now declaring it inherently
fraudulent: “I sincerely believe. . .that the principle of spending money to
be paid by posterity under the name of funding is but swindling futurity
on a large scale” (ibid., Vol. 15, p. 23). A view more opposed to Hamilton’s
can’t be found.
In his first inaugural address (1801) Jefferson promises “the honest
payment of our debts” and a “sacred preservation of the public faith.” In
January 1802, a year before having the United States borrow $12 million
to pay Napoleon $15 million for the Louisiana Territory, he complains
to Du Pont de Nemours that “when this government was first estab-
lished, it was possible to have kept it going on true principles,” but that
Hamilton had “destroyed that hope in the bud,” and the United States
could now “pay off his debts in 15 years, but we can never get rid of
his financial system.” In Jefferson’s second inaugural address (1805) he
applauds budget surplus and pledges “to apply such a surplus to our
public debts” until “their final redemption” (Jefferson, 1904). During his
presidency (1801–09) the US national debt declined by nearly a third, from
$83 million (17 percent of GDP) to $57 million (9 percent of GDP). The
net debt reduction of $26 million was achieved by $41 million in budget
surpluses over eight years; spending was cut 8 percent while revenues
increased 57 percent. Yet Jefferson’s 1808 trade embargo and draconian
cuts in military spending left US revenues and national security exposed,
invited the war of 1812, and led to a sharp rise in US public debt, from
$57 million in 1808 to $127 million in 1815. The United States could repay
all debt by 1835, despite the new debt added by Jefferson and Madison
from 1801 and 1817, precisely because of the Hamiltonian fiscal archi-
tecture against which Jefferson had repeatedly railed. Although Jefferson
frequently implies that Hamilton caused the US debt, in fact it reflected
the Revolutionary War that followed Jefferson’s 1776 Declaration and a

Continental Congress unwilling or unable to tax-finance that war.
In 1813, now out of office, Jefferson endorses Hamilton’s rule that new
public debts be matched by a tax-fed sinking fund that gradually and safely
retires principal. Now he speaks respectfully of creditors, says payments
they’re owed should be “sacredly observed,” and worries that excessive and
perpetual US debt could cause national oppression, bankruptcy, and revo-
lution. But he also reiterates his earlier theme that public debt is immoral
and menacing, and should be repudiated every 19 years:
It is a wise rule and should be fundamental in a government disposed to cherish

its credit, and at the same time to restrain the use of it within the limits of its
faculties, never to borrow a dollar without laying a tax in the same instant for
paying the interest annually, and the principal within a given term; and to con-
sider that tax as pledged to the creditors on the public faith. On such a pledge
as this, sacredly observed, a government may always command, on a reasonable
interest, all the lendable money of their citizens. . . But what limits, it will be
asked, does this prescribe to their powers? What is to hinder them from creating
a perpetual debt? The laws of nature, I answer. The earth belongs to the living,
not to the dead. The will and the power of man expire with his life, by nature’s
law. . . We may consider each generation as a distinct nation, with a right, by the
will of its majority, to bind themselves, but none to bind the succeeding genera-
tion, more than the inhabitants of another country. . . Are [new generations]
bound to acknowledge the debt [bequeathed by ancestors], to consider the pre-
ceding generation as having had a right to eat up the whole soil of their country,
in the course of a life, to alienate it from them, (for it would be an alienation to
the creditors,) and would they think themselves either legally or morally bound
to give up their country and emigrate to another for subsistence? Everyone will
say no; that the soil is the gift of God to the living, as much as it had been to
the deceased generation; and that the laws of nature impose no obligation on
them to pay this debt. . . [T]he modern theory of the perpetuation of debt has
drenched the earth with blood, and crushed its inhabitants under burdens ever
accumulating. . . In seeking, then, for an ultimate term for the redemption of
our debts, let us rally to this principle, and provide for their payment within the
term of nineteen years at the farthest. (Jefferson, 1984, pp. 1280–86)
In one of Jefferson’s last treatments of public debt, writing to Samuel

Kercheval in 1816, he reprises his initial hostility to it and suggests it’s
akin to slavery, but where the rich are the masters and the populace the
serfs. Hamilton had said the US public debt of 1790 was the “price of
liberty,” a crucial means of defeating Britain and founding the new nation.
But Jefferson says public debt impoverishes, destroys liberty, and breeds
social turmoil. “The people, and not the rich,” he says, ensure “continued
freedom,” and to preserve their freedom “we must not let our rulers load
us with perpetual debt.” For Jefferson, the choice is “between economy
and liberty, or profusion and servitude.” Were America to incur debts
proportionate to England’s, its citizens would “labor sixteen hours in

the twenty-four, give the earnings of fifteen of these to the government
for their debts and daily expenses; and the sixteenth being insufficient to
afford us bread, we must live, as [the English] now do, on oatmeal and
potatoes.” The result must be “a war of all against all, which some phi-
losophers observing to be so general in the world, have mistaken it for the
natural, instead of the abusive state of man. And the fore horse of this
frightful team is public debt” (ibid., pp. 1400–401).
Hamilton and Jefferson could not have been more opposite in their
theories of public debt and proposals for handling it, although Jefferson as
president moderated and contradicted his own views; nevertheless, while
most of the US framers and certainly Hamilton called for paying off US
debts in full, Jefferson favored their serial repudiation (Gunter, 1991).
A reversal of the conventional interpretation of Hamilton and Jefferson
on public debt is warranted. Hamilton warns that public debt can become
excessive under more democratic forms of government, and thus opposes
both excessive debt and democracy. Jefferson, in contrast, opposes public
debt as such and applauds more democratic forms of government, even if
they accumulate excessive debt and violate creditors’ rights. To the extent
the constituents of popular, democratic nations endorse more public
spending and less taxation, they also endorse deficit spending. If so, it’s not
the Hamiltonian but rather the Jeffersonian ideal of government that tends
to generate unsustainable accumulations of public debt.
2.5 LATE CLASSICAL DEBATE: SAY, RICARDO,

MILL, AND MARX
Unfortunately, no nineteenth- century classical economist – from

Jean-Baptiste Say to Karl Marx – adopts Hamilton’s realism. Public debt
theory remained pessimistic, even though Britain’s debt peaked in 1819
and declined over the century (both in absolute terms and as a portion
of GDP), even though the US public debt was extinguished by 1835, and
even though government bond yields remained low, implying not pending
“ruin” but a safe investment. As resort to public borrowing plummeted
in the relatively peaceful century after the Napoleonic Wars (the US Civil
War being an exception), political economists generally became less-vocal
pessimists instead of realists. Most simply ceased discussing public debt in
texts and treatises. Few treatments of public debt exist in the works of the
post-1870 neoclassical economists.
Despite the unjustified return to pessimism in the nineteenth century,
a new feature becomes important for public debt in the twentieth century
and beyond – inflation, which enables implicit default. Until the 1790s
theorists assume that public debt is to be repaid in money of the same
value and legal status as when incurred (gold and silver). Britain was on
the gold standard during 1714–97 but abandoned it to fight Napoleon
and issued paper money until 1821, after which it returned to gold. The
United States was on a specie standard starting in 1792 (silver until 1834,
gold thereafter) but during its Civil War it suspended convertibility and
issued paper money (“greenbacks”) until it resumed convertibility in 1879.
Irredeemable money and its inflationary bias weren’t unknown before the
nineteenth century, but now theorists examine the interaction of money
and public debt, showing how unanticipated inflation harms creditors and
benefits debtors and how moral hazard arises if a public debtor becomes a
monopoly issuer of inconvertible money and thus is tempted to use infla-
tion to unilaterally erode excessive public leverage. These issues are even
more relevant today, as no major currency in the world has been on any
type of gold standard since 1971 (see Chapter 5, Section 5.3).
Like Hume and Smith, Jean-Baptiste Say (1767–1832), in his Treatise
on Political Economy (1803 [1821], Chapter IX) contends that whenever
government spends it is “barren consumption,” the destruction of wealth,
even while conceding it should provide national security, law courts, police
protection, infrastructure, and public schools. Do such services destroy
wealth or constitute its precondition? The latter, says Say. Yet he assumes
that since all tax revenues and borrowings derive from private income,
savings, and wealth, they detract from each. “Public credit affords such
facilities to public prodigality,” he notes, “that many political writers have
regarded it as fatal to national prosperity.” Say worries that easy access to
borrowing brings “financial exhaustion,” by making war more likely and
“making capital, which should be the fruit of industry and virtue, the prize
of ambition, pride, and wickedness” (ibid., p. 483).
Melon’s (1738) denial that public debt is ever burdensome, because we
owe it to ourselves, earns Say’s ridicule, with an echo from Smith, as Say
believes “the state is enfeebled” by debt, “inasmuch as the capital lent,”
“having been destroyed in the consumption of it by the government, can
no longer yield anybody the interest it might earn.” By Say’s reckoning,
“before the act of borrowing there will have been in existence two produc-
tive capitals, each of them yielding, or capable of yielding, a revenue,” and
“after the act of [public] borrowing, there will remain but one of these
capitals.” Public loans are a zero-sum game at best; even if they fund
productive infrastructure, those funds, had they remained in the private
sector, could have achieved the same, or more.
For Say, public borrowing supplements demand for loanable funds and
thereby raises interest rates. This is the “crowding out” argument.10 Say
contends that “national loans of every kind are attended with the universal
disadvantage of withdrawing capital from productive employment, and
diverting it into the channel of barren consumption; and in countries
where the credit of the government is at a low ebb, with the further and
particular disadvantage of raising the interest on capital.” Say can’t iden-
tify a single benefit from state loans. “Great pains have been taken to find
in the system of [public borrowing] some inherent advantage beyond that
of supplying the public consumption,” he notes, but “a close examination
will expose the hopelessness of such an attempt.” Yes, public bonds have
value, but they aren’t wealth, only a claim on future tax revenues. Yes,
public bonds can cause public creditors to want the state’s fiscal health (per
Hamilton), but that’s not a national advantage (echoing Hume and Smith).
Say doesn’t deny that the power to borrow can be a powerful weapon
in war, but also predicts that “the gross abuse” of it “will soon destroy its
efficacy.” He’s the first debt theorist to note that prices and yields on public
bonds provide an objective measure of sovereign creditworthiness, but
even a perfect record of debt service can cloak wasteful spending. For Say,
a public debt might prove a net national benefit if it provides a short-term
outlet for funds otherwise unemployed, adding that “this is perhaps the
sole benefit of public debt,” but this too is risky because “it enables a gov-
ernment to squander the national savings.” For Say, “unless the principal
be spent upon objects of permanent public benefit, as on roads, canals, or
the like,” it is better “that the capital should remain inactive or concealed,
since, if the public lost the use of it, at least it would not have to pay the
interest.” Only lenders benefit by public debt, on occasion occasionally
getting artificially higher interest rate; due to crowding out. It’s a zero-sum
game, according to Say: “the whole community is the sufferer, with the sole
exception of the capitalist.”
Oddly, Say applauds governments that demonstrate high credit, or
capacity to borrow affordably. Thus he praises a great ability to borrow, but
not the exercise of that ability. He rightly defines public credit as “the con-
fidence of individuals in the engagements of the ruling power, or govern-
ment,” and says it’s maximized only by constitutionally limited sovereigns.
Monarchs and autocrats can’t easily secure credit, for “where the public
authority is vested in a single individual, it is next to impossible that public
credit should be very extensive.” In contrast, “representative governments
will acquire a marked preponderance in the scale of national power, simply
on account of their superior financial resources” (Say 1803 [1821], p. 482).
As a pessimist, Say agrees that sinking funds can ensure responsible debt
service, but fears they can work too well by boosting borrowing capacity,
and too often they’re expediently raided. He agrees with Adam Smith:
public debt usually accumulates and courts national insolvency. England,
for example, has undertaken a “scandalous abuse” of “the power of bor-

rowing,” including “her substitution of paper-money in place of specie”
(inflationary finance). Say, who died a few years before the United States
repaid all of its debt in 1835, insisted that “national debts have never been
extinguished except by a national bankruptcy” (ibid., p. 486). Like most
pessimists, Say can’t reconcile his view that bonds are not real wealth with
his view that defaults on bonds can inflict real economic harm. National
bankruptcy “would probably obviate the necessity of fresh [public] loans,”
which is a good thing, but there’d be no necessary end to high taxes for
servicing existing debt, and “the ruin of the public creditors would be
attended with [an] abundance of collateral distress,” with “private failures
and insolvency without end,” with “the loss of employment to all their
tradesmen and servants,” and “the utter destitution of all their depend-
ents.” Public bonds have value, but aren’t wealth, so a bond collapse does
harm, but not to wealth.
A succinct synthesis of classical debt theory at this time is given by Sir
Robert Hamilton (1816) in his history of Britain’s public debt, just before
Britain’s debt peaked at 261 percent of GDP in 1819. Britain’s debt is so
“alarming” that no one can “foresee how far this system may be carried,
or in what manner it will terminate” (Hamilton, 1816, p. 3). “The portion
of national income which can be appropriated to public purposes” is finite,
and he believes Britain is “already far advanced to the utmost limit” – but
offers no gauge. A nation understandably runs deficits in war, but in peace-
time should run surpluses and reduce debt. He criticizes Britain for not
reducing debt before fighting Napoleon; the result, “a perpetual increase
of debt,” reached “a magnitude which the nation is unable to bear.” Yet he
offers no measure of what’s fiscally unbearable. “The only effectual remedy
to this danger,” which, if ignored, “would terminate in bankruptcy,” is a
lengthy peace, spending restraint, and higher taxes. When Britain adopted
its first income tax in 1798 (at 10 percent) it pledged to repeal it at war’s end
(a pledge kept, in 1816); not coincidentally, Hamilton imagines 10 percent
as the maximum that can be harvested from British incomes. The sub-
sequent century was relatively peaceful and on the eve of World War I
Britain’s public leverage was only 25 percent of GDP, less than a tenth of
its level in 1819 (261 percent). We now know that a 10 percent income tax
rate lies far below the sustainable taxable capacity of modern economies.
Of all classical contributions to public debt theory, perhaps none is more
overrated or overdiscussed than those of David Ricardo (1772–1823).
He devotes little space to the topic in Principles of Political Economy and
Taxation (1817 [1951]), even though Britain’s public debt had tripled over
the prior three decades (since 1787) and had nearly doubled to 231 percent
of GDP in the years since 1793. In one passage Ricardo derides “the
mischievous policy of accumulating a large national debt” and the “conse-

quently enormous taxation,” because it makes for an “extremely artificial”
fiscal state (Ricardo, 1817 (1951], pp. 241–2). He worries that the heavy
taxes needed to service debt will sap savings, capital accumulation, and
productivity, thus long-term wealth-creation; yet he also agrees with Melon
(1738) that the interest paid and received cancel out, with no necessary ill
effects in the aggregate.
Ricardo is best classified as a public debt pessimist. He offers no defense
of it, other than as a convenient funding source in war, and even then he
prefers full taxation, because it might make war less likely, less costly, and
less lengthy. In a series of letters written over a decade to various debt
pamphleteers, Ricardo’s pessimism is overt. In 1815, as the Napoleonic
Wars ends, he complains of “the disadvantages we labor under from the
pressure of our enormous debt,” and confesses that every day he was
“becoming a greater enemy to the funding system,” with its “evils” and its
“injurious” effects, among them high tax burdens and market distortions
(Ricardo, 1811–23 [1899], p. 13). In a letter from 1819 he proposes that
Britain’s public creditors be paid only the market value of their securities,
then 30 percent below par value (ibid., p. 70). He also wants bond principal
and interest heavily taxed. “During peace our unceasing efforts must be
directed towards paying off that part of the public debt which has been
contracted during war,” and this justifies the sovereign making a “ sacrifice
of any part of its property which might be necessary to redeem its debt,”
preferably by a capital levy. First proposed (he notes) by Hutcheson (1714),
a capital levy is a one-time tax on public bondholders – a confiscation of
wealth akin to deliberate default (repudiation). Ricardo condemns British
politicians for having “neither wisdom enough, nor virtue enough, to adopt
it” (Ricardo, 1817 [1951], p. 248). As for Britain’s debt, he would “pay it
off entirely and never allow any new debt, on any pretense whatever, to be
contracted” (Ricardo, 1811–23 [1899], p. 110). Thus he would legally pro-
hibit public debt. In his “Essay on the Funding System” (1820), he says that
public debt is “one of the most terrible scourges which was ever invented to
afflict a nation” (Ricardo, 1820 [1846], p. 546). The essay purportedly exam-
ines British experience with sinking funds, which typically help sovereigns
meet their obligations, so one might expect Ricardo to defend them; instead
he derides them as prone to political manipulation, and even when properly
administered, as providing a false sense of security that permits government
to borrow still more – a bad thing.
Ricardo is in the pessimist camp, not because he sees public debt per
se as bad, but because he’s pessimistic about any kind of state spending.
His public debt theory is at least as anti-capitalist as Marxian public debt
theory (see below). Apart from Ricardo’s belief in the labor theory of value,
in an inverse relationship between wages and profits, in a secular decline

in the profit rate, and in the harmful effects of labor-saving machinery, his
pessimism and punitive prescriptions for public debt contributed to the
phenomenon of “Ricardian socialism” starting in the 1820s and anticipat-
ing the rise and spread of Marxism in the 1840s. Ricardo’s direct influence
on Marx’s public debt theory occurred with the help of Piercy Ravenstone,
whose Thoughts on the Funding System and Its Effects (1824 [1970]) Marx
cited glowingly in Chapter XXI of his Theories of Surplus Value (1861–63).
Ricardo’s debt theory is overexamined today due largely to the for-
malism of “Ricardian equivalence,” a doctrine Ricardo discussed but
rejected.11 The doctrine holds that there’s no monetary or mathematical
difference (hence an “equivalence”) between the effects of public spending
whether it’s tax financed or debt financed, because debt is but a deferral of
taxes into the future. Were people to discount those future liabilities into
the present, at the prevailing interest rate, they’d find they’re equivalent
in value to the taxes they’d have had to pay today to support the same
spending. Ricardo presents the logic of the case, but his crucial insight is
that public spending itself constitutes the real economic burden, regardless
of how funded, because it deprives private actors of the saving, capital
accumulation, and productivity gains necessary for long-term prosperity.
In the main passage that would be dubbed, decades later, the “ equivalence
doctrine” (Ricardo, 1817 [1951], p. 245), Ricardo notes that the cost of
taxes paid in full today equals the present value of borrowing a like sum
and repaying it over time with interest. Public spending adds nothing to
output and more often retards it. “It is by the profuse expenditure of
government, and of individuals, by loans,” he writes, “that the country
is impoverished” and “every measure, therefore, which is calculated to
promote public and private economy,” that is, less consumptive spending
and more saving – “will relieve the public distress.” For Ricardo “it is not,
then, by the payment of the interest on the national debt, that a country is
distressed, nor is it by the exoneration from payment that it can be relieved.
It is only by saving from income, and retrenching in expenditure, that the
national capital can be increased” (p. 246). In his 1820 essay Ricardo elabo-
rates on the equivalence principle (Ricardo, 1820 [1846], pp. 539–42) and
specifically denies that people view tax finance and debt finance identically.
Yes, the two methods are “precisely of the same value” mathematically,
“but the people who pay the taxes never so estimate them [as identical to
lending to government], and therefore do not manage their private affairs
accordingly.” We are, he says, “too apt to think that the war is burden-
some only in proportion to what we are at the moment called to pay for it
in taxes, without reflecting on the probable duration of such taxes.” Thus
“it would be difficult to convince a man” that the two payment methods
are “equally burdensome” (p. 539). Most people feel debt finance as less
burdensome than tax finance; indeed, Ricardo thinks the bias to be so
great that he advises an all-tax policy, even in wartime. He neglects to note
that taxes also sap savings and capital, but since most income is consumed,
not saved, taxes probably inflict less harm. “This argument of charging
posterity with the interest of our debt, or of relieving them from a portion
of such interest, is often used by otherwise well-informed people, but we
confess we see no weight in it” (ibid.). Thus “war-taxes are more economi-
cal, for when they are paid, an effort is made to save to the amount of the
whole expenditure of the war, leaving the national capital undiminished,”
whereas with debt finance “an effort is only made to save to the amount of
the interest of such expenditure,” not also to repay future principal, so “the
national capital is diminished in amount” (p. 540).
We see Ricardo repeatedly deny the existence of what scholars call
“Ricardian equivalence” and, more importantly, posit what’s now called
“fiscal illusion” – citizens’ bias against paying taxes and penchant for expe-
riencing government spending as less burdensome than it really is when
more debt financed. Ricardo also believes people will save more to pay
current taxes than to service future debts, whereas “equivalence” scholars
today believe the reverse.12 Unfortunately, the vast literature on Ricardian
equivalence focuses far less on the burden of unproductive state spend-
ing – Ricardo’s main worry – and far too much on the derivative question
of whether the debt-financed portion of state spending is shouldered by
the living, by future generations, or both. One unique critique (Tabarrok,
1995) argues that even if the equivalence thesis is proved true, acceptance of
its truth will induce such profligacy that the debt won’t remain innocuous.
The most relevant but least examined aspect of Ricardo’s debt theory is
his proposal that public bonds supplant gold and sterling as backing for
Britain’s currency, in “Proposals for an Economical and Secure Currency”
(Ricardo, 1816 [1846]). Writing when Britain was off the gold standard
during the war with Napoleon, Ricardo’s plan is a precursor to the debt-
based monetary systems that came to dominate the twentieth century
and early twenty-first century. Britain issued vast sums of public debt and
irredeemable paper money while off the gold standard (1797–1821) and
accordingly suffered inflation, price volatility, booms, busts, and excessive
speculation. In this time Ricardo remained a defender of the gold standard
and critic of the Bank of England, fingering the latter as the main cause
of inflation, in his 1810 essay, “The High Price of Bullion: A Proof of the
Depreciation of Bank Notes.” Seeking a way to stabilize the pound’s value
without relying on specie convertibility, Ricardo’s bond-backed pound
scheme presaged what later became known as the “monetization” of
public debt. This “organization of debt into currency” (Carroll, 1855–79
[1964]) was, according to Charles Holt Carroll (1799–1890), an inherently

unstable and unsustainable scheme if public bonds were illiquid, volatile
in value, or prone to default. Indeed, history shows that debt-backed
monetary systems are typically more politicized and less stable than are
specie-convertible monetary systems.
Like other theorists, Ricardo suspects there exist inherent limits to
sovereign borrowing, but doesn’t quantify them. If another war occurs
without Britain having reduced her debt, he warns, it may have to “submit
to a national bankruptcy.” Ricardo is reluctant to predict that Britain will
be “unable to bear any large additions to debt,” because it’s “difficult to set
limits to the powers of a great nation,” but he’s certain “there are limits to
the price, which in the form of perpetual taxation, individuals will submit
to pay for the privilege merely of living in their native country” (Ricardo,
1817 [1951], p. 249). At the least, he says, public debt will cause punitive
taxes and migrations of labor and capital.
The debt theory of Robert Malthus (1776–1834) is relevant in con-
temporary times because he so influenced John Maynard Keynes. Dome
(1997, 2004) and Churchman (1999) acknowledge that Malthus is a
“glut” theorist who rejects Say’s Law and claims that aggregate supply
and demand can be (and often are) unequal. More often, Malthus argues,
there’s excess output and saving, deficient demand, and deflationary
unemployment. Oppositely, an excess of total demand allegedly causes
inflation. Although Hume, Smith, Say, and Ricardo rightly deny the
logical possibility of general gluts, they also say public spending is con-
sumptive, never productive, and that public loans, more than taxes, divert
and waste savings. Malthus agrees on the latter points but defends deficit
spending as a “cure” for gluts. He knows the policy dissipates wealth, but
that’s precisely what’s needed, he thinks, to dissipate “excess” aggregate
supply. A century later Keynes also would reject Say’s Law, claim a general
glut was possible, and endorse deficit spending as a remedy for aggregate
unsold output and mass unemployment.
When Alexis de Tocqueville (1805–59) wrote Democracy in America in
1835–40 he paid little attention to public debt, but offered a hypothesis
that drew on the classical economists and is also relevant for contempo-
rary times: that popular forms of government (democracy) usually cause
more extravagant public spending and a public financing system that relies
more on debt than taxes. The context is important: the United States had
repaid all of its debt by 1835 and in the 1840s Britain was two decades
into a long-term trend of debt reduction, in absolute terms and relative to
GDP. Although the franchise was expanding, democratization didn’t yet
seem to threaten fiscal balance. Nevertheless, in Chapter V of Democracy
in America (1835 [2010]), in a section titled “Of Public Expenses Under
the Dominion of American Democracy,” Tocqueville argues that when

one compares a “democratic republic and an absolute monarchy,” one
finds that “public expenditures in the first are more considerable than in
the second,” indeed, that state spending is more “lavish” under democracy,
and not only in America, for “this is the case in all free states, compared
to those that are not free.” Public spending under democracy is also more
wasteful, because it is unplanned and capricious. “As the democracy
frequently changes views and, still more frequently, changes agents, it
happens that enterprises are poorly conducted or remain incomplete.
In the first case, the State makes expenditures disproportionate to the
grandeur of the end that it wishes to achieve; in the second, it makes
unproductive expenditures.” Despite such dissipation, democracies aren’t
necessarily more prone to bankruptcy, because as free nations they’re also
wealthier than unfree ones and have greater taxable capacity. Tocqueville
fails to stress how this also might boost national creditworthiness, and
how freer nations – to the extent governed by the rule of law – might be
more trusted by public creditors. He also falsely conflates democracy with
liberty, although elsewhere in the work rightly warns against the “tyranny
of the majority” and of democracy’s penchant for “soft despotism.”
How might unlimited democracy breed public profligacy? For
Tocqueville, the poor and lower-middle-class citizens outnumber the rich
and those in the upper-middle class; the majority elect politicians who
expand public spending and pay for it by taxing an outvoted minority.
“Countries in which the poor would exclusively be charged with making
the law could not hope for great economy in public expenditures,” for these
“will always be considerable, either because taxes cannot reach those who
vote, or because they are fixed so as not to reach them.” Consequently, he
writes, “the government of democracy is the only one in which the one
who votes for the taxes can escape the obligation to pay them.” Universal
suffrage would almost guarantee public profligacy, because taxes are
unpopular. He also cites democracy’s history: “The unfortunate influence
that popular power can sometimes exercise over the finances of the State
made itself clear in certain democratic republics of antiquity, in which the
public treasury was exhausted to help indigent citizens, or to give games
and spectacles to the people.” Democracy’s bias towards profligacy might
be mitigated if a widening franchise coincided with an increasingly wealthy
populace. “The profusions of democracy are less to be feared the more
people become property owners,” because “on the one hand, the people
have less need for the money of the rich and, on the other hand, they
encounter more difficulties establishing a tax that does not hit them.” He
blithely and mistakenly assumes, as Marx soon would, that economic class
determines ideology and politics.
The last of the great classical political economists, John Stuart Mill
(1806–73) devotes a brief chapter to public debt in his Principles of
Political Economy (1848 [1909]). In Book V, Chapter VII (“Of a National
Debt”) he doesn’t oppose debt finance in wartime but questions “the
propriety of contracting a national debt of a permanent character,”

because funds are taken from savings and thus what might have been spent
on wages. Mill agrees with Smith, Ricardo, and Say that public debt is
broadly detrimental, but focuses on the potential harm to laborers. “The
system of public loans, in [peacetime], may be pronounced the very worst
which, in the present state of civilization, is still included in the catalogue
of financial expedients,” although not “pernicious” if the funds originate
abroad. No glut theorist, Mill nevertheless agrees with Malthus that in
some cases public loans beneficially activate idle savings, when there is an
“overflowing of the general accumulation of the world,” or when capital,
“after being saved, would have been wasted in unproductive enterprises,
or sent to seek employment in foreign countries,” or when saving “has
reduced profits either to the ultimate or to the practical minimum.” Mill
says sovereigns “may annually intercept these new accumulations, without
trenching on the employment or wages of the laboring classes,” and only
to this extent may “the [public] loan system may be carried, without being
liable to the utter and peremptory condemnation which is due to it when it
overpasses this limit.”
Mill concurs with those predecessors who assume public debt can’t accu-
mulate innocuously or infinitely. But what, precisely, is its outer limit? Here
Mill makes a novel contribution. “What is wanted,” he says, “is an index
to determine whether, in any given series of years, as during the last great
war for example [1793–1815], the limit [of public debt] has been exceeded
or not.” Fortunately, “such an index exists,” “at once a certain and an
obvious one.” Simply ask: “Did the government, by its loan operations,
augment the rate of interest?” The yield on the sovereign’s bond constitutes
Mill’s “index” of public debt capacity. If this yield remains low (that is,
the bond price remains high) and doesn’t rise amid greater borrowing, the
borrowing isn’t excessive or unsustainable. Otherwise astute, self-interested
creditors would sell public bonds, lowering their price while raising their
yield; from a truly profligate debtor they’d require a higher interest rate,
to offset default risk. “If [government] only opened a channel for capital
which would not otherwise have been accumulated, or which, if accumu-
lated, would not have been employed within the country,” Mill suggests,
its borrowing wouldn’t crowd out private borrowing or raise interest rates,
for the capital it “took and expended, could not have found employment at
the existing rate of interest.” By his reckoning, “so long as the loans do no
more than absorb this surplus, they prevent any tendency to a fall of the
rate of interest.” If instead new public borrowing raises interest rates, it is

“proof that the government is a competitor for capital with the ordinary
channels of productive investment, and is carrying off, not merely funds
which would not, but funds which would, have found productive employ-
ment within the country.” Only when yields rise is public debt “chargeable
with all the evils which have been described.”
If valid, Mill’s market- based gauge of public debt has important
implications for public debt theory, for many nations now borrow at
unprecedented levels of public leverage (debt relative to GDP), yet enjoy
fast-declining and low borrowing rates (see Chapter 1, Table 1.3). Either
today’s public debts are precarious, at their “limit,” and supposedly astute
creditors fail to demand higher yields to offset greater default risk, or low
bond yields incorporate a correct pricing of risk, in which case public
debts today are not precarious – not close to any upper limit. Yet highly
leveraged sovereigns today also commit “financial repression” – schemes
that mask high-risk debt by compelling a demand for them. In this way an
excessive supply of public debt can be matched or exceeded by an exces-
sive demand for it, leaving sovereign bond yields unchanged or lower than
they’d otherwise be (see Chapter 5, Section 5.6).
Among the better-known classical economists, only the British Ricardian,
John Ramsey McCulloch (1789–1864), devotes an entire volume to
public finance (McCulloch, 1845). His effort is mostly a synthesis of
classical views, with a tilt towards Ricardian (pessimistic) interpretations.
Nevertheless, McCulloch incorporates sufficient analytical context to be
classified as a public debt realist. Like Ricardo, he prefers that states never
borrow but rely on taxes alone, even in emergencies when the tax burden
can be high. Relevant is McCulloch’s naively optimistic belief that higher
taxes can promote wealth creation; the income effect allegedly surpasses
the substitution effect at high tax rates. This makes him less pessimistic
than Ricardo, who says all taxes hurt wealth creation.
McCulloch’s refusal to be too pessimistic about public debt also benefits
by hindsight. At mid-century he would know that the large debt build-
ups of Britain and the United States were followed not by insolvency but
prosperity and debt reduction. Unlike pessimistic predecessors, he can
see the brighter side of the ledger. Hume, Smith, and Ricardo mistak-
enly predicted an inevitable national catastrophe. Why did disaster not
ensue? McCulloch surmises that population, wealth, and national credit
(borrowing capacity) must have increased at a faster pace than public debt.
A proper analysis incorporates all such factors (McCulloch, 1845, p. 423).
McCulloch foreshadows those theorists a century hence who would relate
public debt levels to GDP, and calculate “optimal” rates of taxation and
public debt. But even had classical political economists deployed such
metrics, there’s good reason to believe they’d have remained pessimistic,

just as resort to debt metrics today doesn’t much reduce the headcount of
contemporary debt pessimists.
Britain’s great, long-tenured prime minister in the nineteenth century,
William Gladstone (1809–1898), didn’t share McCulloch’s realism.
Without reserve he was a public debt pessimist who opposed public bor-
rowing even for war; outstanding bonds should be repaid at once or con-
verted to annuities. By one account Gladstone (in 1854) “opposed with all
his might the increase of the national debt, holding that future generations
should not be mortgaged to the present. It was the present that made the
war in the interest of England and of civilization; let the present, therefore,
demonstrate its patriotism by paying as it went the necessary expense”
(Ridpath, 1898, p. 229). Throughout his career Gladstone “strongly
advocated the reduction and speedy extermination of the national debt of
Great Britain,” arguing that it was “an intolerable mortgage on the future
prosperity of the empire.” He was “convinced that fluctuations and indeed
the very existence of the national debt exercised a hurtful influence, not
only on the industrial but on the social condition of Great Britain.” He
thought Europe remained retrograde because there “the policy of reckless
borrowing and debt-making had become a habit” (ibid., p. 375). Gladstone
epitomized the fiscal conservatism that marked the Victorian era. As prime
minister four separate times (between 1868 and 1894) and finance minister
four times also (1852–55, 1859–66, 1873–74, 1880–82), he held high office
two-thirds of the time between 1852 and 1894, when the UK’s public lever-
age plunged from 129 percent to only 41 percent and its financial-industrial
might soared.
2.6 ANTI-PROGRESSIVE REACTIONARIES: MARX

AND HIS PROGENY
Karl Marx (1818–83) offers no coherent theory of public debt, but he’s
worth examining because his perspective influences many economists to
this day, especially regarding financial crises, cronyism, financialization,
and the role of the so-called “rentier” class. Marx is also the last influential
classical economist – a true believer in the labor theory of value. To hold
that economic value is created by the quantity of labor time expended is to
deny, of course, that the quality of labor (skilled and mental) is pertinent –
to deny that scientific, engineering, and managerial intelligence make
possible the inventions, technology, machines, and intellectual property
indispensable to rising productivity and living standards. Yet Marx and his
progeny deny it all – and this affects their debt theory.
Devotion to the labor theory of value typically animates suspicion of

non-manual labor, especially if it’s well compensated, for devotees feel
that skilled or mental labor isn’t “true” (physicalist) labor and so must
be superfluous or exploitative. Marx, we know, views the capitalist, the
owner of the means of production, in just this way: a “parasite” who sucks
the lifeblood (and economic value) from his host, the manual laborer.
Hatred of financiers is greatest, since they control a fictitious realm of
paper-shuffling more remote from the factory even than capitalists, and
worse, extract largess for idleness.
In truth, financiers are the brains of capitalism and of capital markets;
they foster savings and invest the proceeds in what they project will be the
most productive (that is, most profitable) employments. In sharp contrast,
those who embrace Marxian doctrines and deny that intelligence plays any
legitimate role in wealth creation – let alone a leading role – classify these
least manual of laborers as the least worthy laborers of all. Marx isn’t
alone among classical economists in suspecting the financier, bondholder
or rentier. Hume and others share the suspicion, but whereas others doubt
the productive role of financiers, Marx denies it and sees only parasitism.
A parasite is no producer.
What then of Marx’s theory of public debt? He has none; instead, he
offers emotion. He claims that under capitalism the exploitative capitalist,
accumulating ever more capital, finds it increasingly difficult to extract suf-
ficient “surplus value” from increasingly oppressed workers, and thereby
suffers a diminishing rate of profit. In its late stage, before inevitable col-
lapse, capitalism is dominated by financiers. Imbalances and crises prolifer-
ate. Seeking security, an idle “rentier class” sits atop piles of public bonds,
collects “unearned” income, and makes government adopt policies in its
favor. For Marx, any credit system embodies a vicious nexus between credi-
tor (exploiter) and debtor (exploited). Credit is a “false system” of “extreme
retrogression” and “vileness,” riven by “distrust,” “ dehumanization,” and
“estrangement.” Under capitalism, rich bondholders use the state as an
instrument for taxing workers to get the funds needed to service bonds,
an indirect exploitation that occurs not on factory floors but on the floors
of securities exchanges and in “fictitious” capital markets.13 In the credit
system, Marx (1844 [1975, 2010)) argues, “it appears as if the power of
the alien, material force were broken, the relationship of self-estrangement
abolished and man had once more human relations to man,” “but this
abolition of estrangement, this return of man to himself and therefore to
other men is only an appearance; the self-estrangement, the dehumaniza-
tion, is all the more infamous and extreme because its element is no longer
commodity, metal, paper, but man’s moral existence, man’s social existence,
the inmost depths of his heart, and because under the appearance of man’s
trust in man it is the height of distrust and complete estrangement.” He

elaborates:
What constitutes the essence of credit?. . . First, a rich man gives credit to
a poor man whom he considers industrious and decent. This kind of credit
belongs to the romantic, sentimental part of political economy. . . The life of
the poor man and his talents and activity serve the rich man as a guarantee
of the repayment of the money lent. That means, therefore, that all the social
virtues of the poor man, the content of his vital activity, his existence itself,
represent for the rich man the reimbursement of his capital with the customary
interest. . . One ought to consider how vile it is to estimate the value of a man
in money, as happens in the credit relationship. . . Credit no longer resolves the
value of money into money but into human flesh and the human heart. Such
is the extent to which all progress and all inconsistencies within a false system
are extreme retrogression and the extreme consequence of vileness. Within the
credit system. . .the antithesis between capitalist and worker, between big and
small capitalists, becomes still greater since credit is given only to him who
already has. . . Mutual dissimulation, hypocrisy and sanctimoniousness are
carried to extreme lengths, so that on the man without credit [bears] the humili-
ating necessity of having to ask the rich man for credit. Since. . .counterfeiting
cannot be undertaken by man in any other material than his own person, he has
to make himself into counterfeit coin, obtain credit by stealth, by lying, etc.,
and this credit relationship – both on the part of the man who trusts and of the
man who needs trust – becomes an object of commerce, an object of mutual
deception and misuse. (Marx, 1844 [1975, 2010])
Public debt, for Marx, is even more nefarious. “As regards government
loans,” he writes, “the state occupies exactly the same place as the man
does in the earlier example,” but “in the game with government securi-
ties it is seen how the state has become the plaything of businessmen”
who enjoy “a concentration of wealth.” Financiers manipulate the power
of the state (their captive debtor) for selfish benefit. “The immoral vile-
ness of this morality” as well as “the sanctimoniousness and egoism of
that trust in the state become evident” (Marx, 1844 [1975, 2010]) In Das
Capital (1867 [1887], Vol. I, Part 8, Chapter XXXI) Marx contends that
“the system of public credit, i.e., of national debts” entails an “alienation
of the state – whether despotic, constitutional or republican” and “marks
with its stamp the capitalistic era.” The state is for sale – and the rich alone
are favored bidders. But the people are duped, for “the only part of the so-
called national wealth that actually enters into the collective possessions of
modern peoples is their national debt,” and “as a necessary consequence,
the modern doctrine that a nation becomes the richer the more deeply it
is in debt.” The rich own what the people owe – so the rich, in effect, own
the people. Capitalism and public debt go hand in hand. Marx prefers that
neither exist. “Public credit becomes the credo of capital,” he complains,
for “with the rise of national debt-making, want of faith in the national
debt takes the place of the blasphemy against the Holy Ghost, which may
not be forgiven. The public debt becomes one of the most powerful levers
of primitive accumulation.”
To Marx, public bondholders constitute a “class of lazy annuitants”
that profits “without the necessity of its exposing itself to the troubles and
risks inseparable from its employment in industry or even in usury.” By
his account “state creditors actually give nothing away, for the sum lent is
transformed into public bonds, easily negotiable, which go on function-
ing in their hands just as so much hard cash would.” Public bonds also
foster wasteful speculation and give rise “to joint-stock companies, to
dealings in negotiable effects of all kinds, and to speculation, in a word
to stock-exchange gambling and the modern bankocracy.” Worse, central
banks foster the “sudden uprising” of a “brood of bankocrats, financiers,
rentiers, brokers, and stock-jobbers.” Worse still, public debt creates “an
international credit system, which often conceals one of the sources of
primitive accumulation in this or that people.” Bondholders are, he says,
bloodsuckers. “A great deal of capital, which appears today in the United
States without any certificate of birth,” he intones, “was yesterday, in
England, the capitalized blood of children.”
As the national debt finds its support in the public revenue, which must cover
the yearly payments for interest, &c., the modern system of taxation was the
necessary complement of the system of national loans. The loans enable the
government to meet extraordinary expenses, without the tax-payers feeling it
immediately, but they necessitate, as a consequence, increased taxes. . . Modern
fiscality, whose pivot is formed by taxes on the most necessary means of sub-
sistence (thereby increasing their price), thus contains within itself the germ of
automatic progression. Over-taxation is not an incident, but rather a principle.
In Holland, therefore, where this system was first inaugurated, the great patriot,
DeWitt. . .extolled it as the best system for making the wage laborer submissive,
frugal, industrious, and overburdened with labor. The destructive influence that
it exercises on the condition of the wage laborer concerns us less however, here,
than the forcible expropriation, resulting from it, of peasants, artisans, and in a
word, all elements of the lower middle class. . . Its expropriating efficacy is still
further heightened by the system of protection. . . The great part that the public
debt, and the fiscal system corresponding with it, has played in the capitaliza-
tion of wealth and the expropriation of the masses. (Marx, 1867 [1887], Vol. I,
Part 8, Chapter XXXI)
Contemporary Marxists emote similarly when they critique “financiali-

zation,” the process of advancing economies making greater use of money,
credit, and financial instruments (including liquid, tradable securities) to
facilitate saving, investment, production, and exchange (Van Treeck, 2009;
Sawyer, 2013). Most economists today see financialization as either a cause
or consequence of development, but Marxists see it as capitalism’s death

knell. Piketty (2014) is today’s most acclaimed hypercritic of financializa-
tion and the rentier class, in the Marxian sense, but he’s also influenced
by neoclassical and Keynesian premises. The two aren’t inconsistent, of
course; as we’ll see, Keynes despises creditors and calls for the “euthanasia
of the rentier” class. Piketty mostly hews to the anti-capitalist prejudices
of the 2008 Nobel laureate and Keynesian, Paul Krugman; for this reason
I defer an examination of each theorist to Chapter 3.
2.7 THE NEOCLASSICAL MARGINALIZATION OF

PUBLIC DEBT
Although the classical era is more populated with famous public debt
pessimists (Montesquieu, Hume, Smith, Blackstone, Jefferson, Say,
Ricardo, Tocqueville, J.S. Mill, Marx), it also has some less famous opti-
mists (Berkeley, De Pinto, Mortimer, Malthus), as well as some realists
(Davenant, Melon, Steuart, Hamilton, McCulloch). The classical period
isn’t a theoretically homogeneous era dominated by pessimists, as many
assume.
A less anxious attitude about public debt becomes more discernible
in the mid-nineteenth century, after prolonged reductions in UK and
US debts. As early as the 1860s, even as the US Civil War (1861–65)
brought higher new public debts, some observers mocked the classical
theorists – Hume above all – who’d most feared Britain’s debt b uild-ups.
National bankruptcies simply didn’t occur, which emboldened the debt
optimists. At the turn of the century (1900) political-economic leaders in
the United Kingdom and United States could say they’d seen high public
leverage, feared national ruin because of it, yet survived and prospered
without default. Among those who mock the pessimists, British historian
Thomas Babington Macaulay (1800–59) is the most relevant,14 for he
stresses the need for context when assessing the origin, optimality and inci-
dence of public debt (1855 [1877], Vol. VI, Chapter XIX). It’s important to
situate public debt in a nation’s character, governance, income and assets:
[British public] debt has become the greatest prodigy that ever perplexed the
sagacity of statesmen and philosophers. At every stage in the growth of that
debt the nation has set up the same cry of anguish and despair. At every stage
in the growth of that debt it has been seriously asserted by wise men that bank-
ruptcy and ruin were at hand. Yet still the debt went on growing; and still bank-
ruptcy and ruin were as remote as ever. [In 1737 public debt of only £50 million]
was considered, not merely by the rude multitude, not merely by foxhunting
squires and coffeehouse orators, but by acute and profound thinkers, as an
encumbrance which would permanently cripple the body politic. Nevertheless

trade flourished, wealth increased, and the nation became richer and richer.
(Macaulay, 1855 [1877], Vol. VI, Chapter XIX, p. 139)
[By 1783 our debt was £240 million and] again England was given over; and
again the strange patient persisted in becoming stronger and more blooming
in spite of all the diagnostics and prognostics of state physicians. . . [War with
France raised the debt to near £800 million which] was in truth a gigantic, a fab-
ulous debt; and we can hardly wonder that the cry of despair should have been
louder than ever. But again that cry was found to have been as unreasonable as
ever. After few years of exhaustion, England recovered herself. (Ibid., pp. 141–2)
The beggared, the bankrupt, society not only proved able to meet all its obli-
gations, but, while meeting those obligations, grew richer and richer so fast that
the growth could almost be discerned by the eye. . . It can hardly be doubted
that there must have been some great fallacy in the notions of those who uttered
and of those who believed that long succession of confident predictions, so
signally falsified by a long succession of indisputable facts. To point out that
fallacy is the office rather of the political economist than of the historian. Here
it is sufficient to say that the prophets of evil were under a double delusion.
They erroneously imagined that there was an exact analogy between the case
of the individual who is in debt to another individual and the case of a society
which is in debt to a part of itself; and this analogy led them to endless mistakes
about the effect of the system of funding. They were in error not less serious
touching the resources of the country. They made no allowance for the effect
produced by the incessant progress of every experimental science, and by the
incessant efforts of every man to get on in life. They saw that the debt grew; and
they forgot that other things grew as well as the debt. . . They greatly over-rated
the pressure of the burden; they greatly underrated the strength by which the
burden was to be borne. (Ibid., pp. 142–3)
Macaulay finds crucial insights missing from the failed predictions of

past pessimists, notably a failure to recognize that highly indebted sover-
eigns can choose to operate by “the benignant influence of freedom and
of equal law” and thereby achieve, as Hamilton heartily hoped, a “strength
which is derived from the confidence of capitalists”:
It is manifest that all credit depends on two things, on the power of a debtor
to pay debts, and on his inclination to pay them. The power of a society to pay
debts is proportioned to the progress which that society has made in industry, in
commerce, and in all the arts and sciences which flourish under the benignant
influence of freedom and of equal law. The inclination of a society to pay debts
is proportioned to the degree in which that society respects the obligations of
plighted faith. Of the strength which consists in the extent of territory and in
number of fighting men, a rude despot who knows no law but his own childish
fancies and headstrong passions, or a convention of socialists which proclaim
all property to be robbery, may have more than falls to the lot of the best and
wisest government. But the strength which is derived from the confidence of
capitalists such a despot, such a convention, never can possess. That strength –
and it is a strength which has decided the event of more than one conflict – flies,
by the law of nature, from barbarism, and fraud, from tyranny and anarchy, to
follow civilization and virtue, liberty and order. (Ibid., p. 144)
The neoclassical political economists predominant in the 1870s to World

War I paid little attention to public debt theory, because in these decades
public debt wasn’t empirically salient. Almost no discussion of the theory
or history of public debt can be found in the works of Carl Menger, Leon
Walras, William Jevons, or Alfred Marshall. The biggest public debtors
had demonstrated an ability to handle large war debts and even reduce
them (the United Kingdom after 1815, the United States after 1865). The
famed neoclassical economists instead focused on marginal utility theory
and advances in microeconomics.15
All of this changed dramatically in the twentieth century, as public lev-
erage reached new heights due to wars and depressions. Ironically, public
debt optimists then became more prominent, especially in the Keynesian
school, to which I turn next.
NOTES
1. See Peacock (1959), Blewett (1981), Rowley (1987), O’Brien (2004), and Tsoulfidis
(2007).
2. Stabile (1998).
3. Buchanan (1958 [1999]) portrays the “mercantilist position” as arguing “that public debt
creation was in the social interest” (Chapter 2, Section 8.6) and was proto-Keynesian:
“A conception of public debts strikingly similar to those which are currently orthodox
was widely prevalent in the eighteenth century and before, and this was considered an
essential part of the whole mercantilist doctrine” (Chapter 2, Section 2.27). Smith (1776
[1937], Book V, Chapter III) conflates the mercantilist view with the plain fact that the
paying and receiving of interest is a wash, in aggregate (“the right hand which pays
the left”), a view he derides as a mere “apology founded altogether on the sophistry of
the mercantile system,” which is “unnecessary to say anything further about it.”
4. On De Pinto, see Cardoso et al. (2005).
5. For more on Steuart’s view of debt, see Stettner (1945).
6. For more on Smith’s view, see Nicholson (1920), Jadlow (1977), Rowley (1987), and
Tullio (1989).
7. Reinhart et al. (2015) describe “defaults on government debt” that occur “either through
outright default or high inflation,” whether modeled as “inflationary finance” (Bailey,
1956; Barro, 1983) or as a “fiscal theory of the price level” (Bajo-Rubio et al., 2009;
Eusepi and Preston, 2011). On the latter see also Cochrane (2011): “As a result of the
[US] federal government’s enormous debt and deficits, substantial inflation could break
out [if] people become convinced that our government will end up printing money to
cover intractable deficits.”
8. Hamilton (1774), accessed 29 August 2016 at http://founders.archives.gov/documents/
Hamilton/01-01-02-0054.
9. For other interpretations of Hamilton (and Jefferson) on public debt, see Taylor (1950),
Swanson (1963), Gunter (1991), Savage (1992), Swanson and Trout (1992), Gordon
(1997), Sloan (2001), Wright (2002, 2008), Wright and Cowen (2006), DiLorenzo
(2009), Devanny (2010), Sylla and Irwin (2011), McGraw (2012), and Krugman (2016).
10. Friedman (1978) and Clark (2001).

11. O’Driscoll (1977).
12. For worthy interpretations of Ricardo’s debt theory, see Roberts (1942), McCallum
(1984), Anderson and Tollison (1986), Motley (1987), Asso and Barucci (1988), Barro
(1989), Dooley (1989), Evans (1989, 1993), Vissagio (1989), Tullio (1989), Toso (1992),
Seater (1993), Wagner (1996), Dome (2003), and Ricciuti (2003).
13. For contemporary accounts of the Marxian view, see Magdoff and Sweezy (1987), Michl
and Georges (1996), Foster (2007, 2010), Bryan et al. (2009), Hudson (2010), Giacché
(2011), Stravelakis (2012), Lapavitsas (2011), Ahn (2013), Carchedi and Roberts (2013),
Fine (2013), Hansen (2014), Plys (2014), and Sotiropoulos and Lapatsioras (2014). For
a Marxian history of debt, see Graeber (2011).
14. See Suplee (1916).
15. See Diamond (1965) and Bernheim (1989).
3. Keynesian theories of public debt
Whether or not political economists today endorse a deficit spending state,
most acknowledge that the theories of John Maynard Keynes (1883–1946)
originated broad debate on the topic. Yet it wasn’t Keynes but influential
successors – Keynesians like Alvin Hansen, Abba Lerner, Seymour Harris,
Paul Samuelson, Richard Musgrave, and Paul Krugman – who made the
aggressive case for public profligacy that Keynes did not. The most strenu-
ous (albeit not so convincing) arguments for perpetual deficit spending and
public debt accumulation come not from Keynes but Keynesians.
3.1 PRE-KEYNESIAN VIEWS CONSOLIDATED:

ADAMS AND BASTABLE
Near the end of the nineteenth century, after decades of world peace, the
spread of industrialism, and near-universal adoption of the gold stand-
ard, public leverage ratios (public debt/GDP) were low. Classical views
of public debt remained dominant even though their pessimism hardly fit
the facts. In less than two decades public leverage again skyrocketed, amid
World War I, even as combatants raised taxes, although not enough to curb
budget deficits (or patriotism). Professor H.C. Adams (1851–1921) reflects
the prevailing view; a “progressive” who favored a greater role for the state,
his 1895 textbook on public debt conveys a concept, later dubbed “fiscal
illusion,” in which loans help obscure the full burden of government:
The most obvious, as perhaps the most serious, of the political tenden-
cies that accompany credit financiering, is found in the relation it bears to
constitutional government. Its workings in this regard may be very shortly
and very definitively stated. The funding system stands opposed to the full
realization of self-government. This is not at all difficult to understand. As
self-government was secured through a struggle for mastery over the public
purse, so must it be maintained through the exercise by the people of complete
control over the public expenditure. Money is the vital principle of the body
politic; the public treasury is the heart of the state; control over public sup-
plies means control over public affairs. Any method of procedure, therefore, by
which a public servant can veil the true meaning of his acts, or which allows
the government to enter upon any great enterprise without bringing the fact
fairly to the knowledge the public, must work against the realization of the
94
Keynesian theories of public debt 95
constitutional idea. This is exactly the state of affairs introduced by a free use
of public credit.
Under ordinary circumstances, popular attention cannot be drawn to public
acts, except [as] they touch the pocket of the voters through an increase in
taxes; and it follows that a government whose expenditures are met by resort
to loans may, for a time, administer affairs independently of those who must
finally settle the account. . . [Public debt] calls for no immediate payment from
the people, but produces vast sums for the government. It requires a certain
degree of thought to recognize that debts imply burdens, and for this reason a
government that resorts to borrowing may for a time avoid just censure. . . The
administration is satisfied, since its necessities have been relieved without excit-
ing the jealousy of the people; the lenders are satisfied, since they have secured
a good investment for their capitals and are not bothered with its management;
while the people are not dissatisfied because of their profound ignorance of
what has taken place. Herein lies the danger of permitting a government freely
to mortgage its sovereign credit. (Adams, 1895, pp. 22, 24)
Adams endorses what classical political economists preferred: responsible

fiscal policy with budget balance and limited debt issuance. Yet he also
favors “the full realization of self-government” – further expansions of
unlimited democracy and the franchise, mainly to curb capitalism (Fine,
1969; Fried, 2001). Adams concedes that unlimited majoritarian rule is
antithetical to US constitutionalism and classical financial principles, but
he prefers greater state power to spend, tax, and borrow. The Wilsonian
project to “make the world safe for democracy” included elevating the
“popular will” and making government less rule-bound. Adams knows
that as government expands and draws more on populism it’s motivated
to “veil the true meaning” and cost of its growth and lessen the higher
burdens voters might otherwise feel. This is best achieved by displacing tax
finance with debt finance, although this also risks fiscal integrity. This was
the central conflict of public finance at the turn of the twentieth century:
liberty and fiscal rectitude on one hand and on the other an ideological
commitment to expand the size, scope, and cost of government without
alienating taxpayers. For Adams and the progressives, the “free use of
public credit” must “work against the realization of the constitutional
idea” and unlimited borrowing power might become a “danger,” but it’s an
ideal way to reconcile the conflict between a costly state and a popular one.
America’s progressives erode public fiscal responsibility in the twentieth
century by jettisoning constitutional limits in favor of vast new state power
to regulate, spend, tax, borrow, and underwrite public debt through money
issuance by newly established central banks. This is seconded by a revival
of mercantilism, which seeks a larger role for the state and claims free
markets are prone to “overproduction,” excess saving, business slumps,
trade imbalance and mass joblessness; were sovereigns to undertake
chronic deficit spending and debt build-ups the failures could be fixed
and prosperity resumed. In time this was dubbed the “new economics” of
Keynesians, but more precisely it was the new Malthusianism.
The public finance norms extant in the early twentieth century were suc-
cinctly summarized in a widely used textbook, Public Finance (Bastable,
1903, p. 611): “Under normal conditions, there ought to be a balance
between these two sides [expenditure and revenue] of financial activity.
Outlay should not exceed income. . .tax revenue ought to be kept up to
the amount required to defray expenses.” “This general principle must,
however, admit of modifications. Temporary deficits and surpluses cannot
be avoided. . . All that can be claimed is a substantial approach to a balance
in the two sides of the account. The safest rule for practice is that which
lays down the expediency of estimating for a moderate surplus, by which
the possibility of a deficit will be reduced to a minimum.” Most c lassical
economists had viewed deficit spending as improper and detrimental
to savings, capital formation, and prosperity, but for progressives such
dangers occurred only amid full employment. Unemployment supposedly
reflected excessive saving and insufficient private investment, but could be
cured by dis-saving (deficit spending) and public investment. In the United
States during the 1930s, unused industrial capacity averaged 30 percent, the
jobless rate averaged 18 percent, and banks held vast excess reserves.
Keynes, we’ll see, believes that deficit spending cures depression but
otherwise isn’t warranted. Public debt should be incurred to match
public capital investment, not ordinary spending or transfers. He’s a debt
optimist, but being wary of perpetual public debt, he isn’t a full-fledged
optimist; he cares about the proper use of debt. Yet Keynes didn’t think
mass unemployment was an exception to the rule in a free economy, as did
the classical economists (who said it was curable by lower wage rates); he
believes it’s the normal case (thus his “general” theory) and advises deficit
spending to bolster private spending, “absorb” savings, boost investment,
and cut joblessness. Subsequent Keynesians push the view to its “logical”
conclusion and claim a “paradox of thrift” and “secular stagnation”
will become permanent unless there’s permanent (and limitless) deficit
spending. If unemployment is now the rule, so also should be its fiscal cure.
Buchanan and Wagner (1977 [1999]) argue that Keynes in the 1920s and
1930s overturned the “old time fiscal religion” of the Victorian era, with
its balanced budget norm, and post-war Keynesians couldn’t have become
influential without Keynes’s base:
Without Keynes, government budgets would have become unbalanced, as they

did before Keynes, during periods of depression and war. . . But these events
of history would have been conceived and described differently, then and now,
without the towering Keynesian presence. Without Keynes, the proclivities of

ordinary politicians would have been held in check more adequately in the 1960s
and 1970s. Without Keynes, modern budgets would not be quite so bloated,
with the threat of more to come, and inflation would not be the clear and
present danger to the free society that it has surely now become. The legacy or
heritage of Lord Keynes is the putative intellectual legitimacy provided to the
natural and predictable political biases toward deficit spending, inflation, and
the growth of government. (Buchanan and Wagner, 1977, pp. 25–6)
By the 1970s “few could quarrel with the simple thesis that the effective
fiscal constitution in the US was transformed by Keynesian economics.
The old-time fiscal religion is no more” (ibid., p. 23). US public debt in
1977 was $707 billion, or just 35 percent of GDP, and only 11 percent of
US federal spending in the prior decade was borrowed. In contrast, by
the end of 2015, after a six-year revival of deficit spending (to combat
the “Great Recession” of 2007–09), US public debt totaled $19 trillion, or
105 percent of GDP, and nearly a quarter (23 percent) of total US federal
spending in the prior decade was borrowed. Thus US public leverage
(public debt/GDP) tripled from 35 percent in 1977 to 105 percent in 2015,
while the borrowed portion of public spending (in each prior decade)
doubled to 23 percent. For some, the consternation of Buchanan and
Wagner in 1977 seemed validated in 2015; but Keynesians could point to
a ten-year US bond yield that averaged only 2.1 percent in 2015, versus
7.4 percent in 1977. If US public debt was entering a danger zone, why
weren’t bond prices plunging and bond yields skyrocketing?1
Keynes’s theory of deficit spending’s power to “stimulate” an economy
without causing fiscal ruin was more influential after World War II than
previously. As deficit spending amid war coincided with a GDP boom and
less joblessness, acolytes of Keynes credited his theories, even though the
boom was in munitions and joblessness plunged due to war deaths. Post-
World War I debt theory and policy is more radical than what Keynes
prefers, but even before Keynes a relaxation of fiscal orthodoxy was
discernable:
Even before Keynes, economists had challenged the classical (and Victorian)
equivalence of public and private debt. Fallacies of aggregation antedate
Keynesians, and the argument that “we owe it to ourselves” was ushered in early
in the century. This aggregation fallacy, to the extent that it gained acceptance,
served to loosen somewhat the precepts of fiscal prudence for governments,
although the principle of budget balance kept public debt creation within
bounds of reason. . . Norms of private capital accumulation and preservation
remained pervasive, however, until Keynes and the Keynesians promulgated
the “paradox of thrift.” With this step, even the norms of private, personal
prudence came to be undermined. Spending, not saving, spilled over to benefit
society. Alongside this inversion of private norms, the Keynesian theory of

public policy directly undermined any intellectual basis for the maintenance
of balance in governmental budgets. The modern era of profligacy, public and
private, was born. Through their effects on public and political attitudes, ideas
do have consequences. But these consequences emerge only with significant
time lags.
After Keynes, the anti-classical, anti-Victorian ideas were firmly in place
among academics and in the dialogues of the intellectuals. Politics, however,
reflects the behavior of politicians, whose ideas change but slowly. Hence,
during the years after World War II, many politicians adhered to the old
fashioned precepts of fiscal prudence, only to be treated condescendingly
and with scorn by academics and intellectuals. . . The politicians who made
the policy decisions of the 1950s and 1960s had fully absorbed the Keynesian
lessons on both macroeconomic policy and public debt. . .because [these
lessons] offered apparent intellectual support for their natural proclivities to
spend and not to tax. The era of seemingly permanent and increasing gov-
ernment deficits was upon us, an era from which we have not yet escaped.
(Buchanan, 1987, pp. 366–7)
The radically optimistic (naive) Keynesian view of public debt did not
arise in an intellectual vacuum. A cultural ethic – which Buchanan calls
“Victorian” – had slowly eroded, and as it did there arose important pre-
cursors to Keynes, to which I now turn.
3.2 WORLD WAR I, LARGE DEBTS, AND

REVISIONIST THEORY: PIGOU
Not until World War I (1914–18) and its aftermath do we find political
economists again hotly debating (as they hadn’t for a century) whether
pessimism, optimism, or realism was warranted on public debt – for
the obvious reason that public debt once again became empirically
eye-popping. Britain’s public leverage (public debt/GDP) had declined
steadily from an all-time high of 261 percent in 1819 (a few years after the
end of the Napoleonic Wars) to just 25 percent at the outbreak of World
War I in 1914, but by the end of the war (1918) it was 115 percent, and
then climbed further, to a peak of 182 percent in 1923, before declining in
the 1930s, to 110 percent (1940). Leverage increased again due to World
War II and peaked at 238 percent in 1947. Likewise, US public leverage
had declined steadily in the five decades before World War I, from a peak
of 33 percent (in 1869) to just 3 percent in 1914; by 1918 it had returned to
33 percent and was halved to 16 percent by 1929 before doubling again to
35 percent in the 1930s. US leverage tripled to 121 amid World War II but
was still half the UK’s leverage.
The analysis of UK Cambridge professor A.C. Pigou (1877–1959) is
important historically because he originates welfare economics and is used

as Keynes’s theoretical foil, a stand in for classical economists. In fact,
many of Pigou’s views conflict with classical political economy, above all
his advocacy of state intervention. He’s a transition figure between the
neoclassical era that began in 1870 and the spread of Keynesian ideas in
the 1930s. The first edition of his Study in Public Finance (1928), a third of
which is devoted to debt, appears just before the Great Depression. He says
that ordinary outlays should be tax financed, while extraordinary outlays
(mostly during war) should be partially debt financed, with debt build-ups
reduced in peacetime. Here Pigou concurs with classical prescriptions:
that public finance should foster the long-term prerequisites of national
wealth creation, that saving and investment facilitate capital accumulation,
productivity gains, and sustained advances in prosperity, and that exces-
sive state borrowing – particularly for non-productive purposes (social
transfers) – undermines prosperity. Yet the final edition of his Study in
Public Finance (1956) provides a quasi-Keynesian justification for deficit
spending, to mitigate “involuntary” unemployment. In the 1928 edition
Pigou argued that “in a well-ordered state, [regular] expenditure will be
provided for out of taxation, not by borrowing,” for “to meet [ordinary
spending] by borrowing, whether from foreign or domestic lenders, would
involve an ever-growing debt and a corresponding ever-growing obligation
of interest” such that “the national credit would suffer heavy damage, and
ultimately the annual obligations of the government might come to exceed
the maximum sum that it had the power to raise in tax revenue.” The
thesis is “universally accepted” in the 1920s, says Pigou, because “nobody
would suggest that government expenditure of a regular nature, such as
expenditure on the army, navy, and civil service [in peacetime], should
normally be met otherwise than out of taxation” (Pigou, 1956, p. 231).
Public loans should facilitate tax smoothing, to preclude disruptive gyra-
tions in tax rates (especially procyclical tax hikes to narrow a budget deficit
in recession); they’re also proper if proceeds are “devoted to producing
capital equipment” and infrastructure, for they can yield revenues that
assist the economy and provide a source of debt service. This is close to the
classical position.
Pigou also eschews perpetual debt build-ups; even proper public loans
(incurred in rare cases) should be “paid off out of taxes before the need
for further similar expenditures is likely to occur,” otherwise there’ll be
“an ever-growing debt and, eventually, the need for ever-growing taxes”
(p. 233). He knows that Britain’s taxable capacity has increased since the
end of World War I; public spending had declined from 57 percent in 1918
to 29 percent in 1928, as the 1920s saw mostly budget surpluses; meanwhile
the yield on the 2.5 percent consol (long-term bond) fell from 5.67 percent
at the end of 1920 to 4.46 percent at the end of 1928. Similarly, during
World War II, public spending reached 70 percent of GDP and public
leverage peaked at 238 percent in 1947, yet the bond yield dropped from
3.35 percent in 1940 to 2.85 percent in 1947. Pigou realizes that by now it’s
become politically acceptable (and popular) for sovereigns to debt finance
instead of tax finance their outlays, but he warns that “to allow govern-
ments anxious for popularity to base their financial arrangements upon
speculations of this kind is not a little dangerous” (ibid.). Prudence, he
argues, demands a sinking fund, the classical way of sequestering current
funds to amortize distantly due bond principal.
As to the burden of public debt, Pigou acknowledges but doesn’t endorse
the “common belief that when an enterprise is financed out of taxes the
cost of it is borne by present taxpayers, but that when it is financed out of
loans, the present generation, since the lenders get value for their loans,
bears no real costs, the whole of this being borne in future years” (p. 234).
Empirically, “the British nation owes the predominant part of [the national
debt] to itself ” and thus isn’t burdened by it; only if it owes foreigners is its
position “analogous to that of an individual debtor.” Likewise, repayment
“involves no drain on the resources of the community as a whole, because,
though no part of the community transfers resources to another part, the
community as a whole pays nothing” (pp. 288–9). This is confirmed, he
says, by supposing an immediate retirement of all UK debt by a capital
levy, as Pigou (1918) once advised to retire the debt incurred in World
War I. A levy permits more saving and deprives only idle bondholders,
he insists; it harms only if it curbs investment or causes capital flight. But
“when [interest] is taken from the income of taxpayers in taxes” it “goes
into the income of holders of loan stock,” which is “a transfer of income
from one section of the community to another section, and, in so far
as taxpayers and loan holders are identical, from one pocket to another
pocket in the same coat. Plainly, in a transfer of this kind, it is impossible
that any direct objective burden. . .can be involved” (Pigou, 1956, p. 235).
Interest payments aside, what about principal, due far into the future?
Who bears its burden? Is there a corresponding benefit? If repayment is
provided by installment, as by an annual tax to fill a sinking fund (as Pigou
prefers), the debt isn’t a burden to some single, future generation but
instead to those taxed over time to fill the sinking fund. If, as Pigou also
prefers, proceeds from public loans in normal times are invested in public
assets that yield income, a benefit attaches to (and offsets) the burden;
posterity receives both a liability (debt) and an asset (suppose some worthy
infrastructure), not a negative-valued estate. “Posterity will possess the
new capital which it has been induced by the fiscal expenditures of the
state to create,” so “no cosmical catastrophe is in sight,” for “posterity
may be expected to reap the fruits of its investments in the same way as
its ancestors.” In sum, “the bondholder gets no benefit from repayment
[of public debt],” “while it is also true that the taxpayer suffers no loss”
(p. 236). “The payment of interest and the repayment of principal alike are
transfers, not costs, and to whatever is somewhere lost, there corresponds
elsewhere an exactly equivalent gain” (pp. 236–7). Finally, if public debt
arises from a war that preserves a nation’s liberty, independence or security,
“posterity has been protected from enslavement” (p. 234), so there’s no
injustice if posterity pays for the value bestowed by ancestors.
Pigou’s contextual approach makes him a realist on public debt – at least
in his early career; later, under the influence of Keynes, he becomes an
optimist. Writing in 1928, he’d yet to see the Great Depression and with
it a plunge in tax revenues so great that budget deficits would reach levels
heretofore reserved for wartime. Was economic depression an extraor-
dinary case justifying debt finance? If not, wouldn’t tax hikes be worse?
What policy does classical orthodoxy require? In 1928 Pigou claims to
provide “a strict rule,” but it’s ambiguous: “Prudence seems accordingly
to suggest that borrowing should hardly ever be adopted except for strictly
economic expenditure, and then only when the extension of the state
domain is clearly advisable. This strict rule points, I think, to the right
path in all ordinary circumstances” (Pigou, 1928, p. 248). By “economic
expenditure” he means not transfer spending but infrastructure spend-
ing that yields future income. In 1928 it’s unclear that he’d say a depres-
sion justifies a “clearly advisable extension of the state domain,” despite
conditions being so opposite that of “ordinary circumstances.” The strict
(classical) rule of budget balance in peacetime motivated US politicians in
1932 to raise the top federal income tax rate from 25 percent to 62 percent,
purportedly to close a budget gap (then 4.6 percent of GDP); the puni-
tive tax hikes only worsened the economy and widened the deficit (to 5.4
percent of GDP in 1934). In the last edition of Pigou’s Study in Public
Finance (1956), published two decades after Keynes’s General Theory
(1936), he portrays public debt as way to mitigate depression and preserve
jobs – a Keynesian theme. Less pronounced is his earlier (1928) preoc-
cupation with classical prescriptions for public debt; now (1956) he says
that deep depression and mass unemployment are so unprecedented as
to justify unprecedented peacetime deficit spending and a suspension of
fiscal orthodoxy. His 1956 edition adds a new condition that was absent
from his 1928 edition: “in some circumstances a case may be made out
for using budget deficits in bad times offset by surpluses in good times as
a means of steadying and improving employment” (Pigou, 1956, p. 36).
Pigou’s views in 1928 were cast by Keynes (in 1936) as representing the
classical school; by 1956 Pigou is a virtual Keynesian, at least on deficit
spending. In the 1956 edition he devotes new chapters to the job-creating

possibilities of accumulating public debt, especially when wage rates don’t
decline sufficiently to equilibrate the supply and demand of labor. Like
other Keynesians he ridicules “the Treasury view,” whereby the British
Exchequer, adhering to classical fiscal orthodoxy, denies that deficit spend-
ing, public works projects, or money printing can cure depressions or mass
joblessness. For Pigou in 1956 the issue is “less simple than it seems to be
at first sight” (p. 232) – meaning his sight in 1928. “When private industri-
alists think that prospects are black, they so act as to promote a decrease
in aggregate money incomes” so policymakers “must be able to influence
the aggregate money income” (ibid.) through deficit spending. Even loss-
making public projects become defensible; there should be “nothing to
prevent” government “from undertaking, in the interests of employment,
investment whose yield is expected to be nil or even negative” (p. 233).
Even more radically, in 1956 Pigou defends perpetual deficit spending
so as to redistribute income and wealth from the rich, because they save
more, to the middle class and poor, because they save less. “The bulk of
this money is pretty sure to be expended on the purchase of consump-
tion goods, and so indirectly in creating money income for producers of
those goods,” he argues, and although “some of the borrowed money
may have come out of what would been private investment” neverthe-
less “the primary effect of this public finance operation” will be “a larger
proportion of aggregate purchasing power coming to be held by relatively
poor persons” and thus “an increase in aggregate money outlay” (p. 237).
The Keynesian Pigou of 1956 also insists that public debt incurred for
non-productive schemes needn’t be a burden to posterity:
It is sometimes thought that whether and how far an enterprise or enterprises

ought to be financed out of loans depends on whether and how far future gen-
erations will benefit from it. This conception rests on the idea that the cost of
anything paid for out of loans falls on future generations while costs met out
of taxes are borne by the present generation. Though twenty-five years ago this
idea could claim some respectable support, it is now everywhere acknowledged
to be fallacious. It is true that loans raised from foreigners entail a burden
represented in interest and sinking fund on future generations in the borrow-
ing country. But interest and sinking fund on internal loans are merely trans-
fers from one set of people in the country to another set, so that the two sets
together – future generations as a whole – are not burdened at all. . . [Whether
by taxes or debt] it is the present generation that pays. (Pigou, 1956, pp. 37–8)
Here Pigou conceives society as a collective existing eternally and in

which individual elements (whether debtors, creditors, or generations)
are interchangeable; the organism may have its debts, but they’re owed to
itself, so entail no burden to itself. Yet Pigou doesn’t similarly conceive
the broader globe, so international (external) public debts somehow don’t

cancel out; nationalist premises must be introduced, with arbitrary lines at
borders, to make real debt burdens arise after all, at least between nations
(or generations). Pigou fails to see how public debt theory is rendered non-
sensical by such arbitrary line drawing.
Pigou’s pronounced shift between 1928 and 1956 was decidedly towards
Keynesian doctrines. The classical orthodoxy had said sovereigns should
rarely borrow and then only for war; borrowing in peacetime was justified
only for productivity- enhancing infrastructure. The new, Keynesian
orthodoxy counseled loss-creating deficit finance to supposedly create
jobs (even if unproductive) amid mass unemployment. The justification
for “investments by public authorities financed by loans” is not their
financial benefit, Pigou says in 1956, but their power to foster “increases
in aggregate money outlay.” He’s now satisfied to use “the language which
is now fashionable among some [Keynesian] economists,” even to say that
“not only is the relevant multiplier positive, but it is greater than unity”
(pp. 236–7). For the dwindling number of classical economists surviving
into the 1950s it was one thing to see young Keynesians eagerly chase the
unorthodox, but quite another to see Pigou doing it. If he could turn so
easily and so quickly, surely others could also.
An important change occurs over the first half of the twentieth century
in theorizing about public debt, and whether classified as evolutionary
or revolutionary, it undermines and eclipses the previous balance-budget
orthodoxy; the change isn’t revolutionary, because optimistic theories
had always existed, and even occasionally rehabilitated. A pamphlet by
Wilkeson (1865), for example, unabashedly peddled US debt through Jay
Cooke & Co., financier of the Union side of the Civil War, with these
lines: “The five great powers of the world [Great Britain, the United
States, France, Austria, and Russia] have each a permanent national debt”
and despite what pessimists claim, it was “a penal necessity” because their
capacity to service it “has been demonstrated by an exhibit of the resources
of the nation.” By the end of the nineteenth century, attitudes toward
public debt existed on a continuum of pessimists, realists, and optimists.
In that century Hamiltonian realists, who saw public debt as beneficial
under certain conditions but harmful under others (if “excessive”), were in
the minority, outnumbered most by pessimists, who viewed public debt as
always harmful (and to be retired in full if it existed), and outnumbered to
a lesser extent by optimists, who insisted public debt was always beneficial
(and thus could safely be permanent). The nineteenth century was domi-
nated by debt pessimists, a trailing influence of classical political economy;
but the first half of the twentieth century saw the fast-spreading influence
of debt optimists, due mainly to the rise and spread of “progressive”
political economy and its avid advocacy of a more expansive economic role
for government.
3.3 DEPRESSION AND THE NEW

MALTHUSIANISM: KEYNES
Despite Keynes’s reputation for favoring deficit spending, his writing on

the topic is sparse and its substance more mixed than commonly realized.
Clarke (1997, pp. 69–70) peruses Keynes’s entire work and finds few refer-
ences to deficit spending or public debt. Of the 30 volumes comprising
Keynes’s Collected Writings (Keynes, 1978), the last, a 373-page index
covering prior volumes, contains 746 columns but only one-tenth of one
column refers to public debt or deficit spending (“loan-expenditures” per
Keynes). Even these cases occasionally embody classical rules, includ-
ing that in peacetime, should deficit spending be necessary, it must be on
productive projects, not redistributive transfers.
Keynes’s first foray into sovereign debt analysis occurred in the after-
math of World War I, when the victorious Allied Powers (United States,
Britain, France) sought to impose $40 billion in reparations on the
defeated Central Powers (mainly Germany), at the Paris Peace Conference
in 1919. Keynes, then a junior member of the British contingent, became
famous for quitting the proceedings and publishing, in protest, The
Economic Consequences of the Peace (1920). There he mocks demands
for large reparations; the fiscal austerity necessary to pay them in full
would, he insists, bankrupt and starve Germany and large parts of Europe.
“The existence of the great war debts is a menace to financial stability
everywhere” (p. 279) and for political stability too, as they’ll stoke resent-
ment and revolutions. Reparations aren’t strictly public bonds, of course,
but Keynes is justified in analyzing Germany’s capacity to meet foreign
obligations, and endorses the classical view that they’re more burden-
some than domestic ones. He assesses Germany’s debt-servicing capacity
(public credit) and concludes that it “will be exhausted by the direct and
legitimate claims which the allies hold against her” (p. 120). Keynes also
addresses intergenerational equity, and like Jefferson in early America,
says future generations mustn’t shoulder burdens forwarded by ancestors.
“Nations are not authorized, by religion or natural morals,” he argues, “to
visit on the children of their enemies the misdoings of parents and rulers”
(p. 225) – including reparations for “misdoings.”
Keynes contends that Germany can afford to pay just $10 billion in
reparations (Keynes, 1920, p. 200) in a generation, a mere quarter of
the $40 billion (p. 161) required by the Versailles Treaty. Keynes says
the remainder ($30 billion), payable mostly to the United States and
United Kingdom, should be cancelled (p. 270) out of “generosity,” or
unilaterally repudiated. Due partly to this critique, the Allies subsequently
reduced required reparations, by 16 percent in 1921 (to the equivalent of
$20 billion at the time), yet in 1923 Germany defaulted on what it still
owed, so in 1924 this too was reduced, under the Dawes Plan. In 1929 the
sum due was cut yet again, by 50 percent, under the Young Plan, to the
equivalent of $8 billion, payable through 1989. Hitler, gaining dictatorial
power in the 1930s, repudiated all sums still due. All told, Germany paid
very little in reparations in the interwar years, yet many blamed reparations
for Hitler’s rise to power.
Given the abandonment of the classical gold standard during World
War I, public debt theory in the twentieth century had to deal with the
interaction of changes in monetary values and debt burdens. Devoid of an
objective anchor, fiat money was easily manipulated and facilitated infla-
tionary finance. Keynes knows how unanticipated inflation can redistribute
wealth, as debtors gain by repaying loans in less valuable money while
creditors lose to an equivalent extent. Likewise, he knows how inflation
is an opportunistic means by which a sovereign lightens its debt burden,
especially if it also wields monopolistic control over money issuance. In The
Economic Consequences of the Peace (1920) Keynes writes of how:
[b]y a continuing process of inflation, governments can confiscate, secretly

and unobserved, an important part of the wealth of their citizens. By this
method they not only confiscate, but they confiscate arbitrarily; and while the
process impoverishes many, it actually enriches some. The sight of this arbi-
trary re-arrangement of riches strikes not only at security, but at confidence
in the equity of the existing distribution of wealth. Those to whom the system
brings windfalls, beyond their deserts and even beyond their expectations or
desires, become “profiteers,” who are the object of the hatred of the bourgeoisie,
whom the inflationism has impoverished, not less than of the proletariat. As
the inflation proceeds and the real value of the currency fluctuates wildly from
month to month, all permanent relations between debtors and creditors, which
form the ultimate foundation of capitalism, become so utterly disordered as to be
almost meaningless; and the process of wealth-getting degenerates into a gamble
and a lottery. . . There is no subtler, no surer means of overturning the existing
basis of society than to debauch the currency. The process engages all the hidden
forces of economic law on the side of destruction, and does it in a manner which
not one man in a million is able to diagnose. (Keynes, 1920, pp. 235–6)
Unanticipated inflation disorders debt relations, yet Keynes endorses the

policy; he does not, as economists typically contend, oppose merely defla-
tion (which favors creditors at the expense of debtors). He also knows that
blame for rising prices is often lazily assigned, in the popular mind, to the
price setter (business) instead of the money issuer (government). Since “not
one man in a million” can diagnose or cure inflation, “popular i ndignation”
towards rising prices, resulting from “vicious methods” of public finance,
are blamed on “profiteers” and the “entrepreneur class of capitalist,”
those that Keynes otherwise praises as “the constructive element of the
whole capitalist society” (ibid., p. 236). So why punish them? To obscure
politicians’ fiscal-monetary “misdoings” and provide them greater latitude.
“By directing hatred against [the capitalist] class,” Keynes writes, the “fatal
process” of debasing money can be intensified. “By combining a popular
hatred of the class of entrepreneurs with the blow already given to social
security by the violent and arbitrary disturbance of contract” caused by
inflation, governments make “impossible a continuance of the social and
economic order of the nineteenth century” (p. 237). Inflation is a “fraud
upon the public,” he concedes, but one that money holders discover only
when “the worthlessness of the money becomes apparent” (p. 240). Keynes
knows of inflation’s harmfulness, but doesn’t oppose it.
Aware of popular “hatred” of capitalists and entrepreneurs, and of
widespread distrust of creditors, Keynes wants public financial policies
to exploit such sentiments. “A debtor nation does not love its creditor,”
he writes (p. 278), while suggesting (much like Marx) that debtors are
effectively enslaved by creditors when debts accumulate beyond capacity
to pay. In such cases the debtor will justifiably “make constant attempts
to evade or escape payment,” which becomes a source of “friction” and
“ill-will” (ibid.). Large, intersovereign debts are especially onerous and
unjustified, Keynes says; when sovereigns owe each other, sovereignty
itself becomes a sham. On this view “the continuance on a huge scale of
indebtedness between governments has special dangers,” for they are “vast
paper entanglements” that render the international financial system “in the
highest degree artificial, misleading, and vexatious.” The global economy
“shall never be able to move again unless we can free our limbs from these
paper shackles.” At the close of World War I he calls for a cancellation
of intergovernment obligations. “A general bonfire [of public debt paper]
is so great a necessity that unless we can make of it an orderly and good-
tempered affair” it will “grow into a conflagration that may destroy much
else as well.” On internal public debt Keynes echoes Ricardo and Pigou
when he counts himself as “one of those who believe that a capital levy
for the extinction of debt is an absolute prerequisite of sound finance”
(p. 280).
In The Economic Consequences of the Peace (1920) Keynes notes
how “the inflationism of the currency systems of Europe has proceeded
to extraordinary lengths” and how “various belligerent governments,
unable, or too timid or too short-sighted to secure from loans or taxes the
resources they required, have printed notes for the balance” (p. 238). Soon
thereafter, emboldened by Keynes’s critique, Germany mocks reparations
demands by hyperinflating its mark (1921–24), an extreme and surrepti-
tious form of debt repudiation that Keynes applauds as an ingenious
expedient no opportunistic sovereign should eschew. In Chapter 2 of his
Tract on Monetary Reform (1923) he notes with great satisfaction how
“[Germany’s] national debt has been, by these means, practically oblit-
erated, and the bondholders have lost everything” (Keynes, 1923, p. 65).
For Keynes this is no “pernicious” policy of “injustice,” as Adam Smith
once described it, because, he believes, Germany shouldn’t have had to pay
reparations in the first place.
Keynes appears more the public debt pessimist than the optimist in
Economic Consequences of the Peace (1920) given his (subsequent) reputa-
tion for stressing debt’s power to stimulate economic activity. He defends
public debtors and disdains public creditors and he welcomes overindebted
states surreptitiously inflating away their burdens, or ending them through
confiscatory levies – in the name of “sound finance” of course. In his
Tract on Monetary Reform (1923), eyeing Germany’s hyperinflation, Keynes
reprises his view that inflation helps overleveraged states repudiate their debt:
A government can live for a long time, even the German government or the
Russian government, by printing paper money. That is to say, it can by this
means secure the command over real resources – resources just as real as those
obtained by taxation. The method is condemned, but its efficacy, up to a point,
must be admitted. A government can live by this means when it can live by no
other. It is the form of taxation which the public find hardest to evade and even
the weakest government can enforce, when it can enforce nothing else. . . The
burden of the tax is well spread, cannot be evaded, costs nothing to collect,
and falls, in a rough sort of way, in proportion to the wealth of the victim. No
wonder its superficial advantages have attracted Ministers of Finance. . . Like
other forms of taxation, these exactions, if overdone and out of p roportion
to the wealth of the community, must diminish its prosperity and lower its
standards. . . But this effect cannot interfere very much with the efficacy of
taxing by inflation. . . [T]he government can still secure for itself a large share
of the surplus of the community. (Keynes, 1923, pp. 41–3)
Inflation not only taxes cash balances but also diminishes the real value of
public debt, as creditors receive interest and a return of principal in less
valuable money:
We have seen in the preceding section the extent to which a government can
make use of currency inflation for the purpose of securing income to meet
outgoings. But there is a second way in which inflation helps a government to
make both ends meet, namely by reducing the burden of its preexisting liabilities
in so far as they have been fixed in terms of money. These liabilities consist,
in the main, of the internal debt. Every step of depreciation obviously means
a reduction in the real claims of the rentes-holders against their government.
It would be too cynical to suppose that, in order to secure the advantages
discussed in this section, governments (except, possibly, the Russian govern-
ment) depreciate their currencies on purpose. As a rule they are, or consider
themselves to be, driven to it by necessities. (Keynes, 1923, p. 63)
Keynes’s conception of public policy intentions is clear: “cynicism,” not

realism, leads observers to suspect governments might inflate, when it’s
expedient, to avoid the resentment of taxpayers (towards higher taxes) or
bondholders (towards explicit default). Keynes knows the history of cur-
rency debasement involves deliberate intent by cash-strapped sovereigns
to remain electorally popular by securing funds deceptively; indeed, “the
most cogent reason” for a “permanent depreciation” of a currency is to
reduce a real public debt burden. By reducing the real value of its money
a sovereign directly reduces its non-interest-bearing obligations, of course,
but if its bonds are denominated in that same currency, its devaluation also
indirectly reduces its interest-bearing (debt) obligations. For Keynes none
of this policy mix breaches public trust or integrity, nor violates sanc-
tity of contract; it entails merely “moderating the claims of the rentier”
(bondholder) when a state feels its debts are at “an insupportable level,” or
“an excessive portion of the national income” (ibid., p. 64).
In his more famous book, the General Theory (1936), Keynes endorses
a policy of radically depressing the interest rate received by public
bondholders, to the point of achieving, in his own (metaphorical) words,
“the euthanasia of the rentier” class. In this way he harbors medievalist
prejudices about lenders as slothful, greedy, exploitative, “functionless,”
and fundamentally undeserving. The prejudice prevails to this day, along a
lengthy ideological spectrum (Konczal, 2013).
In his Tract (1923) Keynes names three policies to reduce public debt,
besides running budget surpluses: (1) repudiation (explicit default), (2)
currency depreciation (implicit default), and (3) a capital levy. The first
option he deems too brazen to be practical or even popular; the latter
option is too complicated and too avidly opposed by the powerful rich to
be adopted. The second option, currency depreciation (inflation), is least
understood and least detected by victimized cash-holders and bondhold-
ers. For Keynes it’s a mere “expedient,” a viable option, “so to speak,
nature’s remedy,” for it “comes into silent operation when the body politic
has shrunk from curing itself ” (p. 65). In short, if excess public debt is the
disease, surreptitious currency depreciation is the cure.
Keynes detests the “untouchable sacredness of contract” in debtor-
creditor relations for its supposed biased in favor of a “vested interest”
(the creditor). Overleveraged states should effect an “alteration of the legal

tender,” a policy that’s neither unethical nor unprecedented. We mustn’t
ignore “the greatest of all social principles,” which is the “fundamental
distinction between the right of the individual to repudiate a contract and
the right of the State to control vested interest.” Creditors may be due
interest legally, but mustn’t have undue interest politically. For Keynes
“nothing can preserve the integrity of contract between individuals,
except a discretionary authority in the State to revise what has become
intolerable.” Echoing Marx and harboring medievalist bigotry against
lenders, Keynes says “the powers of uninterrupted usury are too great”
and “if the accretions of the vested interest” – public creditors – “were to
grow without mitigation for many generations, half the population would
be no better than slaves to the other half ” (p. 67). He portrays currency
debasers not as embezzlers but as liberators of debt slaves; like Jefferson,
he asserts that no state must be “allowed permanently to enslave the
tax-payer to the bond-holder” (ibid.). A state should care, he says, about
“the continuance of an individualist society,” and “must never neglect
the importance of so acting in ordinary matters as to promote certainty
and security in business” (p. 68), but such values aren’t worth preserving
if a sovereign is overindebted and its citizens thereby overtaxed. “When
great decisions are to be made, the state is a sovereign body of which the
purpose is to promote the greatest good of the whole,” and when expedi-
ent, a state should repudiate its creditors and openly defy “the absolutists
of contract” (ibid.). Note how Keynes doesn’t merely wish to mitigate the
injustice done to debtors by deflation, for most of his calls for inflation
are made prior to the deflationary 1930s. Note also that his purported
concern for an “individualist society” doesn’t deter him from wishing to
see individual creditors sacrificed for the benefit of debtors.
Keynes, although a critic of classical economics, acknowledges how
a sovereign resorting to inflation can erode debt burden, but instead of
opposing the tactic he condones it. His antipathy towards bondholders,
the “rentiers,” is palpable in his main work. He assumes they’re unpro-
ductive and undeserving of their interest income; he endorses a policy of
depressed interest rates, to near zero, to achieve “the euthanasia of the
rentier” class (Keynes, 1936, p. 376). Keynes knows of inflationary finance
but unlike Adam Smith doesn’t critique it, either on positive or norma-
tive grounds; a sovereign that tries to inflate away the real value of its
debt isn’t committing an error or a wrong but doing right, for a policy of
“moderating the claims of the rentier” (bondholder) is justified w henever
public leverage is at “an insupportable level,” defined as being “an
excessive portion of the national income” (Keynes, 1923, p. 64). Keynes
sympathizes with states “driven to [inflation] by necessities,” which, “in
order to secure the advantages” of debt reduction, choose to “depreciate

their currencies on purpose” (ibid., p. 63; emphasis added). Keynes notes
three ways a sovereign can default on its public debt: explicitly (by a repu-
diation, or deliberate non-payment), implicitly (by inflation), and by a
taking (levy on rentiers):
The active and working elements in no community, ancient or modern, will

consent to hand over to the rentier or bond-holding class more than a certain
proportion of the fruits of their work. When the piled-up debt demands more
than a tolerable proportion, relief has usually been sought in one or other of
two out of the three possible methods. The first is Repudiation. But, except
as the accompaniment of revolution, this method is too crude, too deliberate,
and too obvious in its incidence. The victims are immediately aware and cry
out too loud; so that, in the absence of Revolution, this solution may be ruled
out at present, as regards internal debt, in Western Europe. The second method
is Currency Depreciation, which becomes Devaluation when it is fixed and
confirmed by law. In the countries of Europe lately belligerent, this expedient
has been adopted already on a scale which reduces the real burden of the debt
by from 50 to 100 percent. In Germany the national debt has been by these
means practically obliterated, and the bondholders have lost everything. . .
The remaining, the scientific, expedient, the Capital Levy, has never yet been
tried on a large scale; and perhaps it never will be. It is the rational, the deliber-
ate method. But it is difficult to explain, and it provokes violent prejudice by
coming into conflict with the deep instincts by which the love of money protects
itself. (Keynes, 1923, pp. 63–6)
To fully comprehend Keynes’s viciousness towards public creditors, one

must recognize not only his disdain for lenders (“rentiers”) particularly,
but also for the gold standard and capitalism generally. In “The End of the
Gold Standard,” Part III, Chapter 7 of Essays in Persuasion (Keynes 1931
[1932], pp. 288–94), he applauds Britain for abandoning the gold standard
in September 1931, because it (supposedly) imposed “gold fetters” on
states and precluded them from taking the discretionary (inflationary)
actions needed to end mass joblessness. In his 1926 essay, “The End of
Laissez-Faire,” in Part IV, Chapter 2 of Essays in Persuasion, Keynes denies
that individuals – least of all the rich or public bondholders – possess any
inviolable rights to liberty or private property:
It is not true that individuals possess a prescriptive “natural liberty” in their

economic activities. There is no “compact” conferring perpetual rights on those
who Have or on those who Acquire. The world is not so governed from above
that private and social interest always coincide. It is not so managed here below
that in practice they coincide. It is not a correct deduction from the Principles of
Economics that enlightened self-interest always operates in the public interest.
Nor is it true that self-interest generally is enlightened; more often individuals
acting separately to promote their own ends are too ignorant or too weak to
attain even these. Experience does not show that individuals, when they make
up a social unit, are always less clear-sighted than when they act separately. . . I
suggest, therefore, that progress lies in the growth and the recognition of semi-
autonomous bodies within the State – bodies whose criterion of action within
their own field is solely the public good as they understand it, and from whose
deliberations motives of private advantage are excluded, though some place it
may still be necessary to leave, until the ambit of men’s altruism grows wider, to
the separate advantage of particular groups, classes, or faculties. . . I propose a
return, it may be said, towards medieval conceptions of separate autonomies. . .
I think that Capitalism, wisely managed, can probably be made more efficient
for attaining economic ends than any alternative system yet in sight, but that
in itself it is in many ways extremely objectionable. (Keynes, 1931 [1932],
pp. 312–14, 321)
Keynes’s hatred of capitalism is best expressed in a 1933 article,

where he writes that “the decadent, international, but individualistic
capitalism, in the hands of which we found ourselves after the War, is
not a success. It is not intelligent, it is not beautiful, it is not just, it is
not virtuous – and it doesn’t deliver the goods. In short, we dislike it and
we are beginning to despise it. But when we wonder what to put in its
place, we are extremely perplexed” (Keynes, 1933a). Here it is relevant to
recall Keynes’s admission, in Economic Consequences of the Peace (1920,
p. 235), that “permanent relations between debtors and creditors. . .form
the ultimate foundation of capitalism.” His desire to see the world rid
of the gold standard and capitalism fits well with his belief that public
debt burdens should be lightened by curbing the rights and returns
of creditors, whether by a levy, inflation, or a zero interest rate policy
adopted by a central bank to effect a “euthanasia” of the rentier class.
For Keynes, debtor-creditor relations are foundational for capitalism, yet
capitalism causes depression, so to ensure prosperity capitalism must be
eradicated; short of that, policy should periodically disorder or sabotage
debtor-creditor relations.
What explains Keynes’s antipathy towards public bondholders? He
believes they serve no useful or productive purpose; worse, they preclude
recovery from depression by greedily keeping capital unduly scarce and
costly. In his General Theory (1936) Keynes contends that interest rates are
determined not by the interaction of the supply and demand for loanable
funds, as the classical economists held, but by the supply and demand
for cash balances; thus a central bank might depress interest rates by
increasing the supply of money, either by purchasing public debt indirectly
from banks, or directly from the Treasury (through debt monetization).
Keynes wants low to near zero interest rates, to deter additional saving
and (allegedly) foster more investment – but mostly to stop the supposed
“oppressive power of the capitalist to exploit”:
[This] would mean the euthanasia of the rentier, and, consequently, the eutha-
nasia of the cumulative oppressive power of the capitalist to exploit the scarcity-
value of capital. Interest today rewards no genuine sacrifice, any more than
does the rent of land. The owner of capital can obtain interest because capital
is scarce. . . But whilst there may be intrinsic reasons for the scarcity of land,
there are no intrinsic reasons for the scarcity of capital. . . I see, therefore, the
rentier aspect of capitalism as a transitional phase which will disappear when it
has done its work. And with the disappearance of its rentier aspect much else in
it besides will suffer a sea-change. It will be, moreover, a great advantage of the
order of events which I am advocating, that the euthanasia of the rentier, of the
functionless investor, will be nothing sudden, merely a gradual but prolonged
continuance of what we have seen recently. . . Thus we might aim in practice. . .at
an increase in the volume of capital until it ceases to be scarce, so that the
functionless investor will no longer receive a bonus. (Keynes, 1936, p. 376)
Keynes believes financial capital, being neither tangible nor produc-

tive, needn’t and shouldn’t receive interest; it is, in common parlance,
“unearned income.” Capital ages ago may have been derived from savings
in the form of specie, but having abandoned gold (a “barbaric relic”),
central banks now can easily supplement savings by fiat paper money
creation. Capital now needn’t be scarce, per Keynes; sovereigns can create
it easily, in abundance, without a “scarcity premium,” so interest rates
can now be zero, if necessary even negative, so bondholders pay interest
(to much- indebted states) instead of receiving it. The money supply
also should be so abundant as to be virtually costless (and worthless);
obviously, no state should pay interest for the use of near costless cash.
Few classical (or neoclassical) economists will find logic in Keynes’s
thesis, yet it drives policymaking today. In truth, saving and investing are
crucial to prosperity, and creditors ought to be rewarded for both; deprived
of reward, their risk-taking ends and stagnation ensues. Keynes, instead,
believes that stagnation reflects too much saving and too little investment;
he proposes making abundant a “supply of capital,” but his remedy entails
zero rewards and endless paper money, neither of which foster prosperity.
Keynes first publicly advocates deliberate peacetime deficit spending in
a series of brief essays during 1929–31 (Keynes, 1931 [1932]), a period that
began with a fast rise in Britain’s jobless rate and ended with its abandon-
ment of the gold standard. Keynes condemns what he calls “orthodox
Treasury dogma” (Keynes, 1931 [1932], p. 121), a policy of balancing the
budget regardless of circumstances, by steep spending cuts and tax hikes.
Treasury “dogma” includes a pledge to keep the pound convertible into
gold (no devaluation). Writing in April 1929, Keynes blames growing
joblessness on Treasury’s financial orthodoxy and refusal to deficit spend.
British outlays had been cut 34 percent since 1920 and surpluses allowed a
3 percent cut in public debt, but the jobless rate stayed above 10 percent. To
stop “retarding for a decade the economic progress of the whole country,”
Keynes calls for vast public spending, and “even if half of it were to be
wasted, we should still be better off.” He rejects fears that “money raised
by the state for financing [such schemes] must diminish pro tanto the
supply of capital available for ordinary industry” (pp. 120–21). Contrary
to the “Treasury view,” Keynes believes that public capital spending won’t
displace productive employment of private capital; resources are already
underemployed, so slack will prevent crowding out, inflation, or a run on
the pound. The Bank of England should expand money and credit.
Keynes believes that Britain’s high jobless rate in the 1920s reflects
Treasury’s aim of reducing the high public debt and high interest rates that
are left over from World War I. “The less the government borrows, the
better [Treasury argues] are the chances of converting the national debt into
loans carrying a lower rate of interest,” but in doing this, Treasury officials
only “barred the door” to recovery (p. 129). Just before Britain defaults on
the gold standard in September 1931 Keynes denounces Treasury’s plan to
narrow the budget deficit by spending cuts and tax hikes; it is “the crude
idea that there is a fixed loan fund, the whole of which is always lent, so
that, if the government borrows less, private enterprise necessarily borrows
more.”
Keynes rejects the notion of “crowding out” when saving is excessive.
Treasury’s orthodox policy, he believes, will increase joblessness; it should
simply deficit spend. “The immediate consequences of the government
reducing its deficit are the exact inverse of the consequences of its financ-
ing additional capital works out of loans.” Treasury must reject the notion
that deficit spending is artificial, unsustainable, or harmful. “At the present
time all governments have large deficits,” but it is “nature’s remedy, so to
speak, for preventing business losses from being, in so severe a slump as the
present one, so great as to bring production altogether to a standstill.” For
Keynes, it is “much better in every way that the [state’s] borrowing should
be for the purpose of financing capital works, if these works are of any use
at all, than for the purpose of paying doles,” that is, for direct relief of the
unemployed (Keynes, 1931 [1932], pp. 158, 159, 161).
Keynes further advances his case for peacetime deficit spending in a
1933 pamphlet, The Means to Prosperity. He advises the British govern-
ment to make an extra £3 million “loan-expenditure” (his expression for
“deficit spending”), which was then less than 1 percent of total govern-
ment spending of £1.3 billion, when roughly one million were unemployed.
Keynes assumes a modest spending multiplier (1.5). Trying to balance a
budget by tax hikes, as the United States tried in 1932, would make things
worse: “Taxation may be so high as to defeat its object,” he writes; indeed,
“given sufficient time to gather the fruits, a reduction of taxation will run
a better chance, than an increase, of balancing the budget.” Alternatively,

by a “loan-expenditure,” the state can “support schemes of capital devel-
opment at home as a means to restore prosperity.” Previously only war
justified deficit spending; now a peacetime depression does so:
If these conclusions cannot be refuted, is it not advisable to act upon them? The
contrary policy of endeavoring to balance the budget by impositions, restric-
tions, and precautions will surely fail, because it must have the effect of dimin-
ishing the national spending power, and hence the national income. . . Some
cynics, who have followed the argument thus far, conclude that nothing except
a war can bring a major slump to its conclusion. For hitherto war has been the
only object of governmental loan-expenditure on a large scale which govern-
ments have considered respectable. In all the issues of peace they are timid,
over-cautious, half-hearted, without perseverance or determination, thinking of
a loan as a liability and not as a link in the transformation of the community’s
surplus resources, which will otherwise be wasted, into useful capital assets. I
hope that our Government will show that this country can be energetic even in
the tasks of peace. (Keynes, 1933b, pp. 16, 22)
Later in 1933 Keynes opines publicly on the possibility of a coordinated

policy to deliberately deficit spend in peacetime, when The New York Times
publishes his open letter to US President Roosevelt. First he warns that
vast new regulatory reforms and uncertainties are undermining business
confidence; with confidence low, consumer spending “cannot be expected
to work on a sufficient scale.” The only way to create an “initial major
impulse” that boosts the economy is by inflationary deficit spending:
The public authority must be called in aid to create additional current incomes
through the expenditure of borrowed or printed money. . . As the prime mover
in the first stage of the technique of recovery I lay overwhelming emphasis on the
increase of national purchasing power resulting from governmental expenditure
which is financed by Loans and not by taxing present incomes. Nothing else
counts in comparison with this. . . [I]n a slump governmental Loan-expenditure
is the only sure means of securing quickly a rising output at rising prices. . . In
the past orthodox finance has regarded a war as the only legitimate excuse for
creating employment by governmental expenditure. You, Mr. President, having
cast off such fetters, are free to engage in the interests of peace and prosperity
the technique which hitherto has only been allowed to serve the purposes of
war and destruction. The set-back which American recovery experienced this
autumn was the predictable consequence of the failure of your administration
to organize any material increase in new Loan-expenditure during your first six
months of office. (Keynes, 1933c)
There’s remarkably little in Keynes’s General Theory about deficit spend-

ing or public debt, despite his reputation as an aggressive advocate of such
policy. Certainly he wanted government to undertake the vast bulk (more
than half) of all investment in the economy – “a somewhat comprehen-

sive socialization of investment will prove the only means of securing an
approximation to full employment” (Keynes, 1936, p. 378) – and not only
during economic contractions. Yet his most famous book (1936) doesn’t
explicitly advocate deficit spending to achieve a cyclical rebound, nor does
it advise a permanent, structural budget deficit or perpetual build-up of
public debt. From Keynes’s earlier works we know that for high public
debts he counsels default, a capital levy, and the subterfuge of inflation;
but nothing in his broad doctrine seems to require large public debts, or
rising public leverage (debt in relation to GDP). But he hopes the “rentier”
class (bondholders) will lose importance (and income) over time and
wither away, along with the gold standard and capitalism.
To the extent that Keynes condones budget deficits amid recessions
or depressions, it is to counteract the harm that can be inflicted by the
orthodox (classical) prescription that the government budget be balanced
in peacetime, for that requires spending cuts, tax hikes, or both, at an
inopportune time. For Keynes such policies only hurt the economy, as
happened when they were tried under Hoover in the United States. On
this point Keynes is half right, for tax rate hikes can inflict harm; but
opposition to self-defeating fiscal austerity doesn’t prove a case for massive
deficit spending. To his credit Keynes stresses that sustainable recovery is
helped by public investment, not deficit spending per se or by spending on
transfers. But the best policy, he fails to note, is to apply fiscal austerity to
a bloated state (by spending cuts), not to a reeling economy (by tax hikes).
Keynes’s reputation for being cavalier about deficit spending and a pro-
ponent of overtly wasteful spending to achieve recovery isn’t undeserved.
“When involuntary unemployment exists,” he writes in his General Theory
(1936), “the marginal disutility of labor is necessarily less than the
utility of the marginal product.” He doesn’t explain why this would
fail to induce the jobless to take work; normally one works an extra
hour if the utility gained (from income) exceeds the extra disutility
from laboring – the case Keynes describes. He concludes that “if this
[assumption] is accepted, the above reasoning shows how ‘wasteful’
loan-expenditure [i.e., deficit spending] may nevertheless enrich the com-
munity on balance. Pyramid-building, earthquakes, even wars may serve
to increase wealth” (Keynes, 1936, pp. 128–9). Conceding that these are
“absurd conclusions,” nevertheless Keynes chides those who seek budget
balance while condoning “employment relief financed by loans” (which
he designates “wholly wasteful” spending) and opposing “the financing
of [infrastructure] improvements” (which he classifies as only a “partly
wasteful” form of public spending). “It would, indeed, be more sensible to
build houses and the like,” through deficit spending, but orthodox budget
balancers oppose it, and unfortunately, “wars have been the only form of
large-scale loan- expenditure which statesmen have thought justifiable”
(pp. 129–30). Another passage in the General Theory leaves Keynes
exposed to the charge that he sees deficit spending as a magical cure-all. He
notes that “loan-expenditures” encompass two types of spending – “public
investment” (spending on infrastructure, which he describes as only “partly
wasteful”) and “current public expenditure” (spending on jobless subsidies
and income transfers, which he describes as “wholly wasteful”). Although
“loan-expenditure” is a “convenient expression for the net borrowings
of public authorities,” strictly speaking the latter should be reckoned as
negative saving,” for whereas “one form of loan-expenditure operates by
increasing investment,” the other operates “by increasing the propensity
to consume” (p. 129). Here Keynes makes deficit spending appear as a
cure-all – precisely because it is “wasteful” (that is, a welcome dissipater of
supposed wealth “gluts”).
Recall that for Keynes, depression and “involuntary unemployment”
occur when an economy’s aggregate supply exceeds its aggregate demand
and savings exceed investment (a brazen denial of Say’s Law). Neither the
labor market nor capital market clear, in the first case because wage rates
don’t decline enough, in the second because interest rates don’t decline
enough. At root, the relative deficiency of aggregate demand reflects a
relative deficiency of investment. But Keynes claims to identify two poli-
cies to achieve the balance n ecessary for full employment: (1) boost invest-
ment, so it’s no longer deficient, by deficit spending on public investment
(capital goods) and (2) reduce saving, so it’s no longer superfluous, also
by deficit spending, but solely for the benefit of those with a greater pro-
pensity to consume than to save (ideally, recipients of jobless subsidies).
Deficit spending becomes a u niversal cure-all policy, not just for some
aspects of what ails a depressed economy but for all aspects, so it’s sure
to be deployed both extensively and perpetually, especially if most econo-
mists designate “full employment” a rarity.
The last bit of evidence bearing directly on Keynes’s view of deficit
spending and public debt comes from his insistence that public outlays
be partitioned into ordinary spending and capital spending, as is done in
private business accounting. Ideally, he says, ordinary spending is fully
funded by tax revenues, with no deficit, but capital outlays are borrowed,
because the assets created yield longer-term benefits to future genera-
tions. According to Bateman (2005), Keynes doesn’t make this distinction
to rationalize unlimited deficit spending; he first defends the distinction
in 1924, and last wrote about it in 1944, in the British White Paper on
Employment Policy. He insisted that “the ordinary Budget should be
balanced at all times” and opposed “confusing the fundamental idea

of the capital budget with the particular, rather desperate expedient of

deficit financing.” Not merely ordinary budget balance but also, on occa-
sion, even a surplus should be welcomed, he says. “I should aim at having
a surplus on the ordinary Budget,” and thus an ability to “gradually
replacing deadweight debt by productive or semi-productive debt. . . I
should not aim at attempting to compensate cyclical fluctuations by means
of the ordinary budget” (cited in Bateman 2005, pp. 187–8).
Here we find Keynes, a supposed apologist for chronic deficit spend-
ing, characterizing it as a “desperate expedient” and calling for a surplus
to retire the “deadweight” burden of the national debt; moreover, we find
him denying that deficit spending in the ordinary budget should be used to
“compensate cyclical fluctuations.” Many successor Keynesians, we’ll see,
advocate schemes of “compensatory finance” or “functional finance” by
raiding the ordinary budget, an option Keynes clearly rejects. A failure to
distinguish between operating and capital budgets, Keynes warns, coupled
with a refusal by fiscal officials to incorporate the distinction in their budg-
eting, leads to overly loose fiscal policies and excessive deficits. There’s
always the question, of course, of how best to classify spending that shares
both ordinary and capital features, and whether definitions should be fixed
or instead modified by circumstance; but supposing such questions are
resolvable, a key objective for Keynes is more rational and accurate fiscal
reckoning. If there is to be a vast new “socialization of investment” by
the state, as he wished, it would require a more business-like accounting
system that could track public capital projects and not automatically reject
projects on the grounds that they’d unbalance the operating budget. Yet
perhaps Keynes wants the distinction only to appear fiscally conservative
on one front (the operating budget) so he can indulge fiscal liberality on
another front (the capital budget). The latter front he considers far more
important, since he believes the best cure for depression is more spending
on public capital projects (without tax hiking); thus he must justify deficit
spending on the capital front, in the face of classical critiques of generally
unbalanced peacetime budgets.
I’ve focused mostly on public debt history and theory in the
Anglo-American world, but here it’s worth noting that a proto-Keynesian
view had evolved already in Germany, in the decades after the first public
finance writings of Carl Dietzel (1829–84) appeared in the mid-nineteenth
century (Stettner, 1948; Peacock, 1987; Samuels, 2003). By one account,
Dietzel’s 1855 work “attacked the orthodox [classical] view that state
borrowing required a sinking fund, arguing that government investment
financed by renewable loans was a necessary condition for the growth in
national production.” Moreover, his theories “were endorsed by several
prominent German writers, notably Adolph Wagner, and were recalled
during the post-1936 debate in support of Keynesian views on public debt

policy” (Peacock, 1987, p. 837). Dietzel rejects the view that “the public
sector is outside of the overall economy and that all public expenditures
are unproductive,” in other words, the “two premises” by which “the clas-
sical doctrine logically had to oppose a system of public debt” (Samuels,
2003, p. 84). He also holds that “only democratic states are normally cred-
itworthy,” that “non-democratic, absolutist states, in general, could only
borrow if their governments managed their economic affairs effectively,
and therefore are not exposed to economically unfavorable political pres-
sures and/or other corruptive fiscal practices” (ibid., p. 87). Dietzel further
argues for perpetual public debt, believing it helps the economy, and
denies that a rising public debt burdens future generations if it is incurred
solely to fund public capital projects (as opposed to wasteful consump-
tion schemes or ephemeral transfers). Finally, Dietzel denies that there
are any inherent limits beyond which public debts might rise, even relative
to national income. Many of his ideas were imported into US and UK
universities through a wave of student exchanges in the late nineteenth
century.
Paradoxically, Keynes’s intellectual roots are both primitive, meaning
pre-Smithean, and contemporary, meaning appropriate to the spread
of statism in the 1930s. In Chapter 23 of his General Theory (1936) –
titled “Notes on Mercantilism, the Usurer Laws, Stamped Money, and
Theories of Underconsumption”) – he reveals his roots: sixteenth-and
seventeenth-
century mercantilism, early nineteenth- century Malthusian
glut theory, and the early twentieth-century promotion of inflationary
money printing (by German economist Silvio Gesell) as a way to tax cash
hoards and reduce interest rates. By one account, Keynes’s approach was
more than a century old, for “Malthus had anticipated certain aspects of
pump-priming theory” “as a remedy for depressed conditions” after the
war of 1812 (Anderson, 1944, p. 144). The British Fabian socialists, Sidney
and Beatrice Webb, also advocated pump-priming, two decades before
Keynes did, in a book on “the prevention of destitution.”2 By another
account, “countercyclical policies,” in time termed “Keynesian policies,”
were touted “in the early 1930s” “in various quarters before the appearance
of the General Theory,” “by various individuals and groups,” especially by
“German advocates of deficit spending,” as “a road to full employment”
(Garvy, 1975, p. 393, n. 3 and p. 396). According to one scholar, “no more
than Roosevelt did Hitler have to await the publication of the General
Theory to embark on expansionary policies,” for “G. Strasser, G. Feder, and
others in Hitler’s party had already offered the prescription” (ibid., p. 403).
By the early 1930s, Keynes was both influential and acceptable to Weimar
economists and nationalists, especially because of his previous sympathy
(in 1920) for Germany in the post-war debate about reparations, but
ideological compatibility also proved relevant. In his specially prepared
introduction to the 1936 German-language edition of his General Theory
Keynes declared that “the theory of output as a whole, which the following
book purports to provide, is much more easily adapted to the conditions
of a totalitarian state, than is the theory of production and distribution of
a given output produced under the conditions of free competition and a
large measure of laissez-faire.”3 Neither the rise of Hitler, Mussolini, and
Stalin nor the expansion of the welfare, warfare, regulatory states in the
United States and Britain in the 1930s and 1940s dimmed Keynes’s passion
for central planning, the socialization of investment, and deficit spending;
in his view a benign “middle course” between capitalism and socialism
was needed to prevent collapse of the former and forestall adoption of the
latter. State intervention wouldn’t necessarily proliferate beyond all reason,
although that was precisely the theme of Friedrich Hayek’s The Road to
Serfdom (1944). After reading it, Keynes wrote to Hayek that while “it is a
grand book,” “I should say that what we want is not no planning, or even
less planning; indeed, I should say that we almost certainly want more,”
and “what we need” “is not a change in our economic programs” but “an
enlargement of them.”4
Keynes might have described classical economists as wanting to “balance
the budget, the economy be damned,” while he wanted to “balance
the economy, the budget be damned,” but in truth he never counse-
led unmitigated deficit spending. Distinguishing ordinary from capital
budgeting, he tried to synthesize old (classical) and new (his) notions of
fiscal integrity. It was still possible, in summing two sub-budgets, to get
aggregate deficit spending amid recessions. Public capital projects would
yield a return, said Keynes, but outlays were to be for the “public good,”
not private interest or the profit motive, so public project returns would
rarely prove high enough to satisfy a net benefit test, or exceed the cost
of capital, as required in purely private projects. For Keynes this differ-
ence was precisely the advantage of public projects: with inherently lower
hurdle rates, investment (hence the economy) could be made less volatile.
To achieve long-term economic stability and prevent structural, involun-
tary unemployment, Keynes estimated that the greater part (66–75 percent)
of total capital (not ordinary) spending should be state controlled, com-
prising as much as 20 percent of GDP: “If two-thirds or three-quarters of
total investment is carried out or can be influenced by public or semi-public
bodies, a long-term program of a stable character should be capable of
reducing the potential range of fluctuations to much narrower limits than
formerly, when a smaller volume of investment was under public control,
and when even this part tended to follow, rather than correct, fluctuations
in investment in the strictly private sector of the economy.”5 Unlike the

capital budget, funded mainly by loans, Keynes opposes deficits in the
operating budget. As for “other forms of deficit financing,” he writes that
he is “inclined to lay low because I am sure that if serious unemployment
does develop, deficit financing is absolutely certain to happen, and I
should like to keep free to object hereafter to the more objectionable forms
of it.”6 Keynes’s detractors may be surprised to learn that he found some
deficit spending “objectionable.” The idea that it’s justified mainly for
public capital outlays that yield long-term benefits, not for short-term con-
sumptive or transfer spending out of operating budgets, is also stressed by
Musgrave (1939), Eisner (1986, 1989) and Eisner and Pieper (1984).
What was Keynes’s expectation about the likely effect of his friendlier
attitude towards national debt? Just as he distinguished between an oper-
ating budget that should be funded by tax revenues and balanced over the
course of the business cycle, and a capital budget that would be unbal-
anced, he also distinguished between non-productive, or “deadweight”
public debt (related to the operating budget) and “productive” public debt
(associated with the capital budget). He proposed less of the former and
more of the latter, declaring it would be “a good plan” to include in the
operating budget a line item to spend something each year on “the extinc-
tion of the deadweight debt” or for “the conversion of the deadweight debt
into productive debt.” The debt from capital outlays would rise to match
(and undergird) economic growth and infrastructure needs. Assuming
adoption of his advice, Keynes (writing in the early 1940s) expects “for a
long time to come that the government debt or government-guaranteed
debt would be continually increasing in grand total,” yet not “out of pro-
portion to the growth of the national income.”7 Public leverage shouldn’t
rise. Beyond his initial worries in Economic Consequences of the Peace
(1920), Keynes isn’t concerned about excessive public debts or defaults.
The only defaults to worry about (and prevent) are in the private sector,
due to preventable depressions.
By the early 1940s economists can detect a profound change in
viewpoint versus the prior decade. Public deficits, although not novel,
were being reinterpreted in new ways; once they were the natural but
unfortunate result of repressions, but now they were a means of recovery
and sustainable expansion. According to Haley:
There is nothing new about deficits for government units in time of depression.
In such periods it is to be expected that government receipts will decline, while
expenditures fail to decline proportionately, or even increase. There is, however,
a difference between a fiscal policy designed simply to alleviate the distress
accompanying a severe depression and a fiscal policy designed to produce
recovery though a deliberate unbalancing of the budget. The former policy is
based on the assumption that the deficit is the lesser of two evils; the latter, on
the assumption that deficit financing in such a period is a positive good. It is the
latter policy which has been followed since 1933. The new aspects of our recent
deficits have been their extraordinary size, for peacetime, and the complacency
with which they have been incurred. They have been viewed as a necessary and
important means of promoting recovery itself. (Haley, 1941, p. 67)
We’ve seen how Keynes is sanguine about deficit spending and the
capacity of nations to safely implement the policy, even in peacetime; on
that basis he’s a public debt optimist. Yet many passages in his work try to
delimit the extent and magnitude of deficit spending; on that basis he’s a
public debt realist. It isn’t easy to discern whether these passages reflect his
real views or instead a cynical effort to assuage the suspicions of stubborn
budget balancers at the UK Treasury. Regardless, Buchanan and Wagner
(1977 [1999]) classify Keynes as a proponent of “continuing and increasing
budget deficits.” This may be too harsh. Even Buchanan and Wagner don’t
contend that Keynes is solely responsible for the sea-change in professional
and political attitudes about public deficits and debt in the early twentieth
century. “There was no full-blown Keynesian ‘revolution’ in the 1930s,”
they write, for “American acceptance of Keynesian ideas proceeded step
by step from the Harvard economists, to economists in general, to the
journalists, and finally, to the politicians in power. This gradual spread of
Keynesian notions” not coincidentally, accompanied “the demise of the
old-fashioned principles of fiscal responsibility” (p. 6). Thus there’s a ques-
tion whether the shift in thinking and practice on deficits and debts – for
example, whether they should be temporary and rare or long-lasting and
typical – was a consistent extension of Keynes’s views, or a departure from
them. In his 1954 text, Principles of Public Finance, the pro-Keynesian
and one-time British finance official, Hugh Dalton claims to find a radical
break and attributes it mainly to Keynes:
The new approach to budgetary policy owes more to Keynes than to any other
man. Thus it is just that we should speak of the “Keynesian revolution.”. . .
We may now free ourselves from the old and narrow conception of balancing
the budget, no matter over what period, and move towards the new and wider
conception of balancing the whole economy. (Dalton, 1954, p. 223)
Given what’s found in Keynes directly, Dalton’s account is too sweeping.

Yes Keynes wanted to “balance the economy,” to eliminate involuntary
joblessness through a state-driven balancing of savings and investment
(lowering the former and boosting the latter), and by deficit spending on
public capital outlays; but Keynes opposed operating deficits and p
ermanent
deficits; indeed, he wanted the ordinary budget in surplus. Brown-Collier
and Collier (1995) provide a more accurate, nuanced assessment:
It is commonly believed that Keynes’s primary policy prescription for economic

stabilization and full employment is federal government deficit spending [but
his] policy for promoting full employment or reducing economic fluctuations
was the socialization of investment. Any connection between his policy pro-
posal and deficit spending was related to the choice of funding such social
investment. The policies pursued in the United States over the last forty years
[1955–95] have not been consistent with Keynes’s proposals for economic
stabilization and have caused ever increasing deficits and financial instability.
(Brown-Collier and Collier, 1995, p. 341)
A more recent assessment of Keynes that also rejects the stereotype of

him as an aggressive advocate of deficit spending comes from Meltzer
(2010), a monetarist who insists that Keynes was no proponent of large or
long-lasting deficits, or of perpetually rising public debts, and that those
who insist he was badly misconstrue his real meaning:
Keynes was opposed to large structural deficits. He thought that they chilled
rather than stimulated the economy. . . Keynes understood what the [Obama]
administration doesn’t understand – that the proper policy in a democracy
recognizes that today’s increase in debt must be paid in the future. We paid
down wartime deficits. Now we have continuous deficits. We used to have a
rule people believed in: balanced budgets. And now that’s gone. . . Keynes
wanted deficits to be cyclical and temporary. He wouldn’t have been in favor
of efforts to raise tax rates in a recession to eliminate deficits. He viewed that
as suicidal. He was opposed to the idea that governments should balance the
budget during a downturn, and advocated running short-term deficits to spur
the economy. The type of stimulus he advocated was very specific. He said it
should be geared towards increasing private investment. He viewed private
investment, as opposed to big government spending, as the source of durable
job creation. He also said that the deficits should be self-liquidating, so that the
increased economic activity caused by the stimulus inevitably generated a com-
bination of extra tax revenues and lower unemployment payments. With higher
revenues and lower outlays, the deficit would disappear. . . Keynes wanted to
increase employment by smoothing the amount of investment through the up
and down parts of the business cycle. He knew that recessions cause a decline
in investment, and that the fall in investment caused unemployment to rise. So
he wanted the government to stabilize investment through a recession. . . He
believed that the government should plan and direct investment, but not nation-
alize it. . . He said [budget] deficits should be temporary and self-liquidating.
He clearly did not advocate long-term spending in excess of revenues, since that
causes structural deficits. (Meltzer, 2010)
Meltzer’s account is more consistent with what Keynes actually said and
wrote about public deficits and debts than is Dalton’s account; this is ironic,
because monetarists (like Meltzer) typically are more critical of Keynes’s
ideas and policies, while Keynesians (such as Dalton) typically are his
biggest defenders. Traditionally, monetarists have critiqued the Keynesian
system on the grounds that it overstresses the power of fiscal policy rela-
tive to monetary policy; but having assessed Keynes’s views on money and
its power, when depreciated, to reduce the public debt burden, we find
a system that makes monetary policy a very powerful and indispensable
adjunct to fiscal policy. Meltzer’s critique pertains less to Keynes and more
to the Keynesians succeeding him; he thinks they’ve misinterpreted and
misused Keynes’s theories, at least on the issue of government deficits and
debts. It’s to these Keynesians that I turn next.
3.4 STAGNATION AND THE CASE FOR PERPETUAL

DEBT GROWTH: HANSEN
After Keynes’s General Theory in 1936, the Keynesians who theorize

most about public debt and exert the greatest influence on professional-
journalistic thinking and policymaking, include Alvin Hansen,
Abba Lerner, Seymour Harris, James Meade, and Richard Musgrave.
Paul Samuelson and Paul Krugman play lesser roles because they don’t
specialize in public debt theory, but they have broader influence. I devote
little space to Musgrave, Samuelson, and Krugman, not because they aren’t
influential on public debt, but because they aren’t so original about it. In
providing textbook explications of Keynesian debt theory (see especially
Musgrave, 1959), they’ve helped spread it to successive g enerations and to
policymakers globally.
A major thematic innovation regarding Keynes’s thinking about deficit
spending and public debt was made by Alvin Hansen (1887–1975),
a professor of political economy at Harvard from 1937 to 1957, who
became known as “the American Keynes.” He trained many new upstarts.
According to Musgrave (1975), the most prominent Keynesian specializing
in public finance in the twentieth century, “Hansen, in his fifties at the time
[1937–47], rose to the occasion. . . Quick to shed old preconceptions and
to move to the center of new thought, he held a Fiscal Policy Seminar [at
Harvard] in the late thirties that became the catalyst for the development of
the new [Keynesian] ideas. Many of the leading economists of later years
were trained there. What has long since become a matter of introductory
economics still seemed full of mystery.”
Hansen’s initial take on Keynes’s General Theory wasn’t laudatory; he
complained of a “failure to give exact definitions and employ them con-
sistently” (Hansen, 1936, p. 676). Keynes’s work was “more a symptom
of economic trends than a foundation stone upon which a science can be
built” (p. 686). Yet Hansen endorses Keynes’s core claim that an economy
can settle into an awful equilibrium of severe underemployment due to
excessive savings, which can be cured only by a seemingly reckless fiscal

policy: “While a puritanical policy of thrift and saving may be quite appro-
priate in a society in equilibrium at full e mployment, prodigality may be the
appropriate social virtue in a society in equilibrium at underemployment”
(p. 671). Like Keynes, Hansen concedes that labor markets could clear if
only wage rates were to adjust and decline, but, he says (echoing Keynes
and labor union leaders) this is no longer politically acceptable. So he
further endorses Keynes, on (1) using inflation to lower the real wage and
boost the demand for labor, (2) the state redistributing income from those
who save relatively more to those who consume relatively more, (3) central
banks establishing low interest rates to punish rentiers, and (4) the need for
a socialization of capital investment. The last policy Hansen later devel-
ops into a full-fledged case for nearly limitless deficit spending and debt
accumulation (“functional finance”), although his 1936 review of Keynes
says nothing on the topic. Hansen does contend, however, that Keynes’s
proposal entails “forced investment” by “artificially contrived measures,”
that the policy “goes far in the direction of a planned economy,” and that it
“might, indeed, lead straight into a thoroughgoing socialism.” For Hansen
that’s no problem, for “whether or not Keynes’s proposals will in fact prove
effective, it is clear that they are currently popular and are likely to be tried
on an expanding scale,” because “modern communities appear to be in the
process of reverting to the behavior patterns of the pre-capitalistic period.”
Keynes is pre-capitalist – and Hansen likes that. Recall Keynes’s eager-
ness “to propose a return, it may be said, towards medieval conceptions.”
Deficit spending will prove to be popular in democracies, even as it helps
bring “thoroughgoing socialism.” Hansen’s political wishes are certainly
compatible with Keynes’s disdain for capitalism.
What later would be dubbed the “new economics” of Keynes was not,
Hansen insisted in 1936, new at all, for “Keynes’s economic system is, as
he himself admits, a reversion to the economic doctrines of mercantilism”
(Hansen, 1936, pp. 682–3). As late as 1953, in his guidebook to the
General Theory, Hansen commends Keynes because “he did not hesitate
to advocate loan expenditures,” but he also complains that Keynes only
attacked the “dogma” of budget balance, and “rather vaguely,” that he
“never faced up to the debt problem,” and never explored “the implications
of a growing public debt,” “the problems of debt management,” or “the
important role of public debt as a means of providing adequate liquidity
in a growing economy” (Hansen, 1953, p. 219).
On public debt theory, Hansen extends Keynes’s insights from the realm
of the short-term, the cyclical, and the temporary, to that of the long-term,
the secular, and the permanent. Where Keynes says aggregate demand can
be deficient temporarily, Hansen says it can also be deficient permanently;
if so, the cure must also be extended. If deficit spending can boost invest-
ment in the short-term, it can also do so in the long-term. In the late 1930s
Hansen also advances a thesis of “secular stagnation,” or “economic
maturity” (Hansen, 1939). Observing a prolonged slowing of growth and
persistently high joblessness in the 1930s, he worries it’ll last indefinitely.
Long- term (secular) stagnation he believes reflects inherent “limits to
growth” due to a diminution in the prerequisites of growth: the American
frontier, population growth, and technological innovation. For Hansen
there’s not just an occasional cyclical, temporary deficiency of private
investment opportunities but a chronic, permanent deficiency also. In one
sense his “secular stagnation” thesis elaborates Keynes’s notion of an under-
employment equilibrium, adapted to a long-term context. But it’s impor-
tant because it advances an influential case Keynes didn’t make: a case for
perpetual deficit spending and even an ever-rising public debt/GDP ratio.
Recall Keynes’s cure for a cyclical shortfall of investment relative to savings:
deficit spending on public capital goods. Hansen believes the cure, though
valid, should be extended to combat the persistent stagnation he claims to
observe in the late 1930s; if adopted, the policy would boost total public
debt but also steadily raise its proportion to GDP, since secular stagnation
means slow or non-existent growth in GDP (the denominator of the ratio).
Hansen’s stagnation thesis lost influence in the 1940s but was revived in the
1970s and has gained new adherents among today’s prominent Keynesians
(Summers, 2014). Hansen held fast to his pessimistic thesis until at least
1954. “The dogma of the balanced budget may well become a serious
obstacle to maximum production, employment and purchasing power in
the US,” he wrote at the time. “Yet it is by now generally agreed that the
present public debt, considering the manner in which it is held (combined
with the current relatively favorable distribution of the tax burden), is an
important element of strength in the community,” and it is crucial, for “full
employment in the US is not likely to be maintained, either in the cyclical
short run or the long run, unless the massive fiscal powers of the federal
government are employed to ensure adequate aggregate demand,” “not
merely as an anti-cyclical device, but also as a necessary means to achieve
our long-run growth potential” (Hansen, 1954, pp. 412–13).
In the late 1930s Hansen’s fear of secular stagnation was corroborated
by New Deal reformers seeking to excuse their policy failures. Despite a
cascade of deficit spending from 1931 to 1937, when 45 percent of all US
federal spending was borrowed and the national debt had doubled, by
mid-1938 the US jobless rate was still 21 percent, up from 14 percent a year
earlier, and industrial output was down 31 percent (over the same period
year). Meanwhile, socialist and fascist ideologies were ascendant; many
economists believed capitalism was “finally” collapsing, as Marx had first
forecast in 1848. The depression seemed to confirm a secular stagnation

thesis; the system seemed to be suffering from a diminishing capacity to
exploit resources and workers. Socialists happily endorsed Hansen’s claims
about stagnation, but insisted it reflected capitalism’s “inevitable” demise.
They stressed the futility of (Hansen and others) trying to forestall the
inevitable stagnation by impotent deficit spending; the policy only boosted
public debt, which required, in turn, higher future taxes and still more
interest income for parasitical rentiers – at root a ploy to save capitalists by
redistributing upward (Braverman, 1956).
Facing such taunts in the late 1930s, Keynesians insisted that deficit
finance can cure even secular stagnation. In 1938 young Keynesians from
Harvard and Tufts issued An Economic Program for American Democracy,
arguing for a vast expansion of deficit spending and denying there was
any limit to the public debt a nation might safely incur (Gilbert et al.,
1938). Secular stagnation is real and due to excessive savings and deficient
investment; it’s curable by even greater deficit spending than the New Deal
delivered. “The task of raising money for these expenditures is much less
formidable than it appears,” the authors write (Gilbert et al., 1938, p. 53);
“the long-range public investment program should be financed chiefly
through borrowing.” This will mean “a steadily increasing total of public
debt,” which citizens may worry about, but shouldn’t:
To many people – perhaps to most people – the prospect is terrifying. The

public debt, they say, cannot continue to increase forever. The government will
never be able to pay it back. The burden of taxation will eventually become
intolerable. These and other apprehensions are the result in part of confusion,
in part of hostility to the extension of conscious social action in the economic
sphere. Much of the widespread confusion on the subject of debt arises from an
understandable tendency on the part of the average person to reason from his
own personal experience. The wage earner, the salaried worker, and the farmer
know that so far as they are concerned debt usually means trouble. They cer-
tainly cannot go on increasing the amount of their debts indefinitely. . . They
know, too, that any increase in their debts inevitably means the deduction of
an additional slice from their income to meet interest payments. . . They could
scarcely be expected, therefore, to realize that what applies to personal debt does
not in the least apply to the business and public debt of the entire nation. The
fault lies not with them but rather with the economists and publicists who have
failed in their responsibility of educating the public on so important a matter.
If we look at the whole nation as a going concern, we see that its internal debts,
business and governmental, are merely another aspect of its assets. Debt in the
broad sense is the obverse of investment.. . . Individual debtors do, of course,
get into trouble by improvident borrowing. But for the economy as a whole,
trouble comes only when the nation falters in the course of its economic expan-
sion. Only in periods of crisis and depression is there a general questioning of
the solvency of debtors. The expansion of debt at a rate sufficient to absorb the
nation’s savings is both sound and necessary. This rate could be excessive only
in the sense that the rate of savings itself was excessive. Thus, what we should
worry about is not the increase in the debt but the increase in savings beyond
the amount that can be absorbed by investment. It is ridiculous to maintain
that debt in general must be repaid. The mere attempt to repay debts all around
would involve a liquidation of assets which would result in complete economic
paralysis. (Gilbert et al., 1938, pp. 62–3)
The authors try to dispel prevailing popular notions, including that public
outlays are a “waste of resources,” that public debt is “unproductive,” that
it “imposes a weight of interest charges” that “must eventually become
intolerable,” or that public credit “is a delicate thing” that “might easily be
overstrained by a long-continued increase in the public debt,” and so “must
inevitably lead to disastrous inflation.”
Alvin Hansen’s most extensive essay on deficit spending and the national
debt – “The Growth and Role of Public Credit” – is a chapter in his 1941
book on fiscal policy, which appeared on the eve of the US entry into
World War II (Hansen, 1941), a war that eventually caused the highest
ratio of public debt/GDP in US history (before or since): 125 percent,
in 1946 (see Chapter 1, Figure 1.4 in this volume). Here Hansen openly
mocks “opposition to public debt” and equates it to “the medieval opposi-
tion to interest” (p. 135). He tries to show how the long-term trend of debt
issuance has been upward, to imply it’s normal and harmless. Yet his data
show public debts leveling out before declining during the century from the
end of the Napoleonic Wars (1815) to the outbreak of World War I (1914).
Not coincidentally it was also one of the least democratic, freest, most
peaceful, and prosperous centuries in history. Hansen doesn’t relate public
debt to public spending, taxable capacity, or GDP, although he concedes
that in both 1818 and 1923 Britain’s national debt was twice its national
income (p. 136). He hopes to imply that high public leverage isn’t neces-
sarily unsustainable. In fact, recent estimates suggest that Britain’s public
debt/GDP ratio peaked at 2.6x in 1821 and 1.8x in 1923, compared to
Hansen’s estimate of 2.0x (obtained from the report of a British debt com-
mission in 1927); when Hansen wrote in 1941 Britain’s debt ratio was only
1.1x, but it rose again during World War II, and peaked at 2.4x in 1947,
before gradually declining to 1.1x by 1959. Noting that public debt in the
nineteenth century grew rapidly only in wartime, Hansen argues that in the
twentieth century it can also increase dramatically amid economic contrac-
tions, falling tax revenues, and rising relief payments; but this latter trend
is no bad thing, for absent deficit spending (“fiscal stabilizers”), contrac-
tions would worsen. We should be happy that “the sphere of public finance
has been enormously broadened, owing to the political necessity imposed
upon modern communities to pursue an active policy with respect to the
fundamental problem of unemployment” (p. 138). High joblessness is not
a brief setback, but a deeply entrenched, “chronic” and “fundamental

problem,” justifying unprecedented deficit spending.
Hansen also rejects classical school analogizing about private and
public debtors. Here he makes a valid point. The analogy depends on
commensurate elements like income-outgo, productive versus unproductive
spending, thrift versus profligacy, and debt capacity, but elides the fact that
the public creditor, unlike the private one, has a monopoly on the use of
force, that the state can compel citizens to contribute tax revenues to help
service public debts, can extract revenues surreptitiously by inflation,
can offload its debts to future generations, and can default on its debts,
explicitly or implicitly, with relative legal impunity (by the principle of
“sovereign immunity”). This isn’t to say such acts are morally just or politi-
cally expedient, but they are politically possible and historically common.
Hansen knows the modern state can borrow virtually without limit and
how this means (conveniently, for his case) that concerns about public
debt burdens can never be as great as concerns about private debt burdens.
Private debtors can become insolvent and seek bankruptcy protection, but
sovereigns can’t become insolvent, as no state “balance sheet” is indepen-
dently audited, and sovereigns run bankruptcy courts and enjoy broad
“sovereign immunity” from prosecutions. Hansen draws on the case made
by Danish professor Jorgen Pederson, in a 1937 article (Hansen, 1941,
pp. 140–44). “The analogy between the public and private economies leads
to quite erroneous conclusions,” Hansen says. “The success or failure
of public policy cannot be read from the balance sheet of the public
household,” and “cannot be determined by whether or not debt is being
retired or assets accumulated.” Public debt policy must be judged solely by
its economic consequences. On a less convincing note, Hansen insists that
“for the state an increase of expenditures may frequently increase the total
national income and improve the fiscal position of the states.” He cites
Pederson that “it is quite conceivable that the reduction of public debt not
only reduces the national income, but also that the fiscal position of the
state may be deteriorated more by the repayment of the debt than by the
incurrence of more debt” (p. 144). Nor must the taxes required for debt
service deprive the economy. At root, Pederson says, “the state does not
obtain the power of disposal over additional funds [tax revenues], for these
funds were already within the realm of its power” – that is, the modern
state is presumed to “own” its citizens’ wealth – and “thus an internal loan
raised by the state is not really a loan in the ordinary sense,” “for there is
no transfer of funds from one economic unit to another, and no burden
is shifted to future generations.” For Pederson, “every analogy to private
borrowing must be completely false” (p. 142).
Hansen embraces the tripartite public debt taxonomy offered by Ursula
Hicks (1954): “deadweight debt,” “passive debt,” and “active debt.”

Whereas “active debt” contributes the most to economic productivity, by
funding public capital goods, “deadweight debt” contributes nothing to it
(while passive debt has mixed effects). Deadweight debt is usually incurred
to fund war but also transfer payments, such as jobless relief amid eco-
nomic contractions (Hansen, 1941, pp. 144–5). This contextual approach is
common among realists. Yet Hansen remains an optimist. Here he simply
echoes Keynes’s advice that deficit spending be reserved for investment in
public capital, which is presumed to boost new wealth creation, instead
of borrowing to redistribute wealth through transfers. Although Hansen
advocates aggressive deficit spending and limitless debt build-ups, if nec-
essary, for such public capital building, he classifies most public debt as
a deadweight that historically didn’t boost productivity. The deadweight
debt owed by Britain after 1815 didn’t hurt the subsequent, century-long
growth rate of the UK economy, he contends, because other factors (tech-
nology, invention) helped it (pp. 152–4).
As to the limits of public debt, Hansen finds few. “Much of the dis-
cussion about the limits of the public debt is wholly unrealistic,” he says,
because “there are no rigid and fixed limits” to such debt, and the problem
“can best be taken care of by ensuring that taxation is adequate” (p. 175).
“As long as the interest on the public debt is well within the practical
taxable capacity of the government, taking the entire business cycle into
consideration,” “no question can arise with respect to the solvency of the
government.” Taxable capacity itself “has very flexible limits, varying,
however, with the financial integrity of the country” (p. 159). He provides
no metric to gauge “taxable capacity,” but offers the circular argument
that debt-financed public capital projects increase it (pp. 168–70). As for
“financial integrity,” it derives from the profitability of the private financial
sector, which, he insists, is never jeopardized by public debt; if anything,
safe and steady public bonds help mitigate portfolio volatility. Taxable
capacity can be enhanced “when the government provides free services”
and when “some appropriate monetary expansion is justified” (p. 170) –
thus inflationary finance of consumption (which elsewhere he opposes).
Inflation itself isn’t caused by public debt; he knows “the fear is frequently
expressed that an increasing public debt must eventually produce a price
inflation,” and that might occur if government boosts the money supply
by borrowing from the banking system, but it won’t occur if there’s also
material unemployment and a rising demand for money (p. 171).
Hansen complains that so much analysis “implies that there are limits
to public debt which, if exceeded, will tend to affect the workability of the
economy.” He insists that “these limits must be conceived of, not in terms
of a fixed amount or a static situation, but in terms of a dynamic process.
Account must be taken of rates of change and the magnitude of the public
debt in relation to other magnitudes, especially the ratio of debt to national
income” (p. 174). Here the optimist sounds a note of realism, using the
context embedded in public leverage (public debt/GDP); but again he
offers no metric to gauge its outer limits. “With respect to proportionality”
he’s worried only that high and rising public leverage “may imply a dis-
proportionate amount of wealth invested in government bonds and held
by wealthy classes,” which he finds problematic only because “the rentier
class might accordingly become too large at the expense of the active
elements of the country.” For Hansen the dastardly “rentier class” (of
bondholders) isn’t an “active” (productive) element in society but one that
operates “at the expense” of the active element (workers). He fears that
rentiers will oversave, become too important, and breed unemployment; he
neglects to note that his cure for unemployment is still more public debt,
which only supplements rentier income. Socialists cite the contradiction
in saying that Keynesianism is self-defeating (Braverman, 1956). Hansen
joins a conga line of contradictory theorists who advise ever-more debt
issuance while deriding debt-holders as idle parasites to be expropriated by
overleveraged states. Piketty (2014) agrees, but unlike Hansen wants public
debt eradicated by a large tax on debt-holders. In short, don’t pay them,
rob them – a tactic consistent with socialist preferences.
Hansen’s dilemma – issuing ever more public debt yielding “unearned”
income to despised rentiers – explains his case for “controlled borrowing,”
whereby increasingly leveraged states try to minimize their interest expense
by capping interest rates (Hansen, 1941, pp. 175–85). Hansen laments that
explicit money printing, or “crude greenback-ism,” is “no longer seri-
ously proposed.” Yet by “modern greenback-ism” central banks should
monetize public debt and induce private banks to do so too. Central bank
independence is outmoded, he contends. The Federal Reserve “might be
required by law, at the request of the Treasury, to make interest-free loans
to the government” (p. 176). For Hansen “there is a legitimate place for
loan financing within appropriate limits on a continual basis” (p. 184) and
“the attack on chronic unemployment by means of public expenditures
financed by a continually rising public debt is essentially a conserva-
tive proposal” (p. 181). He is an early proponent of what is later called
“financial repression” (see Chapter 5, Section 5.6 in this volume).
Hansen’s account of public debt capacity becomes more expansive
when the United States enters World War II in late 1941 and public lever-
age begins exceeding levels from the 1930s. He had rejected the analogy
between private and public debts as well as the notion of a national
“balance sheet” to include public assets in analyses of national solvency.
He had also rejected the idea of a limit to public leverage, noting that
Britain’s public debt was secure even when public leverage reached 200
percent in 1818 and 1923 (Hansen, 1941, p. 136). But now, in 1940, a fourth
of all US outlays are borrowed and US public leverage reaches 42 percent,
versus 17 percent in 1930. By 1942 US spending has quadrupled and
56 percent of it is borrowed, as public leverage reaches 45 percent, on its
way to a peak of 121 percent by war’s end in 1946. Writing to businessmen
and financial executives through Fortune magazine in 1942, Hansen now
references the private-public analogy and insists that US public leverage
can safely skyrocket from 45 percent to “well beyond” 200 percent:
Public debt might be likened to the capital account of a corporation, made up,
say, of long-term mortgage bonds and of one or more classes of stock. Such
liabilities, it is important to remember, are offset by assets on the other side
of the balance sheet. So long as these are of a character to produce sufficient
earnings to meet the capital charges, including dividends on the stock, nobody
would ever think of the corporation as being overcapitalized. The essential
element determining the soundness of the concern is the ratio of its earning
power to its capital account [and] precisely the same principle holds with respect
to the public debt of a nation, of which the source of earning is usually taxation.
If the power to raise revenue is in manageable ratio to the capital charges (debt
service), it is proper to say that the nation is not, so to speak, over-capitalized. . .
There is little reason to fear that, with the sort of fiscal management we shall
have a right to expect, the debt could not safely go well beyond double the
national income if necessary. Certainly we have no occasion to think of the
debt limit as being like the edge of a precipice from which we must always stay
carefully away. (Cited in Moulton, 1943, pp. 56 and 68)
Hansen’s last pertinent treatment of public debt (Hansen, 1959)

is a review of two works critical of high public debt written by a
British Keynesian (James Meade) and an American conservative (James
Buchanan), each of whom became Nobel laureates. At the time Britain’s
public leverage is 112 percent, versus a peak of 238 percent in 1947 and US
leverage is 56 percent, versus a high of 121 percent in 1946. In the 1950s
industrial output in the United States and Britain jumps 67 percent and
33 percent, respectively, while jobless rates average below 5 percent. By
1959, Hansen seems prescient to have projected in 1942 that public leverage
could safely exceed 200 percent; on the other hand, it’s also obvious that
his two decades-old thesis about “secular stagnation” has been discredited.
Meade (1958) argues that high public debts are a “deadweight” and “a
serious and real economic burden” due to their attendant tax burdens and
disincentives to work, invest, and accumulate capital, and not less a burden
merely because “we owe it to ourselves.” Buchanan (1958 [1999]) also warns
of debt-based barriers to prosperity but insists private and public debt are
analogous, that public debt fosters excessive public spending, and that
voters experiencing “debt illusion” avoid fiscal pain but inflict it unfairly
on posterity. Hansen (1959) rejects these arguments. He dismisses Meade’s
complaint that economists only stress how public leverage can rise safely
to levels above those seen previously, but disparage its power to depress the
national income upon which debt service depends. Hansen (1959) concedes
that public debt can be a real burden and notes how Lerner (1948) admitted
that “too large a [public] debt can be a serious matter.” Hansen says “the
earlier literature” was “designed to minimize fears of the public debt,” yet
it didn’t “neglect consideration of adverse effects.” Hansen and Lerner
alike believe a fast-rising public debt can be a deadweight and trench on
savings, but that it’s warranted amid a savings “glut.” Hansen says Meade
forgets that deficit spending serves as an “automatic stabilizer” to curb
cyclicality. “I regard this aspect of public debt as highly important,” he
writes; with mass unemployment, deficit spending “becomes a powerful
built-in stabilizer,” “a kind of national insurance system to which we all
contribute as taxpayers, and from which we all receive the benefit of insur-
ance against instability” (Hansen, 1959, p. 372). He says that higher interest
outlays on public debt amid recessions boost demand and help end reces-
sions, but worries that with higher public leverage such outlays might dis-
place “much needed social welfare expenditures.” As a Keynesian he fears
“excessive” savings, and thus also that any “diversion of a large part of the
income stream into interest payments on government bonds would tend
to raise the propensity to save, thus intensifying the savings-investment
problem” (Hansen, 1941, pp. 174–5). He’s happy that sovereign loans help
absorb “excess” savings. He’s also pleased about higher inflation, which
averages nearly 4 percent per annum from 1946 to 1958, because it “has
already removed in the last twelve years well over a third of the US debt
burden, so-called” (Hansen, 1959, p. 375). He is a fan of implicit public
debt default by inflation.
Hansen next dismisses Buchanan’s argument (pp. 377–8) that “public
and private debts are basically alike.” This ignores, he says, the fact that
“the national government has the power. . .to issue money. . .and tax all
of its citizens” and how, “as a borrower, this puts the national government
in a class by itself.” Moreover, “an increase in public debt increases the
property holdings of the country – the wealth effect,” whereas “increases
in private debt can have no such effect” (ibid.). Buchanan may oppose the
extent to which states now operate, but can’t deny that they can do so; nor
can he claim that public financial powers are somehow wielded by private
debtors. Hansen’s critique is valid. No clear analogy can be made from
private to public debtors, no strong claim that excess public debt must
make a state submit itself to bankruptcy, no denial that public debts, unlike
private estates, can be bequeathed to posterity without matching assets
(a negative net worth). Surely future generations benefit from prior public
spending funded by the public debt they’ll be servicing – including wartime
outlays, to the extent that posterity is thereby ensured political-economic
freedom – and including debt-financed productive infrastructure. What
should matter most, says Hansen, is the real (not merely financial) impact
of public debt on present and future generations alike. “On balance is the
future generation better or worse off by reason of the [public] debt?” he
asks. “Probably no unequivocal answer can be given.”
Hansen’s main contribution to Keynesian debt theory is his argument
that deficit spending should occur (that is, should rise, unobjectionably)
not only in the short- term as an automatic stabilizer of aggregate
demand but also over the long- term, if necessary, perpetually, to
combat “secular stagnation.” Keynes rejects the classical rule that
deficit spending might be justified in wartime but not in peacetime; he
repudiates the classical school’s denial of an involuntary unemployment
equilibrium, but agrees that deficit spending shouldn’t become chronic
(resorted to in good times as well as bad) and public debt should build
up for public investment projects, not social transfers. Hansen goes
further: large public debts are justified even amid rising public leverage,
even if they are used for transfers, and even if they become perpetual –
anything necessary to prevent structural, secular stagnation. His basic
extension implies others, too, of a kind Keynes doesn’t address: a
nation’s taxable and debt capacities. Hansen shares Keynes’s optimism:
public debt isn’t dangerous or burdensome and it can even cure reces-
sions. If it ever becomes problematic it can be mitigated or repudiated,
whether explicitly (default) or implicitly (inflation), without harming
national solvency or sovereignty, because the harm is inflicted only on
“non-productive” rentiers.
3.5 FUNCTIONAL FINANCE AND ANYTHING

GOES: LERNER
Unlike Keynes and Hansen, Abba Lerner (1903–82) makes an overt, una-
bashed case for unrestrained deficit spending, public debt issuance, and
inflationary finance, by a rubric he calls “functional finance.” “In brief,” he
explains, “Functional Finance rejects completely the traditional doctrines
of ‘sound finance’ and the principle of trying to balance the budget over a
solar year or any other arbitrary period.” Even the “instinctive revulsion
that we have to the idea of printing money, and the tendency to identify
it with inflation, can be overcome” (Lerner, 1943, p. 41). In Lernerian
finance, anything goes.
Lerner emigrated from Romania to Britain and in 1929 at age 26

enrolled at the London School of Economics. He came to know Keynes
during a stay at Cambridge (1934–35), just before Keynes published
his General Theory. In time he taught in the United States, at schools
including Columbia, Amherst, and Berkeley. His most famous work,
The Economics of Control (1944), tries to steer a policy path between
capitalism and socialism, dismissing both as dogmatic. A utilitarian, he
assumes a diminishing marginal utility from income and wealth, and
seeking maximum “social utility,” wants states to impose a near-perfect
equality of wealth and income. Later in life he calls Keynes timid because
“he did not carry his conclusions all the way” (Lerner, 1978). Lerner is the
most logically consistent Keynesian to appear since 1936; by one account,
“what eventually became known as textbook Keynesian policies were
in many ways Lerner’s interpretations of Keynes’s policies” (Colander,
1984, p. 1573). Today Lerner’s radical case for public financial profligacy
is echoed most strongly by Paul Krugman, Thomas Piketty, and their
acolytes.
For Lerner, deficit spending and every other public finance device
are to be justified solely by their actual economic effects, and, above all,
whether they promote “the public interest” or “social interest.” Fiscal-
monetary measures mustn’t be justified or condemned by any preordained
rule, whether the classical budget-balance rule – or the rule to run budget
surpluses in peacetime – or that public debt should support only public
spending on productive capital goods, not transfers – or that deficit spend-
ing debt is advisable cyclically but not secularly – or that public debt
should never be deliberately repudiated – or that public debt shouldn’t be
monetized or inflated away.
Lerner rejects fixed principles of public finance. He’s a consequentialist
in the sense that any rule might or might not be followed, determinative
in some cases but not others, deployed temporarily, or never, with moral,
legal, and political impunity – as long as the consequence is a growing
economy. If complete policy discretion breeds economic stagnation, exert
still more discretion, or designate the stagnation “secular.” Public finance
should guarantee three things, he argues: a level of aggregate demand
that achieves a jobless rate of 3 percent or less; a low inflation rate; and
an interest rate that optimizes investment to secure full employment. The
state should spend and tax, borrow and repay, or issue and rescind money
to achieve these ends only. The purpose of public finance isn’t to fund the
proper functions of a constitutionally circumscribed government but to
foster full employment, even amid burgeoning government. Consequently
sovereigns must practice not traditional modes of public finance but
instead “functional finance”:
The central idea [of Functional Finance] is that government fiscal policy, its
spending and taxing, its borrowing and repayment of loans, its issue of new
money and its withdrawal of money, shall all be undertaken with an eye only
to the results of these actions on the economy and not to any established tra-
ditional doctrine about what is sound and what is unsound. This principle of
judging only by effects has been applied in many other fields of human activ-
ity, where it is known as the method of science opposed to scholasticism. The
principle of judging fiscal measures by the way they work or function in the
economy we may call Functional Finance. The first financial responsibility of
the government (since nobody else can undertake that responsibility) is to keep
the total rate of spending in the country on goods and services neither greater
or less than that rate which at the current prices would buy all the goods that it
is possible to produce. If total spending is allowed to go above this there will be
inflation, and if it is allowed to go below it there will be unemployment. . . The
second law of Functional Finance is that the government should borrow money
only if it is desirable that the public should have less money and more govern-
ment bonds [and] conversely, the government should lend money (or repay some
of its debt) only if it is desirable to increase the money or to reduce the quantity
of government bonds in the hands of the public [in each case, as a means of
optimizing interest rates]. (Lerner, 1943, pp. 39–40)
As to public debt, Lerner echoes his optimistic predecessors: it’s not akin
to private debt, it’s safe if internally held, and it doesn’t burden even future
generations:
By far the most common concern about the national debt comes from consider-
ing it as exactly the same kind of thing as a private debt which one individual
owes to others. . . The simple transferability of this rule to national debt is denied
by nearly all economists. . . One of the most effective ways of clearing up this
most serious of all semantic confusions is to point out that private debt differs
from national debt in being external. It is owed by one person to others. That is
what makes it burdensome. Because it is interpersonal the proper analogy is not
to national debt but to international debt. . . But this does not hold for national
debt which is owed by the nation to citizens of the same nation. There is no
external creditor. “We owe it to ourselves.”. . . A variant of the false analogy is
the declaration that national debt puts an unfair burden on our children, who
are thereby made to pay for our extravagances. Very few economists need to be
reminded that if our children or grandchildren repay some of the national debt
these payments will be made to our children and grandchildren and to nobody
else. (Lerner, 1948, pp. 255–6)
In presenting “functional finance” in The Economics of Control (1944,

pp. 302–22), Lerner insists that only externally owed public debts can
be burdensome, for they “indicate impoverishment of the borrowing
country and enrichment of the lending country. Of this kind of debt the
popular criticism is warranted” (p. 305). A country, he argues, “cannot
by monetary manipulations consume more than it can produce,” and
an internal debt “does not really give the country anything that it did
not have to begin with,” so a repayment of principal and interest “does

not take away anything from the country as a whole.” Unlike internal
public debts, external ones “should be limited because the repayment will
constitute a real burden,” and “there may be great inconvenience which
could lead to default” (ibid.). No one should fear an internal public debt,
for it is “a matter of almost no significance beside the importance of
maintaining full employment” (p. 303). Public debt also needn’t ever be
repaid, whether in whole (especially) or in part, “any more than it is true
that all banks must call in those debts and repay their depositors on some
catastrophic day.” Particular bondholders must be repaid, of course, but
others who purchase (or redeem) their bond holdings now stand in the
seller’s place.
In a still more radical vein Lerner denies that an internal public debt
of any magnitude can ever burden society; since “we owe it to our-
selves,” when we owe more, we also own more, with no decline in “social”
net worth. Every public debt security is an asset and liability, each
offsetting the other. Public bonds constitute neither new “net wealth”
nor new “net liabilities.” Their value resides solely in their functional
capacity, or power to support a government- spending multiplier to
boost demand. Lerner sees no effective limit to public debt or interest
expense; no matter how large they become, even relative to national
income or taxable capacity, they can’t burden society as a whole. Should
public debts ever become truly unserviceable, the state need only print
money:
[If] the result [of Functional Finance is] a continually increasing national
debt. . .[at] this point two things should be made clear: first, that the pos-
sibility [presents] no danger to society, no matter what imagined heights the
national debt might reach, so long as Functional Finance maintains the proper
level of total demand for current output; and second (though this is much less
important), that there is an automatic tendency for the budget to be balanced in
the long run as a result of the application of Functional Finance, even if there is
no place for the principle of balancing the budget. No matter how much interest
has to be paid on the debt, taxation must not be applied unless it is necessary to
keep spending down to prevent inflation. The interest can be paid by borrowing
still more. As long as the public is willing to keep on lending to the government
there is no difficulty, no matter how many zeros are added to the national debt.
If the public becomes reluctant to keep on lending, it must either hoard the
money or spend it. If the public hoards, the government can print the money
to meet its interest and other obligations, and the only effect is that the public
holds government currency instead of government bonds and the government
is saved the trouble of making interest payments. . . The absolute size of the
national debt does not matter at all [and] however large the interest payments
that have to be made, these do not constitute any burden upon society as a
whole. (Lerner, 1943, pp. 42–3, 47)
For Lerner even long-term public debt can’t prove burdensome to any
future generation, because whenever government services the debt it’ll
always pay the same generation then living. Nor is public debt a burden on
the nation, “because every cent in interest or repayment that is collected
from the citizens as taxpayers to meet the debt services is received by the
citizens and government bondholders” (ibid., p. 303). Public debt isn’t “a
sign of national poverty” and “just as increasing the national debt does not
make the nation poorer, so repaying the national debt does not make the
nation richer” (ibid.).
Just as Lerner feels that Keynes doesn’t go far enough in recommending
deficit spending, socialization of investment, redistribution, and inflation, so
he feels Hansen’s policies are too moderate. “[E]ither this [approach] was not
seen clearly or it was considered too shocking or too logical to be told to the
public,” he laments. “Instead it was argued, for example by Alvin Hansen,
that as long as there was a reasonable ratio between national income and debt,
the interest payment on the national debt can easily come from taxes paid out
of the increased national income created by deficit financing” (p. 43). “This
unnecessary ‘appeasement’ opened the way to an extremely effective opposi-
tion to Functional Finance. Even men who have a clear understanding of it,”
who know an internal public debt is no real burden, nevertheless “have come
out strongly against ‘deficit spending’” (ibid.). Keynes is wrong, he says, to
distinguish better from worse investment aims, better from worse forms of
public debt, or better from worse inflation rates, just as Hansen is wrong to
consider any criteria for gauging when public debt or interest expense might
reach unsafe levels. For Lerner no rules should handcuff policymakers or
preclude them from pursuing the single aim of preserving aggregate demand
to achieve full employment. As long as the goal is met, national finances are
sound. Lerner assumes his preferred policy mix achieves the goal.
With full confidence in the Keynesian spending multiplier (implying
that it exceeds three), Lerner asserts that “spending by the government
increases the real national income of goods and services by several times
the amount spent by the government” (p. 46). Will deficit spending be
sufficient, having done its job? Perhaps. “As the national debt increases, it
acts as a self-equilibrating force, gradually diminishing the further need for
its growth and finally reaching an equilibrium level where its tendency to
grow comes completely to an end.” The next result seems paradoxical, for
Lerner contends “the greater the national debt, the greater is the quantity
of private wealth.” If we owe it to ourselves, we also own it by ourselves, so
the more of it (public debt) that’s created, the richer a nation can become.
“The greater the private fortunes the less is the incentive to add to them
by saving out of current income,” and, he says, as savings are curbed,
spending (aggregate demand) increases, which boosts the economy (p. 49).
No further debt is required unless aggregate demand again is deficient.

Nor need we worry, as Hansen does, that ever-larger public debt is self-
defeating because it benefits financial elites (rentiers) at the expense of
workers; for Lerner, functional finance is mutually harmonious.
A final important aspect of Lerner’s theory of public finance implies
a policy stance friendlier to the possibility of a free, prosperous economy
than most Keynesians probably intend. Lerner, we know, is concerned
most about the effects of public finance on the economy, for good or
ill, not with its effects on a sovereign’s fiscal health; as such he generally
opposes policies that sacrifice the stability, strength, or prosperity of the
private economy for the supposed benefit and financial integrity of the
state. In contrast, classical economists sympathetic to free markets and
“sound” public finance are often quite willing to see the strength of the
private sector sacrificed, whether by interest rate hikes (to curb investment
“speculation”) or tax rate hikes (to narrow budget deficits).
Lerner’s preference for debt finance versus tax finance is also relevant
to the status of freedom; unlike taxes, which are compulsory, public
bonds are investments with market returns purchased voluntarily by the
rich and non-rich alike (the latter via mutual funds and pension funds).
When free market economists oppose debt finance in the name of “sound
finance” and “honest money” without also opposing higher public spend-
ing, they effectively demand higher rates of tax and inflation. Lerner isn’t
a pro-capitalist, of course, but his “functional finance” at least privileges
the fiscal health of the private sector above that of the state, whereas free
market economists obsessed with budget balance are prone to sacrifice
private wealth to the alleged greater good of state finances.
Lerner’s theories were embraced by the socialist-leaning Keynesians
of the 1940s, but waned in influence amid the more conservative 1950s.
After the international gold exchange standard was terminated in 1971,
both inflation and deficit spending accelerated, and vestiges of Lerner’s
approach contributed to “stagflation,” or simultaneously high rates of
inflation and joblessness. His radical advice lost further favor in the 1980s
and 1990s amid the rise of supply-side policies and collapse of centrally
planned regimes. Yet the revival of Keynesianism during the crises of
2008–09 mostly revived Lerner (Davidson, 2009; Skidelsky, 2009; Bateman
et al., 2010). Wittingly or not policymakers adopted his rules-free “func-
tional finance” approach by abandoning traditional modes of public
finance and enacting scores of “unorthodox” policies, including bailouts,
massive deficit spending, vast debt issuance, rapid money creation, moneti-
zation (“quantitative easing”), and zero or negative interest rates. In truth,
Japan first adopted such policies, to ill effect, beginning in 1990. Lerner’s
radical system is now called “the new normal.”
3.6 SOME KEYNESIAN DISSIDENTS: CLARK AND

WILLIAMS
A few public debt scholars in the 1930s and 1940s, skeptical about
Keynesian notions, anticipated some important themes of the public
choice school (see Chapter 4), including (1) pessimism about public
debt, (2) skepticism about the motives of political actors, and (3) suspi-
cion about “debt illusion.” The main theorists are John Maurice Clark
(1884–1963), professor of economics at Columbia (1926–57), and John
H. Williams (1887–1980), professor of economics at Harvard (1921–57).
Each offers early and critical assessments of Keynesian notions – whether
the “socialization of investment,” “pump- priming,” “compensatory
finance,” or “functional finance.” They deny that politicians or bureau-
crats enact policies out of “public spiritedness.” Instead, pushers of fiscal
profligacy seek to expand the size, scope, and cost of government. Clark
and Williams are primarily pessimists about public debt. They excoriate
the public debt cascade of the 1930s, the decade of depression when the
US jobless rate averages 18.2 percent, nearly 40 percent of all US public
outlays are borrowed, and US public leverage more than doubles to 44
percent. The UK government, in contrast, borrows only 5 percent of
outlays during the decade and its leverage declines; whereas US industrial
output in 1939 was 9 percent lower than a decade earlier, in the United
Kingdom it was 21 percent higher. Instead of mitigating the contraction
US deficit spending seems to have reflected and deepened it.
Clark (1939) sees some truth in Keynes’s claim that deficit spending can
stimulate output, but says the effect must “dwindle rapidly and disappear
if the deficit spending stops.” “It is highly improbable,” he argues, “that
this form of stimulus can itself serve to initiate a revival that will endure
after the stimulus is removed.” In fact, “indefinite deficit spending is not an
endurably workable remedy for chronic, partial stagnation of an economic
system like our own.” Instead of socializing investment, he believes “a free
flow of private investment” is the “prime requisite of success,” and deficit
spending tends to displace private investment, diminishing confidence.
“If businessmen expect the public deficit to continue for a long time and
in large volume, they will be affected by fear of ultimate impaired public
credit, or of inflation, or, if not these, then at least by fear of burdensome
taxes in the future.” For Clark “these are all retarding forces,” despite
Keynes’s claim that they’d prove ameliorative; yet he also denies that public
borrowing in the 1930s crowds out other credit, evidenced by low private
loan demand and low interest rates. Nor is public debt a problem for the
economy: “There is nothing self-limiting about the debt the government is
piling up,” he claims, and although it “goes on increasing without limit,”
“it does not represent a net burden of this amount on the economic system
as a whole.” Difficulties arise only when the debt becomes “an obligation
on Americans as taxpayers to transfer ever-increasing sums to Americans
as bondholders.” His preoccupation is Hansen-like (1941) and P iketty-like
(2014) – the distributive aspects of debt and supposed privilege of rent-
iers – and conveniently emerges after lenders have lent their capital to the
state, sparing taxpayers. Like many others, Clark believes public bonds but
not bondholders are a good thing; a larger role for the latter “will retard
business activity materially.” He misses the irony that lenders may prefer
lending to the sovereign when its own policies retard business and boost
private bond risk. “We have not reached the limit of our debt-bearing
power,” he says, “but we do seem to have reached a point at which the
piling up of public deficits is a deterrent to private capital outlays.”
Moreover, with the spread of public profligacy the Treasury is “treated as
a bottom-less grab bag for pressure-group interests,” an insight that antici-
pates the public choice theme of rent-seeking.
In his 1941 article “Deficit Spending,” John Williams tackles for the
first time a linchpin of Keynes’s policy. The dilemma is that no US recov-
ery is yet visible despite record peacetime deficits in the 1930s. As today
(see Paul Krugman), the Keynesian response invokes a “counterfactual”
(some might say anti-factual): all would be well now had there been even
more deficit spending than actually occurred. After all, Keynes teaches in
his General Theory (1936) that war can cure economic depression, for it can
lower the jobless rate by conscripting the idle, eradicate “ overproduction”
by destroying factories, and absorb “excess saving” by borrowing to
spend on wasteful state projects. Williams is a proto public choice theo-
rist because he treats not merely the technical economics but the political
economy of deficit spending and realizes it lacks coherence, rationalizes
an expansive but unwarranted role for the state, and is touted by many
academics not because it’s a truly rational policy but because it advances
their career prospects.
Williams identifies three phases of debate in the 1930s. Initially, deficit
spending is described as the passive but unavoidable result of economic
depression and plunging tax revenues; next, it’s defended as a way to
prevent deeper economic decline; last, it’s promulgated as akin to a per-
petual motion machine, complete with mysterious “multipliers” and
“accelerators.” Franklin D. Roosevelt’s [FDR] New Dealers made these
shifts, he says, not by patient economic analysis but pure political expedi-
ency, to save their professional reputations and positions. He relates how
“many persons within the [FDR] Administration favored deficit spend-
ing as a deliberate policy for recovery considerably before such a policy
publicly emerged” and even though FDR initially pledged to balance the
budget by restraining spending “[t]here was little or no evidence [in 1933]

that public spending was to be a major policy of recovery.” However,
Keynes’s influential visit to the United States in June 1934 stoked interest
in the new policy; Williams (1941) cites Keynes as saying “that if we [in
the US] spent $200 million a month [in excess of tax revenues] we could
go back to the bottom of the depression, that a net monthly deficit of
$300 million would hold us even, and one of $400 million would bring
full recovery.” For context, the US federal budget deficit was $2.6 billion
in 1933 ($217 million per month) before widening to $3.6 billion in 1934
($302 million per month) and yet again to $4.4 billion ($368 million per
month) in 1936. In just three years (1933–36) US spending grew at a com-
pounded annual rate of 22 percent per year. By Keynes’s reckoning this
vast deficit spending should have instigated a recovery; instead the US
economy again contracted severely, in 1937–38.
Williams (1941) becomes wary of chronic deficit spending not only
because it can’t “stimulate” the economy but because it undermines
democracy. “My own view is that such a ‘grand experiment,’ besides
being politically impossible in a democracy” would end up “probably
destroying democracy” because it would “eventually break down or would
entirely transform our democratic, private, capitalistic system.” Over time
“its costs would become a constantly increasing fraction of the national
income.” Since the root problem is unemployment, policy should encour-
age lower wage rates, without lowering the aggregate wage bill, instead of
the Keynesians’ policy of above-market wage rates and deficit spending.
Keynesians say labor unions will, by force, prevent cuts in their nominal
wage rates, but that means policy enables and privileges a special interest
group to the detriment of all. In truth Williams is wrong when he asserts
that chronic deficit spending is “politically impossible in a democracy”; on
the contrary, it’s not public financial profligacy that demotes democracy,
but rather democracy that promotes public financial profligacy – which, in
turn, makes free-market capitalism impossible. The view is best expressed
by Griffith (1945), who writes that “the philosophy of deficit financing,” is
“sufficient to destroy the system of Capitalism.”
3.7 KEYNESIAN DEBT THEORY MATURES:

HARRIS AND MUSGRAVE
A year after Keynes dies (in 1946), Harvard professor Seymour Harris
(1897–1974) devotes a rare, entire volume to Keynesian public debt theory:
National Debt and the New Economics (1947). An adviser to the Kennedy
administration, he published more than 40 volumes while at Harvard
(1922–64); part of his time at Harvard overlapped with Alvin Hansen’s

time there (1937–57). Harris took a more balanced approach to public
debt than did Hansen or Lerner; his theory conforms more closely to what
Keynes himself held. Written more as a textbook, Harris’s 1947 volume
cites varied opinion and interpretation on the private-public debt analogy,
the burden of debt, the relation of income and taxable capacity to debt,
the possibility that deficit spending can ensure full employment, and the
question of whether posterity is affected (or not) by public debt. Harris
omits Hansen’s “secular stagnation” thesis and rejects his case for perpetual
deficit spending. He also finds no value in the open-ended, freewheeling,
deficit spending methods and inflationary biases of Lerner’s “functional
finance.” Harris tries to span what seems an unbridgeable gap between old
(classical) and new (Keynesian) economics. He doesn’t want to jettison all
principles of “sound finance” orthodoxy but agrees with Keynes that the
orthodoxy failed to respond to (or cure) the 1930s’ depression, and instead
raised tariff and tax rates, making matters worse.
According to Harris, context is crucial: “the rise of [public] debt cannot
be considered irrespective of national income” (Harris, 1947, p. 78). US
public debt could become a problem, if excessive, as when fiscal policy
undermines prosperity and employment, or fails to bolster them when
they flag. “Our national debt of approximately $260 billion is dangerous,”
he remarks – then near its peak, at 121 percent of GDP, due to World War
II spending – but “only if it is not well-managed” (p. 276). Public debt
certainly “affects the volume of output and income,” which is the ultimate
source of debt service, but “it is easy to exaggerate the importance of
financial arrangements” and to expect deficit spending to pay its own way
(ibid.). “On balance,” it’s possible that “public debt may well be a burden,”
even internally held public debt, but “there are important offsets” –
namely, more liquid assets, more capital assets and national income, lower
interest rates – and if these change materially, so also can the debt burden
(ibid.). Context is important – a quintessentially realist approach. “When
[aggregate] demand is deficient,” Harris says, “the government’s task is
to subsidize demand,” and in such a context “debt repayment is out of
the question, and the presumption is in favor of debt growth” (p. 277).
Yet it is also “conceivable that full employment may be attained without
recourse to government financing,” but “not without significant institu-
tional changes,” including trust-busting, lower trade barriers, and flexible
prices and wage rates (p. 101).
Writing in the Harvard Crimson in 1948, Harris claims that Keynes’s
approach has been vindicated by history and is more conservative on
public debt than many realize. “The essence of Keynesianism,” he says, is
that government must “guarantee a minimum of demand and a relatively
stable demand” to achieve “a prosperous economy,” and although the best

way of “ballasting the economy in depression and deflation is not the
Hoover policy of economy, but the Roosevelt policy of deficit financing,”
“that does not mean a steady accumulation of public debt or continued
inflation.” “The way to deal with inflation is to reduce the amount of
money,” he contends, not to raise tax rates. Keynesian prescriptions didn’t
fail in the 1930s; they were never really (or fully) tried. “Unfortunately, in
Roosevelt’s day, the correct theory of fiscal policy had not quite jelled,”
and “even Roosevelt could not overcome his nurtured fear of debt,”
nor did his party “introduce an adequate policy of tax reduction in the
thirties.” But with wartime financial schemes vindicating Keynes, it’s “time
to pay off debt.” Indeed, the United States “should pay off $10 billion
of debt [4 percent of the total] in the next year” (Harris, 1948). Harris’s
approach is generally balanced; by incorporating context he’s one of the
few Keynesians that can be classified as a realist on public debt.
Two other Keynesians, prominent mostly in the twentieth century
but still important today because of the trailing influence of their
textbooks, are Richard Musgrave (1910–2007), who authored The Theory
of Public Finance (1959), and Nobel laureate Paul Samuelson (1915–2009),
who authored multiple editions of his widely used college textbook,
Economics (1948–85). Each captures the “mainstream” position of the
time (Keynesianism) but neither entirely incorporate the views of Lerner
or Harris. I devote no more space than this to their works, not because they
weren’t influential, but because they mostly popularized (in textbooks) the
works of other Keynesians.
Keynesian theory, unlike that of the classical (and new classical) school,
portrays public debt finance and high public leverage as beneficial, but the
theory didn’t develop scientifically, or even spontaneously; it arose after a
multi-decade expansion of populist and progressive ideology, an avowedly
anti-capitalist mix of ideas that in policy form fundamentally transformed
the United States (and other nations), by anti-trust law, federal income
taxation, estate taxation, central banking, bank deposit subsidization and
bailouts, a wider suffrage, regulatory agencies, fiat paper money, chronic
deficits, and public debt build-ups. Keynesian theory rationalized, fiscally,
this more expansive role for the state.
3.8 KRUGMAN, PIKETTY, AND THE ROAD TO

FISCAL PERDITION
Keynesian theory fell to pieces in the 1970s and 1980s amid stub-
born facts and withering critiques from proponents of “new classical
economics.” In the United States and Britain the 1970s saw a simultaneous
rise in inflation rates and jobless rates, while the 1980s saw pro-market
policies deliver both disinflation and plummeting jobless rates. Neither
combination was possible according to Keynesian theory (as embodied in
the “Phillips curve”), but some important economists (and Nobel laureates,
like Robert Lucas and Robert Mundell), unwilling to evade the facts,
simply refuted the theory. Many others did evade the facts, for decades, so
by the time of the “Great Recession” (2008–09) a Keynesian revival could
occur, led by Paul Krugman, the Nobel laureate of 2008. Resurrecting
Lerner’s “functional finance,” he claims the crisis is a “depression” and
thus must be cured by limitless deficit spending, a vast monetization of
burgeoning public debts (“quantitative easing”), and zero or negative
interest rates8 – the same advice he gave policymakers in Japan after its
equity market began plummeting in 1990. Krugman’s advice was enacted
in Japan, iteratively, which bred a quarter-century of stagnation, together
with a record rise in public leverage, from 68 percent in 1990 to 226 percent
in 2015. During this time Japan’s industrial production declined 3 percent;
it had grown 354 percent in the prior quarter-century (1966–90). Krugman
wants similar policy for the United States.
Another prominent Keynesian, but with more socialist leanings, Thomas
Piketty addresses “The Question of Public” in the final chapter of his
Capital in the Twenty-First Century (2014). He begins with a puerile plaint:
“The problem with debt is that it usually has to be repaid, so that debt
financing is in the interest of those who have the means to lend to the
government.” The discussion only degenerates thereafter. Like Krugman
and so many predecessors, Piketty detests public bondholders, depicting
them as rich, idle, parasites – the dastardly rentiers who receive “unearned”
income when instead they should be paying confiscatory taxes to fund
profligate sovereigns. “From the standpoint of the general interest,”
Piketty intones, “it is normally preferred to tax the wealthy rather than
borrow from them.” He blames the “seemingly interminable” debt crises
of contemporary times on economic-financial inequality. “The question of
public debt is a question of the distribution of wealth,” he insists, “between
public and private actors in particular, and not a question of absolute
wealth” (p. 540). In short, public fiscal integrity requires robbing the rich.
Like most socialists, Piketty detests “financialization,” the relative
expansion of the financial sector and a concomitant rise in investment
income versus total income, even though historically the phenomenon has
been crucial to economic development and prosperity. Piketty believes it
has harmed economies and has hastened capitalism’s demise since the early
1980s. True or not, one might expect a truly dedicated socialist to welcome
the trend instead of critiquing it; as a self- described social democrat
Piketty hopes socialism arrives by vote, so he should welcome the spread

of rentier capitalism and the resentment it supposedly instigates, instead
of proposing to tax it into oblivion.9 Given his gloomy outlook, he’s best
classified (as is Marx) as a public debt pessimist.
Piketty isn’t concerned much with the cause of fast-rising public debts
and public leverage ratios – namely fiscally profligate democratic welfare
states. He openly favors such states, so he can’t easily disfavor their latent
predilection for reckless debt finance. Unlike the debt optimists he feels
it necessary to radically reduce public debts and leverage, but only tan-
gentially because they might harm the economy. His main complaint
is that high public debt skews income distribution towards the richest
(top 1 percent), away from the rest (the 99 percent). He simply assumes
an unequal income distribution is “unjust” and tries to buttress his bias
against rentiers (and the rich) with the dubious claim that inequality breeds
economic stagnation. There’s no evidence for that claim, but that’s his
story (Porter, 2014).
On one hand it’s apparent that Piketty is uncritical of the fiscally prof-
ligate democratic welfare states that cause rising public indebtedness
precisely because he favors them ideologically; they are, after all, vast and
effective redistribution machines. Yet it’s also clear that his main project
is to push policies that compel the rich to pay more than they do already
(through confiscatory taxation) for the sustenance of fiscally reckless
states. He’s bothered that profligate sovereigns have left the rich under-
taxed and thus overladen with “idle” savings and cash hoards; although
the rich invest some savings in public bonds, they’re able thereby to collect
“unearned” income and further skew the income distribution. Instead
of receiving (some) interest income from the state, the rich should be
paying (most of) their total income to the state. That policy, he claims,
could radically reduce or even eliminate public debts (depending on the
country) and eradicate a large portion of the despised rentier class. Oddly,
Piketty seems to assume that the rich become rich by holding public debt,
whereas typically the sequence is the reverse, and besides, the securities
they own aren’t exclusively public bonds. Piketty also assumes that it’s
mainly the rich who hold public bonds, whereas in fact they’re owned by
a wide variety of people and institutions, directly through mutual funds
or indirectly through pension funds. Piketty’s errors are three-fold: that
inequality is inherently “unjust,” that bond income is “unearned,” and that
financialization undermines prosperity. To rid the world of public debt
he advises high income taxes, a direct capital levy on public bondholders
(as Ricardo advised), higher inflation to erode the real value of bonds
(as Keynes advised), and, if a balance remains, an explicit repudiation.
Piketty is unique among public debt pessimists because his main aim isn’t
to restore a profligate nation to fiscal rectitude or to foster prosperity but

instead to impose (financial) capital punishment on rentiers.
3.9 DEMAND-SIDE AND SUPPLY-SIDE ON THE

SAME SIDE
We’ve seen Keynes endorse a resort to monetary debasement (inflation)

to deceptively mitigate real public debt burdens. Crucial to the
institutionalization of his policies was the proliferation of new central
banks in the progressive era at the turn of the twentieth century. The earliest
central banks were Sweden’s Riksbank (1668), the Bank of England (1694),
and the Bank of France (1800). But most modern central banks were
established in a seven-decade span: the Bank of Germany (1870), Bank
of Japan (1884), Bank of Italy (1893), US Federal Reserve (1913), Reserve
Bank of Australia (1920), and Bank of Canada (1935). They were founded
not to correct “market failures” but to assist expanding welfare states in
the sale and distribution of the vast new public debts resulting from deficit
spending. The “organization of debt into currency,” already seen in private
banking, now involved the use of public debt as backing for state money.
The first third of the twentieth century saw a radical displacement
of what had been a largely free-market system of money and banking,
regulated by the automaticity of the gold standard, with nationalistic
and monopolistic central banks issuing fiat paper money with the aim
of assisting client states with their financing needs. The burgeoning new
state-centric monetary system embodied a plank in Marx and Engels’s
Communist Manifesto (1848): “Centralization of credit in the hands of
the state, by means of a national bank with state capital and an exclusive
monopoly.” The power of legally privileged central banks to monetize
public debt (Thornton, 1984), unrestrained by the gold standard, facili-
tated vast new issuance of public debt, adding a new dimension to public
debt theory and practice. Not coincidentally, this vast expansion of the
state’s role in the economy, and in its power to deficit spend and inflate,
accompanied new extensions of democracy and the franchise. Increasingly,
the electorally conscious politician realized that a burgeoning state seemed
best financed by more public debt instead of more taxes. Most voters felt
the pinch of higher taxes; public debt, by contrast, seemed innocuous.
Three other significant developments in the first third of the twentieth
century facilitated the Keynesian case for deficit spending, not as a passive
result of revenue shortfalls amid economic slowdowns, but as an active,
deliberate policy: World War I, the Allies’ demand for war reparations
from the Central Powers (mostly Germany), and the Great Depression.
The war entailed a massive increase in public debts worldwide; reparations,

which Keynes so adamantly opposed in his first book (1920), fostered dis-
cussion about sovereign debt burdens; and the huge deficits of the Great
Depression, which otherwise might have hurt the reputations of politi-
cians, suddenly were excused and even applauded as a means of curing
economic depression and fostering recovery.
Keynes argued that government deficit spending could supplement
national income and stimulate the economy through a “multiplier” effect
unique to public spending, even if the spending was frivolous or wasteful.
The theory denied that public borrowing “crowded out” private borrowing,
because underemployment meant underborrowing. If additional public
debt increases interest rates or precludes a recovery of investment, central
banks can monetize it to keep rates low – indeed, near zero, to “euthanize”
(in Keynes’s words) public bondholders. If central banks can’t monetize
due to the strictures of a gold standard, they could be loosened, according
to Keynes, or simply abandoned. In Keynes’s more p hilosophical essays he
disdained the gold standard and free-market capitalism, and falsely blamed
each for the Great Depression. Seeing deflation during the d epression, he
called for currency devaluation and reinflation.
Although Keynes was occasionally discomfited by chronic deficit
spending, his successors – primarily Lerner and Hansen, but not Harris
and Musgrave – argued for a perpetual resort to it and to inflationary
finance too, whether to combat Hansen’s “secular stagnation” or adhere
to Lerner’s “functional finance.” Free market policies and orthodox
budget balancing, they argued, should no more apply in good times than
in depression years. Perpetual deficit spending and debt build-ups were
justified, since 1936, whenever aggregate demand supposedly fell short
of aggregate supply. The classical economists had argued (correctly) that
aggregate demand and aggregate supply were necessarily equal – two sides
of the same coin. Mass joblessness reflected insufficient price adjust-
ment, due mainly to laws, but easily remedied by lower wage rates. Keynes
rejected this logic and hoped inflationary finance would fix things.
As did the classical economists, most Keynesians argue that only
foreign-held public debts are truly burdensome, as their servicing sends
domestic funds abroad; but unlike most classical economists they say
domestic public debt is no burden because “we owe it to ourselves.” Since
only foreign (“external”) debts are seen as a deduction from national wealth,
Keynesians also say it could (and should) be repudiated o pportunistically,
or periodically restructured on more favorable terms (to public debtors).
The end of the gold exchange standard in 1971 and subsequent shift to
innumerable fiat currencies marked a turning point in this regard; as long
as a sovereign borrowed in its own currency and avoided the “original sin”
of borrowing in other currencies (which it could not print), it would enjoy

an “exorbitant privilege” in international capital markets (see Chapter 5,
Section 5.4). A sovereign with debt denominated in its own money could
easily avoid explicit default, yet still default, g radually and implicitly, by
inflation.
Critics of Lerner’s approach ask how a potentially infinite build-up of
public debt can be innocuous; disaggregating the creditor-debtor nexus,
they’ve tried to show how asymmetric burdens can trigger systematic
instability. But in the 1950s, 1960s, and the 1970s, the impression remained
among mainstream (by now Keynesian) economists that public debt
was benign. In the mid-1950s the Dean of Dartmouth’s business school
described public debt as a lubricant for the economy. “What then is the
real problem of debt?” he asked. “It is one of maintaining a fair propor-
tion between the incomes of those who incur debt and the total amount
of their debts. It is one of maintaining reasonable liquidity.” “Debts are
another case of ‘duplicity’ in economics,” he warns. “Debt per se may
seem undesirable – and when it exceeds our ability to expand, it a ctually
is undesirable. But when used wisely, debt can spur production and
employment. That is wholly desirable” (Upgren, 1955, p. 62). By 1995, two
Keynesians, while conceding that Keynesian theory no longer prevails as
orthodoxy, insists it should, and that then current debt levels were safe:
“We do not think that the present political orthodoxy which states that the
budget should be balanced – whether now or sometime in the future – has
any merit”. So long as the government does useful things, the US budget
deficit can continue at present levels pretty much indefinitely (Galbraith
and Darity, 1995). Fourteen years later, amid the Great Recession and
fast-rising public debt, one such author attributed the meltdown to deficits
caused by tax cuts in 2003, to “the predator state,” and to conservatives
who abandoned the free market, an abandonment that, nonetheless, he
endorsed (Galbraith, 2009).
The “new economics” of Keynesianism took hold in the United
Kingdom during and after World War II, in the United States starting
with the Employment Act of 1946 (which created the President’s Council
of Economic Advisors), more extensively still due to Samuelson’s textbook
(first published in 1948), and through adoption by a then dominant
Democratic Party in the 1960s. This was the “fiscal revolution” that made
for chronic deficit spending and steadily rising UK and US public leverage
(Stein, 1969). Public debt was seen as uniformly beneficial to the economy,
and deficit spending itself enabled a further expansion of the welfare state,
through “Great Society” programs (Medicare and Medicaid), which today
contribute materially to a rising US public leverage ratio.
The Keynesian case for inflationary finance through debt monetization
by central banks was institutionalized in the 1970s, especially after the aban-
donment of the Bretton Woods gold exchange standard in 1971. No longer
did any nation credibly commit to repay its debts in money of steady and
reliable value. In the 1970s, for the first time since the end of World War II,
central bank balance sheets were expanding enormously, and to an even
larger extent later (2008–12, by the policy of “quantitative easing”). As
explained in greater detail in Chapter 5, this expansion is accompanied by
“financial repression,” whereby fiscal and monetary policies either induce
or mandate public debt holdings, which helps keep bond yields inordinately
low, in the process harming creditors (savers) so as to benefit borrowers
(debtors), above all sovereign borrowers. All such p olicies originated in the
state-enabling system of Keynesian public finance.
That Keynesianism constitutes a “fiscal revolution” with lasting effects
worldwide is corroborated by the set of policies that arose in the 1980s and
supplanted its dominance. The “new” approach – dubbed “supply-side
economics,” in contrast to the Keynesians’ (aggregate) demand-side focus –
drew on a previous academic revival of classical economics (the “new
classical macroeconomics”), yet ignored its public finance prescriptions.
Supply-side economists condoned but didn’t advocate large budget defi-
cits, and not on the grounds that deficits “stimulated” the economy. For
that, tax-rate cuts on business and the rich were needed, even if spending
couldn’t be curbed. Moreover, unlike taxes, public debt was purchased
voluntarily. A strong dollar, also part of the supply-side policy mix, would
attract foreign buyers of public debt, defying the common fear that exter-
nal debt is the most burdensome. Debate in the 1980s centered on the
shift to high real interest rates and whether they were due to wider budget
deficits (and “crowding out”); yet nominal yields on US bonds declined
steadily during that decade, even as public leverage steadily increased. This
pattern prompted many supply-siders to insist (as Keynesians themselves
well might) that “deficits don’t matter.”
Still, no supply-side economist – the most prominent being Nobel laure-
ate Robert Mundell (1932–) and Arthur Laffer (1940–) – ever advocated
budget deficits, or claimed that tax cuts could fully “pay for themselves.”
They knew deficits might widen amid cuts in tax rates, but this was justified
if spending couldn’t be cut; the only alternative was to try to reduce a deficit
by an economy-harming tax rate hike, as the United States enacted in 1932,
disastrously converting a recession into a depression. Whereas demand-side
Keynesians usually agitate for deficits to “stimulate” moribund economies,
supply-siders passively condone and reluctantly apologize for them, while
denying that they can, alone, boost any economy, financial sector, or rentier
class. According to supply-siders (see especially Mundell, 1960 and 1990),
public deficits and debts are neither harmful nor beneficial per se; they can
boost production to the extent they result from tax rate cuts on producers.
Context matters. Thus supply-siders are best classified not as public debt
optimists but as realists, in the tradition of Alexander Hamilton.
Have supply-siders identified an optimal level of public debt? No, but
ironically, some contemporary Keynesians have done so, using the Laffer
curve. They’ve known, of course, about the curve’s great influence on US
tax policy in the 1980s; it posits that tax rates might be so high as to deter
the growth or recognition of income, such that they depress tax revenue;
likewise, it implies that tax rate cuts might boost income and tax revenues.
Despite skepticism about use of the Laffer curve in tax incidence analysis,
a few Keynesians have developed what they call the “Laffer debt curve,”
which tries to demonstrate the existence, not of an optimal rate of tax, but
of an optimal degree of public leverage. I examine the principle in greater
detail in Chapter 5, Section 5.2.
Large US budget deficits in the 1980s caused widespread consterna-
tion, but mostly among those who condemned supply-side policies on
ideological grounds while still defending deficit spending (Keynesians).
They couldn’t deny that the 1980s proved more prosperous compared to the
stagflation-ridden 1970s. Writing in 1965, Keynesian professor and Nobel
laureate James Tobin dismissed the public debt theories of pro-capitalist
political economist James Buchanan (see Chapter 4) on the grounds that
“the political theory is questionable, and so is the economics” (Tobin, 1965,
p. 680). Yet two decades later, amid the success of “Reaganomics” and a
growing appreciation for Buchanan’s views, Tobin claimed US fiscal policy
“was quite conservative from World War II to 1981” and that the United
States in 1985 faced “not an apocalyptic day of reckoning” “but the old
story of crowding out of productive investment” (Tobin, 1985, p. 12). He
convinced himself that “crowding out” was impossible in the 1930s but
indisputable in the 1980s amid fully employed resources, as he tried to
portray supply-side policies as failed.
Politically, supply-side theorists and policy advisors have been useful
to center-right politicians wishing to keep public spending up and tax
rates down; meanwhile Keynesian theorists and policy advisors have been
useful to center-left politicians keen to raise both the rate of spending and
rates of taxation (especially on the rich). Politicians representing the vast
middle of the electoral spectrum are reluctant to shorten their careers by
advocating spending cuts or tax hikes; as such they ensure deficit spending
and debt accumulation, whether in war or peace, in bad economic times or
good. That the majority of voters today condone if not actively endorse
chronic deficit spending is unique to unrestrained democracy. Fiscal prof-
ligacy reflects a majority that obtains most of the benefits of the welfare
state while a minority (the rich) shoulders most of its rising cost.
For at least two decades, until the late 1990s, it seemed that Keynesianism
would be eclipsed indefinitely; supply-side policies had revived US produc-
tivity and economic growth, brought simultaneous declines in jobless rates
and inflation rates (the reverse of the 1970s stagflation), a less volatile busi-
ness cycle, budget balanced or surplus, and lower public leverage. Supply-
side policy was ridiculed, morally, as a mere “trickle-down” rationalization
for fiscally privileging the rich, even though the “trickle down” notion
itself conformed closely to the widely-endorsed Rawlsian conception of
“justice” that was held most tenaciously of all by the critics of supply-side
policy. Consequently even flawed Keynesian precepts and policies could
again eclipse the classical (supply-side) approach, in 2008–09, except now it
was considered a specific theory relevant only to recessions, not a “general
theory” pertinent in all circumstances, as Keynes (1936) claimed.
That Keynesian public debt theory made for a permanent fiscal revo-
lution in the past eight decades seems clear from its hasty revival amid
the financial crises of 2008–09, despite its near total eclipse in the 1980s
and 1990s. More remarkable is that this revival seems less inspired by the
relatively reserved approach of John Maynard Keynes and more by the
unrestrained, rules-free approach of Abba Lerner. Finance ministers and
central bankers alike have abandoned most of the remaining (and already
previously loosened) rules and modes of modern public finance, while
pushing for massive deficit spending, vast new debt issuance, perpetually
zero (or negative) interest rates, and stupendous sums of new money crea-
tion and debt monetization (“quantitative easing”). Keynes in the 1930s
had sought to bridge the gap that then existed between classical debt poli-
cies and those he preferred, with limited (initial) success.10 Yet in the early
twenty-first century the developed world enacts Keynesian policy in its
most radical, expansive form. The Keynesians’ dramatic rise (1940s, 1950s,
1960s), fall (1970s, 1980s, 1990s), and (recent) revival contrasts sharply
with the slow but steady ascendancy of the public choice school, with its
unique interpretation of the political origins of public debt and its vast
expansion in an increasingly democratic age. To this school I turn next.
NOTES
1. For two implausible theses see Yglesias (2012) and Varoufakis (2016).
2. Webb and Webb (1911), especially Chapter VI, “How to Prevent Unemployment and
Underemployment.”
3. Keynes cited in Garvy (1975, p. 403).
4. Keynes cited in Wapshott (2012, pp. 198–9).
5. Keynes cited in Brown-Collier and Collier (1995, pp. 342–3).
6. Keynes cited in Brown-Collier and Collier (1995, p. 344).
7. Keynes cited in Brown-Collier and Collier (1995, p. 349).

8. Krugman (1988, 2010, 2011a, 2011b, 2011c, 2012a, 2012b, 2014, 2015a, 2015b, 2015c).
9. For a comprehensive critique of Piketty’s system, see Salsman (2015a).
10. For more about Keynes and Keynesians on public debt, see Meltzer (1981), Lowery
(1985), Middleton (1985), Crescenzi (2011), Itoh (2012), Aspromourgos (2014a, 2014b),
Nelson (2015), and Tily (2015).
4. Public choice and public debt
The public choice school as it pertains to public finance and public debt
is most developed in the works of 1986 Nobel laureate James Buchanan,
Richard Wagner, and Geoffrey Brennan. Unlike other approaches, which
focus more on the consequences of public debt, public choice focuses
more on its causation, particularly on the interaction of politics and
markets and on the institutions that distinguish fiscal regimes of frugal-
ity and integrity from those of profligacy and perfidy. Public choice also
recognizes, however, that the incidence of public debt can influence its
inception. For example, if public debt can “stabilize” the business cycle or
“stimulate” the economy, as Keynesians claim, there’ll likely be a stronger
political willingness to incur it than were it interpreted, instead, as harmful
to prosperity or unfair to posterity.
The “Great Recession” of 2008–09 saw an odd resurgence of Keynesianism;
“odd” because the demand-side model was so discredited in the 1970s and
because its rival, supply-side economics, delivered such positive financial-
economic results in the 1980s and 1990s. A half-century before the latest crisis,
during the first Keynesian heyday, Buchanan issued his Public Principles of
Public Debt: A Defense and Restatement (1958 [1999]); it revived and revised
classical debt theory while questioning the morality and practicality of
deficit spending. Buchanan’s book was the first to discredit Keynesianism,
although other factors also helped, including Friedman’s monetarism, Lucas
and the rise of the “new classical” economics, and the Keynesian cocktail of
“stagflation” in the 1970s.
4.1 THE ESSENCE OF PUBLIC CHOICE
The public choice approach is distinctive in its denial of a bright line between
political and economic realms and its skepticism of the conventional premise
that political actors are selfless, public-spirited altruists promoting the
common good. Public choice theorists presume everyone is self-interested,
but whereas economic actors seek to create and accumulate wealth, political
actors seek to amass and exercise coercive power. To preserve life, liberty
and property, government must be restrained constitutionally.
153
Positive (in contrast to normative) public choice theory interprets the

supposed ubiquity of self-interested utility maximization not as e thically
commendable but as patently factual (while rejecting the common
caricature that self-interest must be atomistic or solipsistic).1 Public choice
embraces realism instead of idealism, and by stressing a universal, root
motive (self-interest), offers a more consistent theory of political economy
(and public finance). For example, it rightly questions those who imagine
Platonic “perfection” in a “purely competitive” market economy, who
denounce its prejudged shortcomings (“market failures”) relative to an
unreal standard, and who then propose to “fix” the failures by the inter-
vention of benevolent, selfless political actors who advance the “public
interest.” In contrast, the realist contends that self-interest rules all realms;
if so, “government failure” isn’t any less likely than is “market failure.” A
harmonious institutional framework of rational norms, rules, laws, and
constitutions can optimize the political-economic mix without conjuring
a need for angelic “public servants.” Public choice theorists also reject the
Germanic-organic view of the state as comprising inseparable, duty-bound
subjects. Citizens are distinct, valued individuals. Of course, while public
choice scholars view political idealists as naive regarding human motives,
political idealists view public choice scholars as cynical about such motives.
Formal institutions will remove or exclude such features of public finance
so long as a culture’s prevailing political philosophy is antithetical to the
strict protection of genuine rights.
For public choice, government failure occurs when any state fails
to protect life, liberty, and property, and instead fosters rent-seeking,
cost-shifting, and fiscal profligacy. States also fail whenever they exploit
minorities (the rich) or the unenfranchised (future generations) as means
to others’ ends, treating them as “fiscal commons.”2 Such failure is pre-
vented only by constitutional limits on the size, scope, and power of
government.
One defect in public choice theory is its implicit denial that the same
ideas that promote public profligacy won’t also influence choices about
reforms of fiscal-monetary institutions. Thus fiscal integrity might be
achieved, as some public choice theorists prefer, by balanced budget man-
dates, privatized entitlement spending, a gold standard, or national sales
tax, but these are opposed precisely because of their likely fiscal effects.
James M. Buchanan (1919–2013), in his Nobel lecture, acknowledges
the great political economist Knut Wicksell (1851–1926) as a major
influence, citing his view that “the science of public finance should always
keep political conditions clearly in mind” (Buchanan, 1986). More recently
he recounts an early (1940’s) influence from the Italian school of public
finance:
Public choice and public debt 155
I went to Italy to understand and learn about the Italian tradition in public
finance, but the effect [on me] really was to change my whole view about poli-
tics, the state, and man’s relation with the state. I absorbed a lot of the Italian
thinking there, without realizing quite how important it [would become] to my
own career. I don’t think public choice or the approach that I took in a lot of
my other research would have ever got off the ground, certainly not in the same
way, had it not been for the Italian influence. My first piece in 1949 [argued]
that people should in fact pay a little attention to the model of the state, and I
notice, looking back at that piece, that I had a reference to De Viti De Marco’s
book [First Principles of Public Finance, 1936]. . . Apparently he had much more
influence on me than I realized. . . [His] development of the idea of two parallel
models of the state – the monopoly model and the democratic model – carries
through [to my work]. One important influence of the Italian year on me was
not only reading this material but also living in the culture, becoming part of
it, and seeing the attitude of the Italians towards politics, politicians and the
state. [Their attitude] is much more skeptical, much more cynical, much less
idealistic, much less romantic about the state and that influenced me a great
deal. (Buchanan, 2010)
The influence of Antonio De Viti De Marco is elaborated in Buchanan’s

essay, “The Italian Contribution to Debt Theory” (Buchanan, 1960,
51–9). Before treating Buchanan’s theories it’s worth examining
pp.
De Viti De Marco’s and those of two precursors of the public choice
approach: long-time professor of public finance at Princeton, Harley
Lutz and the Austrian economist, Ludwig von Mises, who for many years
taught at New York University.
4.2 PUBLIC DEBT AS DEFERRED TAXATION:

DE VITI DE MARCO
De Viti De Marco (1858–1943), a classical liberal, was a land-owning aris-

tocrat and member of Italy’s parliament who in 1887 began his career as a
professor of public finance in Rome. Teaching until 1931, he then resigned
upon refusing to take a loyalty oath to Mussolini’s fascist regime. By one
account De Viti De Marco was “an unyielding defender of liberalism”
(Cesarano, 1991) and his text, First Principles of Public Finance (1936),
first published in Italian in 1888, was “probably the best treatise on
the theory of public finance ever written” (Benham, 1934). By his own
telling De Viti De Marco seeks to “treat Public Finance as a theoretical
science,” assigning it the task of explaining the phenomena of (spending,
taxing, and borrowing) “as they appear in their historical experience,”
by a method “objective, impersonal and theoretical, in contrast with an
approach founded on a priori canons of absolute justice, which do not
exist.”
De Viti De Marco believes traditional public finance has been con-

taminated by political prejudice, by “personal ideals of social justice,”
and expediencies of “practical statecraft” (1936, pp. 15–16). “In modern
society,” he contends, “all income is produced as a result of the free activity
or free choice of the citizens,” and “from this is derived the juridical prem-
ises of equal fiscal treatment of all incomes.” Moreover, “every deviation
from this principle” “is an acknowledgement of the presence of a political
factor, the nature of which must be ascertained and the relative influence
of which must be evaluated” (p. 16). He adamantly opposes redistribu-
tionism, particularly its unjust arbitrariness. The classically liberal state
is “cooperative,” while the interventionist state is “monopolistic.” Their
fiscal practices differ considerably. The cooperative state treats citizens,
especially income earners, equally and with respect, and as public partners,
while the monopolistic state is predatory and exploits the rich for the
benefit of rulers.
De Viti De Marco’s “Theory of Public Loans” is presented in Book
V, Chapter I of First Principles of Public Finance (1936, pp. 377–98). He
first distinguishes “ordinary, normal, and continuous expenditures” from
“extraordinary needs” of state that “arise at great intervals.” The former are
best financed by taxes, the latter by borrowing. In all events, state financial
needs must coexist peaceably with those of citizens. Thus “we start with
the elementary premise that the budget of modern States develops in
harmony with the budgets of the citizens, the two together representing
the organic budget of the nation” (p. 378). De Viti De Marco sees public
debt originating in the state’s need for large revenues in extraordinary
circumstances. Most citizens can bear light taxation payable over time but
not heavy and sudden taxation and even wealthy citizens are often illiquid,
because they are primarily property owners, and so must borrow to pay
any tax. De Viti De Marco contends that the state may borrow legitimately
from cash-rich parties – public creditors – who effectively stand in the place
of those wealthy who are illiquid. The state borrows from them now and
taxes them later, over time, as by installment.
De Viti De Marco views tax finance and debt finance as mostly inter-
changeable: public borrowing entails “the raising of an extraordinary levy
through the flotation of a public loan” but it’s “less of a burden than an
extraordinary tax on property would cause.” Moreover, because it’s impos-
sible to tax non-citizens abroad, “the public loan broadens the market
of subscribers to the extent that it attracts foreign investors,” and “to the
extent that the circle of initial subscribers is enlarged, the financial needs
of the State remaining constant, the burden of the extraordinary levy on
the country’s economic structure is lightened” (p. 385). He believes that
“the institution of the public loan is a more economical fiscal instrument
than the extraordinary tax on property,” so in time “it takes the place of
the latter” (p. 387). “On this network of private loans is founded the theory
of public loans,” he writes, and “in fact, the State can abolish the instru-
ment of extraordinary taxation” altogether “if it asks as a direct loan from
the group of ‘capitalists’ the total sum that they were prepared to lend to
the owners of immobile property, and if, at the same time, [the State] asks
from the owners of immobile property a sum [in future taxes] equal to the
interest that they were prepared to pay the ‘capitalists,’ had they instead
been required to borrow from them to pay the extraordinary tax” (p. 382).
In this way the state “makes itself intermediary between private lenders
and borrowers, combines in a single inclusive figure the sums demanded as
loans, contracts in its own name a single loan for the total amount it needs,
and obligates itself to pay a uniform rate of interest” (ibid.).
Public borrowing entails peaceful, beneficial exchange in De Viti De
Marco’s rendering; a cooperative state could rightly demand a large,
one-time (“extraordinary”) sum, through sudden and heavy taxation, but
that would disproportionately harm illiquid taxpayers. The state achieves
the same end by facilitating an intermediation of credit; crucially, public
bonds are bought by “voluntary subscription,” so “there is, therefore, an
advantage to both of the contracting parties” (De Vito De Marco, 1936,
pp. 383–4). Cooperative (liberal) states minimize coercive methods (taxes,
capital levies, and forced loans).
De Viti De Marco is aware of the potential for what was later called
“crowding out,” and how it might raise interest rates. “The State competes
for the available savings against industry and commerce, which also e xercise
a demand for them,” and “what decides the distribution of savings between
the Treasury and industry is the rate of interest paid by the State” (p. 388).
Echoing J.S. Mill, he argues that the interest rate a sovereign pays on its
bonds reflects the extent of the savings pool and its own creditworthiness
(or lack thereof). “The higher the rate of interest promised by the state,
the more available savings it withdraws from industry and commerce, with
resulting disadvantages similar to those produced by excessive rates of
extraordinary taxation” (p. 389). “Disposable savings will be distributed
between the Treasury and industry according to which use offers the greater
advantage to the savers,” so a sovereign that borrows at the market rate
(or below it) doesn’t harm private sector borrowers. In such cases public
debt “will not disorganize the vital nucleus of the industrial activity of the
country” (ibid.). The truly cooperative state borrows harmlessly.
Public borrowing, for De Viti De Marco, is but delayed taxation, and if
imposed by a cooperative state makes it easier for citizens to pay, whether
by installment or because the future taxes needed to service bequeathed
debt are imposed mostly on the rich, those best able to pay and the main
lenders to the state in the first place. Whereas taxes paid now “induce each
taxpayer to lower his present standard of living” (De Viti De Marco, 1936,
p. 379), public debt means the citizen will have “to reduce permanently his
future standard of living” (p. 378). It’s an inescapable truism that when
any sovereign finances itself, private incomes (and living standards) must
decline; the real question is whether the decline occurs now (taxes, paid
up-front) or later (debt – or deferred taxes – paid in the future).
Incorporating context, De Viti De Marco denies that either tax-financed
or debt-financed spending are necessarily harmful, helpful, or neutral for
living standards, now or later (pp. 378–9). The national balance sheet has
two sides: “Although the heirs and future generations will receive from their
ancestors a budget which, on the liability side, is depreciated by the amount
of the [public debt],” “the asset side” of their ledger will be “increased by
the utility” flowing from the initial outlay (p. 395). Public spending can be
done right – by investment in long-lived, productive‑infrastructure – and
needn’t be dissipated on consumptive items in the short-term. Yet while
public spending can yield current and future utility, if its marginal utility
doesn’t surpass the marginal disutility of servicing future debt, it can’t
increase living standards, now or later. De Viti de Marco here echoes
Ricardo’s thesis of an equivalence between tax-financed and debt-financed
outlays and denies that public loans entail an uncompensated cost shift to
posterity:
[T]here is no basis for the old, but still widespread opinion that a [public] loan,
unlike an extraordinary tax on property, makes it possible to shift a part of [the
cost of] public expenditure to future generations. On the contrary, in every case
the heirs either receive a patrimony which is lessened by an amount equal to
the capital sum involved, or are held responsible for the continuing payment of
the corresponding amount of interest; there is, as we have seen, no difference
from a financial point of view. The heirs who pay perpetual interest can redeem
their obligation by paying a corresponding capital sum. But this operation is
voluntary, and does not represent a burden; if it is carried out, this is because it
is hoped to derive a gain thereby. (De Viti De Marco, 1936, p. 396)
What of internal public debt? “The loan burdens the budget of the
State with a new expenditure in the form of interest” but to this “there
corresponds a revenue equal in amount” (ibid., p. 390). Do we “owe it to
ourselves,” with no net harm? Yes, according to De Viti De Marco, but the
flows must be disaggregated, to discern disparate effects. “[For the] State it
is a matter of debit and credit, but this is not true of the economic budget
of the community, as is sometimes alleged.” Recall his conception of state
and household budgets together comprising a “national” budget; yet “the
community is not a homogeneous group, which pays 50 million in taxes
and receives 50 million in interest,” because “the State receives 50 million

in taxes from one group of citizens and pays 50 million to another group”
(ibid.; original emphasis). The best way to prevent unjust redistribution
and ensure that “the State treats all taxpayers uniformly” is to “make tax-
payers and public creditors the same people, paying and receiving the same
amounts as regards taxes and interest income from public bonds.”
De Viti De Marco practices methodological individualism, by distin-
guishing causes and effects within ostensible aggregates, and by consider-
ing not “society” but the subgroups and individuals comprising it. He also
applauds what he dubs the “democratization” of public debt: as a nation
grows wealthier so does a growing proportion of its people (by an expand-
ing middle class), and as more citizens prosper and save, more can purchase
public debt and receive its interest income, partly offsetting the tax burden.
Thus not only the bondholder but also “the capitalist, the [business]
proprietor, and the professional man” can earn investment income (p. 392).
Even a huge public debt, if widely distributed and owned, “may be
regarded as extinguished in fact” (ibid; original emphasis). The adage “we
owe it to ourselves” is valid, but only if “we” is comprised of the same
people as “ourselves.” Of course, no public debt is truly “extinguished”
(repaid) merely because it is more widely (democratically) held. But for
De Viti De Marco, “this proposition, by virtue of its truth as an abstract
proposition and its truth as a statement of concrete tendencies, demolishes
the current opinion that modern States, because of their enormous expen-
ditures in the form of interest-payments, will not, in the long run, be able
to bear the weight.” On the contrary, he argues, “the burden of the loan on
the economic position of the taxpayers is borne entirely at the moment of
subscription, when provision is made” in the annual budget to pay interest,
so “as we get further away from the time of [the original bond issuance],
the tax-burden of the loan becomes progressively less.” Although “there
remain the alarming figures of the original public debts and the interest on
them,” he concludes, “the interplay of debits and credits tends gradually to
make them devoid of any economic content” (pp. 392–3).
De Viti De Marco believes that public debt can burden a nation only
if it’s narrowly held by a minority rentier class and serviced mainly by
taxes on non-rentiers. Yet unlike the usual haters of the rentier class,
De Viti De Marco appreciates it and wants it to expand into a majority,
for that would mean a nation is becoming wealthier and better able to save
across all socioeconomic classes. This view – that public debt can’t be a
real burden to society if it is widely held (in the form of bonds) – animates
the modern distinction between “gross” and “net” public debt, with the
difference seen as no burden because it is held by state trust funds or
agencies – that is, held “democratically” on behalf of all. Danger arises,
says De Viti De Marco, when officials fearing a large public debt try to
reduce it by odious taxation, inflation, or repudiation. He prefers to leave
“the solution of the problem to the natural play of economic forces.” He
opposes the self-defeating policies of those “dominated by the idea that
every debt contracted formally and publicly must be formally and pub-
licly extinguished.” Although “it would not be true to say, in accordance
with an old belief ” (of mercantilists) “that the public debt is a part of the
wealth of the country,” yet “its presence and its continuance in the market
produces an additional utility,” for it “often renders subsidiary services in
the facilitation of credit operations between private individuals,” given its
safety and liquidity (ibid., p. 394).
For De Viti De Marco the rational state demonstrates its fiscal rectitude
and credit capacity by efficiently servicing its debt and never unnecessarily
repudiating it, an echo of Hamilton’s position:
A State that has already had recourse to borrowing may need to have further
recourse to it. Good financial policy, foreseeing this, must keep the credit of the
State high; and the credit of the State, like that of an individual, depends not
only on the real solidity of its finances, but also on the opinion of its finances
which is formed by the market. Now, only when the State pays its debts does
it give visible and tangible evidence that the proceeds of a first loan have not
been invested at a loss and that, in any case, the savings of the debtor country
that asks for new credit have increased in the interval. (De Viti De Marco, 1936,
p. 395)
The financially strong state inspires the confidence (“opinion”) of markets,

especially of taxpayers and bondholders, not merely by displaying its finan-
cial muscle (maintaining public credit) but also by exercising it (issuing and
servicing public debt). Whereas public credit pertains to a state’s capacity to
borrow, public debt pertains to its use of that capacity – and both are crucial
to maximizing a nation’s financial-economic-military prowess. De Viti De
Marco says that public finance officials needn’t be alarmed about the mag-
nitude of public debt or obsessed about any out-of-context statistic. They
need only ensure that debt prowess exceeds debt usage, that the differential
between capacity to borrow and actual borrowing is optimized. Today this
approach is captured in the concept of “public leverage,” defined as public
debt/GDP, with national income (GDP) as the theoretical base of public
debt capacity (public credit), but taxable capacity is its actual basis.
If the crucial margin between debt capacity (public credit) and capacity
usage (public debt) is narrow, De Viti De Marco warns, credit capacity is
dangerously near exhaustion. Instead of widening the margin by reducing
debt through odious means, states should enlarge it by enhancing their
credit capacity – which depends on a nation’s taxable capacity – which
depends on the economy’s income-generating capacity – which is best

maximized by liberal, cooperative states, not monopolistic and predatory
ones. Regardless of how states are financed, De Viti De Marco argues,
they can become too large relative to an economy’s productive capacity.
The problem with deficit spending isn’t the deficit but the spending (again
echoing Ricardo, but without the pessimism). “Many criticisms which have
been wrongly directed against borrowing as such could with more justice
raised against the nature of the extraordinary expenditure” (ibid., p. 395).
He elaborates:
[T]he problem [of deficit spending] resides in the purpose – that is, in the type
of expenditure – not in the means of procuring the necessary sum. Those who
would have the political strength to force a government to adopt an extraor-
dinary tax instead of a loan would have the political strength to prevent the
expenditure which they consider harmful to the country. Another sterile discus-
sion is that inaugurated by those who champion the extraordinary tax against
the public loan on the ground that the former obliges the present generation to
increase its savings, which later accrue to the advantage of future generations,
who inherit a larger patrimony. This opinion has a basis of truth, in so far as –
ceteris paribus – private loans, which bear a fixed maturity date and a higher
interest rate, induce the debtor to free himself from them, whereas the public
loan allows him more time and greater freedom of movement. Even if we admit
that this is true, it has not been shown that it is useful. The action of the State
that would force the savers to reduce their present consumption below the limit
which they consider useful for their well-being runs up against the economic
principle according to which the individual attains the hedonistic maximum
when he is left to distribute his income between the satisfaction of present wants
and the satisfaction of future wants, according to his own appraisal. . . [It is not]
useful to the community, considered in its entirety over a period of several gen-
erations, that a first generation should be induced to save to the maximum, in
order to permit one of the following generations to consume to the maximum.
The economic principle referred to above, which is valid for the individual, must
be assumed to be true also with respect to the aggregate of individuals who
make up a given generation. (De Viti De Marco, 1936, pp. 397–8)
De Viti De Marco, qua liberal, makes an important distinction between

debt and taxes: the purchase of a public bond is voluntary, hence open to
a self-interested, utility-maximizing calculus, while the payment of a tax
is compulsory. A tax that’s large, extraordinary, and payable at once often
requires a fire sale of assets, which is coercive and confiscatory. The clas-
sical liberal should prefer debt to taxes; only the liberal state cares about
the distinction, so as to minimize burdens. Public debt is preferable to a tax
“upon the assumption of the existence of a liberal and democratic State
and at a time when all the individual citizens” are “universally accorded the
right of participating, in some way and in some degree, in the formation of
the financial evaluation of public costs in relation to public utilities” (ibid.,
p. 398). Yet De Viti De Marco knows (writing in the 1930s) that liberal-
ism is declining globally, with fascism and socialism ascendant; tax-based,
inflationary, and confiscatory schemes are spreading. In statist regimes
decision-making on public finance is less participatory, often “left to a
single individual or a small oligarchy,” with the result that “a political equi-
librium cannot be attained unless the appraisal of the one coincides with
the suppressed evaluation of the many” (ibid.; original emphasis).
De Viti De Marco is a realist on public debt, because he incorporates so
much relevant context. His main thesis is that liberal democracies (relative
to illiberal autocracies) are more prone to deficit spending and debt build-
ups because they more abide by the rule of law (thus are better able to elicit
creditors’ trust), are richer (thus better able to afford higher debt service),
and ruled by liberal governments that value voluntary choice by citizens
who feel debt finance to be less onerous than tax finance.
De Viti De Marco’s First Principles of Public Finance appeared in
English only in 1936, the year of Keynes’s General Theory. It was pub-
lished in Italian in 1888, so 50 years later it couldn’t easily be deployed as
a counterargument to Keynes’s statist theories. But De Viti De Marco’s
innovative distinction between the public finance practices of the rights-
respecting cooperative state versus the predatory monopolistic state facili-
tates a more accurate assessment of the political economy of the 1930s.
Although unintended, First Principles challenges Keynes’s system, which
Keynes declares (in his introduction to the German edition of his General
Theory) to be most appropriate in the context of a predatory state, with a
vast socialization of investment and “euthanasia of the rentier.” De Viti
De Marco’s First Principles also provides important inspiration for public
choice debt theorists, whose first major argument for a new view of public
debt comes in 1958, with Buchanan’s Public Principles of Public Debt: A
Defense and Restatement, and whose first outright assault on Keynesian
debt theory and practice is launched in 1977, with the publication of
Buchanan and Wagner’s Democracy in Deficit: The Political Legacy of
Lord Keynes. Although De Viti De Marco is foundational for public choice
and best classified as public debt realist, public choice theorists generally
tend to be public debt pessimists.
4.3 EARLY SUSPICIONS OF STATE MOTIVES: LUTZ,

MOULTON, AND MISES
Harley Lutz (1882–1975) was the pre-eminent professor of public finance

in the United States during the first half the twentieth century; he taught at
Oberlin, Stanford, and for the last two decades of his career, at Princeton
(1928–47). He authored a widely used textbook (Public Finance), with four

editions appearing during an era of dramatic change (1924–47). When
Princeton professor Harvey Rosen, co-author of today’s most widely used
public finance textbook, also called Public Finance (Rosen and Gayer,
2009), contrasted the field today with its status 50 years earlier he named
Lutz’s 1947 text as most representative (Rosen, 1997).
Unlike Keynes, Lutz extolled constitutionally limited government, pro-
portional taxation, balanced budgets, free trade, and the gold standard.
He criticized rapid growth in government power, chronic deficit spending,
graduated tax rates, protectionism, inflation, and debt repudiation. His
main arguments are best summarized in Guideposts for a Free Economy:
A Series of Essays on Enterprise and Government Finance (1945). Lutz is
one of the last of the realists in public debt theory, in a lineage traceable
to Hamilton in the 1790s; the others are supply-siders Robert Mundell
(1932–) and Arthur Laffer (1940–).
The chapters on public credit and debt in Lutz (1936) begin with an
illuminating discussion about the “nature and principles of public credit,”
illustrated by its origin, evolution, and institutionalization, including its
relation to the spread of representative government, property rights, and
capital markets (Lutz, 1947, pp. 711–33). Next, he treats the “management
of the public debt” (pp. 734–63), debt problems (pp. 764–96), state
and local debts (pp. 797–824), and “the effects of public borrowing”
(pp. 825–47). By the time he treats public debt in the last edition of Public
Finance (1947) the extent of public borrowing due to the Great Depression
and World War II are known. He’s troubled by the trend. In 1936 US
public leverage was 40 percent, but by 1946 it was 121 percent. In the 1947
edition he devotes more pages to public debt (17 percent) than he had in
the 1936 edition (14 percent), and adds a section titled “The Case for a
Balanced Budget” (pp. 682–703).
Lutz contends that the “new economics” of Keynes is neither new nor
true. “During the past ten years [1937–47],” he writes in his 1947 preface,
“various alien doctrines have gained an increasing degree of acceptance,”
and although “they seem to be new,” in fact “they are really old and highly
discredited doctrines,” for “since John Law [1671–1792], to go no farther
back into history, there has been a succession of those whose stock in trade
has been the same old nostrum – easy money.” New labels on old bottles
don’t make for better wine. “The essential theme of these doctrines,” he
argues, “is statism, that dreadful thing for the removal of which from
the earth we have fought two devastating wars. The proposals for using the
fiscal powers to influence, or control, or direct the economy along some
road laid out by the planners necessarily mean a despotic control over
the fortunes and the destinies of all men. Acceptance of such a program
involves the subordination of all other values and objectives to security,”

and “in gaining security by such means we shall become prisoners, at large,
of the state.” For Lutz public spending, taxing, and borrowing aren’t the
means to prosperity – and he coins a phrase that others (most notably,
Milton Friedman) soon make famous: “There is no free lunch” (Lutz,
1947, p. v).
Lutz is right not to attribute the spread of “alien fiscal doctrines”
directly to Keynes but instead to Hansen (the “American Keynes”); he cites
the General Theory but once, on the spending “multiplier” (1947, p. 44). He
sees professors and policymakers as “exploiting the doctrine that public
debt need not be repaid, except as convenient, which usually means never.”
He refutes Lerner’s “doctrine” that debt “can be the means of creating
larger future income,” that “by selling government bonds to the banks,
additional purchasing power is created without depriving the citizens of
any part of their respective incomes.” National income can’t be raised by
means that ignore “the troublesome matter of redeeming these bonds” or
imply that “the only burden involved in the increased debt is the taxation
to pay the interest thereon” (p. 531).
Lutz disdains idyllic theorizing about public debt. The United States in
the 1930s, for example “was in the grip of the experts in panaceas” and of
all the “spurious remedies” peddled, “none was more persistent than the
idea that by working less, producing less, accumulating less, yet borrowing
more, the country could become more prosperous” (Lutz, 1947, p. 609).
Populist governments are prone to fiscal failure. “Too often, democracies
have been wrecked on the rocks of loose fiscal policy” (Lutz, 1945, p. 114).
“The chief reason for resorting to public loans is to obtain additional
funds more easily than they could be secured through heavier taxes or
higher charges for administrative services” (Lutz, 1947, p. 527). Unlike
autocrats, popularly elected politicians try to avoid offending voters; they
spend to benefit only a necessary majority of voters and fund it mostly by
loans (which are voluntary) instead of taxes (which are compulsory). The
result, a financing mix least burdensome to the relevant electorate, is rarely
conducive to fiscal health. Here Lutz reflects Hamilton and anticipates
Buchanan.
In truth, neither autocracies nor democracies have good track records on
public debt, Lutz recounts; a happy medium – the constitutionally limited
federal republic – best ensures fiscal integrity. It precludes the state from
exercising power arbitrarily; it abides the rule of law, respects contracts,
and makes credible commitments. “Public credit means a pledging of the
good faith and the resources of the whole public for the repayment of
debt incurred on their behalf,” and this “could not emerge” until the world
enjoyed some “growth of constitutionalism, whereby the people gained some
degree of control over the public purse” (ibid.). “The rise of public credit
is therefore contemporaneous with modern constitutionalism”(p. 528),
which began with Britain’s Glorious Revolution (1688), continued with
the establishment of the US Constitution (1787–91), and culminated in the
overthrow of European monarchs in the 1840s. Constitutional states foster
public credit; limitless democracies do not.
A constitutionally limited government can more readily borrow because
it fosters confidence and savings, thus a pool of liquid capital from which
to draw, if necessary; at the same time, it doesn’t borrow excessively
because it doesn’t chronically deficit spend. When restrictions on the
domain of majority rule wane, as occurred during the US progressive
era (1890–1920), so also do legal- monetary restraints and fiscal
fiscal-
responsibility. In its wake came “the new fiscal thesis [of the Keynesians],”
which “is the more dangerous because it would use the public debt as the
cushion and shock absorber against the rigidities that have been embed-
ded in the economic system by group pressures, special legislation, and the
reluctance of everyone to face unpleasant facts.” When recessions occur,
advocates of budget balance are castigated as morally insensitive, while
advocates of deficit spending are portrayed as compassionate. “The situ-
ation which is most often brought in as being one involving a greater evil
than a deficit,” he notes, “is unemployment,” so “advocates of a balanced
budget as the regular practice are denounced as stony- hearted Tories
who are utterly indifferent to the suffering and distress of those who are
without work or income,” and “increases of debt for the purpose of pro-
viding relief to those without jobs [are] hailed as the acme of justice and
humanitarianism” (Lutz, 1947, p. 696). Unrestrained democracy is biased
toward deficit spending, which is only intensified by popular fear amid
economic contractions.
The main threat to fiscal balance in democratic settings is political pan-
dering to popular passions and efforts to mask the true burden of govern-
ment (measured by its total spending, which must be drawn from private
incomes) by tapping the least onerous funding methods (pp. 528–9).
If by borrowing relatively more and taxing relatively less a burgeoning
state can divert public attention from the true size, scope, and cost of its
operations, it can grow excessively and perpetually, even relative to national
income, and even to the point that public finances aren’t sustainable. The
state resorts to more compulsory funding schemes (or debt defaults).
Gradually, a free society is lost. Political independence also may be lost
by over-reliance on foreigner creditors, especially if they are sovereigns or
semi-sovereign international agencies.
Lutz anticipates the public choice principle of “fiscal illusion,” which
holds that the true burden of government can be disguised by the mix and
means of finance, and more so in democracies. The principle was first

suggested by Adams (1895, p. 22): “the public servant can veil the true
meaning of his acts” and the true cost of state “by the free use of public
credit.” Likewise, Lutz (1947) sees deficit spending as a “veil” to mislead
unsuspecting voters: “the ostensible purposes [of deficit spending in the
1930s] were provision of relief and promotion of economic recovery”
but recovery was elusive, because other motives were operative: “public
servants were able to veil the true meaning of their acts,” which was to
“embark on great enterprises, including vast and ambitious schemes of
social reform, without having to touch the pockets of the voters through
taxes” (p. 529). Here Lutz echoes Adams’s warning, a half-century earlier,
that “popular attention cannot be drawn to public acts, except [as] they
touch the pockets of the voters through an increase of taxes” (Adams,
1895, p. 22). He elaborates:
During [the 1930s] the doctrine emerged that the manipulation of public credit
was a proper and necessary application of fiscal policy and that no harm could
be done by an indefinite expansion of debt. This is equivalent to saying that
no harm can be done to the democratic system by permitting the government
indefinitely to administer affairs independently by those who must finally
settle the account. By no stretch of the imagination is it conceivable that the
American people would have sanctioned the [government] spending of the
1930s had it been financed through taxation. Public credit prevented the main-
tenance of that scrutiny of expenditures which is essential to popular control
over the purse. There was, therefore, a surrender of some part or element of that
control, and to that degree a failure during these years to realize complete self-
government. (Lutz, 1947, p. 529)
Like Hamilton, Lutz is a public debt realist. Contextual analysis and

careful qualifications are important. He doesn’t deny that governments can
provide necessary and valuable services; what matters most are the uses to
which publicly borrowed funds are put. Lutz acknowledges that in certain
contexts debt proceeds can be productively employed to create legitimate
public goods; he’s pessimistic only when explaining the common misuse
of proceeds so typical of unlimited democracy. Below I examine, in turn,
Lutz’s views on the purpose and potential productiveness of public debt,
on the validity of the private-public analogy, on the effects and possible
burdens of public debt, the limits of public debt, and the usual means
by which excessive public debt is handled – whether by “conversion”
(restructuring), repudiation, monetization, repression, or inflation.
Lutz acknowledges that “writers on public finance and the statesman
in charge of national finances have been divided into opposing camps on
the question of the economic usefulness of public credit” (Lutz, 1947,
p. 536). From the classical tradition, Smith, Ricardo, Say, and Gladstone
deny that public borrowing is ever productive; they “opposed the use of
public credit on the ground that it led to extravagance, encouraged resort
to war, and induced generally disadvantageous economic conditions for
the nation which employed it.” In opposition stands “Dietzel and various
more recent German authorities who approve of the use of credit for
financing all extraordinary expenditure on the ground that the state is
part of the immaterial capital of society and that any unusual outlay in
its service is in the nature of an investment.” In this idyllic view “public
loans become a normal feature of the finances of the progressive state, and
are to be regarded as both just and beneficial” (pp. 536–7). Lutz stresses
that “none of these extreme views can be accepted” – whether pessimis-
tic or optimistic – because “the usefulness of the loan depends on the
usefulness of the purpose to which it is devoted.” Public debt is “proper or
not, according to the circumstances that give rise to its use.” It’s “a hand-
maiden of taxation” and shouldn’t be a main source of funds; at best it’s
“a supplement to the current [tax] revenues under certain conditions” and
thus “a useful and important device for meeting financial burdens that are
too great for the immediate capacity of the revenue system, or which are of
such a nature as to warrant equalization of the load over a period of time.”
Otherwise, it’s inadvisable. Misuse and abuse occurs when p oliticians
resort to debt to avoid alienating the electorate by taxes:
Unfortunately, the motive back of its use sometimes is the desire to evade the
necessity of immediate taxation [because borrowing] looks like an easier way to
pay the bills. The line between legitimate equalization of burden and improper
evasion of the cost is not always easily drawn, and many specious arguments
can always be found to prove that the thing which the community wants to do
is the wise and necessary thing to do. . . Politicians are usually fairly clever in
gauging the popular inclination, and they would be the first to realize the prac-
tical unwisdom of increasing taxes as compared with the (temporarily) easier
method of loans. [But] those who dance to the music should liberally contribute
to the fiddler. (Lutz, 1947, p. 537)
Public borrowing, then, is legitimate in just two contexts: when it funds

“an unforeseen emergency” (brief periods of high spending when tax hikes
would be futile or else depress the economy) – or funds the creation of pro-
ductive, long-lived public capital goods (munitions for national defense or
indispensable infrastructure. It isn’t wise to run perpetual surpluses or build
reserves in advance; they’ll be dissipated by myopic and opportunistic poli-
ticians. Habitual resort to debt in ordinary circumstances isn’t just foolish,
according to Lutz: it is “suicidal for a government to create permanent or
long-term debts for the payment of current expenses” (ibid., p. 539). Beyond
emergencies and productive public goods “we have no valid basis on which
to rationalize the existing public debt as beneficent.” On the contrary,

high public debt “should be recognized as a serious problem,” so “instead
of adding to it, even for such purposes of such primary importance as
the relief of unemployment, we should plan to deal with this and other
problems in ways that will avoid further debt increase” (p. 703).
Unlike classical theorists, Lutz doesn’t downplay or deny the fact
that legitimate public goods are a prerequisite of sustainable national
prosperity; they don’t constitute new wealth per se, because they draw
on private savings that could be invested profitably otherwise, but it’s
acceptable to borrow to pay private industry to build them. “The argument
in favor of borrowing for [public] capital outlays has certain validity,” even
though “the heavier taxes required to pay the interest and sinking fund
charges are a certainty, while the gains which the taxpayers as a whole may
realize” from public goods “are rather uncertain” (p. 540). As to public
borrowing “for projects and activities that are of general social advantage,
but which do not afford any opportunity for a direct financial return” –
highways, education, sanitation, recreation, and public philanthropy – “no
categorical answer can be given” (p. 539). But “in considering the appro-
priate use of public credit, it does not mean a direct creation of wealth.”
Indeed, “the effect of assembling a considerable aggregate of purchasing
power under government control by means of a public loan may be ben-
eficial or otherwise.” Validity depends on purpose – on what things loan
proceeds are spent. “If the expenditure of the government loan results
in a diversion of commodities and labor into wasteful and unproductive
uses, there can be no addition thereby to the community capital, but rather
a loss of wealth and productive power.” If proceeds go to “acquiring
capital goods for the operation of some commercial enterprise, there may
be an equivalent to the capital creation which might have occurred had
the funds remained in private hands.” Deficit spending on public works
and public buildings might be “socially advantageous and productive,”
yet might “yield no return on the outlay.” This might “contribute to the
stock of social wealth, and within limits, sufficient social advantage may be
realized,” but “whether the public loan increases the community’s wealth or
not depends entirely on the way in which the proceeds are spent” (p. 536).
The supposed analogy between private debtors and public debtors, Lutz
believes (unlike Keynesians), is valid; this puts him in legion with classical
and public choice theorists, who are debt pessimists. “Public and private
credit are alike,” he insists, “in that they both depend upon the resources
of the debtor, the promptness and certainty with which obligations are
discharged, and a reputation that is free from any taint or suspicion of
default, intentional or otherwise.” Indeed, “all credit is a mortgage or
lien against future income, and its outstanding amount must be kept
in such relation to that future income as to assure repayment without

undue impairment of the capacity to meet the ordinary requirements
of the future. Over-borrowing against future income means perpetual
indebtedness and eventual bankruptcy” (pp. 530–31). “At all these points,”
he continues, “there is a strong resemblance between the public and private
economy. Neither the government nor the individual can spend more than
[what] has come in, and the appearance of a deficit in either case compels
resort to other devices for making ends meet. The possible choices for
balancing income and outgo are much the same for the government and
the individual” (p. 532). Traditionally, means for curbing deficit spending
are few, well known, and akin to those used by households: curtail funds
outgoing and boost funds incoming. At root, says Lutz, “the principles
underlying government credit are not different from those that apply gen-
erally. The similarities and contrasts. . .between the state and the individual
as debtors do not reveal any important differences between public and
private borrowing. In both cases the credit rating will depend on much the
same factors” (p. 534) – character, capacity, and capital. “In the case of
a government, character means the sense of honorable o bligation on the
part of the whole people with respect to meeting the terms of the contract,”
and “only states of high character are willing to pay.” Ability to pay is the
primary, of course, yet there must also be willingness. “Governments of
high character and integrity are also not myopic; they plan ahead and
make sure they do not put themselves in a position of being perfectly
willing to pay, yet unable to do so in fact” (pp. 535–6).
Despite sharing this interpretation with public debt pessimists, Lutz
remains a realist, for he incorporates a broader context than do they.
Some factors mitigate public debt burdens. For example, his context (in
1947) is the gold standard, under which it isn’t thought possible (or valid)
to erode public debt by inflation; in this regard the state is no more able
than the household to resort to counterfeiting to reduce debt burden.
Lutz also pushes against both Keynesians (who deny the public-private
analogy) and classical writers (who presume it); he finds “a crucial differ-
ence that makes the private-public analogy entirely inapplicable,” for unlike
private loans, public loans aren’t legally enforceable, given the principle of
sovereign immunity. A state operates bankruptcy courts but isn’t subject
to them. Thus “those who lend to sovereign governments are helpless
when it comes to collecting their loan unless the government is willing
to pay, for they cannot use force, nor may they even sue in the courts to
establish a judgment without the government’s consent.” Reputation is all
the more important. “The record that a government has established with
respect to past debt obligations becomes a significant index of the national
character” and this “is not a fixed quantum.” Antipathy towards lenders
erodes a nation’s credibility – and credit. “Every broken debt promise,

whether in major or minor details of the contract, reflects the underlying
popular attitude toward the debt obligation.” But ideas (and credit) also
can improve. “Nations with poor debt records may improve, and those
with good records may deteriorate. The attitude of one generation is not
necessarily that of another” (p. 535).
In the public realm, Lutz notes, the equivalent of private collateral is
“the resources of the state, which are, ultimately, the wealth and taxable
capacity of the people” (p. 534). Yet he frowns on states that spend and
borrow recklessly, as households can’t; such states are goaded into it by
“the modern public debt cult, with its teaching that public credit is an
instrument of policy, and that the obligation incurred may be kept or
disregarded according to the dictates of some broader aspects of policy.”
This false teaching “is responsible for the view that national debt is mys-
teriously different from the debt of private individuals or corporations”
(pp. 702–3). Yes, some defenders of perpetual public debt say it’s safer in
ways that private debt is not because “the state is eternal,” so “the lender
need not, therefore, have the same hesitancy about an indefinite loan to the
state,” but leveraged states should realize “the folly of relying on the course
of [currency] depreciation or upon the progressive increase of the national
wealth, as the means of lightening the burden of the public debt” (p. 555).
Perpetual debt build-ups, he fears, entice sovereigns to debase money and
spread economic ruin.
As to the effects of public debt, what Lutz calls its “mechanistic
aspects,” there results “the creation of a certain volume of assets for the
financial community, since the government’s debt obligations constitute
assets in the hands of its creditors,” and since “the process is also likely
to involve [a] close relationship between the Treasury and the banks,” it
also “touches at many points the problem of banking and credit policy.”
There’s a close link between credit and money: “public debt obligations
may be used to elicit or support credit and currency circulating media, or
issued in a form designed to circulate as money, with legal tender power to
liquidate private as well as public debts.” Lutz laments how publicly bor-
rowed funds “are drawn from the income or savings (past income) of the
people,” which is a “diversion of purchasing power,” and how funds are
also “created by manipulating the credit resources of the banking system,”
which is a “net increase in purchasing power.” He’s not sure if they offset,
but in principle he thinks that “non-inflationary [public] borrowing is the
wiser and safer general rule” (pp. 621–2). Credit expansions can help an
economy, but private credit aids production in ways public credit can’t.
“The most beneficial results are realized when the credit expansion is
generated by the private economic forces.” Unfortunately, unrestrained
sovereigns often undertake inflationary borrowing (from banks) because

it’s easier and cheaper than trenching directly on private savings. Private
credit expansions, in contrast, pay their own way, for “the private demand
for loan accommodation is the pace of private business.” In contrast, the
“force that creates the government demand is an unbalanced budget,” and
“there is a steady credit expansion with no possibility of self-liquidation or
contraction” (p. 626).
In his chapter defending the principle of budget balance over the length
of a cycle, Lutz wants to “challenge the concept of the [public] debt as
a beneficent element in the economy” (p. 697). Unemployment should
be cured by price adjustment (lower wage rates) at the sector level and
“government’s budget policy has no relation to this task.” Moreover,

“budgetary deficits do not really provide employment”; they are only
“a method of providing relief.” For Lutz “the doctrines that have been
recently popularized relative to the role of fiscal policy have been detri-
mental, both to a proper understanding of the central problem [of mass
unemployment] and to the formation of correct measures” (p. 698).
Equally unsupportable is Hansen’s claim that “public debt is beneficial
because it supplies a backlog of safe, highly liquid investment paper for
financial institutions” and “an element of security to those with sizeable
fortunes.” If such benefit exists, it hardly requires a public debt that grows
faster than other financial assets; at most it warrants moderate debt. “With
a huge debt there would be a far greater likelihood of severe price changes
in the event that holders of substantial amount sought to liquidate,” and
besides, “liquidity achieved by the support of the central banks and the
Treasury is artificial and precarious.” In truth, “a huge [public] debt, by its
very size, is a menace to its own safety and security. These attributes rest
on the productive capacity and energy of the people, since the government
cannot, by an economic legerdemain, support the value of its own debt.
Even the open-market operations by which an effort might be made to
prevent serious price decline [i.e., yield increase] involve further juggling
with credit resources, or with the creation of fiat currency. A huge debt
will always present, also, the prospect of efforts to lighten the debt load by
further currency devaluation” (p. 699).
Lutz dismisses as mere “rationalization” the claim that public debt
“will contribute to an expanding economy and to the attainment of
full employment,” for “this position requires a more or less continuous
increase of the debt, which obviously involves no effort at redemption.”
There is no “supposed advantage of an expanding debt” (p. 700). In 1947
Lutz is outnumbered by acolytes of what he calls “alien fiscal doctrines”
(from Keynesians), who extol an alleged power of deficits to stimulate
the real economy; on the contrary, “ordinary economic logic suggests
that budget balance would be a wholesome and stimulating influence,

particularly under the prospects which now confront the nation r egarding
the volume of debt and of debt service to be carried. The balanced budget
would be an assurance against further inflationary policies and pressures,”
“against such doubts as might otherwise develop regarding the future
value of the debt and currency,” and “against the threat of extensive
government competition with private enterprise through the making of
so-called ‘investments’ or otherwise” (p. 689).
What of maintaining budget balance even during a depression? Lutz says
balance won’t prolong it, nor hinder recovery if it’s attained by “transferring
income or purchasing power from the citizens to the g overnment with little
or no net effect upon the aggregate” (p. 685). In depression it’s difficult
(and unwise) to cut public outlays as fast as national income falls, so he
advises higher excise taxes (albeit not higher income taxes, as proved so
disastrous in the United States in 1932). Lutz rightly fears that “the taxes
required for budgetary purposes would absorb a larger share of income
in a depression” (p. 686) and that such “encroachments on incentives may
become serious,” indeed “impair the standard of living.” Yet if public
outlays can be cut to better match lower revenues, it prevents “a net inroad
on purchasing power by reason of taxes” (ibid.).
In his chapter, “Debt, Taxation and Functional Finance,” in Guideposts
to a Free Economy (1945), Lutz likens Lerner’s “functional finance” and
plan to “boost the national income” to a scheme to “lift ourselves by the
bootstraps” – an impossibility (p. 114). “From whom will g overnment
borrow” when it’s overleveraged, he asks, and having taxed the economy to
its capacity, turns in desperation to monetizing its debt and inflation? “As
long as the public is willing to lend, it is said [by Lerner and the Keynesians]
to make no difference how many zeros are added to the national debt,” for
“if the public loses its taste for lending to the government its money, the
government, it is said, can print the money to pay the interest and other
public obligations. It is evidently assumed that the people will gladly
accept this printing press money. But suppose they will not? Will they be
forced to take it? And at what value?” (p. 126). In truth, he says, “phony
printing-press money” is “simply another form of the forced loan,” and
Lerner’s “bootstrap levitation” an “abuse of public credit” (p. 128).
Keynes, like Lutz, knew of inflation’s power to redistribute wealth and
make overindebted nations seem prosperous when they weren’t, while “not
one man in a million” could tell the difference (Keynes, 1920); but Keynes,
unlike Lutz, endorsed the ruse.
As to the burdens of public debt, Lutz believes they’re formidable
only in unique circumstances and as overemphasized by detractors as
underemphasized by fans. Here again, he’s Hamiltonian. Citing an essay by
the optimist Hansen (1942), to the effect that an internally held public debt
is no net burden to society, because the interest paid by taxpayers equals
that received by bondholders, Lutz says it “correctly describes the transfer
character of taxing and spending,” for it’s a plain fact that “the money goes
in and comes out,” but Hansen wrongly infers “that the size of the debt, and
therefore the size of the transfer payments for debt service, are of no con-
sequence, which means the debt itself may as well be a large one as a small
one.” This overlooks the fact that greater debt and higher interest expense
increase taxpayer burdens and “if the taxes for debt service, or for other
purposes, become heavy enough to impair the incentives of those who must
pay them, production, employment, and income are adversely affected” and
this is “by no means offset by the fact that other members of the community
are receiving the funds paid out as interest” (Lutz, 1947, p. 700). Elsewhere
Lutz (1945, p. 119) denies that “the debt is no burden since we owe it to
ourselves,” for current taxpayers suffer from it more than bondholders
benefit by it. The analysis goes awry under the veil of aggregation; for Lutz
“the unity of our common social interest does not go that far.”
By this account, a fundamental and deleterious transformation in public
finance occurred during World War I, long before Keynes became influ-
ential. “The [US] federal debt situation as of June 30, 1914, on the eve of
the first World War, was very favorable” because “the total interest-bearing
debt was relatively small, the interest rate was moderate, and the maturities
offered no difficulties for the future” (Lutz, 1947, p. 566). Then “the trans-
formation in the [US] federal debt situation between 1914 and 1919 was
great enough to shock anyone who could appreciate the essentials of sound
financial policy.” By 1920 US interest expense alone exceeded the principal
it owed in 1914 (p. 568). Yet US public debt was radically reduced in the
1920s, along with federal tax rates and spending; as the economy boomed
amid budget surpluses no top economist dared claim deficit spending was
a “stimulant.” Lutz’s initial critique of 1930s’ deficit spending appeared
in the Harvard Business Review in 1938; there he urges policymakers to
admit that higher taxes and public debts alike can impede recovery, that in
the United States the “[federal] loan policy would retard recovery fully as
much as more taxation would have done” (Lutz, 1938, p. 129), even amid
underemployment and “excessive” savings. The real burden of government
is its spending, regardless of how it’s financed (as per Ricardo); the burden
can’t be mitigated by low capacity utilization. Public spending should have
been restrained in the 1930s, with greater reliance on tax finance (but not
higher tax rates), and more flexible wage rates to clear the market and
avoid mass joblessness (Lutz, 1947, p. 686). Instead, spending, taxes and
debt all skyrocketed, while wage rates remained elevated (with official US
encouragement), which made things far worse than they had to be.
In sum, Lutz believes the US debt incurred between 1930 and 1938
(which more than doubled to $37 billion) “has not been entirely a clear
gain” because of the implicit tax burden it imposes; interest payments flow
to some pockets (public bondholders) but a deadweight resulted. Much of
the newly issued public debt was sold to banks instead of individuals, amid
depressed demand for private credit, which artificially reduced bond yields;
when yields eventually rise bond prices will plummet and the refunding
of maturing principal will necessitate paying higher, less unaffordable
interest rates. Lutz could be describing the United States in 2015 when
he writes (in 1938) that “the government has become committed to the
maintenance of easy money, low interest rates, and low investment yield,
and to the manipulation of the market in order to preserve this status” and
to “a singularly inconsistent policy with respect to banking reserves and
the credit inflation which excess reserves tend to encourage” (Lutz, 1938,
p. 134). Deficit spending and money creation yield a permanently bloated
sovereign:
[Public] credit inflation is so easy, so painless for all, and it produces such a
soothing sense of unlimited financial resources, that it has lulled all but the
very few into a false sense of security. One of the worst results of the manner in
which the depression requirements have been financed is the permanent effect
of this policy on the level of public expenditures. The history of the federal
finances reveals that after every great emergency expansion, it has been impos-
sible ever to reduce the total expenditure to anything like the earlier amount.
Heretofore, war has been the chief national emergency. . .[but now] the lavish
depression spending has had the same effect. When the large deficit was decided
upon, everyone supposed that it would be but temporary. . . Only a few real-
ized that a temporary expansion of this magnitude would leave its permanent
mark. In 2000 A.D. American taxpayers will still be feeling the effects of the
“temporary” spending policy that was adopted in the 1930s. (Lutz, 1938, p. 136)
Lutz makes the novel claim that deficit spending facilitates excessive public
spending, not only the reverse. The result may be a debt spiral, with exces-
sive spending causing deficits, but cheap finance exerting no pressure to
curb outlays, so deficit spending intensifies. This is exactly the pattern
experienced by Japan since 1990.
Lutz, we’ve seen, is respectful of the rentier class, but also knows public
prejudice is otherwise; he thinks it relevant to sustainability, for public
debt embodies “conflicts of group interest and prejudices so serious as to
increase the difficulty of appraising correctly the national or community
integrity” (Lutz, 1947, p. 535). At times the public creditor is understood
as “a progressive citizen and a great patriot,” but other times detested as “a
grasping money lender,” “a Shylock,” or “obstructer of progress” (ibid.).
More likely the creditor-patriot than the devil-patriot will receive empathy
(and due recompense). “Always, when the time for payment comes, the
investor [in public bonds] can be put in the wrong by being classed with
the money changers,” and although most people prize promise-keeping
and the sanctity of contract, it’s rarely so with “the economic conflict
represented by the public debtor-creditor relation,” where “deep-seated
prejudices are very easily aroused, and the appeal to this prejudice is a
sure fire demagogic trick.” Conflict is likely “when there is some doubt
about the underlying justification for the loan,” for “if borrowing has been
undertaken without a first-rate case for it, the fanning of class prejudices is
a good way to shift the blame” (ibid.). Lutz is aware of the sordid history
of popular hatred for the money-lender and (thanks to Keynes) profes-
sional disdain for the “rentier,” but, while conceding it garners votes in a
democracy he rejects such hatred. Abuse of creditors abuses public credit.
For some optimists an expanding public debt isn’t a burden if interest
expense remains a steady proportion of national income. Lutz argues oth-
erwise. First, there’s no guarantee that GDP will keep rising sufficiently, yet
debt load is fixed. Second, interest rates might not remain low (2 percent
at the time), especially given rising inflation. Third, loan proceeds might
be spent on non-remunerative transfers instead of long-lived capital goods
yielding future income; the former, unlike the latter, render public debt
less sustainable. Even if loan proceeds are invested in productive public
infrastructure, bond maturity dates shouldn’t surpass the lifespan of assets
created (Lutz, 1947, pp. 700–702).
As to the limits of public debt, we’ve seen Lutz argue that “public credit
is not indefinitely expansible, nor is it a boundless reservoir that may be
drawn upon indefinitely without replenishment” (p. 556). Public borrow-
ing capacity (credit) can dissipate swiftly if not cultivated and established
far above outstanding debts:
[The] community that has adopted the loan method of financing all of its
permanent improvement projects will find that in time it has about used up its
available credit resources. Such a community is thus placed at a distinct and pos-
sibly a very serious disadvantage whenever a genuine emergency does appear.
Public credit is not an unlimited resource. Rather, it is a limited resource the
supply of which should be conserved in the main for those circumstances and
requirements which cannot be fitted readily into the normal scheme of current
expenditures and revenues. If it is used for defraying costs that should really
be met out of current revenues, there will be no reserve protection against real
emergencies. Since it is probably more costly to finance needed improvements in
this way, a community that yields to the temptation to do so is inclined, without
realizing it, to live beyond its means. (Lutz, 1947, p. 541)
Lutz is careful to distinguish public credit and public debt: the former
pertains to a sovereign’s capacity to borrow, the latter to its actual
borrowing. Whereas public debt is (usually) known and explicit, public

credit is uncertain and ephemeral. The differential constitutes unused
borrowing capacity. Like the classical economists before him and public
choice economists after him (but unlike the Keynesians in his midst) Lutz
believes public credit (hence debt) has a limit; it depends on an economy’s
finite taxable capacity. “The normal long-run test of the ability to support
[public] debt is the amount of public income that is available for the debt
service over and above the requirements of the debtor unit for ordinary
current expenditure,” and “naturally, this surplus of revenue is a variable
quantity,” for “it depends on the taxable resources and on the willingness
of the people to endure the taxes that may be required.” His contextual
assessment of debt capacity again marks him as a realist. Beyond the
metrics of debt capacity, market confidence and expectations are crucial;
a sovereign’s debt service capacity has “both economic and psychological”
aspects (p. 542). In many ways states will try to dispense with an unwanted
debt burden; purely autocratic and purely democratic regimes especially,
neither of them subject to constitutional limits, for mere expediency will
engage in predation, exploitation, and confiscation, resorting to moneti-
zation, inflation, repudiation, and repression. Such punitive policies have
both academic and official support. “So much has happened in recent
years,” he observes, that completely overthrows “accepted notions regard-
ing the proper attitude of governments toward their debt obligations as
to cast doubt upon the validity of some of the old canons.” In fact, in the
1930s “some nations went cheerfully in default with respect to part or all
of their public debt.” The Great Depression, he fears, marked the start of
a troubling, possibly irreversible moral laxity about credit standards and
practices (p. 543).
Might public debt ever become perpetual, constantly rising, forever
unpaid (on net), yet still safe? No, Lutz says. “The use of credit implies
the creation of an obligation to repay or return something of value in the
future,” so a loan is “an incomplete transaction until the debt is repaid.”
Although “it may seem superfluous to raise the question whether public
debts should be redeemed,” nonetheless “it is reasonably correct to say
that there is not much intention on the part of a country with large
amounts of perpetual debt to redeem it.” Yet “public debt should be
redeemed sometime.” With perpetual public debt “the annual burden
of the debt is less, since there is no necessity of including sinking fund
or amortization charges,” so “it’s easier for a nation to carry a heavier
load of debt in this form than would be otherwise possible.” But per-
petual debt can grow burdensome over time, due to what Lutz calls “debt
pyramiding,” avoidable only by periodic principal redemptions, especially
in peacetime:
While it is always advantageous that the national debt be redeemed as soon as

possible, its refunding is less serious in that there is no approaching obligation to
replace wasting tangible assets by borrowing again. Such loss or wastage as may
have occurred in the case of federal borrowing happened once for all as the imme-
diate war or depression expenses were paid. Aside from the question of aggregate
cost, the main argument against undue delay in redeeming the federal debt is the
possibility that another serious emergency may appear before the debt created to
finance the last one has been redeemed. National debt pyramiding from one great
emergency to the next is foolish and dangerous. (Lutz, 1947, p. 554)
How best to close budget gaps to ensure debt sustainability? On occa-

sion deficits are better narrowed by tax hikes than spending cuts. Citizens
in a democracy, he thinks, should feel the real cost of the government they
elect; they should be under no illusion about what they’ve chosen and what
it costs. The tax burden should be broadly felt, not narrowly (thus unjustly)
imposed. If so, the public debtor might finally act like a private one –
responsibly. “[T]he regular appearance of a deficit,” he argues, “is the
signal for revision of the revenue system.” Individuals can’t easily increase
their income to meet high debts, but states can do so “through the exer-
cise of the sovereign power of taxation,” although it’s possible “the tax
burden is already so great as to make further heavy increases inadvisable”
(ibid., pp. 533–4). If so it must borrow, but “the presentation of the request
for funds” must be “on strictly business principles,” for “the greatest success
in making loans will be achieved by those governments which present
terms that are attractive to the investors.” The just and fiscally responsible
state must know that when it borrows it is “competing with private indus-
try for a share of the available surplus funds of the c ommunity,” so it must
appeal to “the economic self-interest of the savers who are to provide the
funds” (p. 551). Public creditors should be well treated.
As to the usual means by which excessive public debt is (or should be)
handled, Lutz places spending restraint before tax hiking, and contrary to
most Keynesians, doubts that more deficit spending can so stimulate an
economy that its growth outpaces growth in debt. If public spending isn’t
restrained, taxes should be raised before new loans are sought. “The objec-
tion that the taxes required for this purpose are merely an added burden
is not valid,” he argues. “Taxes are always a burden and their imposition
for debt repayment will never be a painless operation.” Net debt reduc-
tion, not debt perpetuation, should be the goal. “Redemption of debt is
the surest means of improving the public credit, and some policy looking
to this end is a fundamental feature of every sound financial system.” The
optimists are wrong, for “the advantage of a perpetual debt is illusory,
since it leads gradually to an aggregate principal which cannot be redeemed
and which, therefore, is truly a perpetual burden” (p. 556).
Above all, Lutz condemns deliberate debt repudiations or defaults,

whether explicit or implicit (by inflation). “An undesirable and disagree-
able option is default, and a still more disagreeable one is repudiation.”
These are, he says, “measures of desperation” and “the honorable alter-
native, for the public as for the private debtor who is unable to pay at
maturity, is to seek an extension of the loan. In public financing such an
extension of a matured debt is called refunding. Another procedure that
involves changes of debt terms is conversion. The two are not identical”
(p. 563). “Conversion means an adjustment in the burden of the interest
on debt by some process of substitution” (p. 564). “Default is not repudia-
tion, for it involves in no way the essential terms, but only the capacity of
the debtor, which is a matter not always within his control.” Repudiation
ordinarily isn’t an option for non-sovereign debtors; those attempting it
face lawsuits compelling contract compliance. “Sovereigns cannot be sued
without their consent, and when any manner of debt repudiation is deter-
mined upon, steps are taken to withhold, or to withdraw, such consent”
(p. 590). Where legal recourse is impossible, moral commitment is essen-
tial. “The national government is endowed with sovereign powers, and the
validity of its debt obligation as a contract rests on the sovereign’s goodwill
and beneficent intentions toward the creditors. Should such a government
decide to repudiate its debt there is no protection and no recourse for the
creditors” (pp. 607–8). “From the welter of default and repudiation in the
history of public debt” it’s clear that for any state “it is useless to pledge or
to specify any particular kind or medium of debt payment (such as gold
coin),” because the best assurance is a “pledge of the full faith and credit
of the borrowing government.” After two World Wars and a depression
(1914–45), “governmental obligations are, essentially, as speculative as any
other type of investment security” (p. 543).
Lutz is aware also that the overindebted sovereign is tempted to have
its central bank monetize its debt, which is all the more possible without a
gold standard. The policy is an admission of failure: that the bonds can’t
be fully sold at affordable rates to willing investors in an open market. By
monetization, public debts are bought directly by the central bank and in
concert with private banks; it is but money printed (or digitized) ex nihilo.
By 2015 this once desperate measure was seen as mere orthodoxy; in
1947 Lutz could write of how “it has been proposed at various times that
the Treasury Department be authorized to sell [its] bonds directly to the
Federal Reserve banks,” and how the policy “should never be adopted,”
because “these banks are under fairly complete government influence, even
domination,” so “they are in no position, therefore, to act independently,
whether as critic of the contemplated fiscal action or in other ways.” Lutz
prefers that the Federal Reserve “buy government bonds in the open
market, as anyone is free to do,” not directly from the Treasury, via mon-
etization (p. 552). To be exact then, he doesn’t oppose all m onetization,
only direct monetization. But at least he acknowledges that fiscal d
ynamics
affect monetary dynamics. Monetized public debts can boost inflation
and large debts alone boost inflationary expectations. If “the [public]
debt increase is pushed far enough, the ensuing price inflation may attain
proportions that would be tantamount to complete worthlessness of the
existing currency, and likewise, of all obligations, public or private, that
were payable in such currency” (p. 629). Currency depreciation is “a device
for lightening the [public debt] burden,” and although “complete destruc-
tion of debt through ruinous inflation” is rare, partial erosion by inflation
is common. There’s “a long and disreputable record” of currency debase-
ment “inaugurated [by sovereigns] for the primary purpose of repudiating
a part of the public debt” (p. 630). Tax payers and sovereigns alike gain
at the expense of creditors. Were money stable, as under a gold standard,
Lutz says, deflations and inflations could be avoided and creditor-debtor
relations made secure.
Although politically expedient, Lutz believes sovereign reliance on a
central bank undermines public credit because it jeopardizes operational
autonomy in each realm. The fiscal authority effectively compels the
monetary authority to facilitate its profligacy, which discredits the money
issued by the central bank and disorders the private sector. “Sound finance
requires that each member of this close affiliation [between Treasury and
banks] should be independent of the other. Those who advocate govern-
ment ownership and monopoly of all banking and credit institutions and
facilities overlook or disregard the importance of providing adequate
checks and balances.” If banks become a mere branch of the finance
ministry, the system is compromised. “A government monopoly of banking
under treasury control would eliminate all chance of an i ndependent check
on treasury credit policy. The temptation for treasury manipulation of
credit would be irresistible, and it would never be possible for anyone to
know whether this manipulation was primarily inspired by the exigencies
of government financing or by the requirements of the business s ituation.”
Lutz wants a non-political financial system, even while recognizing the
trend in the twentieth century is towards more, not less politicization.
“Instead of creating a government monopoly of credit, the Federal
Reserve Bank system should be completely free of government influence,
so far as concerns policy” (p. 627). Here he foreshadows the debate about
central bank independence – by now (2015) a thing of the past.
The overindebted state also induces or compels the buying and holding
of its bonds to ensure demand and a lower interest rate; it’s a “forced
loan” in Lutz’s time, but now dubbed “financial repression.” For Lutz “the
compulsory loan is a method of taking private wealth for public purposes”

and although “nominally it differs from taxation in that the state under-
takes to repay the amount contributed,” an important form of it, “the
inconvertible legal tender demand note” is likely to be issued in such excess
as to “culminate finally in the utter worthlessness of the promise to pay”
(p. 550):
The provision of credit support by the use of force or compulsion cannot be

condemned too severely. It means an unjust and inequitable distribution of the
cost of government, since the creditors have no choice but to submit to terms in
the determination of which they have had neither voice nor influence. If paper
money is used, there is the additional danger of over-issue, with the resultant
inflation of prices and serious dislocation of economic interests. Once a govern-
ment has started on this slippery downward path there is the greatest difficulty
in avoiding complete financial collapse. . . Compulsion, moreover, deprives the
borrowing operation of all vestiges of a contract transaction and, indeed, of a
credit transaction. It is fundamentally inconsistent to speak of a compulsory
loan, since the basis of any credit transaction is confidence, and confidence
flies out the window as force comes in at the door. The process is really one of
commandeering private wealth for public purposes, and its real nature is not
disguised by being clothed in the form of the loan. (Lutz, 1947, pp. 550–51)
As a Hamiltonian, Lutz believes government should secure and protect

contracts, even when it benefits the unpopular rentier. The forced loan vio-
lates financial freedom. Just as public debt finance entails an illusion when
the full burden of public spending is disguised and less felt by voters than
were they fully taxed, so compulsory public debt finance and artificially low
interest rates disguise the true costs of the public borrowing.
Beyond repudiation, monetization, and repression, the overindebted
sovereign can resort to implicit default by inflation. The tactic is common
in wartime, not least because that’s typically when the gold standard is
suspended or abridged. The state nominally “pays” its debts, but in fast-
depreciating paper money, and for Lutz (as for Adam Smith), it’s but
a “pretended” repayment, a (barely) disguised default. “Obviously, the
way to escape even the taxes [required to pay] interest would be to force
the banks to accept non-interest-bearing government bonds,” he notes,
but “a still simpler way would be to compel the people to accept non-
interest-bearing government notes or promises to pay,” that is, purely
“fiat” (mandated) money. “The inflationary effects of bonds stuffed into
the banks is no different from the effects of using greenbacks” (p. 531).
Unlike a private debtor, a public creditor “is not so restricted in the
exercise of the taxing power, except by the subjective resistance of the
people,” and even when “there is strong opposition to taxation for debt
payment, such a g overnment has another alternative, in its control over
the currency. A cheapening of the currency standard makes debt payment

easier. While this is a partial repudiation, the government that engages in
the practice usually faces a more disagreeable alternative if it attempts to
collect taxes in sufficient volume to pay the debt on the standard by which
it was contracted” (p. 543). He believes that Keynesians endorse the policy
precisely because it’s a hidden tax.
Lutz also understands the reverse causation: how excessive public
debt can undermine money’s real value and cause price inflation. “Public
debt operations influence the volume of currency, and hence its value or
purchasing power” (p. 628), especially when monetized. Lutz holds to a
classical view of inflation – that it’s solely a monetary phenomenon – but
unlike quantity theorists he stresses the quality of money. A currency best
holds its real value (purchasing power) when freely redeemable in a fixed
weight of gold, namely under the classical gold standard. “The value of the
currency, or its purchasing power in terms of goods tends to be affected
by the relative supply of purchasing power and of goods,” but additionally,
“large-scale public borrowing is virtually certain to involve, directly or indi-
rectly, an expansion of bank credit,” and precisely this kind of (sovereign)
“credit expansion is an inflationary force” (p. 62). World War II involved
massive new public borrowing; fearing a yield spike, the Federal Reserve
agreed with Treasury to adopt a bond-buying scheme to keep bond prices
up and yields below 3 percent; once ended, yields skyrocketed.3 Similarly,
price controls kept retail inflation at 5 percent a year during 1942–45; once
lifted, inflation hit 20 percent (1946–47).
Just as Di Viti De Marco’s insights are a fascinating precursor to sub-
sequent public choice insights, so also are Lutz’s. Each is in the classical
economic (and classical liberal) tradition, but they include more on the
morals and political economy of the case, as do public choice scholars.
Two other theorists are relevant, in this regard, to public choice – Harold
Moulton and Ludwig von Mises – for they provide early, incisive critiques
of the Keynesians’ “new philosophy of public debt.”
Moulton (1883–1965), a professor of political economy at the University
of Chicago for many years and first president of the Brookings Institution,
made waves in Keynesian circles with the publication of The New
Philosophy of Public Debt (1943). He indicted unlimited deficit spending
and debt build-ups of the kind pushed by Lerner (“functional finance”)
and Hansen (the “American Keynes” who feared “secular stagnation” and
counseled perpetual debt creation). Keynes was still alive at the time and
pleased to see Moulton’s monograph critiqued by Wright (1943), who
earlier said an internally held public debt might be a burden (Wright,
1940) while dismissing the claim, in Gilbert et al. (1938), that it could
rise indefinitely without harm. Wright was a debt realist. “The mode
of thought,” he argued, which equates public and private borrowing is

“clearly inadequate,” but it’s “equally unwarranted to go to the opposite
extreme and deny that an internally held debt can ever be a burden.” “The
burden has been enormously exaggerated, but it would be foolish to deny
that it does not exist” (Wright, 1940, pp. 117, 129).
Moulton’s critique is notable because it is more philosophical-political
than technical, as is the public choice approach. At a time when
Keynesianism was still new and for many economists (even acolytes of
Keynes) ambiguous, Moulton offers a sharp dichotomy, “two opposing
philosophies with respect to public finance in high government circles,”
“the traditional view” versus “the new conception” (Moulton, 1943, p. 1).
The first says “a continuously unbalanced budget and rapidly rising public
debt imperil the financial stability of the nation,” the second that “a huge
public debt is a national asset rather than a liability,” such that “continuous
deficit spending is essential to the economic prosperity of the nation”
and budget balance is relegated to “the category of obsolete economic
dogma” (ibid.). The new philosophy says “a rising debt has no adverse
consequences” and that “without a constantly increasing debt we cannot
hope to have full employment and prosperity” (p. 5).
Moulton favors the welfare state but not how the new philosophy of
debt veils and condones public profligacy. Although the United States
runs budget deficits from 1930 to 1943 and borrows an astonishing
54 percent of outlays, Moulton believes the “traditional” view still prevails
among policymakers. Pushers of the new view, he says, work mostly in
academia and at Franklin D. Roosevelt’s National Resources Planning
Board (NRPB); the NRPB was made part of the Executive Office of the
President in 1939, not long after issuing A Plan for Planning in 1934, “a
somewhat imaginative list of planning precedents in American history”
(Warken in Reagan, 1981; see also Smith, 1993; Reagan, 1999) The
NRPB, he says, hopes that “a substantial portion of the government’s
funds would permanently come from borrowing operations,” and if it
becomes “difficult or impossible for the government to borrow,” it should
adopt “the printing press method” (ibid.). Moulton trains his criticism on
Hansen, then an adviser to the NRPB and Federal Reserve; in an NRPB
pamphlet Hansen (1942) says “a public debt, internally held” “has none
of the essential earmarks of a private debt,” that public bonds are “an
instrument of public policy,” “a means to control the national income,”
and a tool “to regulate the d istribution of income.” Hansen’s 1941 book,
Fiscal Policy and Business Cycles, goes over the top, for Moulton, when
it claims that “public expenditures financed by a continually rising public
debt is essentially a conservative proposal” (Moulton, 1943, pp. 7–8;
emphasis added). In contrast, Moulton believes “a great and continuous
growth of the public debt imperils the financial stability of the nation
and undermines the very foundations of the economic system.” Perpetual
debt growth “must be viewed with deep apprehension,” he says (p. 11), but
is vague about the nature of the harm; rejecting Hansen’s “stagnation”
thesis, he denies that chronic deficit spending cures anything, but doesn’t
specify any outer limits for public debt. On the contrary, he claims “the
vast increase in public [wartime] expenditures [1941–43] has mopped up
unemployment and given us a great increase in production.” He opposes
only disproportionate reliance on borrowing. He favors deficit spending
amid “depression and readjustment,” doesn’t insist on budget balance each
year, and doesn’t say cut the debt; “it is only necessary that the debt be kept
under easy control,” “well within revenue possibilities” (pp. 50–52).
What can we make of Moulton’s advice that public debt be limited
by “revenue possibilities?” In 1944–45 US federal tax revenues were
22 percent of GDP but averaged just 17 percent of GDP in the subsequent
half-century. That’s a diminution of revenue possibilities. In a subsec-
tion of his 1943 monograph, titled “Limits to the Public Debt,” Moulton
derides Hansen for wanting public debt “kept within safe limits,” for ref-
erencing national income, types of taxation, and levels of state investment
and spending, and for suggesting “that the [public] debt [of the United
States] might safely be double the national income,” or 200 percent of GDP
(p. 66), on the grounds that Britain’s public leverage reached that high in
1818 and in 1923. He dismisses Hansen’s “alleged fact,” but in fact it was
factual: UK public leverage reached 261 percent in 1821 and 182 percent
in 1923, and although 157 percent in 1943, reached 238 percent by 1947
without default risk. Hansen was correct, not that public leverage had no
limit, but that it could reach heights far above what anyone was willing to
project. Evading the facts behind Hansen’s bold claim, Moulton can only
vaguely claim that “the safe limits of public debt cannot be gauged com-
paring the national income with the public debt alone” (p. 67). He avoids
objective metrics. The United States, he feels, will “drift toward the deep
financial waters from which there is no return other than through repu-
diation in one form or another” (p. 89). He fails to note the de facto US
default in 1933, by the 60 percent devaluation of the dollar and abrogation
of gold clauses in all debt contracts.
Moulton is a debt pessimist, but guilty of what he complains of in
Keynesian optimists: that they are “viewing the debt problem in isolation”
with analysis that “furnishes no guidance as to the safe limits of debt
expansion” (p. 67). At most he can only allude to “the basic fallacy in the
new philosophy of public expenditure and debt,” meaning “the argument
that all government expenditures, for whatever purpose, generate money
income” (p. 60). In the classical mode he suggests why it’s a dubious claim,
especially for spending on social transfers and jobless subsidies, and why it’s
not likely even for most debt-financed spending on public infrastructure.
To his credit (much like Lutz, but nothing like Keynes) Moulton warns
against anti-capitalist schemes of public finance. “With unlimited [public]
debt expansion,” he says, “we cannot prevent inflation without the use of
totalitarian methods of control” (p. 88), due to price edicts and rationing.
Keynes had declared, in the German edition of his General Theory (1936),
that “the theory of output as a whole, which the following book purports
to provide, is much more easily adapted to the conditions of a totalitar-
ian state,” than a free one. Moulton, in contrast, prefers a free state, but
glimpses that unrestrained democracy generates public profligacy. “The
apparently easy way [in public finance],” he laments, “is always the popular
way [politically]” (Moulton, 1943, p. 13). Indeed, “there is nothing in the
long history of public finance which indicates that any government, and
especially a democratic government, can be depended upon to apply
the brakes to credit expansion, when the proper moment has arrived”
(pp. 79–80).
Next comes Ludwig von Mises (1881–1973), a pro-capitalist but public
debt pessimist who in the late 1940s anticipates many public choice
themes well before their ascendency. Mises has numerous works opposing
Keynes’s ideas, deficit spending, and inflation (Mises, 1948) but he devotes
little attention to public debt. His earlier, more formidable studies on
money and credit (Mises, 1912, 1978) ignore public debt, likely because
the world had yet to witness its cascade during World War I and the
Great Depression. Yet Mises has insightful passages on public debt in his
magisterial work, Human Action (1949). His novel contention is that large
public debts redistribute wealth not so much from the present to the future
(intergenerationally) but presently, from hard-working taxpayers to idle
bondholders, which harms both liberty and prosperity. Government bor-
rowing competes unfairly for scarce pools of private saving because the
taxing power is a legalized, monopolistic command over resources, while
the borrowing power is presumed to be “risk free.” Worse, most public
spending is consumptive and even spending on public capital projects is
often dissipated by bureaucratic inefficiency. Public borrowing crowds out
private saving and investment, which impedes capital accumulation and
retards long-term economic growth. Public debts arise because the sover-
eign refuses to curtail spending or raise tax revenues; next it tries monetary
debasement (inflation) to lower debt burden by surreptitiously robbing
creditors. Mises’s account is classical yet anticipates the public choice
approach by assuming states are self-promoting Leviathans. Economists
should expect states to spend, tax, borrow, regulate, and inflate for pure
self-aggrandizement, not to promote the commonweal.
Mises minces no words in declaring that “long-term public and semi-

public credit is a foreign and disturbing element in the structure of a
market society” (Mises, 1949, p. 227) and that there’s “something basi-
cally vicious in all kinds of long-term government debts” (p. 540). The
“disturbing element” isn’t unfair cost shifting or unfair transfers of present
burdens to future generations but the displacement of private borrowing,
lending, investing, and entrepreneurial risk-taking. The root problem is a
philosophy of state worship; public debt facilitates the spread of tyranny
and the diminution of liberty. The deficit spending state is the “new deity
of the dawning age of statolatry,” an “eternal and superhuman institu-
tion beyond the reach of earthly frailties,” presenting its bonds to the
gullible citizen as “an opportunity to put his wealth in safety and to enjoy
a stable income secure against all vicissitudes.” Public debt has “opened
a way to free the individual from the necessity of risking and acquiring
his wealth and his income anew each day in the capitalist market,” for
“he who invested his funds in bonds issued by the government and its
subdivisions was no longer subject to the inescapable laws of the market.”
The false lure of public debt causes savers, who otherwise might fund
productive entrepreneurs, instead to lend to the state and thereby become
“safeguarded against the dangers of the competitive market in which
losses are the penalty of inefficiency” (p. 225). Public debt promotes a shift
from risk-taking and economic vibrancy to security and stagnation:
[T]he eternal state [took the creditor-investor] under its wing and guaranteed
him the undisturbed enjoyment of his funds. Henceforth his income no longer
stemmed from the process of supplying the wants of the consumers in the best
possible way, but from the taxes levied by the state apparatus of compulsion and
coercion. [The creditor-investor] was no longer a servant of his fellow citizens,
subject to their sovereignty; he was a partner of the government which ruled the
people and exacted tribute from them. What the government paid in interest
was less than what the market offered. But this difference was far outweighed
by the unquestionable solvency of the debtor, the state whose revenue did not
depend on satisfying the public, but on insisting on the payment of taxes. . .
[The creditor-investor], no longer prepared to risk his hard-earned wealth,
[comes to prefer] investment in [public debt] because [he wants] to be free from
the law of the market. (Mises, 1949, pp. 225–6)
For Mises the state is mainly a consumptive, redistributive entity pro-

ducing no net value; his is a classical view including its derision of public
bondholders, but whereas classical pessimists believe public debt mainly
harms laborers, the pessimistic Mises insists it mainly harms consumers.
“There is in the social system of the market economy,” he writes, “no other
means of acquiring wealth and of preserving it than successful service to
the consumers.” The state can’t render such service and regardless has no
wealth of its own to invest. The inherently unproductive public borrower

“is in a position to exact payments from its subjects and to borrow funds”
(ibid., p. 226), but it brings net burdens, not net benefits. “If the g overnment
uses the sums borrowed for investment in those lines in which they best
serve the wants of consumers, and if it succeeds in these entrepreneurial
activities in free and equal competition with all private e ntrepreneurs,” it
acts like a business and “can pay interest because it has made surpluses.”
If instead (and more typically) it “invests [borrowed] funds unsuccessfully
and no surplus results, or if it spends the money for current expenditures,
the capital borrowed shrinks or disappears entirely, and no source is
opened from which interest and principal could be paid” (ibid.). In this
case “taxing the people is the only method available for c omplying with
the articles of the credit contract.” A real burden ensues. “In asking taxes
for such payments [to service debt], the government makes the citizens
answerable for money squandered in the past,” for “the taxes paid are
not compensated by any present service rendered by the government’s
apparatus.” In effect, “the government pays interest on capital which has
been consumed and no longer exists,” so “the treasury is burdened with
the unfortunate results of past policies” (Mises, 1949, pp. 226–7). The truly
burdened are the taxpayers.
Although Mises insists public debt is burdensome only when its pro-
ceeds are spent consumptively, for ordinary expenses, or on public capital
projects with no value added, and although he suggests such spending
leaves a trailing burden of debt service on future taxpayers, he stresses that
current generations are the ones most burdened:
A good case can be made out for short-term government debts under special
conditions [as opposed to long-term, perpetual public debts]. Of course, the
popular justification of war loans is nonsensical. All the materials needed for
the conduct of a war must be provided by restriction of civilian consumption,
by using up a part of the capital available, and by working harder. The whole
burden of warring falls upon the living generation. The coming generations are
only affected to the extent to which, on account of the war expenditure, they
will inherit less from those now living than they would have if no war had been
fought. Financing a war through loans does not shift the burden to the sons and
grandson. It is merely a method of shifting the burden among the citizens [who
are currently living]. (Mises, 1949, p. 227)
Mises rejects what he calls the “most popular” doctrine of Keynesian

optimists: that “a public debt is no burden because we owe it to ourselves.”
In fact, “public debt embodies claims of people who have in the past
entrusted funds to the government against all those who are daily [and
presently] producing new wealth,” so it “burdens the producing strata for
the benefit of another part of the people.” If we truly owe it to ourselves
then “the wholesale obliteration of the public debt would be an innocuous

operation, a mere act of bookkeeping and accountancy” (ibid., p. 228). It
isn’t. A policy to obliterate public debt is ruinous precisely because public
debt is an asset (bond) to lenders of capital (itself an asset) – a mortgage on
taxpayers’ current income.
Mises believes public debt shifts net burdens to future generations only
when bond proceeds are spent on transfers instead of value-added public
infrastructure. In his example of an unfunded (pay- as-you-
go) social
security system, Paul saves $100 in 1940 and pays it into the system, in
return receiving a sovereign pledge (bond); the state then instantly spends
the $100 on ordinary outlays, instead of placing it in trust and investing
for a return. No new capital is formed, so to that extent no future income
source can arise. “The government’s IOU is a check drawn upon future
taxpayers,” says Mises, and by 1970 “a certain Peter may have to fulfill
the government’s promise, although he himself does not derive any benefit
from the fact that Paul in 1940 saved $100.” The scheme forwards a net
burden to posterity. “The trumpery argument that the public debt is no
burden because ‘we owe it to ourselves’ is delusive.” He elaborates:
[The] Pauls of 1940 do not owe it to themselves. It is the Peters of 1970 who owe
it to the Pauls of 1940. The whole system is the acme of the short-run principle.
The statesmen of 1940 solve their problems by shifting them to the statesmen of
1970. On that date the statesman of 1940 will be dead or elder statesmen glory-
ing in their wonderful achievement, social security. The Santa Claus fables of
the welfare school are characterized by their complete failure to grasp capital
[and their] implicit assumption that there is an abundant supply of capital
goods. (Mises, 1949, pp. 847–8)
Reflecting the classical position, Mises insists that “it is additional capital
accumulation alone that brings about technological improvement, rising
wage rates, and a higher standard of living,” and unfortunately “history
does not provide an example of capital accumulation brought about by
government” (ibid., p. 851). His analysis, striking at Keynesian plans for
a vast “socialization of investment,” foreshadows studies (by Harvard’s
Martin Feldstein, and others) of unfunded social insurance schemes and
how they erode a nation’s capacity to save, invest, boost productivity, and
prosper.
Mises’s political economy attributes degenerate public finance to the
electoral myopia inherent in populist democracies, for under “democratic
government, the problem of capital preservation and accumulation of
additional capital becomes the main issue of political antagonism. There
will be demagogues to contend that more could be dedicated to current
consumption” and “the various [political] parties will outbid one another
in promising the voters more government spending and at the same time
a reduction of all taxes which do not excessively burden the rich” (p. 849).
Over the following decades Keynesians and Democrats would enact more
spending but not more tax revenues, while supply-siders and Republicans
would enact more tax-rate cuts but not spending cuts; the logical result –
wider deficits and rising debts – reflected not so much partisan bickering
but bipartisan pandering. Yet Mises doesn’t blame democracy per se; in
1949 it wasn’t yet so unconstrained; instead he blames false economic ideas
and statist ideologies, and in this respect he lies outside the usual public
choice perspective.
Mises concedes that when governments in the nineteenth century were
less democratic and more constitutionally limited, public spending was
lower relative to national income, money was redeemable in gold, and
most citizens viewed the state “as an institution whose operation required
an expenditure of money which must be defrayed by taxes paid by the
citizens.” By the mid-twentieth century, however, “the majority of citizens
look upon government as an agency dispensing benefits,” “a spender,
not a taker,” to the point where “the wage earners and the farmers expect
to receive from the treasury more than they contribute to its revenues.”
This echoes Tocqueville (1835–40), a century earlier, who contended that
unchecked democracy created a “soft despotism” of widespread, popular
dependency on the state. By Mises’s account, “these popular tenets were
rationalized and elevated to the rank of quasi-economic doctrine by Lord
Keynes and his disciples.” In truth, “spending and unbalanced budgets
are merely symptoms for capital consumption,” and indeed “the total
complex of [government] financial policies” now “tends toward capital
consumption” (Mises, 1949, p. 850). Instead of salvaging a faltering free
market, Keynesian policies assault saving, rentiers, and capital accumula-
tion, thus productivity gains, real wages, and living standards. The problem
is false economic ideas, which no legislative reform (whether a balanced
budget mandate or a gold standard) can mitigate. What’s needed, he
feels, is more and better economic education. Mises is chagrined about
the economic ignorance of democratic citizenry, but reluctant to indict
any democracy’s politicians; only autocrats, he contends, are selfish,
power-hungry anti-capitalists:
Many who are aware of the undesirable consequences of capital consumption

are prone to believe that popular government is incompatible with sound finan-
cial policies. They fail to realize that not democracy as such is to be indicted,
but the doctrines which aim at substituting the Santa Claus conception of
government for the night watchman conception derided by [socialist Ferdinand]
Lasalle [in 1862]. What determines the course of a nation’s economic policies
is always the economic ideas held by public opinion. No government, whether
democratic or dictatorial, can free itself from the sway of the generally accepted
ideology. Those advocating a restriction on the parliament’s prerogatives in
budgeting and taxation issues or even a complete substitution of a uthoritarian
government for representative government are blinded by the chimerical image
of a perfect chief of state. This man, no less benevolent than wise, would be
sincerely dedicated to the promotion of his subject’s lasting welfare. The real
Führer, however, turns out to be a mortal man who first of all aims at the
perpetuation of his own supremacy and that of his kin, his friends, and his
party. As far as he may resort to unpopular measures, he does so for the sake of
these objectives. (Mises, 1949, p. 850)
How is excess public debt shouldered or discharged, according to

Mises? In the more liberal, capitalist societies of the nineteenth century,
we know, public leverage was radically reduced and kept low. “In the
heyday of liberalism,” he writes, “some Western nations really retired
parts of their long-term debt by honest reimbursement.” In sharp con-
trast, “the financial history of the last century [1849–1949] shows a steady
increase in the amount of public indebtedness” and now “nobody believes
that the states will eternally drag the burden of these interest payments”
(ibid., p. 227). Credit means “to believe,” and although overindebted states
are less believed, less credible and less creditworthy, their taxing power
enables them to accumulate still larger debts. For Mises “it is obvious that
sooner or later all these [public] debts will be liquidated in some way or
other, but certainly not by payment of interest and principal according
to the terms of the contract” (ibid.). “It is possible to free the produc-
ers of new wealth from this burden by collecting the taxes required for
the payments exclusively from the [public] bondholders,” as by a capital
levy, but that is an “undisguised repudiation” (p. 228). He contrasts “debt
abatement,” which favors debtors over creditors, and “debt aggravation,”
which does the reverse (pp. 783–4). Abatement is more common (because
states are more commonly net debtors) and achieved by monetary debase-
ment, for “a government resorts to inflation in order to favor the debtors
at the expense of the creditors.” Inflation is “by no means a tool of con-
structive action,” but “a bomb that destroys [capital] and can do nothing
but destroy” (p. 785).
Despite his consternation, Mises at least defends public debt as a
crucial asset, a valid claim for capital willingly lent, and a property right
deserving protection. He derides demagogues who profit from the fact
that “public opinion has always been biased against creditors.” The
public often “identifies creditors with the idle rich and debtors with the
industrious poor” and “abhors the former as ruthless exploiters while
it pities the latter as innocent victims of oppression.” Demagogues
portray policies “designed to curtail the claims of the creditors as
measures extremely beneficial to the immense majority at the expense

of a small minority of hardboiled usurers.” The vote-getter becomes an
anti-rentier. When credit sours and loans go bad, demagogues blame the
most harmed as “predatory lenders” while exonerating (or bailing out)
reckless borrowers. If the extra-constitutional democracy isn’t respectful
of contracts, especially between creditors and debtors, how much less
respectful must it be when the state is the biggest debtor? Overindebted,
unrestrained democratic states are motivated and empowered to exploit
popular prejudice and repudiate their debts. “Over all species of deferred
payments hangs, like the sword of Damocles, the danger of government
interference,” writes Mises, and if “the masses are unwittingly attack-
ing their own particular interests” then “no kind of investment is safe
against the political dangers of anti-capitalist measures” (Mises, 1949,
pp. 540–41).
Much like Lutz and Mises, public choice scholars since the 1950s have
indicted Keynesian theories for public fiscal profligacy, but they concur
with Lutz only when they indict Keynesian theory and democratic
theory alike. Mises is mixed on the issue, variously indicting and exon-
erating popular rule, but almost always indicting Keynesian notions as
economic quackery (Mises, 1948 [1980]) and central banking as a scheme
not to stabilize free markets but to empower central planners (Mises,
1978). As is clear in Buchanan and Wagner’s Democracy in Deficit: The
Political Legacy of Lord Keynes (1977 [1999]) and related works, the
public choice perspective doesn’t endorse Mises’s charitable interpreta-
tion of democracy as blameless for the erosion of prudence in public
finance. A succinct public choice view of today’s fiscal state is given by
Lee (2012, p. 474), synthesizing economic theory and political practice:
“[E]ven if Keynesian remedies could be implemented in a timely
manner,” Lee writes, “there are other serious problems undermining
Keynesian hopes for moderating the decline, duration, and frequency
of economic downturns.” First, “Keynesian prescriptions are filtered
through a political process that’s driven by many competing agendas,
of which balanced growth is only one.” Second, “Keynesian econom-
ics and the political process are almost entirely focused on short-run
demand-side concerns while largely ignoring the long-run importance
of economic productivity.” Consequently (and tragically), “a politi-
cal dynamic” has turned Keynesianism into “a prescription for fiscal
irresponsibility that undermines economic growth without promoting
economic stability.”
4.4 PESSIMISM REPRISED: BUCHANAN, WAGNER,

AND BRENNAN
Nobel laureate James Buchanan (1919–2013) was the pre-eminent scholar

in both public choice theory and its treatment of public debt. Although
public choice entails a positive political theory of how and why elites,
bureaucrats, and voters act, it also makes moral judgments and, through
policy advice, seeks to limit Leviathan. Buchanan, for example, examines
“Ricardian equivalence,” on the incidence of public debt (Buchanan,
1976) but also explores “the moral dimension” of public debt financing
(Buchanan, 1985).
Buchanan’s path-breaking performance in Public Principles of Public
Debt: A Defense and Restatement (1958 [1999]) was the first full-length
treatment of public debt in a half-century, after Public Debts: An Essay in
the Science of Finance (1895) by Adams. No theoretical effort comparable
to Buchanan’s has appeared since. The book provoked much debate and
research.4 An early review characterized it as a “rehabilitation of clas-
sical debt theory” (Peacock, 1959). Here Buchanan’s focus is mainly on
positive, not normative aspects of public debt, and on its incidence instead
of cause. Only later does his theory incorporate normative elements
and suspicions of political motivation. Whereas public choice is subtext
in Public Principles of Public Debt, it becomes explicit in Democracy in
Deficit: The Political Legacy of Lord Keynes (Buchanan and Wagner, 1977
[1999]).
The empirical context of Buchanan’s 1958 book is worth knowing. In
the decade prior to its release the United States ran budget deficits just
30 percent of the time, borrowed only 4 percent of all outlays, and reduced
its leverage (public debt/GDP) from 94 percent to 54 percent. In the decade
subsequent to 1958 the United States ran deficits 90 percent of the time
and borrowed 6 percent of its outlays, reducing public leverage further,
to just 38 percent. A half-century before Buchanan’s book appeared US
leverage was only 4 percent (1908) and had averaged only 10 percent over
the previous century (1808–1908); in sharp contrast, a half-century after
his book appeared (in 2008) US leverage reached 75 percent.
In Public Principles of Public Debt Buchanan reintroduces what he sees
as the classical theory of public debt, a theory of its nature and effects.
His own theory he unabashedly associates with the “vulgar opinion” of
the man on the street, in contrast to the Keynesians’ “new orthodoxy.”
He examines the methodology of debt analysis; the extent to which public
debt unduly burdens future generations; whether analogizing private and
public debtors is valid; whether domestically held (“internal”) public loans
are less burdensome than foreign-held (“external”) loans; the effects of
issuing debt during war versus depression; the impact of debt on infla-
tion (and vice versa); and whether deficit spending can promote economic
stability or full employment.
Buchanan begins by examining “the currently dominant theory of
public debt,” which is the “new [Keynesian] orthodoxy.” This account
has currency today, given the resurgence of Keynesian policy since 2008.
Buchanan is aware that the “new orthodoxy” isn’t genuinely novel but in
truth a reprise of mercantilist and Malthusian notions (as even Keynes
acknowledged in 1936 in the penultimate chapter of his General Theory).
Buchanan believes adherents “should have realized that the same a rguments
[had] been floating around since the early years of the e ighteenth century”
and that classical theorists had rebutted them (Buchanan, 1958, p. 15). A
real scientist must know the history of his field.
Buchanan believes confusion on public debt often reflects false con-
ceptualizing. “Public debt is far too generic a term,” he contends; indeed,
he finds nine distinct meanings of the term (ibid., pp. 18–25). Apparently
public debt can have both real and monetary effects, can exert distinct
effects under full employment as against unemployment, under infla-
tion versus price stability, or amid war versus peace. Its effects differ if
it’s underwritten by banks or by the public, and if its proceeds are spent
on ordinary consumption and transfer payments or value-added public
capital projects (infrastructure). Buchanan’s analytical disaggregation is
more typical of classical economics and microeconomics than it is of
Keynesian macroeconomics. “What has all of this to do with the theory
of the public debt?” he asks. Buchanan wants to explain and predict “the
size of the debt itself ” as well as “the effects of issuing debt, or of changing
the magnitude of the outstanding debt” (p. 20). Only three main methods
finance public spending: taxing, borrowing, and money creation. If spend-
ing is “given” and debt finance forbidden, taxation alone remains, be it
explicit or implicit (inflation):
Borrowing is only one means through which the government secures command
over monetary resources, which, except in the case of anti-inflationary debt
issue, the government uses to purchase real resources. Borrowing is, therefore,
an alternative to taxation. If a given public expenditure is to be financed, this
can only be accomplished in three ways: taxes, loans, and currency inflation.
The analysis of the effects of debt issue must, therefore, compare what will
happen under the debt with what will happen under the tax or inflation. . . Debt
creation is an alternative to increased taxation, currency inflation, or expendi-
ture reduction. When we analyze the effects of debt we must always conduct the
analysis in differential terms; that is, we must allow one of the three possible
compensating variables to be changed in an offsetting way. This is the only per-
missible means of actually comparing what will happen with and without the
debt. (Buchanan, 1958, pp. 21–2)
Someone must pay the piper; the burden is unavoidable. Opposition

to public debt isn’t opposition to a fiscal burden per se, for the burden
originates in public spending; all else equal, opposition to borrowing

is support for taxation, inflation or both. Buchanan believes that debt
finance is opposed improperly, on the grounds that it mismatches gains
and losses between living generations (who enjoy benefits without burdens)
and subsequent ones (who suffer burdens without benefits). In the private
sector no person can legally bequeath an isolated debt (and no heir can be
compelled to pay a decedent’s debts), nor can a person legally bequeath an
estate with assets but a negative net worth. Yet government can forward
the equivalent of a negative-worth estate to future generations (and their
own government) through public debt issuance. Sovereign immunity also
legally shields states that expropriate bondholders. Buchanan opposes
intergenerational transfers of negative net worth public balance sheets, on
both economic grounds (it causes capital depletion and successively lower
living standards) and normative grounds (it unfairly burdens unborn,
unenfranchised future citizens).
The “bulwark” of the Keynesian theory of public debt, according
to Buchanan, is three basic propositions: (1) “The creation of public
debt does not involve any transfer of the primary real burden to future
generations,” (2) “the analogy between individual or private debt and
public debt is fallacious in all essential respects,” and (3) “there is a sharp
and important distinction between an internal and an external public debt”
(Buchanan, 1958, p. 5). Buchanan rejects each proposition. He says that
public debt shifts the real burden of government’s current costs to future
generations. Moreover, a tight and valid analogy exists between private
debt and public debt. Finally, domestically held public debt is no less bur-
densome than foreign-held debt. Buchanan notes further that “these three
propositions are clearly not independent of one another.” By accurately
summarizing the Keynesian theory of public debt, we know he hasn’t
erected a straw man.
As to the first proposition – that public debts don’t shift current burdens
to posterity – Buchanan recasts it as an argument that “the process of
government borrowing transfers current purchasing power from the hands
of individuals or institutions to the government,” and “the utilization of
this purchasing power by the government employs resources in the same
general time period as that in which the borrowing operation takes place,”
such that “the real cost of the public expenditure” is “borne by those indi-
viduals living in the initial or ‘current’ time period,” not by posterity. The
current generation supposedly sacrifices real income, reflecting not the
debt itself but government’s choice to spend in the first place. Whether
spending is tax financed or debt financed, say the Keynesians, doesn’t alter
the fact that only the present generation is burdened; it’s impossible to
“shift” this burden to the not-yet-born, or to do so without also forwarding
assets, which means forwarding a positive net worth. Buchanan knows how
Keynesian theory concedes that subgroups can be affected d ifferently by tax
finance versus debt finance, but also holds that “debt issue leaves ‘future’
generations with a heritage of both claims and obligations,” and these “can
represent no aggregate real burden because they cancel each other, at least
for the internally-held public debt” (p. 6). “The public debt is, of course,
not burden-less,” Buchanan argues, for “the process of making the required
interest transfers involves a net burden,” and “these transfer burdens are
essentially of a ‘frictional’ or ‘stresses and strains’ variety,” depending on
the extent of overlap between taxpayers and public bondholders. Still,
the “primary real burden” of a public debt is on future generations. (p. 7).
Posterity must pay the taxes to service the debt.
For Buchanan, as for Lutz, public debt is mainly deferred taxation; if
the cost of public spending today, which mostly benefits living generations,
is deferred, they enjoy benefits without costs, while future generations
get the (debt) costs without the benefits (of spending); living generations
exploit future generations, treating them as means, without consent. The
Keynesians insist that every generation at every point in time receives both
assets and liabilities – two sides of the same fiscal coin. Moreover, they
don’t deny that public debt is a burden, only that if it is, it is so presently,
as a form of tax, not a deferred tax. Central to Buchanan’s case is the
insight that public creditors, unlike taxpayers, aren’t compelled; they lend
freely and expect to gain, not lose or sacrifice anything, so the real sacri-
fice is shifted, or deferred, to other shoulders. Buchanan insists that future
taxpayers are forced to repay the heirs of initial creditors.
Buchanan’s refutation of the first (Keynesian) proposition, that the
primary real burden of a public debt is not shifted to future generations,
appears in Chapter 4 (“Concerning Future Generations”) of Public
Principles of Public Debt (Buchanan, 1958, pp. 26–37). His argument, he
admits, is in “classical form,” for he assumes full employment, that public
debt is incurred for real (economic) purposes, that sovereigns use savings
that otherwise would be invested privately, and that debt issuance doesn’t
materially alter interest rates (because public spending is low relative to
GDP). But it’s crucial to realize that “the mere shifting of resources from
private to public employment does not carry with it any implication of
sacrifice or payment,” for if the shift reflects “the voluntary actions of
private people, it is meaningless to speak of any sacrifice having taken

place.” This is so especially when “an individual freely chooses to purchase
a government bond,” for “he is, presumably, moving to a preferred position
on his utility surface by so doing.” The bond buyer “has improved, not
worsened, his lot by the transaction,” and is “the only individual who actu-
ally gives up a current command over economic resources,” while “other
individuals in the economy are presumably unaffected.” In short, “the
economy, considered as the sum of the individual economic units within it,
undergoes no sacrifice or burden when [public] debt is created” (pp. 28–9;
original emphasis). It’s quite an admission for a debt pessimist like
Buchanan; yet it’s undeniable that a consensual purchase is non-sacrificial.
What he opposes, then, is what he imagines to be a future sacrifice of the
not-yet-born, who presently lack consent.
Interestingly, Buchanan suggests that divergent political theories might
explain ostensible differences about public debt incidence. “It is perhaps
not surprising,” he writes, “to find this essentially organic conception of the
economy or the state incorporated in the debt theory of [nineteenth-century
German economist] Adolf Wagner,” a theory which denies that public debt
burdens posterity. If all groups and generations are bundled analytically in
some collective “volk,” none can be specifically victimized or “burdened.”
But, Buchanan notes, some nations embody “democratic governmental
institutions” with a “social philosophy [that] lies in the individualistic
and utilitarian tradition,” and it’s there that real perpetrators and victims
will feel true costs and benefits. Buchanan thinks most fiscal scholars are
ignorant of political theory and its effect on their analyses. He worries that
“with rare exceptions, no attention at all has been given to the political
structure and to the possibility of inconsistency between the policy impli-
cations of fiscal analysis and the political forms existent” (p. 29). One tragic
result is that “English- language scholars” who might otherwise reject
the Wagnerian ideal of the monolithic, organic state, nevertheless push
theories requiring such a state. One thinks of Keynes, purportedly eager
to “save capitalism,” yet telling German readers in the 1936 preface to the
German edition of his General Theory that his policies are most appro-
priate in a totalitarian state. For Buchanan, “an individualistic society”
usually “governs itself through the use of democratic political forms,”
so “the idea of the ‘group’ or the ‘whole’ as a sentient being is contrary
to the fundamental principle of social organization.” In this setting “the
individual or the family is, and must be, the basic philosophical entity in
this society,” in which case “it is misleading to speak of group sacrifice or
burden or payment or benefit unless such aggregates can be broken down
into component parts” and “imputed to the individual or family.” But “this
elemental and necessary step cannot be taken with respect to the primary
real burden of the public debt,” for “the fact that economic resources are
given up when the public expenditure is made does not, in any way, demon-
strate the existence of a sacrifice or burden on individual members of the
social group” (pp. 29–30).
Buchanan concludes his argument against the first proposition of the

“new orthodoxy” by insisting he has shown “that the creation of debt
does involve the shifting of the burden to individuals living in time periods
subsequent to that of debt issue,” that “these are the individuals who suffer
the consequences of wasteful government expenditure,” but who also
“reap the benefits of useful government expenditure.” His conclusion is
“diametrically opposed to the fundamental principle of the new orthodoxy
which states that such a shifting or location of the primary real burden is
impossible” (Buchanan, 1958, p. 37). His critique counts heavily on the
fact that, unlike taxes, public debt is purchased voluntarily by those who
gain from the exchange. Yet the cost of the public spending that borrowing
enables must be borne by someone, in some form, at some time. Buchanan
insists that it’s borne by future generations in the form of deferred taxes.
He leaves unexamined the fact that living generations pay at least some
taxes to service the public debt incurred (and bequeathed to them) by
ancestors whose living standards would have been lower had they funded
their own public outlays more by taxes than debt. But had the ancestors
done so, they wouldn’t have been able to bequeath as much in assets (living
standards) to their heirs (living generations). Can the living rightfully com-
plain about receiving both the debts and assets of ancestors? Yes, if they
receive a negative net worth estate (with debts owed exceeding asset values).
Otherwise, no.
Buchanan seems to concede this point, for when states borrow for what
he calls “useful” (versus “wasteful”) outlays, he says posterity will “reap
the benefits” and suffer no net burden. He rejects the “general assumption
of the classical economists that all public expenditure is unproductive”
(p. 66). As a classical liberal, why doesn’t he prefer debt finance to tax
finance, especially when (as he admits) the first funding source is voluntary
and the second compulsory? Because he also sees public debt as deferred
taxation, so its voluntariness is transitory; in effect he views public debt as
deferred compulsion, thus compulsion all the same, and worse (for liberty
and rights), because public debt burdens are forwarded to people not-yet-
born who can’t now consent. His main aim isn’t to privilege voluntary
over compulsory financing but to ensure that public benefits match public
costs, for the same people (and generations), so that no one, whether living
now or in the future, can politically (or fiscally) exploit others.
As to the second Keynesian proposition – that there’s no valid analogy
between private debt and public debt, such that a state may borrow more,
and on cheaper terms unavailable to mere households and businesses –
Buchanan characterizes it thus: “To the individual or the private institution,
the interest charges which are necessary to service a private debt clearly rep-
resent a real burden,” and “either consumption spending or savings must
be reduced, and purchasing power transferred to the holder of the debt

claim,” so “the private debt is in this way analogous to the external public
debt.” In contrast, “if the public debt is internal, the holders of the claims
are from the same group of individuals as the taxpayers” and “no net
real income is transferred outside the budget of the collective entity.” The
indebted individual is “placing an obligation on his expected real income
over future time periods,” so “he should exercise caution and restraint in
making expenditures which can only be financed by borrowing,” for too
much personal debt “can place such a weight on future income that the
individual may be threatened with bankruptcy” (p. 8). When it comes to
government, Keynesians claim, such conclusions don’t pertain (except
for externally held debt). The debt can neither burden future genera-
tions nor bankrupt current sovereigns. Buchanan puts it thus: since “all
resources employed in making the [public] expenditure [today] must come
from within the economy initially and must be used up in the initial time
period,” “there can be no shifting of the primary real burden forward in
time,” so “the ordinary prudence suggested for the private individual is
not fully applicable as advice to the national government.” Moreover, “the
size of the public debt is of relatively little concern for the public economy
because the debt carries with it claims as well as obligations. To individuals
who own the bonds, public debt is an asset” with a value that “just matches
the value of the liability represented by the debt” (ibid.).
Buchanan’s rebuttal to this second proposition appears in Chapter 5
(“The Analogy: True or False”) of Public Principles of Public Debt
(Buchanan, 1958, pp. 38–57). Again he assumes “classical” axioms, such
as full employment. “When an internal debt is created, resources for public
use are withdrawn from private uses within the economy,” such that “the
creation of debt and the correspondent financing of the public project
does nothing toward increasing or adding to the wealth of the society”
(p. 39, original emphasis). But, he says, Keynesians infer wrongly, for
“when the bond purchaser buys the government bond, he draws down
some other asset” (like cash) “and replaces this with the government
securities,” leaving his net worth unchanged. Taxpayers, recording no new
assets or liabilities, also see no change in net worth. New debt doesn’t alter
national net worth. Yet public leverage – the ratio of public debt to national
income – surely increases.
Initially then, the analogy of public debt and private debt holds, in
Buchanan’s view. Thereafter, he argues, “the payment of interest on a
public debt” constitutes “a reduction in aggregate individual net wealth,”
even though “bondholders receive the interest paid as taxes by domestic
taxpayers,” just as “the payment of interest on a private debt represents a
drainage from the real income stream of the individual, a reduction in his
net worth” (p. 41). He notes that tax deferred payments reduce taxpayers’
assets and net worth, while the receipt of interest increases the assets and
net worth of the public bondholder by a like sum. There is no change in
aggregate net worth. If so, the private-public debt analogy seems false after
all. Yet Buchanan insists the analogy is true, that to reject it is methodo-
logically erroneous and a failure to compare relevant alternatives. It’s mis-
leading to count the public bondholder’s net worth as “uniquely increased
by the receipt of interest” on his bonds, for he could have invested his
capital elsewhere and still earn interest. No extra interest income flows
from public bonds. In short, “the increase in net worth of the bondholders
would have occurred without the public debt,” so “only the decrease in net
worth of the taxpayers” can be attributed to the new issue of public debt
(p. 42; original emphasis).
Although a taxpayer sees no change in his net worth when a new public
loan is floated, his worth is surely reduced when he pays taxes to service
it. Absent that he would have maintained his worth. “From this corrected
analysis,” Buchanan concludes, “the public borrower (that is, the taxpayer)
is at no time in a position different from the private borrower,” so “the
analogy between the two holds good in all of the essential respects” (p. 45).
The Keynesians are wrong to claim that the public borrower is fundamen-
tally different from the individual borrower – wrong to believe sovereigns
face no inherent debt limits and thus can’t truly falter or default, because
“we owe it to ourselves,” while all relevant payments cross-cancel. In
truth, Buchanan argues, each accesses income, to service their debts. Each
faces debt limits. Each might misuse loan proceeds and spend them on
“wasteful” things. Each can become insolvent and default. The false belief
in the second Keynesian proposition is that the interest received by public
bondholders uniquely offsets the taxes citizens must pay to service the
bonds; in fact, had the investor lent elsewhere instead of to the state, he still
would have earned interest income. Buchanan denies that a net addition
of interest income can arise from new public debt, whereas a new interest
expense surely arises, and is borne by taxpayers.
A realist might note that there’s some truth in both the optimistic view
of the Keynesian and pessimistic view of Buchanan: that public debt
incidence falls on the living, not on posterity (per Keynes, but contra
Buchanan), but if the proceeds aren’t spent productively, it’s burdensome
to taxpayers (per Keynes, but contra Buchanan).
A matter of greater relevance isn’t even discussed in Public Principles
of Public Debt – the fact that government, by its nature, holds a legal
monopoly on the use of legitimate force, while persons and companies
don’t. Only a state can legally compel tax paying, which is crucial to its
capacity for debt servicing, whereas private actors who do so commit
larceny. Only a state can legally conscript labor (for military purposes) and
pay it less than market value (Siu, 2008), whereas private actors who do so
commit kidnapping. Only a state can legally issue unlimited sums of irre-
deemable paper money (or its electronic equivalent), whereas private actors
who do so commit counterfeiting. Only a government can run its court
system, including bankruptcy courts, and by the principle of sovereign
immunity exclude itself from prosecution, whereas private actors who do
so commit an obstruction of justice. In all these ways, Buchanan neglects
to note, a state differs from the citizen, so likewise the public debtor differs
from the private debtor, and not merely on legal grounds, because legal
sanction permits equally vast differences in the financial-economic realm.
Taxes can be raised to service public debts. No state that runs its own
bankruptcy courts subjects itself to bankruptcy. How then can a public
debtor be at risk of “going bankrupt?” Inflation alone permits highly
leveraged states to “live beyond their means.” As Keynes explained in 1923
in A Tract on Monetary Reform: “a government can live for a long time by
printing paper money,” and “by this means secure the command over real
resources” every bit as “real as those obtained by taxation,” and although
“the [inflationary] method [of public finance] is condemned,” one must
admit its “efficacy,” for a profligate “government can live by this means
when it can live by no other.” Such tactics, although not morally laudable,
nonetheless are now legally permissible.
Buchanan also fails to note that in a more enlightened age like the nineteenth
century, when most Western governments were more c onstitutionally limited
than now, not yet aware of the wide range of potentially r emunerative taxes
that could be imposed, and restrained monetarily by the classical gold stand-
ard, it made more sense to find similarity in the powers of the individual and
of the state, or in the capacities of private and public debtors. Each faced
constraints; each had to behave, fiscally, or risk financial ruin. Today’s sov-
ereigns, in contrast, face few such constraints, while citizens and firms face
even more of them, because they face governments with even greater taxing,
borrowing, and inflating power. Classical liberals may wish the change
hadn’t occurred, but it’s indisputable that it has largely negated the public-
private analogy.
As to the third proposition of Keynesian debt theory – that there is
“a sharp and important distinction between an internal and an external
public debt” – Buchanan characterizes it thus: “The public economy, the
government, has within its accounting limits both the debtors and the
creditors. The debt in such circumstances is a mere financial transaction.
No outside resources are imported and employed when debt is created; no
net reduction in income flow takes place (aside from the frictional effects
of transfer) when interest is paid or the debt is amortized.” But “if the debt
is externally held,” it is a real burden, so only “for external or foreign debt

[are] the ‘classical’ or vulgar ideas” applicable. In truth, Buchanan says,
“the primary real burden [of public debt] can effectively be shifted forward
in time since there need be no net domestic sacrifice of resources during
the period of debt creation. The payment of interest [also now represents]
a real burden,” because the nation’s domestic income is reduced due to
the interest sent abroad. Now it’s valid to say that “future generations will
find their incomes reduced by such transfers,” especially when the princi-
pal is repaid and domestic resources transferred to foreigners. “The real
burden of repayment is also borne by future generations,” so only here
“the analogy with private debt fully holds.” In sum, “external public debt
may be a signal of fiscal irresponsibility, something which must be avoided
when possible” and instead of “the rule of budget balance,” the rule should
be: “taxes plus internal debt should equal public expenditures” (Buchanan,
1958, pp. 9–10).
Buchanan’s counterargument to this third Keynesian proposition
appears in Chapter 6 (“Internal and External Public Loans”) of Public
Principles of Public Debt (Buchanan, 1958, pp. 58–66). He deems it “the
most vulnerable” proposition (p. 58) because it depends on the first two
propositions, which he has already rejected. On close scrutiny, he says, “the
conceptual difference between the two debt forms disappears” (ibid.). The
new orthodoxy contends that “external debt would require that interest
payments be made to foreigners,” which would “represent deductions from
income otherwise disposable,” while “interest payments on the internal
debt represent no such deductions” (p. 60). But this is wrong:
The relevant comparison for meaningful debt theory is not between two situa-
tions which are identical in every other respect than debt ownership. Situations
like these could never be present, and could never be constructed except as
isolated and unimportant cases. Some other respects than debt ownership must
be different, and any analysis which overlooks or ignores the other necessary
differences must embody serious error. (Buchanan, 1958, pp. 60–61, original
emphasis)
At the initial moment of choice, three options exist: raise taxes, borrow,
or curtail outlays. A subsidiary option for debt finance is internal versus
external funding. If a spending increase is approved along with debt
finance, and there are no idle savings, internal debt finance will draw from
a fully invested pool of domestic savings while external funding will draw
from a fully invested pool of foreign savings. In Buchanan’s telling, regard-
less of whether the new funding seeds a remunerative public project, “the
creation of the internal public debt will act so as to reduce the community’s
privately employed capital stock by the amount of the loan,” and thus
future private income streams will be lower, depending on the rate of return
(p. 61). External debt funding, in contrast, neither reduces nor supplements
domestic privately employed capital stock, so future private income streams
are greater than if a new loan was sourced internally (albeit offset by new
interest payments sent abroad). “The internal and the external debt cannot
legitimately be compared on the assumption of an equivalent gross income
stream,” Buchanan writes. Moreover, “the gross income of the community
in any chosen future time period cannot be thrown into the other respects
which are assumed identical in the two cases and thereby neglected” (p. 62).
Now the choice between internal and external funding is less obvious
than Keynesians assume – and they assume that only external public debt
is burdensome. Buchanan explains why, to the contrary, it’s often more
advantageous (because cheaper) than internal funding:
The community must compare one debt form [external] which allows a higher
income over future time periods but also involves an external drainage from
such income stream with another form [internal] which reduces the dispos-
able income over the future but creates no net claims against such income. The
choice must hinge on some comparison between the rates at which the required
capital sum originally may be borrowed. The choice between the internal and
the external loan should, at this level of comparison, depend upon the relative
[interest] rates at which funds may be secured from the two sources. The com-
munity should be indifferent between the two loan forms if the external bor-
rowing rate is equivalent to the internal borrowing rate. . .[for then] the internal
loan would reduce domestic private investment which would, in turn, reduce the
future income in any one period by an amount indicated by the magnitude of
the loan multiplied by the internal rate or net yield on capital, which is assumed
to be the rate at which the government borrows. The external loan would not
cause such a reduction in private investment; income in a future period would be
higher than in the internal loan case by precisely the amount necessary to service
the external loan. Net income after all tax payments and interest receipts are
included will be equivalent in the two cases. . . If the internal or domestic pro-
ductivity of capital investment exceeds the rate at which funds may be borrowed
externally, the community will be better off if it chooses the external loan form.
Net income after all debt service charges are met will be higher than it would
be if the alternative internal public loan were created. . . [Only if] the internal
[or domestic] rate of return on capital investment falls short of the external
borrowing rate [will] the community. . .be worse off with the external than with
the internal loan. Net income of the community after debt service will be lower,
and the external debt will impose a “burden” [only] in a differential sense [not
due, per se, to the necessary exportation of interest expense]. (Buchanan, 1958,
pp. 62–3)
Whereas Keynesians theorize that domestic burdens and risks might exist
only if public debts are owed to foreigners (and there exists no capacity
to service such debts by issuing fiat paper money), Buchanan contends
that foreign-source funding can lessen strains on domestic savings and

minimize a “crowding out” of private investment.
Having treated the three “bulwark” propositions of the seemingly idyllic
Keynesian theory of a care-free, burdenless public debt, Buchanan believes
his analysis “lends support to the so-called ‘vulgar’ or ‘common-sense’
ideas” on the subject of debt – that public debt has real and inescapable
limits and burdens. In the immortal words of Lutz, “there is no free lunch”
(Lutz, 1947, p. v). Buchanan thinks his analysis “also re-establishes, in large
part, the validity of the public debt theory which was widely, although
by no means universally, accepted by scholars prior to the Keynesian
revolution in economic thought” (Buchanan, 1958, p. 79) – classical debt
theory. The Keynesian view of public debt was the “commonly accepted
view during the eighteenth century” and (before Adam Smith’s rise to
prominence) “part of the larger body of mercantilist doctrine.” Indeed,
Buchanan recounts, mercantilist myths about public debt “were called
‘common’ or ‘vulgar’ by the classical writers,” so it’s ironic that Keynesians
deride remaining vestiges of the classical view itself as “vulgar.” “Public
debt theory has turned full circle” (p. 78). Statist political theories and
democratic practice have prejudiced public debt theory so as to ensure
ample financing for burgeoning welfare states.
Buchanan’s critique of the three propositions of Keynesian public
debt theory are not left unchallenged. In Ferguson (1964) debate about
the critique revives the idea, first seen in Lutz (1947), of “public debt
illusion,” where citizens underestimate the true cost of government when
it’s financed to a relatively greater extent by debt than by taxes. With
more debt finance the “tax price” of public goods and services is lower
(even below cost) than otherwise, so citizens demand too much of it;
consequently the size, scope, and cost of government grow beyond neces-
sity, and as this happens government must rely increasingly on debt finance,
creating a vicious circle. The notion of “debt illusion” is analogous to that
of “money illusion,” which says people are fooled by inflation (monetary
debasement), or its effects (rising prices), and feel wealthier by it, whereas
in real terms they’re no better off (or worse off). Buchanan believes that
people are prone to debt illusion and he’s quite critical of politicians and
policymakers who promote it.5
Ricardo, we’ve seen, denies debt illusion, as does Harvard’s Robert Barro
(and other “new classical” economists). On this view public debt can’t
possibly burden posterity. Everyone knows exactly what they’re getting (and
paying), so no one can be fooled or exploited in public finance. Keynesians
(and Mises) likewise believe the real cost (burden) of government spending is
the real resources drawn from the private sector to fund it, whether by taxes or
public loans. They believe more in the p ossibility of money illusion than debt
illusion, but unlike new classical and public choice economists (and Mises),
welcome them as expedients and claim that state spending has a “multiplier”
effect. Buchanan accepts the possibility of debt illusion but denies it refutes
his thesis that public debt is deferred taxation (Ferguson, 1964, pp. 150–63;
Buchanan and Roback, 1987). Indeed, he argues, debt illusion facilitates
intergenerational cost-shifting, for if living generations felt the full debt
burden as much as the tax burden they’d resist shouldering it, or try to shift
it. The counter-claim, of course, is that the same people, free of illusion, shift
the debt burden forward precisely because they might feel it presently.
The principle (Barro-type critics would say “false notion”) of “public
debt illusion,” regardless of its validity, marks an inflection point in public
choice research. As we’ve seen, Buchanan (1958) focuses far more on posi-
tive than normative aspects of public debt, and on its incidence (effects)
far more than its causes. But positive analysis is foundational for normative
analysis; it anchors the debate to empirics instead of to arbitrary moral
“intuitions,” and since the debate addresses sovereign debt, it necessitates
plausible theories (and measurements) of the proper role of government
in an advanced credit economy. Thus contemporary studies of public debt
incorporate not merely positive but also normative insights, and analyze
not merely effects but causes, and causes not solely technical or historical
but moral and political too.
If fiscal-monetary illusion exists, is it perpetrated deliberately by
political elites? If so, to what end? Should we displace traditional, ideal-
istic notions of the “public servant” with more realist conceptions, say, of
the utility-maximizing aggrandizing Machiavellian or Leviathan? Public
choice scholars say yes. But what moral code underlies such politics? What
will be the causes and consequences of public credit and public debt in
this more realistic “paradigm?” If, on the contrary, there’s no such thing
as fiscal-monetary illusion – as Barro and new classical economists insist –
what other incidences are discernable? If no one is ever fooled, perhaps the
vast growth in the size and power of government over the past century was
fully preferred by a fully informed electorate. In unrestrained democracy
objections to an ever-expanding state by even a few large minorities are
easily dismissed as electorally irrelevant; any minority – especially if rich –
can be exploited and made to pay for whatever the majority wishes. Not
coincidentally, a minority in major nations over the past century (the rich)
have paid a disproportionately large share of all taxes and have purchased
a relatively larger share of all public debt. To the extent the majority
doesn’t know how much this minority actually pays, or feels that it should
pay more still, it’ll demand a more expansive (and expensive) state; to the
extent the minority resists more burden, state funding will ebb.
In 1966 Alan Greenspan (1926–), subsequently a chairman of the US
Federal Reserve (1987–2006), gave a more ideological account of chronic

deficit spending and debt in the twentieth century. Although not a public
choice theorist, he shares its skepticism of politicians’ “public-spirited”
motives, and stresses crucial links between deficit spending, ideological
devotion to the welfare state, and electoral success:
[U]nder the gold standard, a free banking system stands as the protector of an
economy’s stability and balanced growth [and opposition to this system reflects]
the realization that the gold standard is incompatible with chronic deficit spend-
ing (the hallmark of the welfare state), [which is] a mechanism by which govern-
ments confiscate the wealth of the productive members of a society to support
a wide variety of welfare schemes. A substantial part of the confiscation is
effected by taxation. But the welfare statists were quick to recognize that if they
wished to retain political power, the amount of taxation had to be limited and
they had to resort to programs of massive deficit spending, i.e., they had to
borrow money, by issuing government bonds, to finance welfare expenditures
on a large scale. Under a gold standard, the amount of credit that an economy
can support is determined by the economy’s tangible assets, since every credit
instrument is ultimately a claim on some tangible asset. But government bonds
are not backed by tangible wealth, only by the government’s promise to pay out
of future tax revenues, and cannot easily be absorbed by the financial markets.
A large volume of new government bonds can be sold to the public only at
progressively higher interest rates. Thus, government deficit spending under a
gold standard is severely limited. The abandonment of the gold standard made
it possible for the welfare statists to use the banking system as a means to an
unlimited expansion of credit. They have created paper reserves in the form of
government bonds which – through a complex series of steps – the banks accept
in place of tangible assets and treat as if they were an actual deposit, i.e., as the
equivalent of what was formerly a deposit of gold. The holder of a government
bond or of a bank deposit created by paper reserves believes that he has a valid
claim on a real asset. But the fact is that there are now more claims outstanding
than real assets [such that the] earnings saved by the productive members of
the society lose value in terms of goods. When the economy’s books are finally
balanced, one finds that this loss in value represents the goods purchased by the
government for welfare or other purposes with the money proceeds of the gov-
ernment bonds financed by bank credit expansion. . . Deficit spending is simply
a scheme for the confiscation of wealth. Gold stands in the way of this insidious
process. (Greenspan, 1966, pp. 101–7)
This is consistent with a public choice approach; the critique is leveled

explicitly at the welfare state but implicitly at the populism that fosters it.
In recent debate about whether to raise the legal cap on US debt issuance,
Greenspan noted that the United States, now decades removed from the
gold standard and shouldering its highest leverage since World War II,
needn’t default explicitly because it had plenary power to default implicitly,
by printing as much fiat paper money as necessary (Greenspan, 2011).
In Democracy in Deficit: The Political Legacy of Lord Keynes (1977
[1999]), Buchanan and Wagner launch what they call the “new political
economy of public debt,” echoing Moulton’s 1943 critique of the
Keynesians’ “new philosophy of public debt.” They believe the Keynesian
approach persists only to rationalize and bolster Leviathan. Rules for
balanced budgets and the gold standard are abandoned not because they
fail but because they impede the spread of statism, which a majority
of voters seem to want. “With a balanced-budget rule,” Buchanan and
Wagner observe, “any proposal for expenditure must be coupled with a
proposal for taxation.” “Elimination of this rule altered the institutional
constraints within which democratic politics operated,” with the result
that “two subtly interrelated biases were introduced: a bias toward larger
government and a bias toward inflation.” Keynesianism blazed a path
for activist policymaking; political elites accepted it not because it was
economically valid but politically expedient. The ideas rationalized prefer-
ences for amassing and exercising power; they diminished suspicion about
deficit spending and debt accumulation. The policies were packaged as
safe, dependable fiscal “tools,” effective in fixing supposed market defects
like saving gluts, production gluts, and jobless gluts.
In the pre-Keynesian era, operating by “old” (classical) fiscal rules,
politicians who resorted to peacetime deficit spending were reviled as
irresponsible cranks deserving ousting; in the Keynesian paradigm they are
saviors and humanitarians deserving re-election. Buchanan and Wagner
(1977 [1999]) incorporate a perennial “vote motive” in their account of
fiscal trends but stress also that absent the right ideas, right policies do
not follow, and can’t gain popular support. The solution is both ideational
and institutional: Keynesian debt theories and policies must be refuted
for the danger they pose and the harm they inflict. To help politicians tie
their own hands, fiscally, Americans should convene to adopt a balanced
budget amendment to the US Constitution. But if balance isn’t wanted at
the operational level, why would it be wanted at the constitutional level?
The political economy “turn” in the public choice of public debt is
unmistakable in Buchanan and Wagner (1977 [1999]). Compared to
Buchanan (1958), they devote far less space to positive analysis and
much more to cultural-political-institutional factors. In their chapter on
“Keynesian Economics in Democratic Politics,” they write:
Those who seek to understand and ultimately to influence the political

economy must become political economists. Analysis that is divorced from
institutional reality is, at best, interesting intellectual exercise. And policy prin-
ciples based on such analysis may be applied perversely to a world that may not
be at all like the one postulated by the theorists. Serious and possibly irrevers-
ible damage may be done to the institutions of the political economy by the
teaching of irrelevant principles to generations of potential decision makers.
Has the teaching of Keynesian economics had this effect? The question is at
least worthy of consideration. We might all agree that something has gone
wrong. The record of deficits, inflation, and growing government is available
for observation. We must try to understand why this has happened before we
can begin to seek improvement. Our central thesis is that the results we see can
be traced directly to the conversion of political decision makers, and the public
at large, to the Keynesian theory of economic policy. At a preliminary and
common-sense level of discussion, the effects of Keynesian economics on the
democratic politics of budgetary choice seem simple and straightforward. . .
Elected politicians enjoy spending public monies on projects that yield some
demonstrable benefits to their constituents. They do not enjoy imposing taxes
on these same constituents. The pre-Keynesian norm of budget balance served
to constrain spending proclivities so as to keep governmental outlays roughly
within the revenue limits generated by taxes. The Keynesian destruction of this
norm, without an adequate replacement, effectively removed the constraint.
Predictably, politicians responded by increasing spending more than tax rev-
enues, by creating budget deficits as a normal course of events. (Buchanan and
Wagner, 1977 [1999], p. 95)
The fiscal context known to Buchanan and Wagner in 1977 doesn’t seem
to corroborate their theme, at least at first glance. By then Keynes’s General
Theory (1936) was 40 years old, its notions dominated most textbooks,
and most policymakers identified as Keynesian. From 1936 to 1977 the
United States ran budget deficits 75 percent of the time and borrowed
10 percent of its total outlays; yet by 1977 its leverage (public debt/GDP)
was only 35 percent, down from 40 percent in 1936 and well below the peak
of 121 percent in 1946. In contrast, over the four decades prior to 1936
the United States ran budget deficits 50 percent of the time and borrowed
27 percent of outlays, as public leverage jumped from 8 percent (1896) to
40 percent (1936). Thus the four decades after the Keynesian “revolution”
(1936) saw less deficit spending (10 percent of outlays) and a diminishing
public debt burden (leverage dropped from 40 percent to 35 percent), while
the four decades before it witnessed more deficit spending (27 percent of
outlays) and an increasing debt burden (leverage quintupled to 40 percent).
Of course, from 1896 to 1936 the US fiscal state was burdened by three
wars and a depression. Still, the Keynesianism “revolution” doesn’t seem
so influential, according to this brief empirical comparison. Instead of
Keynesianism causing the political- economic trend it may have only
reflected it.
On second glance, however, a crucial monetary aspect to the context
of 1977 corroborates Buchanan and Wagner’s theme, an aspect pertinent
to Keynesian policy prescriptions that explains the benign trend in US
public leverage between 1936 (40 percent) and 1976 (35 percent). Keynes
and his acolytes have been long-time critics of the gold standard and
consequently happy to see it abandoned in three major steps over the past
century (1914, 1933, and 1971). By now it’s well understood that fiat paper
money and unanticipated inflation can “erode” the real value and burden
of public debt (Aizenman and Marion, 2011). Buchanan and Wagner
are alert to this phenomenon in their 1977 book; a section titled “Budget
Deficits Financed by Money Creation” examines inflation’s power to dis-
sipate and erode large portions of a public debt burden. By inflating, the
sovereign defaults implicitly (indirectly) in contrast to defaulting explicitly
(directly, by non-payment of interest and principal); public debt thereby is
made to seem less costly than it is, because its costs are so widely diffused
among bondholders and moneyholders alike.
In any nationalistic monetary system of fiat paper money (versus the
traditional internationalist system of gold-based money), sovereigns can
create purchasing media ex nihilo, virtually without limit, and debase
the value of their money, which manifests as price inflation. If unan-
ticipated, inflation erodes the value of public debt, which benefits the
debtor (state) at the expense of the creditor (bondholder). When a nation’s
biggest debtor is also its biggest inflator, the obvious conflict of interest
can be significant. Among the many ways sovereigns extract resources
from the private sector, inflation is the most indirect, as Keynes famously
observed. Of course, sovereigns don’t portray inflation to their citizens
as a form of tax, although it is; they attribute it to non-state actors and
events (profit-hungry firms, greedy unions, oil cartels, poor harvests). If
the effects of inflationary finance on public perception were similar to
the effects of taxes, there’d be no point adopting the policy. If inflation is
a “hidden tax” the policy is politically tempting precisely because it is so
deceptive (Buchanan and Wagner, 1977 [1999], p. 114). If politicians can
easily spend beyond means, needn’t balance budgets, and yet suffer no
electoral harm, they’ll persist in the activity; if inflation results they can be
quite sure the price setters (business) instead of the money issuers (central
bankers) will be blamed.
A brief empirical review helps convey the power of inflation to erode
public debt and inflict implicit, serial defaults on bondholders. Consider
that in the four decades between the appearance of Keynes’s General
Theory (1936) and Buchanan and Wagner’s Democracy in Deficit (1977)
the US consumer price index increased 345 percent, nearly triple the
increase recorded in the prior four decades (+116 percent, 1896–1936).
Nominal GDP in the United States grew 24-fold from 1936 to 1977, but
only five-fold from 1896 to 1936. In absolute terms, nominal US public
debt increased 21-fold from 1936 ($34 billion) to 1977 ($706 billion), yet
declined relative to nominal GDP, due to rapid inflation. Thus the real
value of US debt increased only five-fold from 1936 to 1977. Public debt
increased, but public leverage declined – due mainly to inflation. Likewise,
from 1977 to 2015 US nominal public debt increased 23-fold, but only
eight-fold in real terms. Regardless of how high and fast public debt accu-
mulates, so long as inflation boosts nominal GDP (the denominator in the
public leverage ratio) by more, public leverage can be contained.
Obviously, inflation and default involve not just economic but moral
principles. Most public choice theorists consider normative elements
of public finance, along with economic ideas and political institutions,
to be causal, but it’s not a mainstream view. In “The Moral Dimension
of Debt Financing” (1985) Buchanan chastises economists for having
“almost totally neglected moral and ethical elements of the behavior that
has generated the observed modern regime of continuing and accelerating
government budget deficits,” and because “moral principles affect choice
constraints,” this “neglect is inexcusable.” Buchanan believes “the explosive
increases in debt or deficit financing of public consumption outlays can
be explained, at least in part, by an erosion of previously existing moral
constraints,” those he elsewhere dubs “Victorian precepts” ( prudence, par-
simony, budget balancing) and which Keynes, as “moral revolutionary,”
sought to jettison by resort to “allegedly rational arguments for fiscal-
monetary debauchery.” Unfortunately Buchanan also indicts an innocent
motive for productive behavior: “rational self-interest.” In the political
realm this motive supposedly makes officials myopically opportunistic
and fiscally imprudent, always inclined to seek “non-tax sources of public
revenues.” Buchanan says balanced budgets were “formerly dictated by
[Victorian] moral standards,” but they gave way to caprice and officials
jettisoned rules in favor of discretion: thereafter they’d do whatever they
wanted whenever they wished. A possible remedy is a balanced budget
amendment to the US Constitution, which Buchanan champions, but
its enactment is elusive, for it too is a rule; in a post-Victorian world it is
actively opposed by the champions of discretion. Nevertheless, studies of
the moral aspects of public finance and public debt persist.6
Is there a moral case for public debt default? The notion of “odious”
debt has a long lineage and seeks to justify default if a new political
regime replaces an old one that was corrupt and a deadbeat (Stiglitz,
2003; Jayachandran and Kremer, 2006). Ecclesiastics and socialists alike
consider default moral, for they believe creditors at root are immoral,
whether operating as “usurers,” debt “masters” or “parasites.” In truth
most creditors are moral, productive actors who deserve to have their
contracts and rights protected. This is the Hamiltonian view.
We’ve seen how Buchanan believes in a “moral dimension” for debt
finance and that Keynesian notions are not only economically inefficient
and harmful to credit–debtor relations but in many cases morally dubious,
especially the resort to surreptitious methods of inflationary finance. Yet
Buchanan also believes an ethical case can be made for an overleveraged

sovereign explicitly defaulting on its debts. In “The Ethics of Debt Default”
(1987) he explains that “there is widespread recognition that this pattern [of
reckless] fiscal behavior cannot be sustained permanently” because of inher-
ent limits to public debt – what he calls the “critical threshold.” If the risks of
public debt are widely known by well-informed markets, it can be ethical (or
at least not unjust) to default. Public creditors are financially sophisticated
investors; they know the risks and rewards better than most. If default risk
on a bond is high they pay a price below its face value, which means they earn
a higher yield-to-maturity compared to yields on safer bonds. Buchanan
reckons that investors in risky, high-yielding “junk” bonds, even if they are
public bonds, are fairly compensated for the risks they assume, often for
many years. They aren’t necessarily harmed by a default or the risk of it.
Buchanan doesn’t claim that all defaulters always treat their creditors fairly,
only that most bond investors are astute and always fairly compensated.
At some point, of course, a sovereign’s fiscal distress becomes so acute
that the interest expense on its bonds impinges on other budgetary spend-
ing, to the harm of many citizens. “At this juncture,” Buchanan says,
“it is apparently to the short-run self-interest of citizens, as taxpayers-
beneficiaries, to default on existing public debt, either directly through
explicit repudiation or indirectly through inflation.” A “default on existing
obligations will allow current rates of [public] spending on goods, services
and transfers to increase and/or current rates of taxation to decrease”
(Buchanan, 1987, pp. 361–2). Citizens might have a “short- run self-
interest” in default, given their dependence on non-interest outlays, but no
long-run interest in it, for the defaulting state might lose access to afford-
able credit, perhaps for years to come, in which case it’ll likely impose more
taxation and inflation on its citizens. Buchanan’s plausible case for ethical
default on unduly burdensome and risky public bonds has been questioned
by public choice allies. “In the entire Buchanan output,” writes a duo
(Brennan and Eusepi, 2002), “there is perhaps no more astounding paper,”
because deliberate default seems an inherently immoral act which “many
contractarians might seem unthinkable.” They’re thankful Buchanan
doesn’t make “a ringing endorsement” of the tactic, but they still reject it:
There is a broad and strong intuition, apparently powered by general con-

tractarian sentiments, that defaulting on public debt is ethically outrageous
in principle and could only be contemplated in extreme circumstances. Strong
intuitions ought to require strong arguments to unseat. As far as we can see,
Buchanan provides no such arguments. He certainly appears much more hos-
pitable to the possibility of debt default than one might have expected him to
be, but his grounds for such hospitality strike us as thin. (Brennan and Eusepi,
2002, p. 559)
In fact, broad acceptance today of inflation as a viable policy option rebuts

the claim that today’s standard “intuition” is that debt default is “ethically
outrageous.” In fact it has many proponents, due partly to resentment
against rentiers and empathy for deadbeats.
Interestingly, the counter-case rejects Buchanan’s view that public debt
harms future generations and helps current ones. Brennan and Eusepi
(2002) believe that debt finance “does not necessarily leave future genera-
tions as a whole worse off than tax financing, even when the revenue is
used for current consumption,” and “even if debt financing does lead
to smaller net bequests than would prevail under tax financing, this is
not necessarily a bad thing.” Default is unethical only if debtors could
repay but won’t. It’s justifiable if an overextended state does a fair “debt
renegotiation” with creditors. But Brennan and Eusepi fail to note that
states enjoy sovereign immunity, aren’t subject to the decrees of a trustee
in bankruptcy, and needn’t bargain in “good faith” with creditors. Is a
“fair” renegotiation possible in such a legally lopsided context? Buchanan’s
argument for an ethics of sovereign debt default, based on the rational
expectations of s ophisticated public bondholders who, by receiving high
yields, are compensated for default risk, isn’t novel. It was the UK’s foreign
debt policy as early as 1848, as conveyed in a diplomatic circular, the
“Palmerston Doctrine.” It is recounted by Sir John Simon of the British
Foreign Office in a 1934 speech: “My predecessor Lord Palmerston, who
is not generally regarded as having been backward in the defense of British
interests, laid down the doctrine that if investors choose to buy the bonds
of a foreign country carrying a high rate of interest in preference to British
Government Bonds carrying a low rate of interest, they cannot claim that
the British government is bound to intervene in the event of default.”7
Buchanan does more than just rehabilitate classical public debt theory.
He develops new insights by novel extensions of the “economic man”
premise to political actors: in his view, they aren’t selfless saints exempt
from typical human motives; they too pursue self-interest and for realism’s
sake scholars must examine its role in policymaking. Buchanan also devel-
ops new positive and normative theories relating public debt to matters of
intergenerational justice. But his most enduring contribution is an expli-
cation of the institutions of public finance – the norms, rules, laws, and
constitutional provisions that determine the dynamics of public debt, and
the reasons they’re altered or unalterable. This is “the institutional-choice
approach to fiscal systems” (Buchanan, 1967a [1987], p. 256).
There is in Buchanan’s approach an appreciation for a happy median,
what Aristotle called “the golden mean.” Neither democracy nor a utocracy
perform best, for neither is consistent with liberty, prosperity, or fiscal integ-
rity. What’s morally and practically optimal is the constitutionally limited
republic, a regime that lies “between anarchy and Leviathan” (Buchanan,

1975). Historically, autocracies have found it difficult to establish credit;
they’re untrustworthy and they wreck economies. When they borrow they
tend to abuse creditors. But democratic regimes also have abused public
creditors. That’s no surprise to Buchanan, for “even under the most
favorable conditions the operation of democratic process may generate
budgetary excesses.” Indeed, “democracy may become its own Leviathan
unless constitutional limits are imposed and enforced” (ibid., p. 161). The
recognition that unrestrained democracy brings chaos, class warfare,

subjugated minorities, and tyranny dates at least to Aristotle.8
How does public choice explain the recent peacetime boom in public
leverage? Brennan (2012) revives the insight that “public debt (as opposed
to current taxation) alters the intertemporal pattern of tax rates” by
reducing current tax rates and increasing future ones; but is this back-
ground context for a more novel hypothesis: demographic trends might
explain chronic deficit spending and debt accumulation. Every nation
has an “age profile of income” that influences citizens’ preference for tax
finance versus debt finance. Consistent with “most standard models of
political economy,” Brennan posits that “individuals vote according to
their economic interests,” that public debt is but deferred taxation, and
that tax burdens tend to be greater in one’s later, higher-earning years.
Perhaps the younger a populace the better off it perceives itself to be
with tax finance, while the older it is, the better off it sees itself to be
with debt finance. The young may prefer taxes because they’re not yet in
their high-earning, high-tax years, and may oppose debt because they’ll
likely live long enough to be forced to service it. Older folks may prefer
debt because it lightens their current (high) tax load, and they’ll soon
depart the world, so won’t have to service it. Brennan surmises that “the
pattern of support for public debt will track age” such that “increases in
the median age of [a] population will lead to a larger public debt.” If so,
then “public debt policy collapses [into] a kind of demographic politics.”
That’s the hypothesis. Empirical tests, he notes, yield mixed results; Japan
has an aging populace and fast-rising public leverage, which fits the
hypothesis, but that single case skews results for a dozen other nations
since World War II. Still, the originality of the public choice approach is
clear.
Wagner’s performance in Deficits, Debt and Democracy (2012a) adds
further value to the growing corpus of public choice insights. To public
debt he applies the principle of the “tragedy of the commons,” whereby
unowned land open to use by all is overharvested and ruined. One solution
is clearly defined private property rights, sanctity of contract, voluntary
trade, and institutional rules to mitigate mutually harmful acts. Wagner
believes future generations are unfairly ruined by public debt, because they
are treated as a common resource; against their consent (because not yet
born), they’re forced to bear extra (tax) burdens the moment profligate
ancestors borrow. There is “a tragedy of the fiscal commons.” People are
exploited as fiscal chattel; real capital is dissipated; and living standards
are jeopardized. The problem isn’t public debt per se but unrestrained
democracy: the system with few (if any) constitutional limits on govern-
ment power. A plausible rebuttal to Wagner’s critique is the fact that
the average duration of public securities in recent decades has been five
years, while the longest maturity has been 30 years; each is well within
the definition of a generation. As such, it seems a logical stretch to clas-
sify public debt as an exploitation of “future generations.” Within living
generations there’s certainly much fiscal exploitation of some groups (the
rich, rentiers) by others (the non-rich), but all such groups are living and
comprised of (mostly) consenting adults. The concern should be to pre-
clude any sacrifice of the living, not to prevent harm to the unborn or to
some amorphous “posterity.”
4.5 THE SEARCH FOR CONSTITUTIONAL

CONSTRAINT
Despite the astute insights of public choice scholars on public debt, much
remains unclear. According to Munger (2004) public choice explains why
“the tendency to use [public] debt rather than taxes to finance current gov-
ernment activities is predictable and preventable,” but alas, also “politically
irrepressible.” Most politicians and economists believe “[budget] deficits
and large accumulations of debt are benign,” while voters allegedly fearful
of national debt nonetheless prefer a policy mix of high spending and low
taxes – that is, chronic deficit spending and perpetual debt build-ups:
We have [a] problem with our understanding of deficits. . . What are the actual
impacts of deficits, economically and politically? What will be the impact of the
end of the brief period of surpluses [1998–2001] in the US federal budget?. . .
[W]e don’t know very much about deficits, in the direct “X causes Y” way nec-
essary for policy analysts to advise leaders effectively. While it may be true that
deficits might “eventually” have important real macroeconomic effects, their
short and intermediate term effects are hard to predict. There is something we
do know, however, and the failure to communicate it effectively to the public,
and to policy makers, represents an important failure of academic economists.
The tendency to use debt rather than taxes to finance current government
activities is predictable and preventable, but it seems politically irrepressible. . .
Deficits are not something like earthquakes or floods, the natural conse-
quence of random or deterministic process. Instead, deficits are the aggregate
consequence of the self-interested individual actions of hundreds of elected

and appointed officials. In fact, this observation, based on individual self-
interest and aggregation, are the sine qua non of the public choice approach. . .
[T]he extreme form of Ricardian Equivalence, combined with the Keynesian
policy prescription for deficit spending as a positive good, constitute an impor-
tant “idea.” What this idea has enabled, however, is the empowerment of a set
of interests whose political goals have little to do with the abstract utopian
economysticism of the Keynesian macro-control scholars. . . To most politi-
cians, of any of the main partisan affiliations, it now seems established that
deficits and large accumulations of debt are benign, or at worst only pose a
danger far off in a distant future. The problem is that these political “leaders”
may be sending a message that the electorate would take issue with, if it were
presented as a package rather than piecemeal. The problem is not just that
voters are too passive and disorganized to respond. The real problem is that
[what] voters want is perfectly sensible, but impossible to deliver because it is
not feasible. Voters want three things: (a) lower taxes, (b) increased spending
on “needed” programs, and (c) lower deficits. (Munger, 2004, pp. 236, 242,
244, 246)
Public choice theorists aim their polemical weapons primarily at

Keynesian public debt theory, especially the claim that deficit spending
entails no real economic burden and can, on the contrary, cure unem-
ployment. But they also reject the public debt theories of the new clas-
sical economists (Barro, 1974, 1989) that hold that public debt incidence
is neutral because it doesn’t supplement national wealth, stimulate the
economy, or harm posterity. Public choice theorists believe public debt is
incurred legitimately only during war and other emergencies (depressions),
or for public goods and infrastructure to the extent they confer benefits on
all (including future) generations.
Public debt, in the public choice perspective, is merely deferred
taxation. The political argument is that unlimited democracy embod-
ies elites’ electoral need for majority support, so they’re incentivized to
maximize spending and minimize taxing. The unavoidable result, deficit
spending, increases public debt issuance, but that means it increases
the non-consensual taxation of future generations, a form of “taxation
without representation” that violates fairness, but which unrestrained
democracy demands. Public choice also explains the rise of supply-
side policy prescriptions in the 1980s; instead of opposing deficits
and demanding tax hikes to close them (a losing electoral approach
before 1980), the supply-siders advised tax cuts, allowed deficits, and
hoped rivals might so fear their deleterious effects that they’d restrain
spending.
Unlike Keynes, who asserts that public debt is beneficial in an under-
employed economy, and Barro, who believes it’s innocuous, public
choice theorists say it’s harmful unless incurred by constitutionally
limited states to create remunerative public goods and services. That

Barro denies the possibility of catastrophic consequences from large
public debts doesn’t warrant classifying him as a realist. Yes, he tries
to bring context to public debt analysis by deploying the doctrine of
Ricardian equivalence to claim current generations have the necessary
omniscience, income, and altruism to save and bequeath more wealth
and offset higher public borrowing now, so heirs will have the where-
withal to pay exactly the sum of future taxes needed to service the larger
future debts. But he thereby brings a context devoid of realism. Barro’s
story, to this day still unverified empirically, is perhaps the epitome of
undue optimism.
Public choice makes an important contribution to the debate with its
analyses of debt incidence and debt illusion. The first concept pertains
to the ultimate burden of public debt; since public choice holds that
public debt is a deferred tax, its ultimate burden is said to fall upon
future generations. Obviously, this means current generations are now
burdened by the public debts incurred by ancestors. The second concept,
debt illusion, posits that current generations don’t feel the full burden
of current spending on public goods, due to relatively lower taxes; given
the resulting, artificially low price of public goods, more of them are
demanded than is efficient. The same excessive demand for public goods
leads, in turn, to further deficit spending, which generates still more
public debt. If true, the modern (democratic) fiscal state is unstable and
unsustainable.
If public choice theorists are right that public debt harms future gen-
erations, they help explain the vast rise in the scope, cost, and power of
government over the past century, and how unrepresented generations are
exploited as fiscal commons. Likewise, within living generations easily out-
voted minorities (the rich) are exploited (excessively taxed) as commons.
The critique relies on the ruination of communal property resulting from
the absence of carefully defined, legally protected property rights. Yet the
living today can’t be convinced to stop their exploiting, because they’d get
less in state benefits or pay more in taxes; the costs are too vague and the
future victims are perfect strangers.
Public choice theorists rightly stress both the positive and normative
aspects of public debt; since such debt arises in the context of demand for
public goods exceeding the ability or willingness to pay for them (by taxes),
they address norms pertaining to fairness, free-riding, rent-seeking, and
exploitation. It’s possible that positive insights aside, political elites know-
ingly endorse an expansive, even overleveraged state, without admitting it
publically, on the grounds that normative values should trump positive ones.
Most political economists also stress the need for “ credible commitments”
in fiscal-monetary policy and warn of the “time inconsistency” problem

entailed in policy pronouncements and behavior over time. Governments
over the past century, while becoming more democratic, also became
less just, less honest, and less pacific. The concept of “credible” is linked
closely to “credit.” Unless a sovereign can commit credibly to maintaining
its credit (its ability and willingness to service its debt in real terms), it’ll
be discredited and find it more difficult to borrow affordably, if at all. The
most believable, credible commitment offered by political elites today is
that they’ll keep waging undeclared, often interminable wars, and preserve,
protect, and expand the welfare state at any cost. This requires more public
debt, not less.
If private actors and political elites alike are driven by self-interest, as
public choice theorists contend, the dilemma of the “fiscal commons”
might never be resolved, at least not without a change in society’s predom-
inant ideology, in its prevailing conception of justice, and its expectations
about government’s proper role. Public choice theorists are right to focus
on the intertemporal asymmetries that risk national fiscal ruin, and to
suggest constitutional-institutional cures (a balanced budget amendment,
a gold standard, electoral term limits). But the same public that prefers
policies that generate excessive public debt also oppose the institutional
reforms that might curtail or nullify its preferences. If a democratic elec-
torate truly opposes large public debts it can always vote accordingly and
no constitutional restraint would be needed; if instead it condones large
debts then no constitutional restraint would be effective. If a dilemma
like this can be solved, the public choice school seems best equipped to
solve it.
NOTES
1. On caricatures of self-interest and their influence on public choice theory, see Salsman
(2015b).
2. Wagner (1992, 2012a, 2012c), Brubaker (1997), Wrede (1999), Jakee and Turner (2002),
and Raudla (2010).
3. Starting in early 1942 the Fed pledged to keep the ten-year US Treasury bond yield near
3 percent. Although federal debt increased nine-fold between 1941 and 1946, the bond
yield averaged just 2.4 percent. In the five years after the accord terminated in 1951
(Hetzel and Leach, 2001), when the debt didn’t grow, the ten-year yield increased to an
average of 3.1 percent. The Fed materially increased its Treasury holdings during the
accord period but also offloaded a lot to banks, where Treasury securities increased from
22 to 56 percent of assets between 1941 and 1945.
4. Ferguson (1964), Buchanan and Wagner (1977 [1999]), Buchanan et al. (1987), Balkan
and Greene (1990), Holcombe (1996), Jakee and Turner (2002), Munger (2004), Wagner
(2007), Cullis and Jones (2009), Brennan (2012), and Wagner (2012a).
5. See also Blewett (1981), Wagner (1976), Congleton (2001), and Da Empoli (2002).
6. Patterson (1955), Holcombe (1998), Borna and Mantripragada (1989), Boadway (2002),
Wittman (2002), McGee (2007), Noy (2008), Painter (2009), Alvey (2011), and Friedman
(2013).
7. Cited in Eichengreen and Lindert (1989, p. 19).
8. For more of Buchanan’s views on public debt, see Buchanan (1959, 1967b [1987], 2000),
Buchanan et al. (1987), Buchanan and Musgrave (1999), Templeton (2007), and Wagner
(2014).
5. The limits of public debt
Having assessed theories of public debt advanced over the past three cen-
turies by classical, Keynesian, and public choice scholars, I turn next to
questions concerning the sustainability and ultimate limits of public debt.
How much can a government safely, affordably, and productively borrow?
How does it best cultivate public credit, that is, its capacity to borrow?
Why, when, and how do governments default, and to what effect? Is default
sometimes justifiable? What explains the recent rapid growth in public debt
as well as the unfunded contingent liabilities related to “entitlement” and
“safety net” schemes,1 including pledges to bail out firms deemed “too big
to fail?”2
The distinct strains of pessimism, optimism, and realism among public
debt theorists regarding the origins, effects, and morals of public debt
extend to questions of sustainability and limits. I contend that the realist
interpretation is the most persuasive and most corroborated by fiscal facts;
it’s also best positioned to explain the limits of public debt, because it
incorporates a more relevant political economy context.
The sustainability of public debt is a sovereign’s capacity to borrow
prudently and affordably so as to optimally provide necessary and proper
public goods (infrastructure) and services (police, courts of justice, national
defense), without sacrificing its sovereignty or the rights, liberties, and
prosperity of citizens. Valid assessment of sustainability requires more
than mere metrics; the use and abuse of public debt differs by regime type:
constitutionally limited republics outperform both autocracies and democ-
racies, which are each unconstrained, thus prone to fiscal profligacy and
mistreatment of creditors.
The literature on the limits of public debt investigates such concepts as
“fiscal sustainability,”3 “fiscal space,”4 “fiscal limits,”5 “fiscal dominance,”6
“fiscal fatigue,”7 “debt intolerance,”8 and “debt overhangs.”9 In addition
there are a growing number of studies of public debt restructurings and
defaults,10 facilitated by new databases.11 Many theorists understandably
conceive limits as an optimization problem, so just as the Laffer curve posits
an optimal tax rate that maximizes sovereign tax revenues, so t heorists posit
a “debt Laffer curve” of optimal public leverage; o ptimization necessar-
ily implies a goal (or “objective function”), and whether it be to minimize
217
interest expense, income inequality, or the role of rentiers, or to maximize

economic growth12 or some other goal, is subject to debate.
Pessimists often cite some absolute sum of public debt and say it’s
unsustainable, but it’s a meaningless observation because it lacks context;
optimists often deny that there exist any real limits to public debt, but that
too is meaningless without some metrics that incorporate relevant context.
Yes, tautologically, the “unsustainable” can’t and won’t be sustained, but
this conveys nothing important. What is worth knowing is how, when, and
why some state of fiscal affairs might change, for better or worse. That’s
the challenge for any scholar wishing to examine objectively the limits of
public debt.
5.1 PUBLIC DEBT AND DYSFUNCTIONAL

FINANCE
Until recently the distinction between public credit and public debt
appeared infrequently in the literature, although Lutz (1947) is an excep-
tion. Analysts typically focus on outstanding debt, which is tangible and
(usually) measurable, whereas public credit is more opaque, although
crucial, as it pertains to borrowing capacity. In private credit markets
lenders typically establish a “line of credit” based on a borrower’s cred-
ibility, income, net worth, and collateral. Nothing equivalent or so con-
crete exists in public markets. But this doesn’t mean limits to public debt
don’t exist; a long historical litany of public debt restructuring and default
provides ample evidence that they do.
Unlike private creditors, public creditors have imprecise estimates of
public credit and thus can’t easily specify a “capacity utilization rate” for
public debt. It’s easy enough to measure public debt as a percentage of
national income (GDP), what I call “public leverage.” Its main advantage
is simplicity and international comparability. But not all sovereigns report
their debt or GDP accurately. More problematic still, even in advanced
nations sovereigns have contingent liabilities that are many multiples of
their outstanding bonds, yet very difficult to measure precisely; these
fiscal manifestations of burgeoning welfare states simply didn’t exist in
the century of faster economic growth and lower public leverage before
World War I. Of course, attempts to limit explicit public leverage can be
more than offset by expansions of contingent public leverage. Bonds and
entitlements alike are obligations; each enjoys broad electoral support in
unrestrained democracies because they appear not to involve a material
tax burden. Yet just as explicit public debt is but deferred taxation, so
contingent public liabilities are deferred borrowing – hence also deferred
The limits of public debt 219
taxation; what sovereigns leave unfunded today they must fund eventually
(when cash is due to eligible beneficiaries). States can default on c ontingent
liabilities as much as on bonds, of course, but less conspicuously.
Further complicating accurate assessment of public debt limits is the
fact the nations differ in taxable capacities, depending on their tax codes,
the willingness of their citizens actually to pay taxes (by choosing to work,
or spend, more or less), and rates of compliance. Suppose a nation called
“Reckless” has a public leverage (public debt/GDP) of 100 that’s twice
that of another (at 50 percent) named “Prudence.” Which nation’s debt
is less sustainable? Suppose each year Reckless routinely extracts half
of national income in tax revenues while Prudence extracts only a tenth.
The public debt of Reckless is more sustainable, all else equal, despite its
higher leverage, because its debt is only twice its annual tax revenues, while
the debt of Prudent is quintuple its tax revenues. Reckless doesn’t look so
reckless, while Prudence is far less prudent than a surface view s uggests.
The public debt/GDP metric is better than none but the public debt/
revenue ratio better measures fiscal sustainability. With such refinements
the complexities of debt dynamics multiply. Professional bond- rating
agencies try to build rigorous, proprietary models of debt sustainability,
but they rarely anticipate public debt crises, defaults, or recoveries,13 and
unfortunately there exist no long or comprehensive data series on tax
revenues.
The metaphor of a line of credit is helpful yet not strictly applicable
to today’s public debtor. First, states are unique in that they alone wield
a legal monopoly on the legitimate use of force in a certain territory. A
separate question is how states exercise their power and for what purposes.
Second, the power of most states has expanded enormously over the
past century compared to the previous century. By now most sovereigns
exercise nearly unlimited power to tax, spend, regulate, wage war, issue
bonds, create money, redistribute income, renege on public debt and, by
the principle of sovereign immunity,14 skirt bankruptcy courts and avoid
penalties for tortious acts. This fundamental transformation in state power,
we’ll see, is crucial to properly analyzing the modern limits of public debt.
Recall that in the 1940s Lerner developed an influential approach
to deficit spending and public debt called “functional finance.” Unlike
Keynes or Hansen, from whom he drew, Lerner was unabashed in his
advocacy of virtually unlimited deficit spending, debt issuance, inflation,
and wage-price control. As he put it, “functional finance rejects completely
the traditional doctrines of ‘sound finance’ and the principle of trying to
balance the budget.” For Lerner “the size of the national debt is relatively
unimportant” and interest expense “is not a burden on the nation,” so
a state “cannot be made ‘bankrupt’ by internally held debt.” Indeed, he
argued, “the weird notion of a country ‘going bankrupt’” reflects a con-

spiracy among “private capitalists building up a conception of the State
in their own image and impressing this capitalist mythology on the other
members of the capitalist society” (Lerner, 1944, p. 304). A few years later
Lerner (1948) concedes that “too large a [public] debt can be a serious
matter” if too much debt is held by (owed to) foreigners, but he still offers
no guiding metric, at root because his dogma of “functional finance”
rejects rules altogether. Lerner tells discretionary policymakers what they
most wish to hear: do “whatever it takes” to keep the economy (and state)
functioning, regardless of norms or costs. If public debt seems excessive,
inflate it away (Lerner, 1943, p. 41); if inflation ensues, impose wage-price
controls; if the controls cause queues, adopt rationing. In short: borrow,
spend, print, and control – until things (somehow) “improve.”
In contrast to Lerner, we should characterize breakdowns in public debt
and the economic stagnation it breeds as dysfunctional finance. Public
finance operates best by objective standards that, if violated, undermine
government efficiency, economic productivity, and political liberty. To the
extent that unrestrained deficit spending reflects unrestrained majority
rule, dysfunctional finance reflects a dysfunctional politics. If so, the cure
can’t be more democracy, or autocracy either. That’s a false alternative.
Logic and history alike demonstrate that only constitutionally limited
republics committed to the preservation and protection of individual
rights can immunize public governance from the wills of irrational people
and permit a truly rational and functional form of public finance.
5.2 METRICS FOR DEBT SUSTAINABILITY AND

OVERHANGS
Theorizing about the limits of public credit (debt capacity) is more art
than science. Early efforts by Wright (1940) and Hansen (1941, p. 136)
showed that the United Kingdom safely borrowed more than 200 percent
of GDP in 1818 and more than 150 percent of GDP in 1923. There was no
national ruin. Today Japan has the highest public debt/GDP ratio among
advanced nations (226 percent) even though recent studies (Reinhart and
Rogoff, 2009) suggest a 90 percent ratio as the upper limit beyond which
advanced nations begin to risk default and slow growth, and a still lower
ratio (60 percent) for less developed nations (LDCs). Perhaps Japan isn’t
ruined, but without doubt it has stagnated economically for decades. As
a prerequisite for adopting the euro in 1999, the Maastricht Treaty of
1992 required would-be European members to cap their public debt and
annual deficits at 60 percent and 3 percent of GDP, respectively; many
members have since flouted those rules and consequently have stagnated
and defaulted. In 1940 Wright was one of the first to question the view that
there was no effective limit to sovereign borrowing:
In “An Economic Program for American Democracy” [1938] it is argued that

the national debt may be increased indefinitely – apparently, in fact, without
limit. . . Are there any definite limits to the rise of the public debt? Few ques-
tions evoke more controversy and more confusion. The layman is likely to
consider merely what he would do, if he were confronted by an ever-increasing
number of bills which had to be paid. . . Such a mode of thought is clearly
inadequate, but it is equally unwarranted to go to the opposite extreme and
deny that an internally held debt can ever be a burden. Truth, it is submitted,
lies somewhere in between, but we must realize from the start that we cannot
speak of “limits” in the sense of a sudden line beyond which one cannot pos-
sibly go. We must speak rather of increasing frictions. At what point these fric-
tions will become unbearable depends on the political attitude and enthusiasm
of the people. The economist cannot prophesy a breaking point, he can only
indicate tendencies toward one. . . The most nearly definite limit on the amount
of government spending is the desire to avoid a price inflation. . . Clearly, credit
creation within a period must not exceed the flow of purchasable goods in that
period; if the flow of credit creation is greater, price inflation will result. But
aside from this limit on stimulation there are certain other limits of an institu-
tional nature which are said to confine the growth of the national debt. I need
not mention the statutory debt limit of the country, for that can obviously be
changed. The two problems which concern us most here are, first, whether the
size of the national debt is limited by the size of bank reserves, and second,
whether the expansion is limited by a saturation of the market for government
bonds. (Wright, 1940, pp. 116–18)
Wright’s discussion contains the usual elements of public debt theory,

including its many shortcomings and ambiguities: he can’t pinpoint a limit
for public debt but surmises that one exists, he suspects the private-public
analogy is inadequate, he says excessive debt financing can become infla-
tionary, he senses that “political attitudes” are influential, and hopes insti-
tutional rules can limit public debt. Unfortunately, “the economist cannot
prophesy a breaking point.” Public bonds might not find willing buyers, but
banks could be compelled to buy them; what limits public debt existentially
isn’t interest expense (which is someone’s income) but the ultimate futility
of imposing higher taxes and inflation rates. For Wright “it is theoretically
possible for deficit financing actually to cause a decrease in investment and
consumption” (Wright, 1940, p. 123) – meaning, contra Keynes, a reverse
multiplier effect. But he says no more about limits. He tries to bridge the
gap between fiscal conservatives who oppose fast spending growth and
foresee dire results for public debt and Lerner acolytes who deny any limits
whatever.
A valiant effort to specify a limit for public debt is made by Buchanan
(1987), synthesizing such factors as the sum of debt, its growth, the
economy’s growth, the ratio of public debt to national income, the prevail-
ing interest rate, and interest expense on the debt as a share not only of
public spending but also of the annual budget deficit:
So long as the rate of increase in interest-bearing public debt exceeds the rate
of economic growth, the interest charges on the public debt as a share of total
product must increase. Either total public outlay must increase as share of total
product or interest charges as a share of total budgetary totals must increase.
At some point, the annual interest charge will come to equal and then exceed
the annual deficit. Once this critical threshold is passed, the simple economics
of default come into play. If government is unable to borrow funds that are suf-
ficient to meet annual interest charges on accumulated debt, default on existing
obligations will allow current rates of spending on goods, services and transfers
to increase and/or current rates of taxation to decrease. At this juncture, it is
apparently to the short-run self-interest of citizens, as taxpayers-beneficiaries,
to default on existing public debt, either directly through explicit repudiation or
indirectly through inflation. (Buchanan, 1987, pp. 361–2)
Buchanan sees that if public debt grows faster than the economy then
public leverage (public debt/GDP) must rise, and if there’s no offset-
ting decline in the interest rate on public debt then interest expense also
must rise relative to GDP. Interest expense is also a budget outlay, and
non-discretionary if a sovereign’s bonds are to be credible. The danger is
that interest expense grows relative to total public spending. The “critical
threshold,” for Buchanan, is where annual interest expense on public debt
equals the annual budget deficit: the state borrows not merely to rollover
or repay maturing principal but borrows anew just to pay interest on its past
borrowing. The debt burden can multiply quickly. Conditions worsen if
interest expense exceeds the annual deficit, for then “the simple economics
of default come into play,” as “the government is unable to borrow funds
that are sufficient to meet annual interest charges on accumulated debt.”
Assessing the “critical threshold” for the United States in fiscal year 2015,
we see federal debt carried at an average interest rate of 2.73 percent and
interest expense at $450 billion, compared to a budget deficit of $438 billion.
The US national debt now totals $19 trillion. To exceed Buchanan’s “ critical
threshold” the “annual interest charge” must “come to equal and then
exceed the annual deficit.” Indeed, interest expense on US public debt in
2015 ($450 billion) is slightly larger than the deficit ($438 billion). Is the
US thereby in fiscal danger? Its deficit was substantially larger in 2009
($1.4 trillion), when interest expense wasn’t much different than it was in
2015. By Buchanan’s calculus the United States was in less fiscal danger
in 2009 despite a deficit three times as large as in 2015. It seems odd that
a larger budget deficit could less jeopardize debt service capacity than a
smaller one simply because it dwarfs interest expense. Were the US deficit a
mere tenth of its current size (say $44 billion) it would be far below interest
expense; but why would that necessarily spell trouble for debt service? By
Buchanan’s calculus it would.
Buchanan’s algebra seeks to quantify the risk of a “debt spiral,” in which
large debts sink by the inexorable law of compounding interest. If a debtor
must borrow merely to pay interest on past borrowings, it pays interest on
interest and is less likely to emerge whole from its deepening debt hole. The
“magic” of compounding interest for creditors is a curse for overleveraged
debtors. Initially fiscal decay is slow and default risk low; soon each is swift
and severe. In Hemingway’s The Sun Also Rises someone is asked, “How
did you go bankrupt?” Answer: “Two ways. Gradually, then suddenly.”
Buchanan’s novel approach has since been elaborated, debated, and
revised by various algebraic analyses of public debt dynamics.15 The
basic algebraic truth is that any particular public debt/GDP ratio (public
leverage) is stabilized only if the interest rate on public debt equals the
growth rate in GDP, in a context of budget balance. If instead there’s a
primary budget deficit – that is, a deficit after deducting interest expense –
public leverage will rise unless the interest rate is less than GDP growth.
This assumes that an existing public debt/GDP ratio is already sustainable
and merely to be stabilized. To reduce public leverage amid a primary
deficit, the interest rate must be substantially below the GDP growth
rate. In a world of high public leverage, low inflation, slow GDP growth,
and an unwillingness by politicians to achieve a primary budget balance
(or surplus), it’s obvious why policymakers would try hard to depress
public bond yields. The zero-interest-rate policies (ZIRPs) of central banks
in recent years supposedly seek to maximize demand, but surely they also
try to minimize public interest expense.
Rising public debt in recent decades has prompted studies of the
political-economic causes of debt accumulation,16 optimal levels of public
debt,17 the aftermath of excessive public leverage (“overhangs”),18 and the
causes of defaults.19 Below I explain how this research promotes a better
understanding of the limits of public debt.
In Barro’s model (1979) public debt is incurred innocently by “tax
smoothing” over the business cycle, a passive approach that avoids fre-
quent, disruptive and procyclical shifts in tax policy. Instead of meeting
cyclical deficits (from recessions) with tax increases or spending cuts
(which might depress the economy), and instead of meeting cyclical budget
surpluses (from expansions) with tax cuts and spending increases (which
might stimulate the economy), policymakers simply allow deficits and
surpluses to run their course. They borrow to plug deficits in downturns
but repay with surpluses in upturns. Debt accumulates only in emergencies
(like war); there’s no chronic deficit spending over the cycle. “A central
proposition is that deficits are varied in order to maintain expected con-
stancy in tax rates.” “Debt issue would be invariant with the outstanding
debt-income ratio” and also “with the level of government spending”
(Barro, 1979).
In a more sophisticated model of a “Leviathan” state, Brennan and
Buchanan (1980, pp. 103–12) see government as “intent on maximizing
not the public good but its net revenues,” be it permanently (“perpetual
Leviathan”) or occasionally (“probabilistic Leviathan”). Borrowing is
deferred taxation but because it “provides a means for Leviathan to
allocate desired revenue use inter-temporally, its major importance stems
from the fact that [it] offers an additional revenue source in its own right.”
In this model Leviathan’s debts “must be honored,” else creditors will stay
away. Moreover, “the total amount that a government can borrow may be
constrained in three ways: (1) by the ability of the government to service
and redeem the debt – that is, the future revenue capacity assigned to gov-
ernment defined by its constitutionally allowable taxing powers; (2) by the
relative preferences of individuals as between government bonds and other
assets; and (3) by the general extent to which individuals wish to postpone
current consumption (and acquire assets)” (pp. 103–5).
Of course, “the power to create bonds is futile unless government also
has the power to tax,” for “the power to borrow in itself assigns to govern-
ment no power that is not already embodied in the assigned revenue instru-
ments to which it has access.” In essence, “the power to borrow permits
government [to] appropriate now, in some current period, rather than later,
the capitalized value of the future revenue streams.” Whereas borrowing
by a perpetual Leviathan (autocracy) shifts the timing but not the level of
outlays, the case is “dramatically different under probabilistic Leviathan
(democracy),” because there “the power to borrow implies that the
revenue-maximizing government, finding itself in office and not anticipat-
ing to remain, may, by means of borrowing, appropriate to itself the full
value of tax revenues in all future periods, including those in which such
a Leviathan is no longer operative.” In short, “the power to borrow effec-
tively transforms the ‘probabilistic Leviathan’ into ‘perpetual Leviathan’
from the standpoint of the taxpayer” (p. 104). In effect, democracy gives
way to autocracy. To the extent that other bonds compete with public
bonds, the state “may find it necessary to pay higher and higher rates,” such
that “future [tax] revenue may be exhausted before all private assets are
replaced by [public] bonds” (p. 105). Finally, “limits are set on the ability of
government to sell bonds by the maximum level of the community’s capital
formation,” for “government cannot acquire more from” the saver than his
level of savings in the current period – assuming bond purchasing remains
voluntary. Individuals may not fully discount into the present the higher
future tax bills associated with higher future debts, so they’ll provide more
savings to the state today, so it can borrow more than it otherwise might.
External funds also expand borrowing capacity. Ultimately, “the limits [to
public borrowing] are those imposed by the full capitalized value of future-
period tax revenues,” plus current tax revenues.
For Brennan and Buchanan (1980), the more fiscally credible a state,
the more it can borrow, and from a greater variety of sources. If so, “the
‘burden of debt’ can be much larger under external than under internal
debt, because more debt will be issued in the former case.” Absent any
strict “constitutional constraints on the ability to borrow externally,”
Leviathan’s debts become excessive and risky to bondholders. This analysis
“tends to reinforce classical precepts that limit government resort to this
revenue-raising instrument to periods of demonstrable fiscal emergency,”
and “if the citizen-taxpayer, at the constitutional stage of decision, projects
only the possibility that a revenue-maximizing Leviathan may emerge,”
then “rational choice should dictate a preference for quite severe con-
straints on the governmental power either to levy taxes on capital or to
create public debt” (p. 108). A state’s “power to create money” constitutes
its third revenue source, for “money is rather like a form of debt,” but
free money, for it “needs to pay no interest on its implicit loan.” Indeed,
“the value to [Leviathan] of a perpetual interest-free debt is equal to the
principal – the real value of the money stock itself ” (pp. 111–12). By print-
ing money without the strictures of a gold standard, any state can dissipate
much of the real value of its debt (Brennan and Buchanan, 1981).
Cukierman and Meltzer (1989) argue that public debt is driven by
popular demands for wealth redistribution, both intragenerationally and
intergenerationally. Privately, of course, no one can legally impose net
debts (negative estates) on others, including heirs; public debt arises, they
contend, when free riders on government services try to forward a negative
worth (public) estate to posterity. “The existence of a positive national debt
is directly traceable to the existence of a sufficient number of individuals
who desire to leave negative bequests but are prohibited [under law] from
doing so,” they explain. “By voting for [government] deficits, they increase
their consumption, crowding out capital.” The more people are “bequest
constrained” (less wealthy, thus less likely to bequeath positive estates),
the more they’ll vote for debt-financed (versus tax-financed) spending.
Beneficiaries include those earning lower wages today plus “those with
low wages relative to the wages expected by the next generation.” They
“will try to tax future wealth,” meaning: vote for borrowing now and leave
repayment to subsequent generations (pp. 730–31).
Of course, the boosting of public debt needn’t be partisan. In some cases
it’s not the prototypical free-spending Keynesian but “fiscal conservatives”

who pile up huge debts (as in the United States in 1981–89 and 2002–09).
In one model that asks “why a stubborn conservative would run a
[budget] deficit,” Persson and Svensson (1989) answer that “a conservative
government,” ostensibly “in favor of a low level of public c onsumption,”
may suspect it’ll soon be “replaced by a government in favor of a
larger level of public consumption.” Borrowing in advance, conservative
incumbents can saddle liberal successors with debts and deficits that will
require what (future) voters will hate: tax hikes and/or spending cuts.
In a series of papers published in the 1990s, Harvard’s Alberto Alesina
and co-authors provide both positive and normative theories of public
debt.20 Building on the thesis of Cukierman and Meltzer (1989), one
study argues that public debts “provide a means of redistributing income
over time and across generations” and “serve as a means of minimizing
the deadweight losses of taxation” from public spending (Alesina and
Tabellini, 1990a, p. 403). Influenced by the public choice approach, they
“abandon the assumption that fiscal policy is set by a benevolent social
planner who maximizes the welfare of a representative consumer,” and
imagine two self-interested political rivals who alternate officeholding;
yet they reject “the political economy of budget deficits” presented by
“Buchanan and his associates,” because it’s “based upon the somewhat
questionable notions of ‘fiscal illusion’ and voters’ irrationality.” Alesina
and Tabellini try to reconcile public choice assumptions about selfish poli-
ticians with new classical insights about rational expectations, to improve
public debt theory. If there’s sharp “disagreement between current and
future” policymakers, “public debt is used strategically by each govern-
ment to influence the choices of its successors.” The result is “a bias
towards budget deficits” whereby “the equilibrium stock of public debt
tends to be larger than [is] socially optimal.” Citizens, free of fiscal illusion
and irrationality alike, nonetheless are ill served by politicians. Blame goes
not to democracy but to a lack of democratic consensus: “It is citizens’
disagreement, rather than their myopia, that may generate a deficit bias
in democracies.” In the model, “the equilibrium level of public debt tends
to be larger: (i) the larger is the degree of polarization between alternat-
ing governments; (ii) the more likely it is that the current government will
not be reappointed; (iii) the more rigid downward is public consumption”
(Alesina and Tabellini, 1990a). In short, if politicians can’t cut spending or
even slow its growth, and partisanship is strong while electoral turnover is
high, deficit spending and public debts will be high.
In another valuable effort, Alesina and Tabellini (1992) consider which
political regime types tend to generate high public leverage, and whether a
sovereign is best modeled as a benevolent dictator devoted to public good
or instead as a self-interested revenue maximizer. “A general result” is that

a “fragmentation of [political] power and lack of unified control leads
to myopic [fiscal] policies, such as borrowing or delaying a tax reform.”
There’s “a bias towards both high debt and high inflation.” For some
scholars the bias reflects “frequent turnover of governments with different
preferences,” while others blame “decentralized government,” adding that
“a myopic [fiscal] policy does not reflect a deliberate choice, but rather
the inability to make a collective decision” due to “a fragmentation of
power.” It seems the problem is democracy; scholars find that “high public
debt countries are almost exclusively parliamentary democracies with a
highly proportional electoral system,” that “almost all countries” of that
type “have very high public debt.” High debt and inflationary finance
accompany “unstable governments” formed from “a coalition of parties.”
In a related study Alesina and Perotti (1995) examine why OECD nations
accumulated high debt between 1970 and 1990. In certain high-income
democracies public leverage doubled. Unable to identify economic causes,
the authors cite “political- institutional factors” – electoral laws, party
structures, budget laws, plus polarization. Ultimately they blame “ strategic
conflicts between political parties or social groups” (p. 16). It’s not a
market failure but a political failure – specifically, a failure of democracy in
its “purer” form (proportional representation). Yet the authors imply that
budget balance is attainable only amid near-perfect political consensus.
Does that require one party rule? What price fiscal responsibility?
Persson and Tabellini (2000) build “a simple two-period economic model
that embeds special-interest politics,” and “a common pool problem,”
where collectively the incentive is to raid the Treasury. Deficits are inescap-
able. “As the property rights to current and future tax revenues are not
well-defined, all actors have an incentive to spend a lot and to spend soon,
in order to appropriate more resources.” The living treat future generations
as fiscal commons. Where revenue-raising is centralized, but “spending
decisions are decentralized,” as in parliamentary systems with proportional
representation, “there is a tendency not only [for sovereigns] to overspend,
but also to over-borrow” (p. 345). Here the influence of the public choice
school is obvious. Velasco (2000) likewise “develops a political-economic
model of fiscal policy” and public debt in which “government resources
are a ‘common property’ out of which interest groups can finance expen-
ditures on their preferred items,” a case that yields “striking macroeco-
nomic implications,” including that government “transfers [of income and
wealth] are higher than a benevolent planner would choose them to be,”
and in the long run government debt tends to be excessively high, as “high
net transfers early on” generate “high taxes later on.” Rent-seekers are
induced to game the system and free ride off the productive. Although
these “implications” are “striking” to Velasco, they’d elicit little sur-

prise from scholars like Mises, Lutz, and Buchanan, who are critical of
democracy’s tendency to become unlimited, deny that state planners will
be “benevolent,” and recognize that centralized and socialized systems
fail because property rights are undefined (or illegal) and resources are
dissipated in a commons.
A “positive political economy of public debt” is offered by Franzese
(2000), with a focus on post- war empirics in 21 advanced (OECD)
nations. He notes how “theoretical literature seeking to explain public-
debt accumulation exploded in recent years as debt crises emerged in
many nations” in the early 1990s (notably in Nordic nations). He laments
that Barro’s (1979) tax-smoothing thesis remains dominant, for it only
explains infrequent, dramatic episodes of deficit spending (amid wars and
recessions), not perpetual debt build-ups. Franzese for the first time tests
“nine positive-political-economy-of-public-debt theories” of perpetual
debt accumulation, including “government fractionalization,” political-
ideological “polarization” (partisanship), wealth and age distributions
(affecting intergenerational transfers), electoral and political budget cycles,
“strategic debt manipulation” (to restrain opposite party successors),
“distributive politics and multiple constituencies,” tax code complexity,
fiscal illusion, and a lack of central bank autonomy from the state. He
finds evidence for six factors: tax smoothing, fractionalization, polariza-
tion, electoral budget cycles, tax code complexity, and fiscal illusion. He
rejects the thesis that wealth or age distribution spawn large public debts
(as a way to defer taxation and burden future generations), and the notion
that officeholders cleverly incur debt so as to tie successors’ hands. The
impetus for high and/or rising public leverage is “different distributions
of political and economic influence, which fostered transfer- payments
growth, which drove spending-growth more generally, which, finally, gov-
ernments typically partially debt-financed.” Even so, his “all-encompassing
model” explains “only about half (53%, un-weighted) of the total variation
in developed democracies’ debt experiences from 1956 to 1990” (p. 67).
Distinct from theories of the origins of rising public debt are those that
try to specify optimal degrees of public leverage, a precursor to theories
of default. Sachs (1989) is the first to suggest an optimal rate of leverage,
with problems associated with rates that are too low and too high. The
onerous debt service of states in LDCs is akin to a punitive tax rate, and
were they leverage reduced, they’d more likely repay a lesser total debt.
Claessens (1990) elaborates, with what he calls a “debt Laffer curve,”
modeled after the supply-side economist who, in the 1970s, posited an
optimal tax rate that maximized tax revenues; too high a tax rate can
yield less than a lower tax rate if it curbs incentives to produce or declare
taxable income. Claessens (1990) uses the approach to estimate optimal

public leverage. Calculations incorporate the gap between the nominal
(face) value and market value of public bonds; the latter is lower if default
probability is higher, which means the yield-to-maturity is higher than the
fixed coupon rate – a sovereign “junk” bond. In two-dimensional space a
debt Laffer curve, moving northeasterly from the origin, is a joint plot of a
public bond’s face value (horizontal axis) and market value (vertical axis).
At lower leverage (here, public debt in proportion to a nation’s exports),
bondholders expect full payment, so nominal and market value are close;
at higher leverage default is more likely, so a bond’s market value declines
relative to its face value, and the latter also increases with more debt
issuance. The crest of the debt Laffer curve signifies optimal public lever-
age.21 As with J.B. Say and J.S. Mill, this approach seeks a message (about
debt sustainability) in the market prices (and yields) of public bonds.
Joines (1991) asks how large a deficit a sovereign can handle.
“Governments may be unable to sustain large budget deficits indefinitely,”
he argues, if only because astute investors monitor leverage. Although
he “explores the sustainability rather than the economic consequences
of government budget deficits,” they’re not unrelated; if deficits hurt
(or help) the economy, they also hurt (or help) taxable capacity and thus
debt service capacity. But he knows nominal GDP is real growth plus infla-
tion, so by definition inflation mitigates leverage, citing the “historically
typical” public debt/GDP ratios in the United States. Joines reckons that
the United States can safely run deficits of $175 billion per annum near
term and eventually even wider ones. “One need not reduce the deficit to
zero, to hold the public debt stable at its current ratio” to GDP, he notes.
Moreover, “the real value of the government debt cannot grow forever
at a rate greater than the real interest rate.” To ensure public debt is sus-
tainable “government must run current and future non-interest [budget]
surpluses equal in present value to the principal and accrued interest on
its outstanding debt.” Moreover, if the real interest rate “exceeds the
growth rate of real national income,” public leverage (public debt/GDP)
will increase without bound, with the result that government will feel “a
greater incentive to default, either explicitly or by eroding the debt’s real
value through inflation” (Joines, 1991, pp. 3–4). In truth, Joines contends,
“economists have no idea of the upper limits” of public leverage, nor
“evidence that relatively high levels of debt are inconsistent with rapid
economic growth” (pp. 4–5). Yet “the size of the debt/income ratio is still
important” because high leverage “forces a government to levy higher tax
rates for any given level of spending,” which imposes “welfare costs on
society, since it distorts economic decisions.” Worse, “at sufficiently high
debt/income ratios [he doesn’t say how high] the government cannot collect
enough tax revenue to service its debt. Thus the assumption that investors
impose an upper limit on the size of government debt is reasonable” (p. 7).
Likewise, Smyth and Hsing (1995) ask “whether an optimal [public] debt
ratio exists that will maximize [real] economic growth.” They find real US
GDP growth determined by public leverage and by growth rates, respec-
tively, in employment, capital services, and money supply. The optimal
public debt/GDP ratio is 49 percent for gross (total) debt and 38 percent
for net debt (gross debt less that held by government trust funds and
agencies). Higher ratios retard future economic growth rates. In contrast,
Aiyagari and McGrattan (1998) believe that “concerns regarding the high
level of [public] debt in the US economy” are “misplaced.” Despite the US
public debt/GDP ratio in 1998 (64 percent) being double the ratio in 1980,
no worries are warranted. Any “welfare gains” from an “optimum quantity
of [public] debt” are too small to justify a harsh scheme of fiscal austerity.
The problem is that in the long run public debt crowds out private savings,
curbs capital formation, and distorts employment. In this model “the
optimum quantity of debt will be high if debt is effective in smoothing out
consumption over the lifetime of an individual” but “low if debt crowds
out capital and therefore lowers consumption” or “if the incentive effects
of higher distortionary taxes are important.” They estimate “the optimum
quantity of debt” to be “equal to the average public debt/GDP ratio for the
US over the post-WWII period,” or 54 percent (p. 461). But their simple
average masks a wide range during this period, from a low of 32 percent in
1974 to a high of 121 percent in 1946.
Although difficult to imagine in today’s climate of anxiety (mostly
popular) about high and rising public debt, in 2000 analysts worried about
its decline and disappearance. The worry was best captured in a report
titled “Life After Debt” (US Department of the Treasury, 2000; see also
Reinhart and Sack, 2000; Kestenbaum, 2011), prompted by the United
States registering budget surpluses (1998–2001) for the first time since
1969. This led some economists to predict an end to US public debt (due
to full repayment) by 2012; debate ensued about whether it would be good,
bad, or innocuous for the economy and those conducting monetary policy
with US debt.22 By 2001 the debate was moot: deficit spending resumed
due to recession and war spending after the terrorist attacks. Instead of
US debt plunging from $5.7 trillion in 2000 (55 percent of GDP) to zero
by 2012, it tripled to $16.4 trillion (102 percent of GDP). In 2000, Reinhart
had worried about the negative “economic consequences of a disappear-
ing government debt” (Reinhart and Sack, 2000) but by 2012 was worry-
ing about the negative economic consequences of excessive public debt
(Reinhart et al., 2012). Pessimists worry about public debt regardless of
context; optimists, of course, are similarly biased.
Having examined theories of the origin and persistence of public debt

and of optimal leverage, I turn to studies of what theory and history tell us
about the typical aftermath of high public debts, high public leverage, and
large debt defaults.
Reinhart et al. (2003) develop the notion of “debt intolerance,” while
Reinhart and Rogoff (2004) delineate the concept of the “serial defaulter.”
This helps organize their vast empirical record in This Time is Different:
Eight Centuries of Financial Folly (Reinhart and Rogoff, 2009) and subse-
quent studies.23 The work focuses on the worst failures in Western financial
history since 1800: currency debasements, banking crises, and public debt
defaults. The definitive broader history, which includes good and bad
public debt performance, remains Homer and Sylla (1991).
Reinhart and Rogoff (2009), examining 66 countries over two centu-
ries, find 320 distinct cases of public debt default, the majority of which
(250) pertain to externally held public debt, with the balance (70) entailing
defaults on domestically held public debt. For comparability they focus
on central government debts (those issued by national or federal govern-
ments, not provincial, state or local governments) and on gross public
debt (all outstanding public bonds, not omitting those bonds held by
government trust funds or agencies). For lack of solid data they do not
count total public obligations, which include both public bonds and the
present value of unfunded future contingent liabilities. The latter, which
for most modern welfare states are now many multiples larger than out-
standing public bonds, relate to entitlement programs, “safety nets,” loan
guarantees, bank deposit insurance, and pledges to bail out institutions
deemed “systemically important” or “too big to fail” (including, via the
IMF, other sovereigns).
In their analysis Reinhart and Rogoff (2009) measure gross, central
government debts in proportion to national income (nominal GDP) –
hereafter “public debt/GDP.” They also provide data and narrative for
major defaults, distinguishing advanced nations and less developed coun-
tries (LDCs). In general, public debt/GDP ratios of 60 percent or less
are innocuous, neither sapping economic growth nor increasing default
risk. In contrast, leverage above 60 percent tends to be harmful eco-
nomically and unsustainable financially for LDCs, while leverage above
90 percent is typically deleterious for advanced nations. The relationship
is non-linear, with no persistent deterioration in economies or default
risk as leverage climbs, but for some reason all hell breaks loose if the
thresholds are breached; in truth many breaches have occurred without
material effects. Indeed, Pescatori et al. (2014a, 2014b) deny that there’s
any “magic threshold.” But for Reinhart and Rogoff there’s often a public
debt calm before a public debt storm, due to a latent “financial fragility in
economies with massive [public] indebtedness.” They’re not alone in their

assessment. Calomiris and Haber (2014) contend that today’s financial
sectors and public financial systems are “fragile by design,” under the sway
of democratic populism, with its prejudicial disdain of banks, rentiers, and
capitalism. As for the status of public debt in a populist context, Reinhart
and Rogoff note that “all too often, a period of heavy borrowing can take
place in a bubble and last for a surprisingly long time.” Readers are led to
infer that a “bubble” must “burst.” By “bubble” the authors mean public
bond prices remaining high (and yields low) despite high and rising public
debt/GDP ratios. Such paradoxes aside, they insist that highly leveraged
states, especially those for which rollovers of short-term debt are easy
because of continual access to credit markets – and in turn, because of
creditworthiness – can’t forever skirt insolvency, if their leverage expands
unchecked. “This time may seem different,” they mock, “but all too often a
deeper look shows it is not” (Reinhart and Rogoff, 2009a, p. 292).
But why must public leverage grow unchecked? Historically, rising
leverage has been checked and drastically reversed, to positive effect, with
no defaults, in the United States and United Kingdom alike, twice in the
nineteenth century and once again in the three decades after World War
II. Such success stories aren’t of much interest to default-focused research-
ers. As to the paradox of public bond yields declining amid rising public
leverage, Rogoff thinks it advisable to discount bondholders’ “benign”
optimism:
The fact that the markets seem nowhere near forcing adjustment on most
advanced economies can hardly be construed as proof that rising debts are risk-
less. Indeed, the evidence generally suggests that the response of interest rates to
debt is highly non-linear. Thus, an apparently benign market environment can
darken quite suddenly as a country approaches its debt ceiling. Even the U.S. is
likely to face a relatively sudden fiscal adjustment at some point if it does not
put its fiscal house in order. (Rogoff, 2010)
By “debt ceiling” Rogoff refers not to the statutory US debt limit that’s
become a periodic source of partisan brinksmanship, but to the theoretical
90 percent “ceiling” he and Reinhart infer from their empirical work. In
August 2011 the leverage-yield paradox intensified in ways that were seem-
ingly inexplicable in a Reinhart-Rogoff model: amid Congressional wran-
gling over the statutory debt limit and a rising risk that the US Treasury
might be precluded from new borrowing for a while, Standard & Poor’s
for the first time stripped US Treasury bonds of their highest possible
rating (AAA), reducing it a notch. One might suspect that a lower rating,
implying higher risk, would make bondholders demand higher yields, yet
US bond yields plunged and bond prices skyrocketed during the episode,
and a year later (August 2012) when the public debt/GDP ratio was even
higher (105 percent), the ten-year US Treasury bond yield was even lower
(1.70 percent). Rogoff foresees a “sudden fiscal adjustment” – presumably,
a sky-rocketing US bond yield – “at some point,” but the point is that such
a point is rarely, if ever, actually pinpointed in the literature.
Important to analyses of debt sustainability is the concept of an
“overhang,” where public leverage is so high that it exceeds an optimal
level.24 The danger is that most fiscal “austerity” schemes enacted to fix the
problem depress GDP growth to rates below that necessary to service the
debt. Officials may try to cut debt, but if their policies cut GDP by as much
or more, public leverage (public debt/GDP) remains unchanged or rises.
Whereas the studies presented in Reinhart and Rogoff (2009) and in
Reinhart and Rogoff (2010) are restricted to exploring contemporaneously
correlations between a nation’s public debt/GDP ratio and its history of
default and economic growth, Reinhart and Rogoff (2010) try to demon-
strate how abnormally high public debt/GDP ratios (more than 60 percent
for LDCs and more than 90 percent for advanced nations) tend to presage
multiple years of economic stagnation. This theme, with additional
evidence, is developed in Reinhart et al. (2012), where “debt overhang” for
advanced nations is defined as public leverage above 90 percent. Twenty-six
overhangs since 1800 “are associated with lower [economic] growth than
during other periods” when leverage was below 90 percent. Moreover, 80
percent of the overhangs lasted more than a decade; they weren’t due to
recessions and during such episodes interest rates weren’t always higher, yet
there was a “massive,” “cumulative shortfall in output.” Understandably,
the authors fear “the growth-reducing effects of high public debt.”25
In none of their works do Reinhart and Rogoff consider possible
causes of the empirical link which they say exists between high public debt/
GDP ratios and economic stagnation (or default), whether contemporane-
ous or lagged. Theirs is mainly an empirical-historical exercise. But three
reasonable hypotheses can be offered. First, economic stagnation may
result from the higher interest rates that often accompany higher public
leverage. Second, public interest expense may so increase as to require less
spending on law and order or on productivity-enhancing public infrastruc-
ture. Finally, policymakers often try to narrow deficits by growth-curbing
“austerity” schemes – mainly by higher taxes.
As of 2015 one can find three large economies overseen by sovereigns with
public leverage above 90 percent (debt “overhang”): Japan (250 percent),
the United States (106 percent), and United Kingdom (92 percent). Japan
has suffered “lost decades” since its economy and equities peaked in 1990.
Its public leverage first exceeded 90 percent in 1995 and since then its real
GDP has grown at a compounded rate of only 0.7 percent per year, versus
3.7 percent per year in the prior two decades (1975–95), when its leverage
averaged only 60 percent. Were the United States and United Kingdom to
share Japan’s fiscal fate over the next two decades, while Japan stagnated
further, the combined global output loss would be considerable.
The Reinhart- Rogoff studies of public debt are path- breaking, but
constructive criticism is warranted. First, correlation is not causation,
and even if some “overhang” causation is discernable, a reverse of the
thesis is possible. A rising public debt/GDP ratio may have less to do with
higher public borrowing (the numerator) than with lower growth (the
denominator); instead of higher leverage slowing economic growth, slower
economic growth (and accompanying deficits) could be raising public
leverage. Second, the studies don’t incorporate leverage in the private
(and especially financial) sector, nor discuss how easily private debts can
become contingent public liabilities due to the bailouts that are now the
norm in crises (Munger and Salsman, 2013). Third, the studies omit meas-
ures or discussions of the large, off-balance-sheet obligations associated
with unfunded (or underfunded) entitlement programs, even though these
dwarf the size of public debts in the form of bonds. Finally, results for
some nations lack the requisite robustness: as one example, Reinhart and
Rogoff (2009) include 216 data points for the United States, but only 11
of them (5 percent) involve a public debt/GDP ratio lying near or above
the supposedly crucial threshold of 90 percent. Consequently their key
warning, that high public debt is “associated” with lower economic growth
over many years and even, perhaps, with secular stagnation, as in Japan –
based as it is on experience in 65 other nations over two centuries – may not
legitimately extend to the United States.
The Reinhart and Rogoff studies also ignore taxable capacity. They
presume that national income (nominal GDP, the denominator in lever-
age ratios) is a fully accessible source of funds for public debt service. In
truth, tax revenues are the only practical (and direct) source of funds and
different nations tend to wrest quite different tax shares from their respec-
tive national incomes. As explained above, a sovereign within a higher
public debt/GDP ratio may be less financially precarious than one with a
lower public debt/GDP ratio, if it’s able to extract a greater share of taxes
from GDP. These analytic shortcomings aren’t unimportant, but a greater
problem is that Reinhart-Rogoff studies generally ignore the changing
role of monetary regimes. To their credit, they document a long and
dishonorable litany of currency devaluation and debasement, but don’t
explain how unanticipated inflations have relieved profligate sovereigns
from having to take unpopular steps to reduce their real debt burdens and
avoid explicit debt defaults. This is precisely what’s needed to resolve the
paradoxes they cite. The problem is not that Reinhart and Rogoff don’t
discuss inflation or neglect its boosting of nominal GDP (the denominator

in their public debt/GDP ratios), which lowers public debt/GDP ratios and
lightens debt burdens. That inflation can “erode” public debt is ably exam-
ined by Calvo (1989), Cochrane (2011), Aizenman and Marion (2012)
and others. The deeper problem is that Reinhart and Rogoff don’t adjust
or qualify their dire conclusions about “excessive” public debt or thresh-
olds by incorporating the manipulative powers of inflationary monetary
regimes. I next discuss how this factor provides a more realistic context for
public debt analysis.
5.3 DEBT DEFAULTS: EXPLICIT, PARTIAL, AND

IMPLICIT
Having examined theories of the origin and optimality of public debt and
leverage, as well as of the prolonged stagnation that can result from debt
“overhangs” (excessive leverage), I next examine theories of the causes and
consequences of defaults of various types. Viewed broadly, default entails
an overextended debtor unable to pay principal or interest in full when
due, while repudiation entails a debtor unwilling to pay despite having a
capacity to pay. In the past, overindebted sovereigns have defaulted three
main ways (1) explicitly, by non-payment of interest or principal when due,
(2) partially, by a restructuring that extends due dates and reduces interest
and principal, and (3) implicitly, by a debasement of the currency in which
its debts are denominated. I examine studies of each default method after
a brief review of default history.
During Latin America’s sovereign debt crises in the early 1980s Eaton
and Gersovitz (1981) assessed debt default and repudiation using game
theory, with rival players (debtors and creditors), strategies, reputational
risks, costs, and payoffs. They tried to explain how LDCs could default
repeatedly over the years yet still attract lenders. “A crucial characteristic
of [LDC] borrowing is the absence of explicit penalties for non-payment,”
they note; lenders can neither appeal to a court nor seize collateral.
Repudiators “face future exclusion from capital markets,” but not per-
manently. Lenders “will establish a credit ceiling above which they will be
unwilling to increase loans” based on their “perception of borrowers’ disu-
tility of exclusion.” If a credit limit lies below what a borrower seeks, it is
rationed (p. 304). This model situates debt capacity in “a set of observable
borrower characteristics,” mainly export revenues; it also assumes that
“one particular attribute of all [public] borrowers is that they are inherently
dishonest, in that they will default if it is to their benefit.” Loans are still
made because the sovereign borrower, unlike an individual, “optimizes
over an infinite horizon in which repayment. . .is a condition for borrow-

ing in subsequent periods.” For a public debtor “the benefits of default
grow with the size of the outstanding debt” and more is borrowed until
“the costs just exceed the benefits of default” (p. 290). Cohen and Sachs
(1986) likewise view repudiation as a legitimate “policy option,” while con-
ceding it can cause “financial autarky and a loss of productive efficiency.”
They argue that “the equilibrium strategy of competitive lenders is to
make the growth of the foreign debt contingent on the [economic] growth
rate of the borrowing country.” Mendoza and Yue (2012) agree that repu-
diation is an “optimal decision of a benevolent planner” who sees in it a
“higher payoff,” “even after internalizing the adverse [economic] effects,”
and knowing it risks the isolation of “financial autarky.” The main factor
in the cost-benefit calculus is how long autarky might last; in time even
repudiators can find new victims.
Distinct from full debt default is partial default – dubbed “debt relief ” –
whereby public leverage is reduced by some mutually agreed renegotia-
tion of the original terms. Alterations (“concessions” by the creditor) can
include a lower interest rate, a principal reduction, or extended repay-
ment schedule. Of course, one may question whether public debt relief
is ever truly voluntary given the sovereign’s inherent immunity from
prosecution for torts; also in the background stands an implicit threat of
plenary repudiation. Yet studies show that public creditors “granting” debt
relief can preserve or improve their returns relative to the complete loss
associated with a full default.26 A related factor is major central banks and
international agencies (the IMF or World Bank) guaranteeing or bailing
out sovereign debt, in part or whole, and thus displacing private sector
lenders or bondholders; most studies show that the policy creates “moral
hazard” – both higher public leverage and riskier behavior by those who
lend to sovereigns.27
Partial defaulters are “identifiably bad states,” according to Grossman
and Van Huyck (1988), that try to avoid the prolonged ostracism repudia-
tion can bring. Public debts are “above the law,” so creditors can suffer
from the lawless acts of deadbeats; it’s not clear why scorned and greedy
creditors are so forgiving (or myopic). The prodigal defaulter always seeks
new credit sources. Indeed, as discussed more fully below, Reinhart and
Rogoff (2004) and Kohlscheen (2007) identify “serial defaulters.” How
can they persist? Grossman and Van Huyck (1988) believe lenders view
“identifiably bad states” as having “debt-servicing obligations that are,
implicitly, contingent claims,” and can differentiate “excusable defaults”
from “debt repudiation.” Only the latter hurts a state’s reputation, par-
ticularly if the same elites rule persistently. Indeed, Grossman and Van
Huyck “regard the power to abrogate commitments without having to
answer to a higher enforcement authority to be the essential property of

sovereignty.” What motivates the overleveraged state? Foreign bondhold-
ers can’t compel payment, so states that foreswear repudiation aren’t altru-
istic but self-interested; they try to preserve (or bolster) their reputation
for paying their debts. A “trustworthy reputation for validating lenders’
servicing” is a valuable long-term asset. A “reputational equilibrium”
results, whereby “the amount of debt and lenders’ expectations about con-
tingent debt servicing” induce the debtor to “validate these expectations”
and maintain “continued access to loans” (Grossman and Van Huyck,
1988, p. 1088).
As for the “serial defaulters” mentioned earlier – sovereigns with
excessive debt that default, again incur excessive debt, default again, and
borrow yet again, seemingly free of penalty – Reinhart and Rogoff (2004)
find them “throughout history,” primarily in Latin America (Argentina,
Brazil, Mexico, Venezuela) but also in Europe (France, Germany, Portugal,
Spain, Greece). These states “have demonstrated that serial default is the
rule, not the exception.” In contrast, external public defaults have never
occurred in India, South Korea, Malaysia, Singapore or Thailand, despite
occasional and severe turmoil (the currency crises in Southeast Asia in
1997–98). The authors dismiss the view of some economists that defaults
are random and unpredictable; in truth they “recur like clockwork in
some countries.” Nor do they see a paradox in capital not flowing from
richer to poorer nations; on the contrary, “too much capital (specifically
in the form of debt) is channeled to ‘debt-intolerant’ serial defaulters,” and
the fault lies in “government and government-guaranteed external debt”
(Reinhart and Rogoff, 2004, p. 53). Serial defaulters, despite poor reputa-
tions, regain access to credit markets only because they are guaranteed and
periodically bailed out by non-market agencies like the IMF and World
Bank, which are funded by non-serial defaulting states. But thereby, moral
hazard spreads – spawning still more debts and defaults. In Reinhart et al.
(2003) “debt intolerance” is fingered as a constitutionally genetic cause of
serial defaulting: victimized lenders agree to relend because they become
overoptimistic during booms. Yet borrowers are also complicit because
“throughout history, governments have often been too short-
sighted
(or too corrupt) to internalize the significant risks that over-borrowing
produces over the longer term” (Reinhart et al., 2003, pp. 4–5). What
might alter the genetics of serial defaulting? No answer is given. To avoid
it, Reinhart and Rogoff (2004, p. 57) suggest that governments “may need
to aim for far lower levels of external debt-to-GDP than what has been
conventionally considered prudent” and “prudent external-debt thresholds
may be closer to 15–20 percent (the level seen in several of the defaulters)
than the much higher levels one sees today.” Recall that Manasse et al.
(2003) estimated that public debt defaults were much more likely when
nations had external debts greater than 50 percent of GDP. Reinhart and
Rogoff say a safe threshold is less than half that.
The importance of institutional structures and incentives (for good or
ill) in the pattern of “serial defaulters” is stressed by Kohlscheen (2007).
He counts presidential democracies five times more likely to default on
their external debts than parliamentary democracies; the difference “lies
in their constitutions.” Venezuela and Mexico defaulted on their external
debts on nine separate occasions over 180 years, but the same decades
saw no such defaults by India, Malaysia, or Thailand. He believes that
parliamentary democracies default less because the ever-present risk of
a “no confidence” vote ensures responsible fiscal incumbency. There’s
“a credible link between economic policies and the executive’s survival”
that “tends to strengthen the repayment commitment,” even though
“politicians are opportunistic.” In contrast, presidential democracies give
executives fixed terms regardless of performance and without periodic leg-
islative approval; thus executives can be irresponsible about public debts.
Kohlscheen’s conclusion contradicts earlier findings that defaults are more
likely in systems of proportional representation with unstable coalition
governments lacking a political capacity (or will) to act consistently and
responsibly, including in the servicing of public debts.
Besides explicit default and partial default there’s the possibility of
implicit default, whereby an overleveraged sovereign inflicts on creditors
(and the economy at large) a high and unanticipated inflation; the decline
in the purchasing power of money “erodes” the value of public debt and
cuts the market value of public bonds (Aizenman and Marion, 2011).
To be “effective” the inflation must be unexpected, a negative surprise to
bondholders who fail to command the higher yields necessary to offset
depreciated principal. Inflation also reduces the public debt/GDP ratio
(public leverage) merely by boosting the denominator (nominal GDP). The
power to erode a public debt burden is stressed by Irons and Bivens (2010)
in rebutting forecasts by Reinhart and Rogoff (2009) of dire results from
high leverage after the Great Recession of 2007–09.
Monetary debasement is a type of sovereign default, although most
economists today dismiss the interpretation as nostalgia. Since 1700 a dozen
or so major cases of dramatic, one-time currency defaults have occurred,
as when Britain, the United States or France left the gold standard, or
remained on it but after a material devaluation (with a currency’s gold
content reduced). Since the last abandonment of any currency links
to gold in 1971, implicit debt default by debasement has occurred not
by one- time acts but by perpetual inflations (“inflationary finance”).
Official debasement to cut the value of public debt wasn’t unknown to
the classical economists; they wrote in the context of the gold standard,
but reneging on that standard and on public debts wasn’t uncommon.
Recall Smith (1776 [1937]) deriding the mere “pretended payment” on a
public debt “when national debts have once been accumulated to a certain
degree” by “the raising of the denomination of the coin,” an “expedient
by which a real public bankruptcy has been disguised.” For Smith infla-
tion is “pernicious,” an “adulteration” of money, an “unjust” “juggling
trick” (Smith 1776 [1937], pp. 882–5). Reinhart and Rogoff concur but,
whereas they believe explicit default is more likely than implicit default,
Smith believes the reverse, that the “usual expedient” is default by inflation
(monetary debasement). Keynes, we’ve seen, agrees that inflation can sur-
reptitiously erode the value of money and debts, indeed that it’s a “usual
expedient,” but also one that he heartily endorses.
Keynes is smart enough to realize how inflation can erode debt burden
and cynical enough also to suspect the common man doesn’t realize it
very well; but instead of opposing the tactic he condones it, because sov-
ereigns usually can get away with it (electorally) and because creditors
are overpaid anyway. Recall in the General Theory (1936) his antipathy
towards bondholders, the “rentiers.” They’re unproductive, idle, and unde-
serving of their interest income; he endorses a policy of depressed interest
rates, to near zero – like the ZIRPs that major central banks have adopted
since 2008 – to achieve “the euthanasia of the rentier” class (Keynes,
1936, p. 376). A sovereign that debases money and erodes the real value of
its debt isn’t violating a trust or contract but “moderating the claims of
the rentier” (bondholder), and justifiably if its debt is at “an insupportable
level,” which he defines as “an excessive portion of the national income”
(Keynes, 1923, p. 64). Keynes cites no public leverage threshold beyond
which default invariably results, but by inflating, a state, he says, is merely
“reducing the burden of its preexisting liabilities in so far as they have been
fixed in terms of money.”
The political economy literature contains abundant analysis of
“inflationary finance.” For centuries public finance scholars have known
that in addition to taxing and borrowing, sovereigns could secure real
resources by creating money ex nihilo, whether by printing press or
electronic entry. Some of the earliest, important contributions are made
by Seligman (1921), who provides a history of currency inflation and
how it affects public debt, and by Clark (1945), who writes amid the high
inflation and fast-rising public debts of World War II. More sophisticated
treatments arrive later, from Bailey (1956), Friedman (1971), Auernheimer
(1974), and Barro (1983), who are critical of inflationary finance, although
not of central banking or of fiat paper money. After the abandonment of
the Bretton Woods gold exchange standard in 1971 inflationary finance
becomes more overt and obvious. Thus appear studies like Ruebling
(1975), which notes that to the extent private banks participate in money
creation (through deposit creation) they too (like the state) profit by it.
Toma (1982) finds an “inflationary bias” in central banking itself. Barro
(1983) explores the degree to which inflationary finance occurs under
systems of monetary “discretion” (post-1971) versus “rules” (pre-1971).
Grossman and Van Huyck (1986) portray it as sovereign predation.
Mankiw (1987) examines how states might secure an “optimal collection
of seigniorage,” a theme buttressed by Calvo (1989), who asks how infla-
tion might “liquidate” bill and bond values when they already incorporate
inflation expectations. The last major contribution comes from Neumann
(1992) but thereafter the literature on inflationary finance diminishes,
because US budget deficits dwindle along with inflation rates; worries
about excessive public debt and inflation fade. With the reprise of massive
deficit spending since 2008, of vast expansions in central banks’ money-
creating powers, and of various bond-buying schemes (debt monetization),
a revival of inflationary finance studies is more likely.
The fact that implicit (inflationary) defaults on public debt are easier to
inflict than explicit ones, coupled with the fact that inflation itself is easier
to inflict in the absence of a gold standard (or another viable constraint
on state monetary power), means sovereigns are encouraged to borrow
more than they otherwise might. But while the contemporary monetary
system fosters public indebtedness, it also provides an efficient means of
surreptitiously melting it. This may explain why persistently high public
leverage has predominated since 1971; since then governments have been
empowered and motivated to default implicitly. Since then some sovereigns
(Hong Kong, China, Argentina) have tried to fix or “peg” their currencies
to others, particularly more stable and trusted reserve currencies, but
without surrendering their power to create their own money, if necessary
by altering or terminating pegs; not coincidentally, they’ve borrowed less.
Some public debt scholars contend that sovereigns worry about public
creditors being robbed by inflation. The public choice approach is rightly
skeptical of the claim; as long as a sovereign benefits by implicitly default-
ing, as when it’s overleveraged or when it’s less costly than explicit default,
it’ll do it. Of course, sovereigns in recent decades also have introduced and
sold inflation-indexed bonds, which protect holders from the corrosive
power of inflation by accreting principal at the official inflation rate. Falcetti
and Missale (2002) provide an informative account, while Dornbusch and
Simonsen (1983) explain their use as guides in monetary policymaking. By
design, yields on inflation-indexed public bonds are lower than those on
nominal (unindexed) public bonds, because the inflation premium built
into nominal bonds by investors is removed from an indexed bond. So why
issue indexed bonds? Sovereigns seem willing to be fair, by immunizing

creditors from inflation’s harm; it’s the opposite of “inflationary finance.”
Yet sovereigns also limit the issuance of indexed bonds to a fraction of their
total debt, and stress their goal of providing central banks with a market
gauge of inflation expectations. The real aim isn’t fairness to c reditors;
were it so, sovereigns would mostly issue inflation-indexed bonds, or better
yet, return to the gold standard (Salsman, 1995). Public-spirited sover-
eigns keen on protecting bondholders from the ravages of inflation aren’t
found in contemporary times; the preponderance of public bond issuance
is nominal, not indexed, so sovereigns can preserve their power to ravage
bondholders by inflation (Bohn, 1988). Most contemporary models that
seek to explain chronic deficit spending and high public debts, with the
exception of Brennan and Buchanan (1980, 1981), elide the fact that after
the abandonment of the Bretton Woods gold exchange system in 1971 no
sovereign in the world has been obligated to redeem its currency in gold,
or even in US dollars. Overindebted sovereigns have operated with a safety
valve since then; they no longer need close deficits by spending cuts or tax
hikes. Central banks readily monetize their debts and thereby help mitigate
rising public leverage ratios.
The fact that inflation is destructive and generated by s overeign-sponsored
central banks with a monopoly power to issue fiat paper money is well
documented. The argument is made in Brennan and Buchanan (1981).
The role of contemporary central banking has been acknowledged by one
of its leading practitioners, Paul Volcker, who was President of the Federal
Reserve Bank of New York (1975–79), Undersecretary at the US Treasury
(1969–74), and Chairman of the Federal Reserve Board (1979–87):
It is a sobering fact that the prominence of central banks in this century has
coincided with a general tendency towards more inflation, not less. [I]f the over-
riding objective is price stability, we did better with the nineteenth-century gold
standard and passive central banks, with currency boards, or even with “free
banking.” The truly unique power of a central bank, after all, is the power to
create money, and ultimately the power to create is the power to destroy. (Cited
in the foreword to Deane and Pringle, 1995)
Bondholders can’t always perfectly anticipate the implicit inflationary

defaults of sovereigns; some creditors gain and some lose, but sovereigns
mostly gain by the tactic, else they wouldn’t keep practicing it. Just as
governments inflate to inflict hidden but lucrative taxes on the currency
holder, so they inflate to inflict real losses on the public creditor, because
doing so reduces the value and burden of what they owe. Even if, as
new classical economists insist, inflation rates are perfectly anticipated
and mitigated by prescient public creditors, to a degree that they exert
real economic effects, it remains true that policymakers, whose job is to

create such effects, will seek to impose inflation at volatile, deceptive, and
unexpected rates (Phelps, 1973; Dominguez, 2009).
Does history reveal no rational or moral way of curing excess public
leverage besides defaults of various kinds? Reinhart (2012) notes that
“throughout history, debt-to-GDP ratios have been reduced in five ways:
economic growth, substantive fiscal adjustment or austerity plans, explicit
default or restructuring of private and/or public debt, a surprise burst in
inflation, and a steady dose of financial repression that is accompanied by
an equally steady dose of inflation.” The latter two methods – repression
and inflation – are by now the most commonly used to reduce leverage.
The only reputable alternative to a sovereign repudiating or defaulting
on its debt is to make it more serviceable by a rational program of fiscal
reform, consolidation, and austerity – supplemented, where appropri-
ate, by a privatization of state assets. Although much maligned, fiscal
austerity can effectively, safely, and justly reduce public leverage. The key
to an efficient and honorable program that doesn’t ruin the economy is
one that forces change on the actual fiscal miscreant (the sovereign, by
spending cuts) instead of on innocent victims (in the private sector, by
tax hikes). To deprive the weak economy instead of the bloated state, as is
common, invites more fiscal decay. Whereas Blyth (2013) sees fiscal auster-
ity as a “dangerous idea” wherever tried and Kitromilides (2011) believes
it helps isolated states but does harm in the aggregate when many states
try it simultaneously, Alesina and Ardagna (2010) and Mauro (2011) are
more subtle and find that whenever austerity is done right – by judicious
spending cuts, not punitive tax hikes – it reduces public debt without also
harming the economy (and reduces leverage, or public debt/GDP ratio).
If such a fiscal mix isn’t adopted it’s not because it doesn’t work well but
because a free-riding democratic electorate opposes spending restraint.
5.4 EXORBITANT PRIVILEGE AND THE PARADOX

OF PROFLIGACY
To understand fiscal sustainability today one must realize how

overindebted sovereigns exploit post-1971 monetary regimes to disguise
and mitigate their debt burdens. The key concept is “exorbitant privilege”
(see Eichengreen, 2011), coined in the 1960s by French Finance Minister
d’Estaing to describe the advantage enjoyed by a sovereign whose money
is a “reserve currency” held by central banks to back their own currencies.
The “privilege” is that an issuer of reserve currency can create an excessive
supply of it without suffering a higher inflation rate, because the currency
is in greater demand relative to others. Whereas the US dollar has been a

reserve currency for the past century, the UK pound was the dominant
reserve currency in the previous century.
By the law of supply and demand, an enlarged supply of money met by
an equally enlarged demand for it retains its value (real purchasing power)
relative to other monies also issued liberally but less demanded. Since a
reserve currency is in great demand globally, it’s less prone to deprecia-
tion even if liberally supplied. “Exorbitant privilege” permits the reserve
money issuer to acquire real resources virtually without limit, as long as
its purchasing power is preserved, but even if not “without limit,” then
to a greater extent relative to other issuers. A reciprocal process explains
why a money that becomes a reserve asset might retain that status for
many decades. Reserve status is initially achieved when a currency is more
trusted, globally, hence more demanded for its steadier purchasing power
over longer periods of time. It becomes the more liquid, more easily traded
currency, which further boosts demand for it. Reserve status can be main-
tained for a while by inertia, or trailing reputation, but if relative liquidity
and stability of purchasing power diminish, so will reserve status and the
“privilege.”
Monetary aspects of public debt are crucial for contextual analysis.
Any degree of “exorbitant privilege” enjoyed by a sovereign extends to its
debt securities. Typically a central bank’s foreign cash reserves are invested
in the bills, notes, and bonds of a reserve-currency nation, partly for
convenience (as the debt is usually denominated in the reserve currency)
and partly from self-interest (because those factors that render a reserve
currency attractive also make the public debt of a reserve currency issuer
remunerative). If a sovereign’s currency is trusted, so also are its securities.
A derivative demand also exists: if the currency is strongly demanded so
also will be the public debt denominated in that currency. Just as the value
of a sovereign’s reserve currency can be preserved even amid enlarged issu-
ance if matched by greater demand, so also can the value of an enlarged
sovereign debt be preserved by greater demand.
If economic historians consult only additions to the supply of a
sovereign’s money, or bonds, while ignoring possibly higher demand for
each asset, empirical records may appear pockmarked with paradox, espe-
cially when a dramatic boom in supply involves no corresponding plunge
in price. For example, the US money supply (M-1) increased by 88 percent
in the decade ending 1982 and by 99 percent in the decade ending 2012, but
whereas prices (measured by the GDP deflator) increased 109 percent in
the first case (1972–82), or 21 percentage points faster than the monetary
growth rate, they increased only 25 percent in the second case (2002–12),
or 74 percentage points slower than the monetary growth rate. In the
latter decade the demand for dollars outpaced growth in the supply of
them. Likewise for US bonds, lesser rates of increase in supply sometimes
accompany declines in their price (increases in yield), while in other cases
larger increases in supply have brought increases in price (lower yields). In
the first case the new bond supply is moderate but demand weaker still; in
the latter case bond supply skyrockets but demand for the bonds more so.
For example, US federal debt increased only 30 percent in the 1960s and
public leverage (public debt/GDP) dropped from 53 percent to 35 percent,
yet the price of the ten-year Treasury bond plunged 27 percent as its yield
jumped from 4.12 percent (1960) to 7.35 percent (1970). In contrast, US
federal debt skyrocketed from $8.2 trillion in 2005 to $19.0 trillion in 2015
and leverage increased from 62 percent to 105 percent, yet the price of the
ten-year Treasury bond also skyrocketed, by 93 percent, as its yield fell
from 4.29 percent (2005) to just 2.14 percent (2015). In the first case a mod-
erate rise in bond supply was met by a diminished demand for it, so bond
prices declined and yields rose; in the second case, despite a big increase in
bond supply, a larger demand for it raised bond prices and lowered yields.
The strength of demand that accompanies a reserve currency and the
public bonds it denominates often only intensifies in financial crises.
Investors flee less trusted currencies and less creditworthy sovereign bonds
and seek greater liquidity; a “flight to safety” accompanies greater demand
for higher-quality public bonds denominated in the reserve currency. This
explains the paradox that in crises, even as budget deficits are widening
and public debt/GDP ratios are soaring, bond prices rise and yields
decline for certain sovereigns – specifically, those that enjoy an exorbitant
monetary privilege.
Under the classical gold standard (1870–1913), gold itself, not fiat paper
currency, was the monetary reserve for the world’s 60 redeemable c urrencies.
Some scholars liken the regime to one with a “Good Housekeeping Seal
of Approval” (Bordo and Rockoff, 1996). Others extend the argument to
insist that a credible currency can’t be issued by mere fiat but only under
exogenous, rules-based constraints (Dove, 2012), which may include a gold
standard (Selgin and White, 2005). A sovereign signals its commitment to
good-faith dealing with holders of its currency and bonds by pledging to
redeem them on demand in a fixed weight of gold; ex ante, it promises not
to break its debt contract by debasing its money. Commitment was sounder
under the classical gold coin standard of 1870–1913 than under the gold
bullion standard manipulated by central banks during and after World
War I (Obstfeld and Taylor, 2003). The United States defaulted on its gold-
redeemable dollar and gold-based bonds in 1933 and since then “the power
of governments in general to debase their currencies is firmly established,”
and “an important part of that power is the ability to prevent private agents
from taking action to insulate themselves from the effects of such policy”
(Green, 1986, p. 14).
A century ago, on the precipice of World War I, the UK pound was
the world’s most trusted currency, due partly to London’s large role in the
financial system, but mostly to the fact that over the prior two centuries
(excepting 1797–1821) the pound was indubitably redeemable in gold. For
a century the United Kingdom enjoyed an “exorbitant privilege,” but in
the century after World War I the pound’s reserve status was gradually dis-
placed by the US dollar; its reserve status was hurt most when Britain went
off the gold standard in 1931. In the Bretton Woods system (1948–71) only
the US dollar was defined as a fixed weight of gold (at 1/35th of an ounce)
and only non-US central banks (not individuals) could redeem dollars for
gold. Most foreign central banks (except the Bank of France) refrained
from doing so, choosing instead to invest dollars in US debt securities.
Today the US dollar retains its reserve currency status as a vestige of
the prior system, but it now comprises only 65 percent of central bank
reserves. The fact that no currency in the world since 1971 has had any
formal tie to gold hasn’t negated the principle of “exorbitant privilege.” In
the century through 1914 the privilege was Britain’s; in the past century the
United States has held (and exploited) the privilege; the coming century
may see China play this role. Ironically, although reserve currency status is
earned by decades of monetary integrity and fiscal rectitude, once attained
it’s often politically exploited through inflationary finance; it then loses
its status to any rival sovereign that can develop a global reputation for
monetary integrity and fiscal rectitude.
A second important principle of public debt sustainability holds that
a sovereign guards against default by borrowing only in its own currency.
Stated negatively, no sovereign should commit the “original sin” of
borrowing in the currency of another sovereign – of pledging to repay its
debts in a medium it has no power to print.28 As long as a government
issues an irredeemable fiat paper currency it can service any debt it incurs,
no matter how large, and as long as it’s denominated in the currency
it alone issues. To service its debts it needn’t cut spending, raise taxes,
narrow deficits, or reduce its leverage; it need only print (or create elec-
tronically) what it needs. It’s not a moral or even practical course, merely an
expediency common to lawless, often reckless issuers of fiat money.
The principle of “exorbitant privilege” applies to a single sovereign
issuer of a reserve currency advantaged because it enjoys lower rates of
inflation and interest; but the principle of “original sin” applies to all sov-
ereigns, regardless of their currency status. The fact that most sovereigns
tend to borrow in their own currency doesn’t guarantee that they’ll be able
to borrow at low rates; a currency less trusted will be less demanded and
thereby lose value; and if so, its bonds, denominated in that currency, will
also lose value. That central banks can radically reduce public bond values
by raising interest rates or inflicting unanticipated inflation means they
can lighten a state’s debt burden; and as discussed, “inflationary finance”
entails an implicit debt default.
Reinhart and Rogoff’s findings on public debt are misleading to the
extent that they omit the complicating role of contemporary money
(Reinhart, 2009; Reinhart et al., 2012). Both exist on a continuum: (1) fiat
money – non- interest-
bearing means of payment that serves as bank
reserves, issued jointly by a central bank; (2) treasury bills – short-term,
lower-interest-bearing sovereign obligations of the sovereign; (3) treasury
notes – medium- term moderate- interest-bearing sovereign obligations;
(4) treasury bonds – long-term higher-interest-bearing sovereign obligations;
and (5) entitlements – long-term, non-interest-bearing political promises of
benefits, in the future, to pensioners, patients, the disabled, bondholders
of failed firms, or depositors of failed banks. The first sovereign obliga-
tion, currency, can be issued without limit (since 1971), a factor neglected
by Reinhart and Rogoff. In seeking to explain two centuries of public debt
defaults of every variety and context, they insist that the key measure is
the public debt/GDP ratio, regardless of taxable capacity or the monetary
regime. First, they concede that higher leverage needn’t coincide with higher
default risk. Second, they don’t explain why the default-inducing threshold
is 60 percent leverage for less developed nations and 90 percent leverage for
advanced nations. Third, they don’t explain why so many defaults occur
with low leverage nations and so few with high leverage nations; fourth,
they don’t distinguish debt defaults under the gold standard, when mon-
etary discretion is restrained, versus those under a pegged fiat currency,
or under a fiat currency that fluctuates against others; they exclude cases
where “exorbitant privilege” and “original sin” pertain.
A sovereign with hands tied monetarily lacks discretion and might
default despite low leverage, while one with full discretion to create money
can survive high leverage, especially if it enjoys exorbitant privilege and
doesn’t borrow in a currency it can’t print. Thus the United States over
the past decade has become more leveraged at ever lower interest rates; in
contrast, Greece has defaulted frequently due not just to high leverage but
also because in 1999 it jettisoned its drachma, joined the euro, and couldn’t
immunize itself from global crises. Greece’s public leverage was stable at
roughly 110 percent from 1994 to 2008 before jumping to 130 percent in
2010 and 177 percent by 2015 and its bond yield jumped from 4 percent
in 2009 to 44 percent in 2012, before it defaulted; when Greece borrowed in
drachma from 1971 to 1990 it didn’t explicitly default, although it repeat-
edly debased its currency (an implicit default). While on the gold standard
Greece defaulted periodically due less to high leverage and more to its
monetary limits.
Significantly, Reinhart and Rogoff’s database of defaults contains no
cases of sovereigns defaulting explicitly when they borrow only in their
own currency. The case doesn’t arise because it simply needn’t; there’s
no political advantage in it. Implicit default by inflation is easier, less
visible, and typically uncontroversial. The policy isn’t moral or practical
(in the long run) but there’s no question it’s politically advantageous, for
in unrestrained democracies politicians prefer implicit defaults and most
economists encourage them in this, believing inflation to be indispensable
to a growing economy. Most cases of default in Reinhart and Rogoff’s
studies occur not because a sovereign is heavily leveraged but because it
doesn’t issue a reserve currency, or lacks monetary latitude, or borrows
in another’s currency. Likewise, to the extent that less developed nations
have higher default rates it’s not because they’re more leveraged or rely
more on externally held than internally held debt, as Reinhart and Rogoff
imply, but because the money they owe isn’t the money they sow. Disputes
about how best to measure debt burden or default risk are relevant to
policymaking, but the presumption that only public leverage matters, or
that leverage above 90 percent must cause crises or stagnation can elicit
tax-oriented austerity schemes that make matters (and leverage) worse.
Next consider what I call “the paradox of public profligacy,” where
increasingly leveraged sovereigns, presumably riskier credits, nevertheless
pay ever-lower interest rates (see Chapter 1, Table 1.3: “The paradox of
profligacy: higher public debt leverage, yet lower borrowing rates, G-7
nations, 1980–2015”). The pattern is the reverse of what prevails in private
credit markets and rebuts the classical school’s premise of an analogy
between public and private debtors. One implausible thesis says there’s
no paradox because there’s no real debt crisis (Yglesias, 2012); another
asserts that public creditors are suddenly “uninterested in getting their
money back” (Varoufakis, 2016). Perhaps higher-leveraged sovereigns with
lower borrowing costs aren’t truly profligate; and if presumably rational,
egoistic creditors don’t require a high interest rate, perhaps the debtor,
however leveraged, isn’t so risky after all. Public debt pessimists must be
wrong; they miss crucial mitigating factors. On the other hand if highly
leveraged sovereigns should be paying higher interest rates but aren’t, due
to “financial repression” or “unorthodox” central bank schemes to depress
yields (including ZIRPs and public debt buying), then debt optimists are
wrong; they ignore latent profligacy and believe that policy artificiality can
mask reality with impunity.
At some point, debt pessimists might say, artificially low public bond
yields will rise to reflect excessive debt, unsustainable leverage, or pending
default; if so, bond prices will plunge and many financial institutions
would become insolvent, because they too are highly leveraged and own
large sums of public debt. Few of them could survive a sharp decline in
net worth from a public bond meltdown. Worse, the largest, most widely
held public debts – those of the United States and Japan – may be the
most overpriced (with excessively low yields); their decline would have a
widespread negative impact. The magnitude of financial destruction could
surpass that of 2007–09, because the public debt market is so much larger
than that of mortgage-backed securities. Moreover, most governments
now pledge ex ante to subsidize or bail out banks deemed “too big to fail.”
Sovereigns would become even more leveraged and spread more ruin.
There’s value in comprehending the paradox of profligacy; it may be
true in some respects but not in others. Self-interested creditors require
riskier borrowers to pay more than safer ones; the profligate pay more than
the frugal, because creditors must be compensated for default risk. If, as
the classical school insists, public and private debtors are analogous, they
should be paying roughly the same interest rates, adjusted for leverage and
risk profile. They don’t. On the classical view, either private debtors are
paying too much, public debtors are paying too little, or both. Whereas the
new classical school might insist the yield differential is rationally based,
Keynesians might say it reflects the stupendous benefits of a growing
public debt, while the public choice school might argue that it reflects the
political advantages enjoyed (and exploited) by a democratic, constitution-
ally unrestrained sovereign (whether by its taxing power, fiat paper money
monopoly, exorbitant privilege, or resort to financial repression).
We’ve seen some theorists consult sovereign bond yields as a sign of
whether public leverage is safe and sustainable or whether instead it
crowds out private savings and borrowing. Recall how J.S. Mill, writing
in the mid-nineteenth century, sought an objective measure of excessive
public debt and suggested the bond yield; if it wasn’t rising alongside an
increase in public debt issuance, no one could say the increase was exces-
sive or harmful. Likewise, De Viti De Marco looked to the sovereign
yield as indicative of the upper limit on leverage. “The higher the rate of
interest promised by the state,” he wrote, “the more available [the] savings
it withdraws from industry and commerce, with resulting disadvantages
similar to those produced by excessive rates of extraordinary taxation”
(1936, p. 389). If, in borrowing more, the sovereign pays only the prevailing
market rate, or less, there’s likely no additional burden or crowding out.
By such accounts most sovereigns in recent decades can’t be described
objectively as having overborrowed.
Indisputably, highly leveraged sovereigns today can borrow at
inordinately low rates. Of greater relevance, however, is the fact that today’s
norm is for public sector bonds to yield less than private sector bonds. It
hasn’t always been the norm: in the nineteenth century, sovereigns even of
advanced nations paid relatively higher interest rates than private sector
borrowers. The “positive yield spread” of contemporary times was once a
“negative yield spread.” What changed – and was it change for the better?
The reversal of the public-private yield differential may be attribut-
able to the distinct fiscal-monetary regimes prevailing in each era. In
the nineteenth century, when the taxing and money- creating powers
of most sovereigns weren’t as yet so extensive as they’d become in the
twentieth century, perhaps public creditors looked like private debtors.
If in the n ineteenth century the sovereign’s revenues came mainly from
tariffs and excise taxes, and not as yet from taxes also on incomes, estates,
capital gains, payrolls, property, or retail sales, as became the norm in the
twentieth century, and if tax revenues then comprised less than 10 percent
of GDP, the nineteenth- century sovereign couldn’t establish sufficient
command over resources to mark it a superior (let alone “risk-free”) credit.
Yet this considers the fiscal regime only. The prevailing monetary regime
can further explain a negative yield spread, when sovereigns borrow at
higher rates than the private sector. If in the nineteenth century a sovereign
operated by politics-free rules of the game of the classical gold standard,
as did 60 nations from 1870 to 1913, it restricted its capacity to create
money; in principle, this is the status of the usually law-abiding private
borrower barred from counterfeiting. As a final factor, the private sector
in the nineteenth century was less burdened by taxation or regulation; with
more autonomy and income, private debtors could be more creditworthy
– more so even than the state, which was more limited (constitutionally,
fiscally, and monetarily).
Given vast growth in the size, scope, taxing power, monetary power,
regulatory power, and takings power of twenty-first-century sovereigns,
and the extent to which such powers are used to limit, burden, and decapi-
talize productive elements of the private sector, it shouldn’t be surprising
that sovereign bonds today yield less than private bonds. Should the
pattern ever re-emerge that the private sector borrows more cheaply than
does the public sector, it may indicate a healthy renewal of economic vigor.
5.5 CENTRAL BANKS AS FISCAL ENABLERS AND

POLITICAL DEPENDENTS
Inflationary finance is neither the sole result of a deficit spending state nor
of a money-issuing central bank; any state can choose to borrow exclusively
from the private sector, just as its central bank can elect to issue money in
exchange only for private sector assets and securities. There needn’t be a
symbiotic relationship between a finance ministry and a central bank; a
central bank might be politically “independent.” In fact this is rare; central
banks exist primarily to accommodate the fiscal needs of states. Goodhart
(1988) documents the origins of major central banks; without exception
they were established not to rectify some “market failure” but to finance
deficit spending states, typically in wartime. In some cases they began as
the nationalized remains of a private bank that had failed because it was
forced to lend to an already overleveraged government. Selgin and White
(1999) contend that it’s no accident that central banks reflect the fiscal
needs of the state; it’s the main reason they exist even today and why
their powers and capacities in service to ever-expanding governments are
periodically enhanced and rarely reduced.
Initially, central banks operated on the gold standard, only as a vestige
of what had been the institutional norm and reputational requirement of
a more private banking system. As sovereigns’ fiscal demands prolifer-
ated, so did their demands for debt monetization, to the point where fiat
money exceeded gold reserves; instead of curbing the excesses, central
banks abandoned the gold standard, leaving holders of once-redeemable
money with paper claims to nothing in particular, but which legal tender
laws compelled them to use and accept in payment of debts. The norm,
then, is not central bank “ independence,” but political dependence. For
much of the past century, unlike the previous one, there’s been a sustained,
symbiotic relationship between the deficit spending sovereign and the fiat
money-issuing central bank (Salsman, 2013a, 2013b). The central bank
underwrites, buys, and sells (makes markets in) the government’s securi-
ties, in alliance with private banks. Inflationary finance is the joint policy
product of a finance ministry and central bank.
In the 1990s economists explored central bank independence partly
because central banks had monetized more public debt than usual after
the 1971 cessation of the gold exchange, partly because some restraints
were desired on the higher inflation rates resulting from 1971, and partly in
response to the break-up of the USSR in 1991 (as former Soviet s atellites
sought advice on disentangling banks from states). Cukierman (1992)
offers an early treatment of the issue, while Havrilesky and Granato (1993)
delineate the institutional attributes of central bank autonomy and its
relation to inflation. Pollard (1993) examines autonomy’s impact on the
economy, while Wagner (1986) and Posen (1993) offer a more skeptical
view, suspecting that even “independent” central banks are biased toward
inflating, for purely political motives.
The economic case for central bank independence – that it more likely
fosters low-inflation prosperity and fiscal rectitude – is often trumped by
the political case against it, in effect, by a case for central bank depend-
ence. The central bank is made to serve, first and foremost, the fiscal
needs of the state; in turn the state can compel the central bank to do its
bidding – to serve as a lender of last (or even first) resort to the state, on
favorable terms, to monetize state debts, credit funds to its account, and
purchase, at the state’s behest, the bonds or assets of troubled but favored
financial institutions, industrial firms, or foreign allies. The politically
dependent central bank can assist the state in its financing needs by both
quantitative and qualitative (price-based) measures, by money creation
(“debt monetization” and “quantitative easing”) or interest-rate “target-
ing” (keeping short-term interest rates low or near zero, to depress govern-
ment bond yields and lower the overall cost of government borrowing),
or by directly purchasing extant public bonds, to artificially depress their
yields and permit refinancing at lower levels.
The literature on central bank independence shows that economies
perform far better when central banks are truly independent, institutionally
and structurally, and not opportunistically subordinated to a sovereign’s
fiscal needs; yet much of the literature also exposes the impossibility of
genuine independence. Bowles and White (1994) depict how genuine segre-
gation is impossible, yet also inadvisable; they favor “a more a utonomous
but not fully independent central bank.” Beetsma and Bovenberg (1997)
investigate the interaction between public debt policy and monetary policy,
in a European (albeit pre-euro) setting, and find that all works out for the
best, but only “in the absence of political distortions,” and yet such dis-
tortions invariably intrude on monetary policymaking due to the state’s
borrowing needs. There exists a “need to establish the credibility of discre-
tionary monetary policies,” but it can’t be met unless the finance ministry
“restrains debt accumulation,” which it usually can’t. Lohmann (1998) asks
whether “political business cycles” can be avoided by a scheme of central
bank independence, and says “this solution works only if central banks are
not perfect agents of their political principals,” but mostly they are political
agents, so central banks are rarely truly a utonomous. Analytical contradic-
tions abound in such accounts, one might argue, precisely because central
banks by definition can’t be non-political.
Bernhard (1998) seeks what he calls “a political explanation” for global
variation in central bank independence: “politicians will choose an inde-
pendent central bank” if disparate branches of government have disparate
policy preferences, but if instead preferences are homogeneous, a state will
require a dependent central bank. There’s no fixed criterion; autonomy
is prone to political opportunism. Miller (1997) examines the theoretical
difference between the “fiscal authority with access to the channels of
money creation” and one without such access; the first will more likely
denominate its debt in the currency issued by the dependent central bank,
even though that also boosts inflation risks; moreover, “the degree of
central bank independence is ultimately determined by the government
and may be viewed as another policy variable,” such that a government
may only feign a commitment to autonomy, so that later it can “take away
the independence of the central bank in order to inflate” away the value of
its public debt. Such cases are but sham independence. The most realistic
accounts of the inescapability of central bank dependence can be found in
Tabellini (1987), Fry (1997, 2007, on “the fiscal abuse of central banks”)
and in Selgin and White (1999).
In contrast to Hamilton’s preferred system of non- political,
non-
monopolistic, national banking with a specie- convertible dollar
(Chapter 2, Section 2.4), since the early 1970s we’ve had an ever-more
democratized system, with dozens of inconvertible, monopolized paper
currencies fluctuating wildly against each other as increasingly indebted
sovereigns become ever more dependent on central banks, the latter now
devoted mainly to underwriting and trading public bonds so as to ensure
artificially low yields. In the past decade the balance sheets of major
central banks have been multiplied and by now contain large sums of
public debt of increasingly dubious quality. Public debt theory has yet
to specify the extent to which these policies might bring a future rise in
inflation (or hyperinflation), and with it, higher public bond yields – or
whether zero interest rates will persist indefinitely and breed secular
stagnation.
5.6 CAPITAL LEVIES, FORCED LOANS, AND

FINANCIAL REPRESSION
Public debts, we’ve seen, can be reduced honorably, by generating budget

surpluses through spending restraint and using the proceeds to redeem
debt; it might also use proceeds from the privatization of state assets.
We’ve also seen why a sovereign might default by a deliberate inflation; but
beyond inflation there’s the insidious tactic of financial repression, includ-
ing capital levies, forced loans, zero-interest-rate policies, mandated bond
holdings, and other regulatory means by which sovereigns indirectly secure
resources. It was first identified by Lutz (1947, p. 500): “the compulsory
[public] loan is a method of taking private wealth for public purposes,”
which “cannot be condemned too severely” because “once a government
has started on this slippery downward path there is the greatest difficulty
in avoiding complete financial collapse.”
The capital levy is a discriminatory tax imposed on public bondholders,
best classified as legalized confiscation. Instead of paying what it owes,

the state simply takes from its creditors. Ricardo advised such a levy to
lessen the burden of the large British public debt incurred during the
Napoleonic Wars. It was advocated also in the aftermath of the large
public debts incurred during World War I.29 More recently it was sug-
gested by Eichengreen (1989). It’s not out of the question, given recent
experience with unorthodox fiscal schemes, that capital levies will again
be imposed. The “forced loan,” another act of repression, indeed an old
one, is still used today. The sovereign either induces or mandates that
financial institutions (banks, endowments, pension funds, insurance
companies) own and hold its bonds, which fosters an artificial demand,
raises their price and lowers their yield; sovereigns obtain cheaper funding
thereby.
Finally, financial repression occurs when central banks deliberately
hold down the short-term, overnight interest rate under its control, to
very low or near-zero levels, to reduce or cap public bond yields; states
can finance themselves more cheaply than otherwise. Zero-interest-rate
policies (ZIRPs), in place in Japan since the mid-1990s and since 2008 in
the United States, Britain, and the eurozone, were enacted by the Federal
Reserve and US Treasury between 1942 and 1951, to help depress US
bond yields during the high-debt, high-inflation years of World War II
and afterwards (Hetzel and Leach, 2001). The policy had critics at the
time (Poindexter, 1944), but its latest version was defended, even before
Bernanke and Reinhart (2004) enacted it in 2008. ZIRPs have been criti-
cized on the grounds that “low rates depress savers,” while “governments
reap benefits” (Rampell, 2012); it’s an apt description of the policy, but
also its main purpose: not to encourage saving, investment, and private
capital formation, nor stimulate moribund economies, but to permit highly
leveraged sovereigns to borrow more cheaply.
Resort to financial repression will likely intensify in the coming decades;
beyond question it benefits public creditors, and public debtors certainly
will become much more indebted over the coming decades.30 Artificially
low public bond interest rates disguise the full cost of public borrowing
just as public borrowing itself disguises the full cost of public spending;
each reflect a policy of making a costly welfare state seem less costly to a
democratic electorate than it really is.
5.7 THE FUTURE OF PUBLIC DEBT AND PUBLIC

DEBT THEORY
In recognizing dramatic, unprecedented change in the realm of public debt

in recent decades, many scholars have begun to speculate about its future
(Cecchetti et al., 2010). Below I offer my own speculations.
For one, we may well see a troubling conflation of money and debt in the
future, due to the excesses of public debt and political enabling by central
banks. Traditionally, under a gold standard and a smaller, more fiscally
sound sovereign, money is a non-interest-bearing note redeemable in a real
asset, while a public debt is an obligation to pay principal and interest at a
reasonable and remunerative market-based interest rate, say 4 to 5 percent.
In contrast, amid growth in the size and fiscal profligacy of government
in recent decades, currency has become mere fiat paper redeemable in
nothing yet imposed by legal tender laws, while public debt securities have
been gradually transformed into cash equivalents, or non-interest-bearing
state pledges to pay the same irredeemable money. Thus money becomes
debt as debt becomes money, each increasingly politicized and each
created ex nihilo, in ever-increasing sums, by sovereigns wielding ever-more
discretionary power. Meanwhile, private financial institutions essentially
become subdepartments of finance ministries and central banks. The
public sector co-opts the private sector, reflecting the spread of statism and
deeper, of anti-rentier animosity. The result is a populist, fiscally reckless
polity. Capitalism’s critics, meanwhile, insist the reverse is true – that the
private sector co-opts the public sector to establish a plutocracy, or rule by
the rich. Yes, rulers today increasingly are rich, but that doesn’t make them
pro-capitalists advocating a system known to create riches.
If the root cause of public financial profligacy is unrestrained democ-
racy, and the latter remains the moral ideal, the profligacy surely will
persist. The deeper problem of contemporary public debt lies in unlimited
majority rule. Prudent and just acts of fiscal rectitude become less common
the more a nation becomes populist, the more it eviscerates constitutional
restraints on government, the more it rejects the rule of law, and the more
it disdains sanctity of contract. The populace and its electorally sensitive
representatives lobby hard for the benefits associated with public spending
but resist the accompanying tax burden; there results an electoral bias
favoring deficit spending and perpetual public debt accumulation; free-
riding voters want their taxes both light and deferred, meaning paid by
others, whether intragenerationally or intergenerationally. The injustice is
obvious, yet the system is promulgated as the epitome of “social justice.”
As to the relation between democracy and public debt, Plumper and
Martin (2003, p. 27), building on Barro (1996), try to demonstrate an
optimal level of democratic participation in governing; too little and too

much participation likewise breed excessive public spending and less rapid
economic growth. “The beneficial impact of democracy on [economic]
growth holds true only for moderate degrees of political participation.”
Both pure (absolutist) autocracy (see Anderson, 1988) and pure (direct)
democracy are suboptimal for prosperity and fiscal rectitude; the optimal,
intermediate point is the constitutionally limited state in which popular
choice occurs in a circumscribed domain. In earlier work, Olson (1982)
similarly argued that democracies are prone to rent-seeking and a perpetual
and worsening diversion of resources from long-term investment, capital
formation, and the creation of wealth to the short-term redistribution and
consumption of wealth. “Countries that have had democratic freedom of
organization without upheaval or invasion the longest will suffer the most
from growth- repressing organization and combinations” (Olson, 1982,
p. 77; see also Clague et al., 1996). Brennan and Buchanan (1980) argue that
the democratically elected state eventually resembles a revenue-maximizing
autocracy, which nonetheless chronically deficit spends. On the other
hand, Balkan and Greene (1990) detect no significant difference between
the public debt propensities of autocracies and democracies.
The future of public credit and public debt is unfavorable, given high
public leverage, the spread and persistence of economic stagnation, and
the high probability that aging populations and entrenched entitlement
schemes will cause still larger build-ups of public leverage in the coming
decades. Public bondholders are likely to be the major victims, losing large
sums even while being forced to hold more public debt.
Public debt analysts and theorists should better incorporate in their
studies the profound shifts in monetary regimes that have been witnessed
in the past half-century. Public debt/GDP ratios mustn’t be interpreted
out of context, outside, for example, a nation’s taxable capacity, or apart
from its monetary regime. Public debts are always owed in some monetary
medium, and the nature, attributes, and effects of that medium must be
understood, else the performance of public debts won’t be well understood
or anticipated. It is crucial to realize that (1) inflation helps debtors at the
expense of creditors; (2) electorally, sovereigns prefer to defer taxation
(deficit-spend and accumulate debt); (3) sovereigns are now the largest
debtors; and (4) sovereigns, as monopoly issuers of their own money, are
the source of inflation. These four propositions imply a dangerous fifth
one: sovereigns by now have a strong incentive to default implicitly, since
they possess the power, motivation, and willingness to do so.
Current public debt theory is prone to being overly technical, narrowly
focused, and enamored of either overly pessimistic or overly o ptimistic
accounts. Theory would benefit from a broader, political economy
perspective investigating why the size and scope of government tends to

expand in the first place and why there’s an insufficient willingness and/or
ability of taxpayers to pay for the public goods they claim to want. Public
debt is a derivative, not a primary factor in public finance; it’s the form of
finance required when spending exceeds tax revenues, and if excessive, in
today’s monetary context, it’s also the form most prone to being repudiated
by monetary debasement. Ideological factors may be the most relevant in
determining the size and scope of government, and thus, in a system where
unlimited populist majorities reign, also most relevant in determining the
magnitude of deficit spending and public debt. At root, unlimited democ-
racy, the contemporary political ideal, is the source of fiscal profligacy.
NOTES
1. Kotlikoff and Burns (2004), Kotlikoff (2006), and Bova et al. (2016).
2. See Stern and Feldman (2004) and Munger and Salsman (2013).
3. Wilcox (1989), Bohn (1991), Joines (1991), Roubini (2001), Kraay and Nehru (2006),
Huang and Xie (2008), Neck and Sturm (2008), Yakita (2008), Aspromourgos et al.
(2010), Escolano (2010), Moraga and Vidal (2010), Cottarelli and Moghadam (2011),
Contessi (2012), Aso (2013), Carlberg and Hansen (2013), Kopits (2013), E. Tanner
(2013), M.D. Tanner (2015), D’Erasmo et al. (2015), and Fincke and Greiner (2015).
4. Heller (2005), Aizenman et al. (2013), and Ghosh et al. (2013).
5. Wright (1940), Hamilton and Flavin (1986), Hillman (2003), Davies (2011), Bi and
Traum (2012), and Daniel and Shiamptanis (2013).
6. Turner (2011) and Blommestein and Turner (2012).
7. Gale and Auerbach (2013) and Ghosh et al. (2013).
8. Reinhart et al. (2003), Catao and Kapur (2006), and Eichengreen et al. (2007).
9. Krugman (1988), Sachs (1989), Reinhart et al. (2012), Lo and Rogoff (2015), and
Tsuchiya (2015).
10. Kaletsky (1985), Eichengreen and Portes (1986), Grossman and Van Huyck (1988),
Aghion and Bolton (1990), Betker (1998), Aguiar and Gopinath (2006), Sturzenegger
and Zettelmeyer (2006), Kohlscheen (2007), Tomz (2007), Tomz and Wright (2007),
Cuadra and Sapriza (2008), Borensztein and Panizza (2009), Fuentes and Saravia
(2010), Hatchondo and Martinez (2010), Yue (2010), Altman and Rijken (2011),
Celasun and Harms (2011), Greenspan (2010, 2011), Kolb (2011), Yeyati and Panizza
(2011), Bi and Traum (2012), Chatterjee and Eyigungor (2012), Furth (2012),
Mendoza and Yue (2012), Cruces and Trebesch (2013), Elgin and Uras (2013), Stähler
(2013), Tomz and Wright (2013), Arellano and Kocherlakota (2014), Arellano and Bai
(2014), Henderson and Hummel (2014), Schwarcz (2014), and Asonuma and Trebesch
(2016).
11. Reinhart and Rogoff (2009), Das et al. (2012), Enderlein et al. (2012), Oosterlinck
(2013), Beers and Nadeau (2015), and Reinhart et al. (2016).
12. Froot (1989), Anderson and Young (1992), Calvo and Guidotti (1992), Smyth and
Hsing (1995), Turnovsky (1996), Barro (1998, 2003), Heise (2002), Zhang (2003),
Reinhart and Rogoff (2009a), and Mayr (2010).
13. Lee (1993), Cantor and Packer (1996), Bruner and Abdelal (2005), and Gaillard (2012,
2014).
14. Delaume (1989), Lienau (2008, 2014), Lipson (2008), Blackman and Mukhi (2010),
Young (2012), Ryan (2014), Weidemaier (2014) and Weidemaier and Gulati (2015).
15. Blejer and Cheasty (1991), Meijdam et al. (1996), Frisch (1997), Escolano (2010), Denes
et al. (2013), and Watts (2013).
16. Barro (1979), Brennan and Buchanan (1980), Cukierman and Meltzer (1989), Persson
and Svensson (1989), Alesina and Tabellini (1990a), Alesina and Tabellini (1992),
Alesina and Perotti (1995), Persson and Tabellini (2000), Franzese (2000), and Velasco
(2000).
17. Claessens (1990), Anderson and Young (1992), Smyth and Hsing (1995), Husain (1997),
Aiyagari and McGrattan (1998), Agénor and Aizenman (2005), Mendoza and Ostry
(2008), and Irons and Bivens (2010).
18. Reinhart and Rogoff (2009, 2010, 2011a), and Reinhart et al. (2012).
19. See works on default cited in endnote 10.
20. Alesina and Tabellini (1990a, 1990b), Alesina and Tabellini (1992) and Alesina and
Perotti (1995).
21. In addition to Claessens (1990), see Husain (1997), Agénor and Aizenman (2005)
and Tsuchiya (2015).
22. Reinhart and Sack (2000), Fleming (2000), and Greenspan (2001).
23. Reinhart and Rogoff (2010, 2011a, 2011b) and Reinhart et al. (2012).
24. See Krugman (1988), Sachs (1989), Reinhart et al. (2012), Lo and Rogoff (2015), and
Tsuchiya (2015).
25. Herndon et al. (2014) identify errors in Reinhart and Rogoff (2010) that supposedly
exaggerate the harm done to growth by high leverage, and consequently to wrongly
countenance growth-stunting “fiscal austerity” schemes; after corrections, Reinhart and
Rogoff insist their basic conclusions remain justified.
26. Krugman (1990), Easterly (2002), Edwards (2003), Arslanalp and Henry (2005),
Chauvin and Kraay (2007), Sturzenegger and Zettelmeyer (2007), Gunter et al. (2008),
and Reinhart and Trebesch (2016).
27. See Atkeson (1991), Aizenman and Turnovsky (2002), Stern and Feldman (2004),
Mishkin (2006), McGee (2007), Noy (2008), Toussaint and Millet (2010), Breton et al.
(2012), Friedman (2013), Ryan (2014), Bratis et al. (2015), and Altamura and Zendejas
(2016).
28. Bordo et al. (2003), Eichengreen and Haussmann (2005), and Eichengreen et al. (2007).
29. Arnold (1918), Hook (1918), Mitchell (1918), Pigou (1918), Dalton (1923), and
Eichengreen (1989).
30. Giovannini and De Melo (1993), Alm and Buckley (1998), Reinhart and Sbrancia
(2011), Reinhart et al. (2011), and Reinhart (2012).
Conclusion
I’ve examined public debt history and predominant theories of public
debt over the past three centuries in light of the recent, unprecedented
peacetime expansion of public leverage to levels not seen since World War
II. First I provided empirical context, charting public leverage as far back
as the early 1700s (Chapter 1). Next I examined public debt theory in the
three most influential schools of political economy – classical (Chapter 2),
Keynesian (Chapter 3), and public choice (Chapter 4) – and how various
theories try to explain the cause and evolution of public debt, its economic
and political effects, its intergenerational aspects, the meaning of debt
sustainability, and the conditions under which sovereigns tend to mon-
etize or repudiate their debts. Finally, I explored the limits of public debt
(Chapter 5), including how much debt can be incurred safely, how leverage
can become excessive, plus when (and what type of) defaults are likely. I
further examined the economic-financial aftermath (usually d eleterious)
of high leverage and defaults. I join with the handful of other scholars in
finding the system of unrestrained democracy to be an important cause of
public financial profligacy; yet that system is also the one that most politi-
cal theorists today find most acceptable.
There’s no better time than now for a comprehensive guide to what polit-
ical economy has said on public debt over the centuries and what it has yet
to say, or say well. The developed world in recent years has seen an astound-
ing reversal of fiscal fortune. At the turn of the last century, a decade after
the end of the Cold War and after a decade of decent economic growth,
some governments routinely ran budget surpluses and many seemed to be
in good shape fiscally (Japan being the most notable exception). From 1998
to 2001 the United States itself recorded consecutive years of surpluses,
causing some economists and policymakers to project their continuance
and, in all seriousness, to debate whether a reduction or even an elimination
of outstanding national debt was safe or advisable. At the time (2001) the
US national debt was $6 trillion, or 56 percent of GDP; by 2015 the debt
was $19 trillion and 105 percent of GDP. Like the United States, most sov-
ereigns over the past decade have been registering chronic deficits, and now
expect their indefinite continuance. Central banks, beholden to profligate
sovereigns, now routinely monetize vast public debts and try to cap bond
258
Conclusion 259
yields by keeping short-term policy rates near zero indefinitely. Leading

sovereign debtors have lost (or are losing) their top credit ratings. By now
the debate isn’t about whether lower public debt is problematic but whether
higher public debt is sustainable, and if not, why not and how not.
The main thesis of this book has been that public debt realists present
the most persuasive theories of public credit and debt, and as such, the
most plausible perspectives and interpretations of the long, fascinat-
ing history of public debt, including the most recent experience. Unlike
the realists, public debt pessimists and optimists have presented unbal-
anced and thus inadequate accounts of public debt. While optimists have
exaggerated the benefits of public debt, pessimists have exaggerated its
hazards; the benefits and hazards are real, to be sure, but rarely in the
magnitudes asserted. In place of bias and hyperbole, realism provides con-
textualized assessments of the benefits and hazards, alike, of public credit
and debt; as such, it should be able to provide superior analytic guideposts
for future interpretations of public debt trends and policies.
In arguing for the analytical value of classifying political economists as
pessimists, optimists, or realists on public debt, I stress most that it helps
clarify public debt history, but it should also help scholars participate more
informatively in a debate that’s likely to expand by at least as much as
public leverage over the coming decades.
Public debt pessimists, I’ve shown, tend to deny that governments
provide truly productive services; as such, they view taxation and public
borrowing as a drain on the private sector and a burden on future
generations; they insist that high and rising public leverage is economically
harmful and fiscally unsustainable, even though similar patterns in the
past haven’t brought economic or fiscal ruin. Ominous enough for public
debts, pessimists also suspect the bondholder is unproductive, so they often
recommend explicit default or deliberate repudiation when they believe
public leverage has become excessive. They doubt that much harm could
result from a refusal to repay the undeserving. The pessimists’ position,
to the extent that it encourages a pro-default cultural attitude, could turn
even the most bullish of public bondholders into raging pessimists. Public
debt optimists, although typically sanguine about a larger economic role
for the state and about the potential benefits of deficit spending, nonethe-
less share the pessimists’ prejudice against bondholders; they too assume
that they’re unproductive, even a parasitical menace, and as such want
policymakers to subject them to near-zero interest rates, autocratic finan-
cial oppression, and, if possible, repudiation and confiscation. The pessi-
mists and optimists have more in common than is commonly realized – and
each perpetuate long-established falsehoods.
The realists, in contrast, acknowledge that government can (and should)
provide certain productive goods and services, primarily national defense,

police protection, courts of justice, and basic infrastructure, but that
spending on social insurance or redistributive schemes, whether debt
financed or tax financed, tend to undermine productivity, p rosperity and
liberty. Unlike their rivals, realists insist on public debt being analyzed
contextually, in ways that incorporate rational assessments of a nation’s
productivity and taxable capacity. Public leverage, for the realist, is neither
inevitably disastrous nor metaphysically infinite. Since realists tend to view
financiers as honest and productive, they insist that sovereign debtors
service and redeem their debts honorably and fully, while eschewing any
resort to explicit or implicit forms of default.
Sadly, there’s a disturbing lack of public awareness of public debt
history and good theory, due mainly, I think, to the pessimists and opti-
mists. If they knew the data and the doctrines better, pessimists might
judge themselves as more pessimistic than they need be, while optimists
might see themselves as more optimistic than they should be.
Our study also reveals how a thinker’s political ideology influences his
or her interpretations about public debt; whereas advocates of constitu-
tionally limited government tend to be public debt pessimists, proponents
of a more expansive, redistributive state are usually optimists. It’s not as
though these positions can’t comfortably (or even logically) coexist, but
public debt analysis too often begins and ends with political ideology, with
the resulting spectacle that pessimists seem continually dumbstruck that
things aren’t deteriorating as much as they had feared, while optimists
seem perpetually surprised that things aren’t improving as much as they
had hoped. A realist approach can do much to avoid these twin biases.
Political economists and historians through the centuries have demon-
strated beyond much doubt that public debt has been most productively
deployed and properly administered under constitutionally limited commer-
cial republics, mainly in the eighteenth and nineteenth centuries, and has been
most abused and dishonorably conducted by two types of unconstrained
states: the autocratic and the democratic. But the Republic of Rentiers, as
I affectionately label the superior system, is long gone, even though today
there exist more public bonds and public bondholders, relative to the global
economy, than ever before. The realist must concede that democracy and (to
a lesser extent) autocracy, although by now the world’s predominant political
systems, are also the most fiscally reckless, because the least constitutionally
constrained; even their most avid proponents seem (mostly) to realize this,
yet not worry very much, because they have other priorities, which they claim
include justice. But there’s nothing particularly just about fiscal profligacy
and the dishonest, dishonorable, and destructive debt policies it entails.
Not coincidentally, there’s now a fast- growing literature on the
Conclusion 261
unsustainability of the ever-expanding welfare state and thus on the

relationship between unrestrained democracy and public debt.1 But
there isn’t much doubt that they go hand in hand, and that public debt in
particular is here to stay and here to grow. Few such studies question the
legitimacy of unlimited (or “pure”) democracy, despite its bias towards
profligacy. It’s well known that today’s electorally sensitive politician
resists spending cuts or tax hikes because (most) voters simply won’t
have it; yet they both want the welfare state, so they’ll have deficit spend-
ing, thus highly leveraged sovereigns enacting policies that risk causing
decades of grueling economic stagnation.
My account may seem pessimistic, but I think it’s a realistic assess-
ment of the current state of the state; for the hopeful and the rationally
optimistic, there’s always the option of constitutionally limiting govern-
ment. Alexander Hamilton, speaking at the New York State convention
to debate ratification of the US Constitution, which he had shaped
at Philadelphia and then defended in the Federalist Papers (1787–88),
remarked that:
[it] has been observed by an honorable gentleman that a pure democracy, if it

were practicable, would be the most perfect government. Experience has proved,
that no position in politics is more false than this. The ancient democracies, in
which the people themselves deliberated, never possessed one feature of good
government. Their very character was tyranny; their figure deformity. When
they assembled, the field of debate presented an ungovernable mob, not only
incapable of deliberation, but prepared for every enormity. In these assemblies,
the enemies of the people brought forward their plans of ambition systemati-
cally. They were opposed by their enemies of another party; and it became a
matter of contingency, whether the people subjected themselves to be led
blindly by one tyrant or by another.2
In 1787 Hamilton and the other US framers authored a republic, not a

democracy, let alone a “pure” democracy, but it is towards the latter system
that the United States and most of the world has been moving over the
past century, with generally deleterious results. In his last letter, written
to fellow Federalist Theodore Sedgwick in 1804, Hamilton expressed the
anxiety that in time there might be a “dismemberment of our Empire”
which would entail “a clear sacrifice of great positive advantages, without
any counterbalancing good,” and yet also would offer “no relief to our real
Disease; which is DEMOCRACY.”3 Excessive public debts and contingent
obligations, together with repudiations and defaults (explicit and implicit),
seem more likely over the coming few decades than ever before; if so,
it’ll be merely symptomatic of excessively-sized governments, which will
reflect, in turn, ever-more democratic (and autocratic) forms of rule. The
alternative form – a constitutionally-limited state devoted to protecting
genuine rights and liberties – is likely to be more fiscally sound and politi-
cally just, yet rarer too.
NOTES
1. See Fine (1969), Buchanan and Wagner (1977 [1999]), Crain and Ekelund (1978), Balkan
and Greene (1990), Franzese (2000), Fried (2001), Holcombe (2002), Jakee and Turner
(2002), MacDonald (2003), Vissagio (2003), Gillette (2004, 2008), Ferguson (2006),
Browning (2008), Eusepi and Giuriato (2008), Lipson (2008), Bruner (2009), Arezki and
Brückner (2010), Yared (2010), Kane (2012), Roche and McKee (2012), Motha (2012),
Schragger (2012), Wagner (2012a, 2012b), Catrina (2014), Martinez-Vazquez and Winer
(2014), and Mellor (2015).
2. Hamilton (1788 [1962]).
3. Hamilton (1804 [1979]).
APPENDIX
Table A.1 Public debt theorists classified as realists, pessimists, and optimists
Realists Pessimists Optimists

Davenant, Charles (1656–1714) Adams, Henry C. (1851–1921) Barro, Robert (1944–)
De Viti De Marco, Antonio (1858–1943) Blackstone, William (1723–80) Berkeley, George (1685–1753)
Hamilton, Alexander (1757–1804) Brennan, Geoffrey (1944–) De Pinto, Isaac (1717–87)
Harris, Seymour (1897–1974) Buchanan, James (1919–2013) Dietzel, Carl (1829–84)
Laffer, Arthur B. (1940–) Clark, John Maurice (1884–1963) Hansen, Alvin (1887–1975)
Lutz, Harley (1882–1975) Gladstone, William (1809–98) Keynes, John Maynard (1883–1946)
Macaulay, Thomas Babington (1800–59) Hamilton, Robert (1743–1829) Krugman, Paul (1953–)
McCulloch, John Ramsey (1789–1864) Hume, David (1711–76) Lerner, Abba (1903–82)
263
Melon, Jean-François (1675–1738) Jefferson, Thomas (1743–1826) Malthus, Robert (1776–1834)
Mundell, Robert (1932–) Marx, Karl (1818–83) Mortimer, Thomas (1730–1810)
Pigou, Arthur C. (1877–1959), pre-1930 Mill, John Stuart (1806–73) Musgrave, Richard (1910–2007)
Steuart, James (1713–1780) Mises, Ludwig von (1881–1973) Pigou, Arthur C. (1887–1959), post-1930
Wright, David McCord (1909–68) Montesquieu, Charles (1689–1755) Samuelson, Paul (1915–2009)
Moulton, Harold (1883–1965)
Piketty, Thomas (1971–)
Postlethwayt, Malachy (1707–67)
Ricardo, David (1772–1823)
Say, Jean-Baptiste (1767–1832)
Smith, Adam (1723–90)
Tocqueville, Alexis de (1805–59)
Wagner, Richard (1941–)
Williams, John H. (1887–1980)
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Index
“active debt” 129 Hemingway on 223
Adams, H.C. 94–5, 166, 191, 263 Keynes on 104
American Revolution 10, 14–15, 53, Lerner on 219–20
58, 60, 69–70, 74 Lutz on 169
analogy between public and private of monarchs 38
debt Say on 78
Buchanan’s view 131, 193, 196–200 Smith on 56–7, 239
classical school’s view 199, 247–8 Steuart on 48–9
Hansen’s view 128, 130–33 Tocqueville on 83
Keynesians’ view 168–9, 193, 196, in United Kingdom 17, 42–3, 48, 51,
198 78, 82, 90–91
Lerner’s view 135 of United States 10
Lutz’ view 168–9 “barren consumption” 76–7
question of 6 Bastable, C.F. 96
Wright’s view 221 Berkeley, G. 32, 34, 90, 263
Ancient era 12–14, 39, 261 Blackstone, W. 44–5, 90, 263
Aquinas 13 bondholders
Aristotle 13, 210–11 benign optimism of 232
autocracy 6, 15, 210, 220, 224, 255, 260 Buchanan on 193–4, 197–8, 207,
see also dictatorship; Leviathan state 210, 225
capital levy on 79, 145, 189, 252–3
bailouts 138, 143, 234 central banks displacing 236
see also “Too Big to Fail” doctrine Clark on 140
(US) current prevalence 260
balance of trade 14, 46 and debt Laffer curve 229
balanced budget future prospects 255
amendments 7, 205, 208, 215 Hamilton on 59
Buchanan on 208 Hansen on 130, 173
dogma of 125 and implicit default 238
Lutz extolling 163, 171–2 Keynes’ antipathy towards 107–12,
mandates 154, 188 115, 147, 239
norm 31, 96, 165 Lerner on 136–7
rules 205 Lutz on 173–4
unbalanced 171, 182, 188 Marx on 87, 89
Bank of England 26, 68, 81, 113, 146 Mises on 184–5, 189
Bank of the United States (BUS) 68–70 and pessimists and optimists 3–4,
bankruptcy 259
Brennan and Eusepi on 210 Pigou on 100
Buchanan on 197, 199 Piketty’s antipathy towards 144–5
Hamilton on 66, 78 public debt costs diffused among
Hansen on 128, 132 207
303
return of capital to 17 public debt reduced by generating

and sinking funds 36 252
and sovereigns 241–2 related to peacetime 7, 32, 53–4, 134
see also rentiers in United Kingdom 48, 99
Brennan, G. 153, 209–11, 224–5, 241, in United States 73, 173, 230
255, 263 business cycle 120, 122, 129, 153, 223,
Bretton Woods system 26–7, 149, 251
239–41, 245
Britain see United Kingdom (UK) Cameralism 14
Buchanan, J.M. capital accumulation 14, 54, 58, 79–80,
as American conservative 131 97, 99, 184, 187–8
critics of 131–3, 150, 226 capital levy
on ethical default 209–10 on bondholders 79, 145, 189, 252–3
on inflation 192–3, 199, 202, 205–10, as coercive method 157
222, 241 for extinction of debt 106
as influential mind of political in Germany 110
economy 1 as policy to reduce debt 108, 115
on Keynes 96–8, 121 retirement of UK debt by 100
and public choice 153–5, 191, 211 capital markets 30, 87, 116, 148, 163,
on public debt 131–3, 191–203, 235
205–8, 210–11, 221–3, 228 capitalism
as public debt pessimist 4, 263 Adams on 95
Public Principles of Public Debt 153, finance 14
162, 191–2, 194, 197–200 and “financialization” 41, 144
and state borrowing 224–5, 255 financiers as brains of 87
budget Griffith on 9, 141
capital 116–17, 119–20 “inevitable” demise of 126
operating 6, 117, 120 Keynes on 105, 110–12, 115, 119,
ordinary 116–17, 121 124, 147, 195
see also balanced budget Lerner on 134
budget deficits Marx on 88–90, 125–6
belief they are benign 212 Piketty on 144–5
Buchanan and Wagner on 207 populism’s disdain of 232
in crises 244 and rule by the rich 254
and governments 226, 229 capitalists 31, 77, 87–8, 91, 106,
and interest-bearing debt 222–3 111–12, 124, 150, 157, 159, 184,
Keynes condoning 115, 121–2 220
procyclical tax hikes for 99 Carroll, C.H. 16, 81–2
and sovereigns 16 central banks
supply-side economists condoning ability to lighten state’s debt burden
149 236, 246
of United Kingdom 57 effect on tax revenues 9
of United States 3, 27, 141, 148, 150, and fiat paper money 26–7, 69, 112,
182, 191, 206, 222–3, 240 146, 241, 246, 250
in wartime 94, 101, 113 “fiscal dominance” of 3
budget surpluses as fiscal enablers 249–52
in Barro’s model 223 gold bullion standard manipulated
and governments 229, 258 by 26, 244, 250
Jefferson applauding 73 increasing power and reach of
major nations enjoying 2–3 25–6
Index 305
independence of Keynesian 111–12, 115, 128, 133,

economic case for 250–51 138, 143–4, 147, 151
norm as political dependence Lutz 169
250–51 thought similar to
outmoded 26, 130, 179 Buchanan 191–2, 194, 197,
political explanation for global 199–200, 202, 210, 225
variation in 251–2 Keynesian 104, 109, 119, 147
“inflationary bias” in 240, 250 Lutz 168, 176, 181
Jeffersonian system 252 Mises 185–7
low interest rates to punish rentiers “compensatory finance” 117, 139
124 Congressional Budget Office (CBO) 28
Marx’s view of 89 constitutional constraint 212–15
monetizing public debt 27, 144, constitutionalism 30–33, 95, 164–5
146–9, 178–9, 241, 250, 258–9 contingent liabilities 217–19, 231
origins and evolution of 26–7, 146, contract, sanctity of 12, 108, 175, 211,
250 254
political dependence of 249–52 “countercyclical policies” 117–18, 125,
political enabling by, as cause of 132, 223
future troubles 254 credit capacity 4, 160–61
pressure to print money 10 see also public credit
and reserve currency 242–3, 245 creditor-debtor nexus 8, 30, 70, 148,
role of contemporary 241 179
as scheme to empower central “crowding out” 76–7, 113, 149–50,
planners 190 157, 202, 225, 248
sovereign reliance on, as
undermining public credit 179 Davenant, C. 32–3, 90, 263
zero interest rate policies 1, 3, 25, De Pinto, I. 90, 263
111, 223, 239, 253 de Tracy, A.D. 71
see also “quantitative easing” De Viti De Marco, A. 155–62, 248,
Clark, J.M. 139–40, 263 263
classical liberalism 7, 155, 161, 181, “deadweight debt” 117, 120, 129,
196, 199 131–2, 174
classical theories debasement see inflationary finance
anti-progressive reactionaries 86–90 “debt slavery” 31, 53, 70, 74
deepening debate 37–57 debt sustainability
early American debate 58–75 closing budget gaps to ensure 177
early theories 33–7 definition (public) 217
late debate 75–86 important principles of 233, 245
neoclassical marginalization of metrics for 61, 220–35
public debt 90–92 US debt projections 27–8
pre-Keynesian views 95–102 Declaration of Independence (US) 70,
on productiveness of public 74
borrowing 166–7 default see public debt default
public and private debtors as deferred taxation, public debt as 31,
analogous 199, 247–8 155–62, 194, 196, 203, 211, 213,
public debt and constitutionalism 218, 224
30–33 deficit financing 117, 120–21, 137, 141,
thought opposing 143, 208, 221
Buchanan 196 deflation 46, 82, 105, 109, 143, 147, 179
Dietzel 117–18 demagogues 187–90
demand-side economics 146–51, 153, Fabian socialists (UK) 118

190 Federal Reserve Bank (US) 178–9,
democracy 241
constitutionally limited 4, 8, 14–15, feudal era 12–13
36, 45, 47, 77, 163–5, 188, 199, fiat paper money
210–11, 217, 220, 255, 260 central banks issuing 26–7, 69, 112,
direct 9, 255 146, 241, 246, 250
majority rule 8–9, 95, 165, 220, 254 as eroding real value and burden of
as “our real Disease” 261 public debt 207
popular states 38–9 as fix for market failure 26
unlimited 8, 83, 95, 166, 213, 228, and foreign-source funding 201–2
256 governments issuing 13, 204
unrestrained 1–2, 7–8, 15, 150, 165, widespread during wartime 69
184, 190, 203, 211–13, 218, “finance capitalism” 14
247–8, 254, 258, 261 “financial exhaustion” 76
demographic trends 211 financial repression 3, 85, 130, 149,
depreciation/devaluation (currency) 179, 242, 247–8, 252–3
108, 110, 147, 170–71, 179, 234 financial revolution 14–17, 30
see also inflation “financialization” 41, 89–90, 144–5
depression financiers
deficit spending as result of 140 as brains of capitalism 87
Keynes on 96, 111, 114–17, 120, 140, as exploiters 31, 70
141–3, 147 Hume’s hostility towards 38, 40
Lutz on 172, 174, 176–8 Marx’s view of 87–9
Moulton favouring deficit spending pessimist and optimist views of 4
during 183 realists’ views of 4, 260
Pigou on 101–2 Steuart’s view on 49
public choice theorists on 213 as unproductive and parasitical 36
and public deficits, Haley on 120–21 fiscal austerity 104, 115, 230, 242
and solvency of debtors 126 fiscal chattel 212
see also Great Depression fiscal commons 6, 8, 154, 212, 214–15,
dictatorship 31, 105, 188–9, 226–7 227
see also autocracy; Leviathan state fiscal dominance 3, 217
Dietzel, C.A. 117–18, 167, 263 fiscal enablers, central banks as
Dionysus of Syracuse 13 249–52
Dutot, N. 34 fiscal fatigue 217
dysfunctional finance 218–20 fiscal illusion 81, 94, 165–6, 226, 228
fiscal integrity 61, 95, 119, 154, 164,
“economic man” premise 210 210, 227
Economic Report of the President 3 fiscal perdition, road to 143–6
electoral incentives (“vote motive”) 8, fiscal profligacy 139, 150, 154, 190,
205 217, 254, 256, 260
Employment Act of 1946 (US) 148 “fiscal religion” 96–7
Enlightenment era 13–17, 30 fiscal space 217
“entitlement” programs 217, 231, 234, fiscal stabilizers 127
255 forced loans 157, 252–3
“equivalence doctrine” 31, 80–81, 158, Franzese, R.J., Jr. 228
191, 213–14 free banking 26, 204, 241
Eusepi, G. 209–10 French physiocrats 58
exorbitant privilege 148, 242–7 French Revolution 71
Index 307
functional finance Haley, B.F. 120–21

critics of 142, 172, 181 Hamilton, A.
Hansen developing 124 on creditors 60–63, 66–8, 208
Keynes’ rejection of 117 on democracy 1–2, 261
Krugman’s resurrection of 144 hope of 91
Lerner’s theory of 133–8, 219–20 influenced
see also dysfunctional finance by Blackstone 44
by Postlethwayt 45
G-7 nations 25, 247 vs Jefferson 32, 58–75, 252
game theory 235 Lutz reflecting 164, 172, 180
Germany offering sanguine views on public
Bismarck’s welfare state 33 debt 32
Cameralism 14 opposing both excessive debt and
central banks established in 26, 146 democracy 75
gross public debt as percentage of on public credit 5, 59–61, 63–4,
GDP 23 66–7, 70
organic view of state 154 as public debt realist 4, 10, 45, 90,
paradox of profligacy 25 103, 150, 263
proto-Keynesian view 117–18 as US Treasury Secretary 17
public spending as percentage of Hamilton, R. 78
GDP 24 Hansen, A.
reparation demands 104–5, 107, as “the American Keynes” 123, 164
118–19, 146–7 Clark’s preoccupation similar to 140
“serial defaulters” 237 endorsement of Keynes 123–4
Gilbert, R.V. 126–7, 181 essay on deficit spending and
Gladstone, W. 86, 166–7 national debt 127–8
Glorious Revolution (UK) 12, 14–15, fear of secular stagnation 125–7, 133
17, 30, 33, 165 and inflation 124, 128–9, 132–3
gluts 4, 52, 82, 116, 118, 132, 205 initial take on Keynes’ General
gold-based money 207 Theory 123
gold standard Lerner drawing from 219
Bretton Woods system 26–7, 149, Lerner’s criticism of ‘too moderate’
239–41, 245 policies 137–8
classical 14, 17, 26, 31, 105, 181, 199, as making case for public profligacy
244–5, 249 94
gold bullion standard 26, 244 public debt
gold exchange standard 26, 138, capacity 130–31, 220
147–8, 250 case for “controlled borrowing”
money (and coinage) 9, 16, 76, 81, 130
94, 110–13, 115, 146, 154, 163, embracing taxonomy of 128–9
169, 178–81, 188, 204–6, 215, Harris’ more balanced approach
225, 238, 246, 254 to 142
Great Depression 20–21, 26–7, 99, 101, on limits of 129–30
125–6, 139, 142, 146–7, 163, 176, Lutz refuting claims on 171, 173
184 main contribution to Keynesian
Great Recession 20–21, 97, 144, 148, theory of 133
153, 238 Moulton’s criticisms 181–3
“Great Society” programs (US) 148 review of works critical of 131–3
Greenspan, A. 203–4 on theory of 124–5
Griffith, E.C. 9, 141 as public debt optimist 4, 263
rejecting analogizing of public and helping to mitigate leverage 229

private debt 128 and implicit default 56, 76, 132–3,
Harris, S.E. 94, 123, 141–3, 147, 263 148, 207, 238–40, 247
Hayek, F. 119 and indexed bonds 241
Hemingway (The Sun Also Rises) 223 and Keynes 105–11, 113, 115, 124,
Hitler, A. 105, 118–19 145–6, 172, 207, 239
Hume, D. and Lerner 133–9, 219–20
belief that government should live and Lutz 163, 169, 172, 174, 178–81
within its means 30 and Mises 184, 189
comparison with Steuart 45–9 in political economy literature
vs Hamilton 64 239–40
hostility towards financiers 40, 46, power to erode public debt 207–8,
87 235
as influential mind of political and “pretended payments” 52
economy 1 public debt as “inevitably leading
mistaken prediction of national to” 127
catastrophe 85 and Roosevelt 143
vs Mortimer 51–2 and sovereign borrowing 221
on public debt 31, 37–44 sovereigns as source of 255
as public debt pessimist 4, 37, 45, United Kingdom suffering 81
90, 263 as way of states repudiating debts
public spending as consumptive 82 8, 160
Say echoing view of 76–7 inflationary finance 13, 27, 78, 105,
Smith echoing view of 55 109, 129, 133, 147–9, 207–8, 227,
238–41, 245–6, 249–50
ideology 6–7, 9, 143, 260 infrastructure
Industrial Revolution 15 and classical theorists 30, 64, 76
inequality of income and wealth 144–5 fostering long-term prosperity
inflation through 8
1990s decline, in US 151 and Keynesian theorists 96, 99–101,
acceptance as viable policy option 103, 115–16, 120, 133
210 optimist and realist views on
bias towards high 227 provision of 4, 259–60
and Buchanan 192–3, 199, 202, and public choice theorists 158, 167,
205–10, 222, 241 175, 184, 187, 192, 213
central banks’ relation to inflation and Reinhart and Rogoff 233
250–52 and sustainability of public debt 217
as “clear and present danger to free insolvency 4, 42, 45, 48, 64, 78, 232
society” 97 interest rate policies 1, 3, 25, 111, 223,
as commonly used to reduce 252–3
leverage 242 interest rates
as destructive and generated by 1980s debate on 149
sovereign-sponsored central Buchanan on 194, 201
banks 241–2 and debt overhang 233
excess of total demand causing 82 effect of artificially low public bond
expectations in 1970s 27, 144 253
and Hansen 124, 128–9, 132–3 efforts of central banks 3, 124, 151,
as harming creditors 76 246, 251
helping debtors at expense of and government deficit spending 204
creditors 255 Hansen on 130
Index 309
Harris on 142 Japan

hypothesis of economic stagnation adoption of “unorthodox” policies
resulting from 233 138
inflationary money printing as way central banks
to reduce 118 established in 26, 146
Keynes on 109, 111–13, 116, 139, policy 27
147, 239 debt overhang in 233–4
Lerner on 135 economic stagnation in 220, 234
Lutz on 174–5, 180 fast-rising public leverage and aging
Mill on 84–5, 157 populace 211
non-linear response to debt 232 gross public debt as percentage of
and paradox of public profligacy GDP 21, 23, 220
247–8 intensification of deficit spending
Say on 76–7 174
and sovereign debtors 15, 249 Krugman’s advice to 144
Steuart on 46–7 as not in good fiscal shape 258
of United Kingdom in wartime 47 possibly most overpriced public
in United States 20, 246 debts 248
see also yields; zero interest rate public spending as percentage of
policy (“ZIRP”) GDP 24–5
interventionist states 9, 156 stimulus and stagnation 3
investment zero interest rate policies in 253
Adams on 95 Jefferson, T.
Buchanan on 201–2 as against all debt 58, 70–71
Clark on 139 as against public debt 73–5
De Viti De Marco on 158–9 anti-capitalistic approach 70
and democracies 255 as anti-Federalist 58
Dietzel on 117, 167 as Francophile and physiocrat 70
Hansen on 124–5, 129, 132, 171, vs Hamilton 32, 58, 70–75
183 on inheritance 72, 104
Keynes on 96, 111–12, 115–17, on public bonds 72–3
119–22, 125, 129, 133, 137, 147 as public debt pessimist 32, 90, 263
Keynesians on 126–7 seeing debt as crucial to national
Lerner on 134, 137–8 defense 71
low government yields implying safe thought, as similar to Keynes 109
75 Jeffersonian system 252
Lutz on 172, 174, 178 Jevons, W.S. 32, 92
Mises on 184–7, 190 Joines, D.H. 229
Pigou on 99–103 justice
Piketty on 144 absolute 155
productive 85, 150, 158 acme of 165
secular stagnation due to deficient answering the calls of 63
126 and bondholders 59
socialization of 115, 117, 119, 122, courts of 4, 217, 260
124, 137, 139, 162, 187 injustice 56, 101, 107, 109, 254
Steuart on 46 intergenerational 210
unemployment as reflecting Rawlsian conception of 151
insufficient 96 social 156, 254
Wright on 221 society’s prevailing conception of
ZIRPs as not encouraging 253 215
of state, confidence in 53 and “multiplier” effect 147

vigorous administration of 67 as overturning “old time fiscal
religion” 96–7
Keynes, J.M. Pigou
on achieving long-term economic under influence of 101
stability 119–20 used as theatrical foil to 98–9
as anti-capitalist 9, 106, 110–12, 124 policies for full employment 116
assessments of 121–4 proponent of zero interest rates 9,
attitude towards national debt 120 147
calling for “euthanasia of rentier on public debt 96, 104, 108, 114–15,
class” 9, 90, 108–12, 115, 147, 142, 146, 151, 213, 239
162, 239 as public debt optimist 4, 96, 263
as critic of gold standard 147, 206–7 as public debt realist 121
critics of 163, 184, 188, 190, 208 rejecting “crowding out” notion
on currency debasers 109–10 when saving is excessive 113
deficit spending rejection of Say’s Law 82
as advocating peacetime 112–14, on theory of output 119, 184
133 visit stoking interest in new
characterized as “desperate American policy 141
expedient” 117 war curing economic depression 140
as discomfited by 147 wartime financial schemes
distinction between ordinary and vindicating 143
capital spending 116–17 Keynesian spending multiplier 103,
little written on 104, 114–15 113, 136–7, 140, 147, 164, 203, 221
as never counselling unmitigated Keynesian theories
119 consolidation of pre-Keynesian
power to “stimulate” an economy views 94–8
without causing fiscal ruin 97 critics of 153, 162, 165, 169, 176,
on public capital goods 125 181, 186–8, 190, 192–209
reputation for being cavalier demand-side and supply-side
about 115–16, 121 together 146–51
reserved for investment in public Depression and new Malthusianism
capital 129 104–23
as stimulating output 139 dissidents 139–41
and demands for German reparation functional finance and “anything
104–5, 107, 110, 147 goes” concept 133–8
echoing theme that financial liberty maturation of 141–3
breeds political tyranny 40 public debt theory 141–2, 151,
favoring fiat money 9, 199 193–209, 213, 248
and inflation 105–11, 113, 115, 124, road to fiscal perdition 143–6
145–6, 172, 207, 239 stagnation and case for perpetual
as influenced by Malthus 82 debt growth 123–33
as influential mind of political World War I, large debts and
economy 1 revisionist theory 98–104
and integrity of contract 108–9 Krugman, P. 9, 90, 94, 123, 134, 140,
intellectual roots 118–19 144, 263
on intersovereign debts 106–7
Lerner’s view of, as timid 134, 137 labor theory of value 32, 79–80, 86–7
logic of, as driving policymaking 112 Laffer, A. 149, 163, 263
medievalist bigotry 108–9, 111, 124 Laffer Curve 150, 217–18
Index 311
Laffer Debt Curve 217, 228–9 Macaulay, T.B. 90–92, 263

laissez-faire Malthus, T.R. 32, 52, 82, 84, 90, 118,
America’s populist-progressive era 263
away from 33 Malthusian thought 118, 192
mercantilism in contrast to 45 Malthusianism (new) 96, 104–23
output produced under conditions marginal revolution 32
of 119 marginal utility theory 92, 134, 158
legal tender 109, 170, 180, 250, 254 “market failure” 4, 26, 146, 154, 227,
Lerner, A. 250
critics of 142, 148, 164, 172, 181, 221 Marshall, A. 92
and functional finance 133–8, 144, Marx, K.
147, 219–20 belief that economic class determines
and inflation 133–9, 219–20 ideology and politics 83
making case for public profligacy as believer in labor theory of value
94, 134, 147, 219 86
as prominent Keynesian 123, 134 echoing view of Hume 40
on public debt 132–3, 135–8, 219–20 forecasting collapse of capitalism
as public debt optimist 4, 263 125–6
rejecting fixed principles of public as influential mind of political
finance 134 economy 1
unrestrained, rules-free approach Keynes echoing view of 106, 109
133, 151 non-adoption of Hamilton’s realism
waning influence 138 75
Leviathan state 184, 191, 203, 205, 211, prejudice against rentiers 14, 31
224–5 on public debt
see also autocracy; dictatorship anti-capitalist 31, 79
liberty 8, 30, 62, 64, 74, 83, 95, 110, as anti-progressive reactionary
153–4, 184–5, 196, 210 86–90
limits to growth see secular stagnation Ricardo’s direct influence on 80
“loan expenditure” 104, 113–16, 124 as public debt pessimist 90, 145,
loanable funds 46, 76–7, 111 263
Lockean thought 7 and state-centric monetary system
London School of Economics 134 146
Louisiana Purchase (US) 73 Marxian debt analysis 53
Luther, M. 13 McCulloch, J.R. 31, 52, 85–6, 90, 263
Lutz, H.L. Meade, J.E. 123, 131–2
anticipating principle of “fiscal Medieval era 12–14, 49
illusion” 165–6 Melon, J.-F. 32–4, 52, 76, 79, 90, 263
career 162–3 Menger, C. 32, 92
immortal words of 202 mercantilism 14, 35, 45–6, 48–51, 55,
on inflation 163, 169, 172, 174, 92, 95–6, 118, 124, 160, 202
178–81 Mill, J.S.
on Keynes’ new economics 163–5 belief that government should live
main beliefs and criticisms 163, 228 within its means 30
on main threat to fiscal balance 165 De Viti De Marco echoing view of
as precursor of public choice 157
approach 155 and debt Laffer curve 229
on public debt 164–81, 194, 218, 252 on public debt 31, 52, 84–5, 248
as public debt realist 163, 166, 169, as public debt pessimist 90, 263
263 on usury 13
Mises, L. von 155, 181, 184–90, 202–3, in debt 52–3

228, 263 early political system 31
monarchy 36, 38, 83 gross public debt as percentage of
money (and coinage) see fiat paper GDP 23
money; gold-based money; gold public spending as percentage of
standard GDP 24
money illusion 202–3 United Provinces 31, 52
Montesquieu, C. 31, 34–7, 90, 263 “New Classical” economics 143–4,
“moral hazard” 1, 76, 236–7 149, 153, 202–3, 213, 226, 241–2,
Mortimer, T. 45, 51–2, 90, 263 248
Moulton, H. 181–4, 205, 263 “New Deal” (US) 125–6, 140
Mundell, R.A. 144, 149, 163, 263
Munger, M.C. 212–13 obligations
Musgrave, R.A. 94, 120, 123, 143, 147, bonds and entitlements as 218
263 and claims 194, 197, 236
Mussolini 119, 155 England meeting 91
of future generations 32, 194
Napoleonic Wars 17, 19, 31, 37, 52–3, German’s capacity to meet foreign
73, 75–6, 78–9, 81, 98, 127, 253 104
national defense 4, 64, 71, 167, 217, government 99, 108, 136, 169–70,
260 172, 176, 178
national income (GDP) impact of defaults of 209, 222
as accessible source of funds for incurred during American
public debt service 234 Revolution 58
Dietzel on 118 Keynes’ call for cancellation of 106
Hansen on 127–8, 130–32, 137, lower-interest-bearing sovereign
182–3 247
Harris on 142 non-interest-bearing 108
Hume’s thoughts on increasing of plighted faith 91
40–41 sinking funds to ensure repayment
Keynes on 108–9, 114, 120, 147, 239 of 31, 79
Lerner on 136–7, 172 “odious debt” 31, 43, 208
Lutz on 164–5, 172, 175 OECD nations
Mises on 188 public debt of 21–4
Moulton on 183 public spending of 24–5
public debt for major nations organization of debt into currency 16,
relative to 17–25 81–2, 146
and public debt/GDP 231–2, 234 “original sin” 147–8, 245–6
and public leverage 197, 218–19, over-production see gluts
222, 229 overhangs 223–35
as theoretical base of public debt
capacity 160 “Palmerston Doctrine” (UK) 210
of United Kingdom “paradox of profligacy” 25, 247–9
Hamilton’s thoughts on 78 “paradox of thrift” 96–8
Hansen’s thoughts on 127 Paris Peace Conference (1919) 104
Williams on 141 “passive debt” 129
neoclassical theories 32–3, 90–92 Peel, R. 52
Netherlands “perfect competition” model 154
beginning of public borrowing 15 Phillips curve 144
central banks established in 26 Pigou, A.C. 98–103, 106, 263
Index 313
Piketty, T. 9, 40, 90, 130, 134, 144–6, direct democracy suboptimal for 255
263 economic 8–9
Pinto, I. de 32, 45, 49–52, 54, 90, 263 financial revolution causing growth
political dependents, central banks as in 30
249–52 government loans as cause of 71
political regime types 6–7, 226–7 governments borrowing to foster 8
political theories 8, 150, 191, 195, 202, Hamilton on 61, 64–5
258 Harris on 142
populist-progressive era 33, 143 Keynes on 107, 111–14
posterity (future generations) large debt build-ups followed by 85,
after 1688 Revolution 44 95–6
Buchanan on 131–2, 193–6, 198 Lerner on 138
De Viti De Marco on 158 Lutz on 164, 168
governments as prone to Mises on 184
“mortgaging” 39 Moulton on 182
Hamilton on 58, 64–7 national
Hansen on 132–3 Gladstone on 86
Harris on 142 Hume on 41
Jefferson on 72–3 private capital bolstering 56
Keynes on 198 public credit as fatal to 76
Keynesians on 153 schemes undermining 4
Mises on 187 “passive” creditor as crucial to 36–7
Pigou on 100–102 Pigou on 99
public borrowing as burdening 39 Piketty on 144–5
public debt as harming 202, 212–13 public debt holders as making 46
and Ricardian equivalence theorem realist view of 260
31, 158 requiring public frugality 55
Ricardo on 81 resources drawn from private sector
Steuart on 47 diminishing 31
Postlethwayt, M. 45, 58, 263 Ricardo on 80
private debt and public debt, analogy Smith’s views on 55–6
between 6, 128, 130–33, 135, of state standing on precarious
168–9, 193, 196–200, 221, 247–8 footing 47
profligacy and sustainability of public debt 217
fiscal 139, 150, 154, 190, 217, 254, Protestant Reformation 13
256 proto-Keynesians
public 9, 83, 94, 140, 154, 182, 184, freespending 226
247 in Germany 117–18
see also “paradox of profligacy” Hamilton portrayed as 61, 64, 68
progressives 95–6 mercantilists typically cast as 49, 92
property (private) 8–9, 110, 211 public bonds
property rights 7, 9, 110, 163, 211, 214, and autocracy 224
227–8 average duration of 72
prosperity becoming “unfunded” 17
accumulation of debt spurring 41 Buchanan on 198, 209
Buchanan on 131, 210 and central banks 251–2
and central bank independence Clark on 140
250–51 current prevalence 260
claim that public debts deduct from De Viti De Marco on 157, 159
45 and debt Laffer curve 229
effect of purchasing power of money search for constitutional restraint

238 212–15
escrow-type fund used to purchase skepticism over claims about
undervalued 16 sovereigns 240
Hamilton on 63, 68, 77 slow but steady ascendancy of 151
Hansen on 129, 182 theorists influenced by 226–7
Hume’s hostility towards 40–41 public choice theorists
inflation-indexed on achieving fiscal integrity 154
governments issuing 13 belief that public debt harms future
reasons for issuing 240–41 generations 214
Lerner on 136, 138 as focusing on causation of public
Lutz on 175 debt 208
Marx on 87, 89 opposing Keynesian public debt
Mill on 84 theory 213–14
Mortimer on 51 presumption that everyone is self-
and organization of debt into interested 153, 215
currency 81–2 prominent 153
Piketty on 145 rejecting Germanic-organic view of
plunging yields 3 state 154
in popular and absolutist states 38 stressing both positive and
public debt normative aspects of public
gross, as all outstanding 231 debt 214–15
and investors’ willingness and tendency towards debt pessimism 8,
capacity to buy and hold 6 162, 168
and reserve currency demand 244 Williams as proto 140
Ricardo on 81 see also Brennan, G.; Buchanan,
Say on 77–8 J.M.; De Viti De Marco, A.;
Smith on 53 Lutz, H.L.; Mises, L. von;
Steuart on 46 Moulton, H.; Wagner, R.E.
Wright on 221 public credit
yields 3, 27, 77, 223, 232, 247–8, Adams on 95, 166
252–3 as capacity to borrow 217
public capital investment see Clark on 139
infrastructure De Viti De Marco on 160–61
public choice definitions 5, 77
early suspicions of state motives future of 255
162–90 Hamilton on 5, 10, 59–61, 63–4,
essence of 153–5 66–8, 70
as focusing on causation of public Hansen on 127, 130–31
debt 153 Hume on, in relation to UK 42–3
Hume adopting view of 39–40 Hume’s essay on 37, 39, 51
important themes of 139–40 Keynes on 104
pessimism reprised 191–212 Lerner on 172
possible argument on paradox of Lutz on 163–8, 170, 174–7, 179,
profligacy 248 218
public debt as deferred taxation 31, Marx on 88–9
155–62, 194, 196, 203, 211, 213, Mill’s index of 84
218, 224 Mises on 185
recognizing influences of Mortimer on 51–2
unrestrained democracy 7 as public debt capacity 28, 160
Index 315
relation to public debt 5–6, 8, 28, extinguishment 32, 50, 52, 58, 63–7,
175–6, 218 75, 78, 159–60
Say on 76–7 future of 254–6
Smith on 53 gross 23–5, 159, 231
as sound, in United States 15 history
Steuart on 46–8 finance in ancient and medieval
public debt times 12–14
“active” versus “passive” 129 financial revolution and
analogy with private debt 6, 128, Enlightenment 14–17
130–33, 135, 168–9, 193, US debt sustainability 27–8
196–200, 221, 247–8 visual depictions 17–27
build-ups (accumulations) illusion 132, 139, 180, 202–3, 214
classical economists on 30, 41, incidence 32, 90, 153, 191, 195, 198,
52, 84 203, 213–14
De Viti De Marco on 162 internal/domestically-held 6, 45,
electoral bias favoring 254 48–9, 55, 106, 108, 110, 126,
future likelihood of larger 255 135–7, 142, 158–9, 173, 181–2,
Hamilton on 1–2, 5, 65–7, 75 191, 193–4, 197, 199–202, 219,
Hansen advocating 129, 147, 181 221, 225, 231, 247
interventionist states 9 intolerance 217, 231, 237
Keynes on 115, 124 issuance 16, 45, 133, 193, 213, 248
Keynesian theorists on 143, 150, limits
205 capital levies, forced loans and
Lerner advocating 147–8, 181 financial repression 252–3
Lutz on 170 central banks as fiscal enablers
Moulton on 181 and political dependents
Munger on 212–13 249–52
norm since 1930 7–8 debt defaults 235–42
optimists on 4 and dysfunctional finance 218–20
Pigou on 99–100 exorbitant privilege and paradox
public choice theorists on 211, of profligacy 242–9
212–13 literature on 217–18
studies of political-economic metrics for debt sustainability and
causes of 223, 228, 251 overhangs 220–35
of UK and US 85, 90, 96 management 124, 163
burden 1–4, 108, 111, 117–18, 123, metrics 220–35
128, 146, 169, 179, 195–6, monetization 27, 81, 111, 144,
206–7, 238 148–9, 151, 240, 250–51
case for perpetual growth 123–33 neoclassical marginalization of
and constitutionalism 30–33 90–92
crises 10, 144, 219, 228, 234–5, 244, net 6, 73, 159, 176–7, 230
246–7 optimists 3–5, 62, 90, 103–4, 175,
as “deadweight” 117, 120, 129, 218, 230, 247, 259–60, 263
131–2, 174 optimization 217–18
as deferred taxation 31, 155–62, 194, overhangs 220–235
196, 203, 211, 213, 218, 224 pessimists 3–5, 48, 62, 85–6, 90–91,
and dysfunctional finance 218–20 103, 145–6, 168–9, 185, 218,
external/foreign-held 6, 48–9, 103, 230, 247–8, 259–60, 263
135–6, 147, 149, 191, 193, 197, realists 4–5, 10, 37, 48, 90, 103, 129,
199–201, 225, 231, 237–8, 247 150, 259–60, 263
relief 236 Buchanan on 210

repudiation causality due to imprudence,
Buchanan on 209, 222 argument 8–9
De Viti De Marco on 160 central conflict of 95
as deliberate default 79 De Viti De Marco on 155–6, 160,
Hume on 37–8, 43, 47 162
Jefferson on 71, 74–5 financial revolution 14–17, 30
Keynes on 104–5, 107–10, 133 Hansen specializing in 123, 127
Keynesians on 147 ideology influencing assessments
Lerner on 134 of 9
Lutz on 163, 166, 176, 178–9, 181 Keynes on 106, 199
Mises on 189–90 Lerner on 134, 138
by monetary debasement 256 Lutz on 162–3, 173
Moulton on 183 McCulloch on 85
pessimists’ advice 4, 259 mercantilism as system of 14
Piketty on 145 Mises on 187, 190
reputable alternative to 242 Moulton on 182, 184
state tendency 8, 31 as operating best by objective
Steuart on 47 standards 220
theoretical framework 235–7 Pigou on 99, 101–2
Tracy on 71 public choice offering more
restructuring/renegotiation 63, 147, consistent theory of 154, 208
166, 210, 217–18, 235–6, 242 public debt as derivative of 256
spiral 174, 223 radical transformation of 8
sustainability 27–8, 217, 220–35, 245 state-enabling system of Keynesian
theory 149
classical 30–92 summary of norms 96
future of 254–6 public goods 6–7, 54, 64, 166–8, 202,
Keynesian 94–151 213–14, 217, 256
public choice 153–215 public leverage
tripartite taxonomy of 128–9 Buchanan on 197, 222–3
“vulgar” view 48, 191, 200, 202 central banks helping to mitigate
in wartime 3, 7–8, 14, 16–17, 19–21, rising 241
26–7, 32–4, 37–8, 51–4, 57–8, concept of 160
60–62 and crises 247
public debt capacity see public credit debt Laffer curve of 217–18
public debt default decline in 37–8, 86, 98
explicit 4, 13, 27, 108, 145, 148, 176, explicit and contingent 218–19
191–2, 209, 218, 222, 235–42, Franzese on 228
259 future of 259
implicit 13, 52, 56, 76, 108, 132, of Greece 246–7
178, 180, 192, 207, 236, 238–42, Hansen on 127, 130–33, 183
246–7 historical methods of reducing
partial 179, 181, 236–7 242
“serial defaulters” 71, 75, 207, 231, inflation reducing 238
236–8 at “insupportable level” 109
public finance of Japan 24–5, 144, 233
abandonment of rules of 151 Keynes on 120, 239
as analogous to household finance Keynesian theory on 143, 151
52 large economies with high 233–4
Index 317
nations borrowing at unprecedented Tocqueville on 82–3

levels of 85 during wartime, in UK 99–100
optimization 228–30 Williams on 140–41
and partial default 236 “pump priming” 118, 139
peacetime boom in 211, 258
pessimist view of 259 “quantitative easing” 27, 138, 144, 149,
and political regime types 226–7 151, 251
potential causes of build-ups 255 see also public debt; monetization
ratios 3–5, 21, 94, 145, 148, 208, 234,
241 redistribution 137, 145, 156, 159, 225,
realist view of 4, 260 255
reasons for unchecked growth regime type (political) 6, 36, 217,
232–3, 240 226–7
rising rates of 1, 24–5, 27, 115 Reinhart, C.M. 220, 230–39, 242,
sovereign bond yields as sign of 246–7, 253
safety 248 Renaissance era 13–14, 16, 53
US, contemporary 97, 148 rentiers
use of inflation to erode excessive 76 central banks as punishing 124
in wartime 21, 33, 92, 94, 100 Clark on 140
public pensions 138, 145, 246, 253 De Viti De Marco on 159
public spending democratic populism’s disdain of
Buchanan on 131, 192–4, 196, 209, 232
222 Hansen on 130, 133, 138
as consumptive, never productive 82 Hume’s view of 40
De Viti De Marco on 158 and inflation 210
deadweight losses of taxation from Keynes’ euthanasia of 9, 90, 108–12,
226 115, 147, 162, 239
devoted to public debt service Lutz on 174–5, 180
future generations 133 Marx’s dislike of 14, 86–7, 89
in United Kingdom 42 as parasitical 126
and electorally sensitive Piketty on 90, 144–6
representatives 2, 150, 254–5 prejudicial premise on 36, 40
Hamilton on 65 “Republic” of 15, 260
Hansen on 127 revolutions fired by 14–15
Keynes on 113, 115, 147 and vote-getters 190
Lerner on 134, 138 reparations 104–5, 107, 118–19, 146–7
Lutz on 164, 173–4, 177, 180 republics and republicanism
Mises on 184, 188 constitutionally limited
as percentage of GDP commercial 15, 260
of OECD nations 24–5 federal 164
of United Kingdom 19 regime 210–11, 217, 220
of United States 22, 97 debts contracted by 34
popular, democratic nations enacting more tax-rate cuts but not
endorsing 75, 82 spending cuts 188
public borrowing disguising full cost imposition of tax burdens 39
of 253 Italian 15, 52–3
and repudiation of debts 8 vs monarchical governments 38,
and Ricardian equivalence theorem 52–3, 83
80 Montesquieu on 36
Smith on 54 United States moving towards 261
reserve currency “safety net” 217, 231

and exorbitant privilege 242–7 Samuelson, P. 94, 123, 143, 148, 263
US dollar as 26–7, 245 savings
revisionist theory 98–104 Buchanan on 194, 196–7, 200, 202,
“Ricardian equivalence” 31, 80–81, 224–5
158, 191, 213–14 constitutionally limited governments
Ricardian socialism 80 as fostering 165
Ricardo, D. De Viti De Marco on 157, 160–61,
belief in labour theory of value 79–80 248
belief that government should live and deficit spending 30–31, 96
within its means 30 and expansion of debt 126–7
De Viti De Marco echoing view of financiers as fostering 87
158, 161 Hamilton on 58, 60
denial of debt illusion 202 Hansen on 123–5, 132
equivalence doctrine 80–81 Keynes on 96, 112, 116, 121, 123–5
“fiscal illusion” 81 Lerner on 132, 137
as influential mind of political Lutz on 168, 170–71, 173
economy 1 Mill on 84, 157
Keynes echoing view of 106 Piketty on 145
Lutz echoing view of 173 public debt as crowding out private
McCulloch echoing view of 85 230, 248
mistaken prediction of national public loans as wasting 82
catastrophe 85 Ricardo on 79
Piketty echoing view of 145 Say on 76–7
on public debt secular stagnation due to excessive
as broadly detrimental 84 126
non-productive dissipation of Smith on 55
wealth 52, 166–7 usury defended as 30
opposed to excessive use of 31 Say, J.-B.
“organization of debt into belief that government should live
currency” 81–2 within its means 30
and war 32, 79, 82, 253 “crowding out” argument 76–7
as public debt pessimist 78–80, 90, and debt Laffer curve 229
263 on dissipation of wealth 52
public spending as consumptive 82 on government spending 76–7
on usury 13 and labor theory of value 32
rights on national bankruptcy 78
of citizens 217 opposed to excessive use of public
creditors’ 61, 63, 75, 111, 208 debt 31
of individuals 110–11, 220 on public borrowing 76–7, 166–7
property 7, 9, 110, 163, 211, 214, on public debt as detrimental 76,
227–8 84
as respected, in republics 15 as public debt pessimist 75, 77–8,
respecting state 64, 162 90, 263
state, to breach credit 37 public spending as consumptive 82
of the whole 72 on sinking funds 77
Rogoff, K.S. 220, 231–9, 246–7 on usury 13
Roosevelt, F.D. 114, 118, 140–41, 143, Say’s Law 82
182 secular stagnation
rule of law 12, 36, 83, 162, 164, 254 critics of thesis 131, 142, 181
Index 319
as due to excessive savings and Seven Years War 57

deficient investment 126 Shylock 174
governments as providing means of sinking funds
mitigating 4 extinguishment via 32
Hansen’s thesis of 125–8, 183 Hamilton on 59
Japan’s 144, 234 Mortimer on 51
and permanent deficit spending 96 as prudent method of debt service 46
view that deficit finance can cure Ricardo on 79
126, 133 Say on 77
and zero interest rates 252 Smith on 52–3
see also stagnation (economic) United Kingdom
securities use of 47, 79
in ancient and medieval times 12 Walpole creating first fund in 36
average duration of 212 use by US federal government 16–17
and central banks 249–50 use in peacetime 16, 31
in financial revolution era 15, 30 slavery see “debt slavery”
as gradually transformed into cash Smith, A.
equivalents 254 belief that government should live
Hamilton on 66 within its means 30
Hume on 39–40 vs Hamilton 64
Keynesians on 197 as influential mind of political
Marx on 87–8 economy 1
mortgage-backed 248 vs Keynes 107, 109, 239
Mortimer on 51 Lutz echoing views of 180
Piketty on 145 and mercantilism 45
Ricardo on 79 mistaken prediction of national
sovereign 243 catastrophe 85
Steuart on 47 opposed to excessive use of public
US debt 245 debt 31
see also public bonds on public borrowing 166–7
seigniorage 240 on public debt 52–7, 84, 239
self-interest as public debt pessimist 4, 52, 90,
Buchanan on 208–10, 222 263
of central banks 243 public spending as consumptive 82
of citizens 209, 222 Say echoing views of 76–8
of creditors 33, 84, 248 on usury 13
De Viti De Marco on 161 social insurance 1, 4, 7, 187, 259–60
of elected officials 213 “social utility” 134
individual 213 socialism 9, 80, 119, 124, 134, 145, 162
Keynes on 110–11 “socialization of investment” 115, 117,
private actors and political elites 119, 122, 124, 137, 139, 162, 187
driven by 215 “soft despotism” 83, 188
of public bondholders 56 sovereign debt see public debt
public choice theorists on 153–4, 215 sovereign immunity 128, 169, 193, 199,
rational 208 210, 219
realist view of 154 speculation 34, 64, 81, 89, 100, 138
of savers 177 “stagflation” 138, 150–51, 153
sovereigns best modeled as 226–7 stagnation (economic)
states foreswearing repudiation 237 commercial, public debt
virtues of 30 counteracting 46
complete policy discretion breeding Smith on 55

134 Steuart on 48
and high public debt/GDP ratios Wagner on 212
233–4 “tax smoothing” 99, 223, 228
partial, indefinite deficit spending taxable capacity
not a remedy for 139 and 10 percent income tax rate 78
perpetual, public leverage ratios and calculation of public debt/GDP
bringing 4, 247 ratios 255
persistent, and stimulus 3 De Viti De Marco on 160–61
Piketty’s belief that inequality democracies with greater 83
breeds 145 Hamilton supplying metrics for
prolonged calculating 61
highly leveraged sovereigns Hansen on 127, 129
enacting policies causing 261 Joines on 229
resulting from debt overhangs 235 Lerner on 136
public debt promoting shift to 185 Lutz on 170, 176
and saving and investment 112 realist view of 4, 260
spread and persistence of 255 Reinhart and Rogoff studies
see also secular stagnation ignoring 234, 246
Stalin 119 United Kingdom’s 99
state motives 162–90 taxation
statism 118, 163–4, 205, 254 Buchanan on 192–4, 203, 205, 209,
Steuart, J. 222
on Davenant 33 center-left politicians keen to raise
as influential mercantilist theorist 150
45–6 De Viti De Marco on 156–7, 160, 248
on public bonds 46, 58 deadweight losses of 226
on public debt 32, 45–50, 64 electorally sensitive representatives
as public debt realist 4, 90, 263 resisting 255
and sinking funds 46–7, 49–50 Gilbert on 126
suffrage (franchise) 15–16, 83, 143, 146 governments in wartime 32
supply-side economics 146–51 Greenspan on 204
sustainability see debt sustainability Hamilton on 10, 60, 65, 67
Hansen on 129, 131, 183
tax burden Jefferson on 75
of bonds and entitlements 218 Keynes on 107, 113–14
Brennan on 211 Lerner on 136
Buchanan on 203 Lutz on 163–4, 166–7, 173, 177,
De Viti De Marco on 159 180–81, 194
electorally sensitive representatives Marx on 89
resisting 254 McCulloch on 85
Hansen on 125 Mises on 189
Hume on 41 Moulton on 183
Lutz on 174, 177 opposed by declarers of
McCulloch on 85 independence 62
Meade on 131 pessimist view of 259
of nineteenth century private sector Pigou on 99
249 Piketty on 145
republics usually imposing light 39 political elites’ electoral incentive to
Ricardo on 79 minimize 8
Index 321
public debt unemployment

as handmaiden of 167 Buchanan on 192
as minimizing scope of 46 Griffith on 9
as preferable to oppressive 32 Hansen on 127, 129–30, 132
Ricardo on 78–9, 82 involuntary 99, 115–16, 119, 133
see also deferred taxation, public Keynes on 96, 115–16, 119–20, 122,
debt as 133
taxpayers Lerner on 135
avenue for future research 255–6 Lutz on 165, 168, 171
Buchanan on 194, 197–8, 209, 222 Malthus on 82
in central conflict of public finance Moulton on 183
95 Pigou on 99, 101, 103
Clark on 140 progressives on 96
De Viti De Marco on 157, 159–60 public debt theorists on 213
Hansen on 132, 173 Williams on 141
Keynes on 108, 198 United Kingdom (UK)
Lerner on 137 history 26, 30–31, 33–4, 37–8, 41–9,
Lutz on 168, 173–4 51–2, 56–7
Mises on 184, 186–7 as prudent fiscal role model 31
Pigou on 100 public debt 17–18, 23, 25
popular state reliant on acquiescence public interest expense 17–19
of 38 public spending 19, 24
revolutions fired by 15 United States (US)
Tocqueville, A. de Civil War 20, 75–6, 90, 103
on democracy 2, 31, 82–3, 188 debt projections 27–8
opposing excessive use of public history 58–75
debt 31 public debt 19–20, 23, 25
as public debt pessimist 90, 263 public interest expense 20–21
“Too Big to Fail” doctrine (US) 217, public spending 21–2, 24
231, 248 US Congress 58–60, 62, 64–8, 74, 232
“tragedy of the commons” 211–12 US Constitution 59, 62, 71, 73, 165,
see also fiscal commons 205, 208, 261
transfers US Treasury 3, 16–17, 20, 25, 58, 61,
analogy 72 71, 130, 140, 178–9, 181, 227, 230,
Buchanan on 193–4, 200, 209, 232–3, 241, 244, 253
222 usury/usurers 13, 30, 89, 109, 190, 208
Dietzel on 118
as generating high taxes 227 Victorian era 86, 96–8, 208
Hansen on 129, 133 “vote motive” (electoral incentives) 8,
intergenerational 193, 228 205
Keynes on 96, 115–16, 129
Lerner on 134 Wagner, A. 117–18, 195
Lutz on 175 Wagner, R.E. 96–7, 121, 153, 162,
Mises on 187 190–91, 205–7, 211–12, 250, 263
non-remunerative 175 Walpole, R. 36
Pigou on 101–2 Walras, L. 32, 92
redistributive 104 Webb, B. 118
social 99, 133, 184 Webb, S. 118
wealth, in medieval era 14 welfare state
“Treasury View” (UK) 102, 112–13 Bismarck’s German 33
central banks founded to assist 146 yields

electorally sensitive politicians Buchanan on 209–10
wanting 261 decline in, among developed nations
fiscal manifestations of burgeoning 5
218 efforts of central banks 247, 251–3,
and fiscal profligacy 150, 182 258–9
and “Great Society” programs 148 and financial repression 149, 253
Greenspan on 204 inflation-indexed bonds vs
literature on unsustainability of unindexed bonds 240
260–61 with larger increases in supply 244
making seem less costly than it is Lutz on 174–5, 181
253 Mill on 85, 229
Moulton favoring 182 paradox of declining, amid rising
Piketty favoring 145 public leverage 232, 244
relation to public debt 7, 28, 215 pessimists on 247–8
and unfunded future contingent public bonds 3, 27, 77, 223, 232,
liabilities 231 247–8, 252–3
in United Kingdom 19 remaining low, while bond prices
William III 26, 47 remain high 232
Williams, J.H. 139–41, 263 remaining low, while debt
World War I 17, 19–21, 26, 33, 37, accumulates 48, 97
48, 78, 92, 94, 97–100, 104–6, Say on 77, 229
113, 127, 146, 173, 178, 184, 218, as signalling safety of public leverage
244–5, 253 248
World War II 3, 17, 19–21, 97–8, 100, ten-year sovereign bond 25
127, 130, 142, 148–50, 163, 178, see also interest rates
181, 204, 211, 232, 239, 253, 258
Wright, D.M. 181–2, 220–21, 263 zero interest rate policy (“ZIRP”) 1, 3,
9, 25, 27, 109, 111–12, 138, 144,
yield spread 249 147, 151, 223, 239, 247, 251–3, 259

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The Political Economy of Public Debt

NEW THINKING IN POLITICAL ECONOMY

NEW THINKING IN POLITICAL ECONOMY

Cheltenham, UK • Northampton, MA, USA

All rights reserved. No part of this publication may be reproduced, stored

Edward Elgar Publishing, Inc.

A catalogue record for this book

Library of Congress Control Number: 2016949925

This book is available electronically in the

ISBN 978 1 78536 337 5 (cased)

Typeset by Servis Filmsetting Ltd, Stockport, Cheshire

[There is a] danger to every Government from the progressive accumulation of

Four decades later, writing in Democracy in America, Alexis de

Limiting the accumulation of public debt in democracies has always been

The past two decades entail an astonishing reversal of fortune in

or markets. In 2000 the US Treasury submitted a draft chapter for the

●● questions as to the nature of public credit and debt, including: the

Although fiscal institutions, interacting with voter preferences, shape

accumulation. The radical transformation of public finance over the past

economic prosperity. Direct democracy breeds public profligacy – and the

To be clear, Griffith doesn’t contend that deficit spending by itself destroys

In place of pessimism or optimism, Hamilton offered a balanced, realistic

1.1 FINANCE IN ANCIENT AND MEDIEVAL TIMES

Governments in ancient and medieval times required funding, as do

farmers or serfs, in return for military protection.3 Government funds in

1.2 THE FINANCIAL REVOLUTION AND THE

The origin and development of today’s modern system of public finance

in 1688 and America’s Revolution in 1776 (Fisk, 1920). Each was a

relations, including those between government (as debtor) and private

semi-­annually, eliminating the burden of repaying a huge lump sum of

1.3 VISUALIZING THE HISTORY OF PUBLIC DEBT

Visual depictions of the history of public debt provide perspective on

Figure 1.1 Public debt of the United Kingdom as a percentage of GDP,

Figure 1.2 Public interest expense of the United Kingdom as a percentage

Figure 1.3 Public spending of the United Kingdom as a percentage of

Figure 1.4 Public debt of the United States as a percentage of GDP,

Figure 1.5 Public interest expense of the United States as a percentage of

Figure 1.6 shows that US federal spending is now 20 percent of GDP,

Figure 1.6 Public spending of the United States as a percentage of GDP,

Source: Reinhart (2012, Figure 1).

Figure 1.7 Public debt of 22 OECD nations as a percentage of GDP,

Sources: www.carmenreinhart.com/data, and Reinhart and Rogoff (2011b).

Table 1.2 Public spending as a percentage of GDP, 15 OECD nations,

Nation 1910 1920 1940 1960 1980 1990 2000 2010

Sources: 1910–80: Tanzi and Schuknecht (2000); thereafter, OECD Factbooks.

11.3 percent, compared to the 15-­nation average of 76.9 percent, more

Nation Gross Public Debt as a % Ten-­year Sovereign

Sources: OECD, IMF, and www.carmenreinhart.com/data.

the Bretton Woods system in 1971 no central bank resumed issuance of

1.4 QUESTIONS OF SUSTAINABILITY

Source: National Commission on Fiscal Responsibility (2010, p. 10).

Figure 1.8 Three projections of the US debt*/GDP ratio (leverage),

slow-growing tax revenues due to stagnant (because overtaxed and over-

2.1 PUBLIC DEBT AND CONSTITUTIONALISM

Britain’s Glorious Revolution of 1688 revolutionized and institutional-

­ roduction; indeed, it only diverted private savings from productive pur-

2.2 EARLY THEORIES: DAVENANT, MELON,

superfluous creditor is also crucial to prosperity and indispensable to a

2.3 DEBATE DEEPENS: HUME, STEUART, AND

he overestimated its relative magnitude and burden; given his pessimism,

growth rate of national income. First, he warns, “national debts cause a

prefers that Britain survive as a nation, he prefers her credit be destroyed

people” it would be worthwhile, to save the nation. Laursen and Coolidge

1.2 THE FINANCIAL REVOLUTION AND THE

semi-annually, eliminating the burden of repaying a huge lump sum of

Figure 1.1 Public debt of the United Kingdom as a percentage of GDP,

Figure 1.2 Public interest expense of the United Kingdom as a percentage

Figure 1.3 Public spending of the United Kingdom as a percentage of

Figure 1.4 Public debt of the United States as a percentage of GDP,

Table 1.2 Public spending as a percentage of GDP, 15 OECD nations,

11.3 percent, compared to the 15-nation average of 76.9 percent, more

Nation Gross Public Debt as a % Ten-year Sovereign

roduction; indeed, it only diverted private savings from productive pur-

2.2 EARLY THEORIES: DAVENANT, MELON,

2.3 DEBATE DEEPENS: HUME, STEUART, AND

Every speculative projector, every disappointed statesman, every pseudo-

Smith especially detests the fact that a sovereign’s inflation-driven default

2.4 EARLY AMERICAN DEBATE: HAMILTON

2.5 LATE CLASSICAL DEBATE: SAY, RICARDO,

Unfortunately, no nineteenth- century classical economist – from

2.6 ANTI-PROGRESSIVE REACTIONARIES: MARX

2.7 THE NEOCLASSICAL MARGINALIZATION OF

3.1 PRE-KEYNESIAN VIEWS CONSOLIDATED:

3.2 WORLD WAR I, LARGE DEBTS, AND

spending. In the 1956 edition he devotes new chapters to the job-creating

3.3 DEPRESSION AND THE NEW