From: ipser@solomon.technet.sg (Ed Ipser)
Subject: Re: Confronting the Deficit/Debt Boogyman
Organization: TECHNET, Singapore
Date: Sat, 11 Apr 1992 06:02:20 GMT

In article <8864@alvin.mcnc.org> ekp@mcnc.org (Edward Pavelchek) writes:
>In article <1992Apr7.052044.25065@nuscc.nus.sg< ipser@solomon.technet.sg (Ed Ipser) writes:
><In theory, we are all shareholders in the federal 'corporation' (all of
><voting age, anyway). Of course, we are not all equal shareholders to judge
>
>NO!! Shareholders enjoy limited liability, US citizens do not, and may
>be liable for all federal debt.

All right, lets get down to brass tacks.

How are Americans, as individuals, corporations, and cities, counties, and
states responsible for the federal debt? To analyze this question
seriously, we have to hypothesize that there is some limit to federal
borrowing, i.e. that there will come a time when lenders will be unwilling
to buy new federal bonds. Lets not debate this now, lets just assume it.

Let's suppose further that Americans continue to hold the line, politically,
against tax increases and perhaps even demand and receive tax cuts (there
is no economic sense in which new taxes are inevitable) and otherwise let
the deficit run its course.

What happens?

First, those currently holding bonds suddenly face the prospect of not
receiving interest or repayment of the bonds. What can they do about it?
Nothing. If the government defaults, the value of the bonds is wiped out
without further legal recourse. Under this scenario, people suffer in
porportion to their holding of federal bonds.

Now suppose that the federal courts are willing to entertain complaints
from bond holders. What can they do? At best, they can treat the federal
government as bankrupt or in Chapter 11, cutting its spending and selling
off selected assets in an effort to recover the value of the bonds.
Again, individual Americans are only affected in porportion to their
holding of bonds insofar as the repayment is below face value.

However, the most probable sequence of events would be, knowing that
they are gravely at risk of losing their money, long before they refuse to
lend altogether, bond holders will begin to demand higher rates of interest
to cover a perceived risk. As interest rates on federal bonds increase, two
things happen:
  1) the whole process is accelerated; and
  2) interest rates consume an ever higher proportion of spending.
The rising interest rates also signal a warning to the federal government
that its credit is running out. Further, bond holders will gain leverage
over the federal government as interest rates increase and the deficit
(bond creation) becomes an ever greater proportion of federal income.

Still, we have not seen a threat to American citizens and their private
property nor the solvency of the states, etc. At no time are American
citizens liable above and beyond the politial process itself. American
citizens will pay only insofar as a reduction in the net assets held by
the federal government harms the US economy.

Just what are the worst cases?

  1) The bankruptcy of the federal government either slowly through a
     credit squeeze or quickly in a credit crunch.

  2) To avoid the above, the federal government is forced to cut back on
     spending.

  3) The federal government, faced with bankruptcy, runs amok suspending
     the Constitution and seizing private property, etc.

However, the second alternative is essentially the same outcome which is
required to avoid the crisis in the first place. Thus we can ignore it.
The third is most improble and would, in any case, most likely lead to
the first case when American citizens refuse to cooperate and states assert
protection of their residents. You seem particularly enamored with the
third alternative, though. Suffice it to say that whatever power the
government has above and beyond the political process is matched, in kind,
by the power of Americans:

  ...to alter or to abolish [the federal government], and to institute new
  government, laying its foundation on such principles and organizing its
  powers in such form, as to them shall seem most likely to effect their
  safety and happiness. ...

That leaves us with the first alternative. What would happen if the federal
government were successively squeezed by the creditors? How would that
outcome be different from the second outcome or the steps needed to avoid
the crisis?

It seems that the ultimate result, one way or another, is lower federal
spending. Hardly an economic catastrophe.

In no practical nor legal sense are American citizens or states liable for
the debts incurred by the federal government. In every real sense, the
liability of Americans for federal debt is strictly limited to the assets
held by the federal government.