President Biden appears adamant that he will not yield one iota to the Republicans demanding spending cuts in return for increasing the debt limit. He also claims to believe that through the 14th Amendment he can issue debt unilaterally, without Congressional approval. By doing so, he would take the position of an absolute monarch, like James II, Louis XIV or Khufu. Lessons can be drawn as to how that might work in practice.
Before the 17th century, it was impossible for governments to issue long-term bonds. Kings could borrow, but there was no legal process by which one King’s obligations carried on to his successors, so lenders provided only short-term debt. This itself maximized the chance of default in a cash flow crisis, such as the 1672 Great Stop of the Exchequer in England. Even after the Dutch/British invention of funded debt with Parliamentary authorization, other countries such as France remained absolute monarchies, so their debt availability remained very limited – French debt in the 1780s was 110 million livres, abut 5% of Britain’s funded debt at that time, and the difficulty of dealing with that debt and securing resources led directly to the 1789 recall of the Estates-General and thus to the Revolution.
The first to adopt a more permanent debt issuance system was the Netherlands. By an agreement of 1579, the seven provinces of the United Netherlands were each made proportionately responsible for the United Netherlands’ obligations, with Holland, the largest province, being responsible for 57.7% of them. Since each province had a parliament that could authorize debt issuance, Netherlands debt, or that issued by Holland, was long-term from 1579 and by 1620, when the country’s political future was assured, yielded only around 5%.
During most of the 17th Century, Britain was unable to follow this model; the Stuart Kings did not wish to subject their financial affairs wholly to Parliament, and the Interregnum of 1649-60 issued substantial debts, most of which were written off at the Restoration. Thus, even though England in 1674-88 was an excellent credit risk, with expanding trade raising revenues rapidly and no wars, it was only after the Dutch William III took over in 1688 that the Dutch system was adopted, with Parliamentary approval being given to debt issuance, and Parliamentary actions being deemed to bind successor Parliaments.
The move to stable funded debt took another 30 years, because the Whig financiers of the 1690s saw England’s borrowing capacity (Britain’s after 1707) as a chance to make speculative profits from lotteries, tontines and fancy annuities, but after Sir Robert Walpole took over the finances in 1721 stability was assured. Indeed, so stable were Britain’s finances by the 1750s that Henry Pelham was able to re-finance most of Britain’s debt into perpetual 3% Consols, which by definition assumed that the legal guarantee of their interest and principal lasted forever.
The distinction between absolutist and parliamentary-approved debt was still important in the years after the Napoleonic Wars. Barings did the first financings for the restored French monarchy, at very high rates because France had defaulted on her Ancien Régime, Revolutionary and Napoleonic debt. Then in 1818, the great Nathan Mayer Rothschild carried out the first post-war financing for Prussia, a sterling bond issue of £5 million at a lower rate of only 5%, but with a provision that as well as a guarantee by King Frederick William III, approval by the Estates of the territories securing the bonds must be obtained before the bonds could be issued.
Thereby Rothschild ensured that Prussian debts would carry over from sovereign to sovereign and established the methodology for the 19th century London capital market, in which sufficient parliamentary or equivalent approval had to be obtained before each financing to ensure that the bonds would survive changes of monarch or ideally even changes of regime. Rothschild’s methodology did not prevent defaults, but it meant that even when Russia defaulted on its Czarist debt at the 1917 Revolution, repayment was eventually obtained in 1996, after constitutional government had been restored.
In the current case, President Biden appears to believe he has the right under the 14th Amendment or by declaring a State of Emergency to borrow while ignoring the debt ceiling, if it has not been raised by early June, when Federal expenditure blows through it. This would appear to be unconstitutional, and it is possible that the Supreme Court would quickly issue an injunction, citing Section 8 of the Constitution: “The Congress shall have the Power to borrow Money on the Credit of the United States.” That is a legal question which I would not presume to answer.
However, if the President organized a borrowing without Congressional approval, he would appear to put himself in the same position as the Stuarts, ancien régime Bourbons and other monarchs who borrowed money without Parliamentary consent. In that case, as with those monarchs, holders of these “Stuart Treasuries” could have no assurance that the obligation would survive the monarch’s death, or in Biden’s case, retirement from the Presidency. A Republican successor, if he had seen Biden use doubtfully legal means to raise money in defiance of a Republican Congress, would have every right to repudiate the debt, and a re-elected President Donald Trump would almost certainly do so, if I were to guess.
Like those monarchs, it is thus probable that Biden without Congress could borrow Stuart Treasuries only for a short term. Specifically, since his term of office ends on January 20, 2025, he would be limited by the market to borrowing with a maturity before that date, perhaps 1-year Stuart Treasury bills maturing in June 2024. In that case, since on death he would be succeeded by Vice President Kamala Harris, who would ensure payment of debts he had incurred, the Stuart T-bills would have close to the same security as ordinary T-bills (not quite the same, as if the debt ceiling were still not raised in June 2024, refinancing them would be a real problem). Thus, Stuart T-bills should sell for no more than a modest yield premium over regular T-bills, or in today’s market about 5.25%-5.50% compared to 5.00% on a regular 1-year T-bill.
The additional cost of issuing Stuart T-bills in June and then gaining Supreme Court approval or reaching a Debt Ceiling agreement before their maturity in June 2024 would thus be modest, since the additional 0.25%-0.5% of interest would be payable for only a year, so even a borrowing of $200-400 billion would cost only around $1 billion. There is however more difficulty if Biden wishes to borrow beyond the end of his own term. Of course, were he to win re-election in November 2024, he could then borrow 4-year debt at fine spreads over the current Treasury yield for that maturity.
However, if Biden wishes to issue Stuart Treasuries next month with a maturity beyond January 2025, he could expect to pay a substantial premium, equivalent to that of “junk” rated sovereign credits (Stuart Treasuries that outlasted Biden’s term of office could hardly be deemed Investment Grade). At present BB-rated bonds, the best non-Investment Grade quality, yield 6.99% for a 10-year maturity, which is 3.28% above the current yield of 3.71% on 10-year Treasuries. The cost of an issue of long-term Stuart Treasuries is thus high; a 10-year issue of $100 billion would cost an additional $32.8 billion in interest over its 10-year life compared to an equivalent issue of ordinary 10-year Treasuries.
If Biden decides to go this route, there should be no market panic. He simply should announce his intention to issue a limited quantity of Stuart Treasuries, probably in the form of 12-month bills, to mature well within his term of office. The cost of this would be limited, so should have no effect on the overall performance of the U.S. economy. Only if he decides to issue long-term Stuart Treasury Bonds would the cost become significant, and the effect on the U.S. economy equally so. It is to be hoped however that by that stage good sense will have returned.
(The Bear’s Lair is a weekly column that is intended to appear each Monday, an appropriately gloomy day of the week. Its rationale is that the proportion of “sell” recommendations put out by Wall Street houses remains far below that of “buy” recommendations. Accordingly, investors have an excess of positive information and very little negative information. The column thus takes the ursine view of life and the market, in the hope that it may be usefully different from what investors see elsewhere.)