David R. Henderson  

Thomas Sargent on Government Default

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Tom Sargent's Nobel prize lecture is quite clear and informative. True to form, Sargent shows some equations at first. This reflects his view that the way to be a "real economist" is to use equations. Yet he does pretty well with words and one can understand virtually everything he says without even looking at the equations. Indeed, as Sargent tells his narrative, he scarcely refers to the equations.

Sargent starts with Alexander Hamilton pushing for the U.S. Constitution so that the United States could have a strong federal government with taxing power. Result: the bonds that the U.S. government and state governments issued when they were fighting the British, which had been selling at a deep discount, now sold at par. Sargent recognizes, without judging, that the beneficiaries and the lobbyists for a strong U.S. central government were the bondholders and those beholden to them.

Fast forward to the 1830s when state governments were building canals and other infrastructure and issuing bonds to pay for them.

25:50: The depression in the late 1830s caused state bonds to go "belly up." Bondholders and state governments went to the federal government and said, "Our country was born with a big bailout. Let's do it again." The federal government said no, that was different; the stakes then were huge--we were fighting the British.
27:30: One result of the feds saying no to a bailout was that federal credit suffered and U.S. bonds started selling at a discount because foreign creditors were not sophisticated enough to distinguish between the United States and Ohio.
27:54: Another result, though, was a fiscal revolution at the state level. Most states did not have balanced-budget requirements before that. Now they amended their constitutions to require balanced budgets.
28:30: How should you judge this decision not to bail out? If the feds had bailed them out, would you have had these balanced-budget amendments? Also, wouldn't you have set up incentives for future profligacy at the state government level and, therefore, future bailouts? Also, wouldn't the feds, because they were bailing out, have exercised stronger control of the states?
29:30: Statement out of nowhere. (That is, I don't know why he said it. Does anyone else know the connection with the rest of his talk?) "Read the 11th amendment. It's really sleazy."

In the last 2 or 3 minutes of the lecture, Sargent provocatively teases the audience by highlighting some of the ways in which the situation in Europe today resembles (and some of the ways it doesn't resemble) the situation in early America.

HT to Jeff Hummel.


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CATEGORIES: Fiscal Policy



COMMENTS (6 to date)
david writes:

My reading is that the 11th prevents claims by creditors of the states from escalating their claim to a federal court (because the federal court would not be able to hear the suit nor enforce any judgment). Essentially, each US state then became an independent fiscal state authority. Since the federal government cannot enforce repayment, the state negotiating position in restructuring or default is much stronger.

The sleazy part is, I presume, dropping this atop the heads of creditors after the debts has been racked up in funding the revolutionary war.

david writes:

Come to think of it, is Sargent indirectly saying the ECB is being sleazy by not guaranteeing state debts in the way state creditors thought it would?

happyjuggler0 writes:

I think it would be sleazy for State A to run up massive debts (instead of raising taxes to fund their government spending), and then to default on those debts, and having the US be forced to repay those debts.

The citizens of the rest of the states would then be paying for State A's spending. Pretty soon they would decide they were suckers if they too didn't free ride off of the other states.

In effect, in such a situation the states would have unlimited federal spending power, but with all of it self-directed to the states racking up the debt.

Such a situation is "clearly" absurd...or perhaps not so clear (to all) considering how Greece is astutely free riding on the rest of Europe's naivete.

kyle8 writes:

This is new information to me and something I will look at more closely.

There is, indeed, nothing new under the sun and the fact that calls for a bailout were met with a much different answer than in modern times gives us a good measure of the positive effects of just saying NO!

Bob Robertson writes:

May I assume the hat tip to Hummel is his talk, "Martin van Buren: What Greatness Really Means", available on Mises.org in audio and text form?

I certainly hope so, because Jeffrey Rogers Hummel's talk about the late 1830s is one of the first lectures I direct people to who wonder, "What would America do without a central bank?"

Scotty-F writes:

My read explains this as: a state could invoke the Eleventh Amendment to protect itself from being sued in federal court by its own residents, residents of another state, residents of a foreign country, or the government of a foreign country. The Eleventh Amendment should be rooted in Federalism, by enumerating the powers of Congress to govern at the national level, while safeguarding the power of states to govern locally. By limiting the power of federal courts to hear lawsuits brought against state governments, the Eleventh Amendment attempts to strike a balance between the sovereignty shared by the state and federal governments.

As for “sleazy.” I think Dr. Sargent’s comment relates to the nobleness of the first 10 amendments and how they expand rights, vice limit them…like the 11th seems to do. Case precedence would likely shed some light on this.

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