Closed-Loop Demand For Government Bonds

Forbes

27-04-2025

With the whipsawing in the markets over the last month, a concern du jour has arisen. What if the United States cannot sell its bonds to the old reliable ready purchasers, to the same always game counterparties? The Chinese appear to be disgorging themselves of their vast stash of treasuries. (Emphasis on 'appear'—China badly needs to maintain the impression that its currency is convertible in the dollar.) The stodgy economies of Japan and the UK have become the major holders. The United States is supposed to float its massive debt reissues to yesterdays-news buyers such as these? Duck and cover. 'Maybe the Fed will buy it!' he said risibly.
How illuminating history can be on these issues. Let us cast our minds back not to the history of federal debt, but to that of the gigantic newcomer in the twentieth century, municipal debt, particularly of the school-bond variety. Readers will recall the column I wrote on the work of recent economics Nobelist Claudia Goldin, work that absolutely lionizes the tremendous boom in school, particularly high school construction over 1910-1940. The Nobelist forgot to tell us what it cost and what were the consequences of the financing model, namely unbelievably jacked-up property and new state-level income taxation. There is quite a case that financing this school-building caused, yes caused, the Great Depression. Thanks a lot, good government types.
A few years ago, in the Marxist-adjacent journal Capitalism—quite a good journal, actually—appeared a most delicious article on school-bond financing in the golden era, the 1920s through the 1960s. (Michael R. Glass and Sean H. Vanatta's 'Frail Bonds of Liberalism' may be found here.) The finding of the article was that from the 1920s through most of the 1950s, the unprecedentedly massive new issues of school bonds basically had one buyer: state government employee pension plans. Here was the closed loop: districts planned schools, issued bonds, and raised taxes to in the hope of paying for them. The market was dubious, so another government agency, the pension plans, agreed to buy basically all of the bonds up all the time.
It actually was a sound strategy for the funds in the 1930s and 1940s. Who wants to bet on corporate bonds, or stocks, in the 1930s? Property tax levels in 1932 soared to 7 percent of GDP, an absolutely unconscionable number that is utterly inconsistent with maintaining a viable private economy. Corporations were going down the drain in the 1930s. Pension plans wanted governments, governments, governments, because at least they had taxing authority. That authority was being abused to the tune of destroying the private economy, true, but all that meant is make sure you don't buy corporates. It was a ridiculous time, and school districts thought it normal.
Governments got a little smaller after World War II (federal spending fell by 75 percent, 1944-46), and private business began to feel out its new place in the world. The stock market finally went up, achieving 1929 levels in the 1950s. Government pension plans noticed and thought it might be time to let their hair down and buy regular market securities, beyond school bonds, real corporates. So they did.
The school districts threw a fit. We have a compact for you to back school construction, it's a civic duty to be our buyer, you're just looking out for number one, you're becoming a creature of Wall Street, etc., etc., was the gist of the complaint. One of the problems, a real beauty of one, was that federal tax rates were so high (91 percent at the top in the 1950s), that to hold school bonds, like all munis federally tax exempt, made zero sense in public pension plans, because those plans were also tax exempt. Tax-exempt plans should hold taxable bonds, because those bonds pay enough interest to cover taxation, and tax-exempt plans don't have to pay. So the New York system in particular said bye-bye to munis as the schools in their baby-boom boom cried.
The article says that the borrowing costs increased sometimes to the tune of a new school every time a district issued a new tranche. Districts had to raise interest rates on their offerings past four percent on their fixed thirty-year issues in the late 1950s! Give it time—because did these districts ever make out like bandits. When the great inflation hit in the late 1960s, averaging about 9 percent for 13 years, these now silent grinning school districts were paying four percent on their huge long-term obligations. The little old lady holders were getting impoverished, as the districts got fat through the early 1980s on the late 1950s issues they had squealed about—four percent—but it's not about the sucker holders, is it?
Government debt is a 'safe asset,' the economy needs it as a 'benchmark,' it is equivalent to a 'riskless security' in the financial models. All of this stuff is impeding the normal maturation of the market economy. Government debt probably caused the Great Depression, it deteriorated the welfare of widows and orphans in the stagflation period, and it is now all told at some unconscionable number in the many tens of trillions. The history of public debt in whatever variety it comes inevitably uncovers some new pathetic, or hapless, or lame, or sordid tale. Just start getting off the stuff.