Happy Memorial Day from Northern Italy!

Your favorite rock kicker and mine, Byron King, has graced us with his presence once again. We’ve missed him here at the Rude, and I’m thrilled he’s back.

This piece on the origin of the debt ceiling is particularly notable because it threads the needle between raising funds for a just cause and pissing blood and treasure up a wall.

Enjoy the article and your day off!

Yes? …Then Give Your Money to the Government.

I hope you’re having a good Memorial Day weekend. Meanwhile, how do you like that title? Did it catch your attention? Because the idea is to question your patriotism if you don’t fork your money over to the U.S. government.

It’s abrupt, but don’t blame me! That wording isn’t mine.

Our government said this in a poster from 1918 during the Third Liberty Loan drive that raised money to fight World War I. Here it is, courtesy of the National Archives:

Buy Bonds! (Or we’ll question your patriotism.)

This patriotism-questioning, guilt-trip advertising reflects the desperation within the U.S. government in 1917-18, all to raise funds to fight a war. And it’s worth recalling for two reasons.

First, we’ll discuss World War I and the Liberty Bond campaign because it was Memorial Day weekend, when we remember America’s fallen from past wars. 

Second, we’ll discuss government debt. The U.S. government is up to its eyeballs in debt. Treasury Secretary Scott Bessant needs Congress to raise the debt ceiling before the summer recess, or the Treasury will exhaust its ability to borrow.

One intriguing bit of history – still pertinent – is that the idea of a ceiling on national debt originated during World War I. It was part of legislation that enabled the second (of four) Liberty Bond drives, raising the cash that paid for the war. 

In this article, we’ll discuss bonds, money, and war. Rest assured, this history from 100-plus years ago remains relevant. 

Paying for War in the New Age of a Central Bank

Where to start? Okay, let’s start with the second term of President Woodrow Wilson. 

In 1916, the former Princeton professor campaigned for reelection using the slogan “He Kept Us Out of War,” meaning Wilson kept the U.S. out of the then-raging war in Europe. 

But you know what happened, right? Once Wilson was safely back in the White House, he took the martial plunge. 

Wilson was reinaugurated as president on March 4, 1917. Less than a month later, on April 2, he asked Congress for a declaration of war against Germany. The casus belli was German submarine warfare, namely attacks on U.S. ships that carried war materiel to Britain and France. 

Well, wars are expensive: “War costs much silver,” wrote Sun Tzu in his ancient text on strategy. 

The U.S. government had to raise immense sums of money to join the fight in Europe. More money, in fact, than the U.S. Treasury had ever raised before in a very short time. And how does one do that? One way is to sell bonds, and in ways and amounts never before seen. 

That is, neither the U.S. government nor the general economy was geared toward selling massive levels of bonds, let alone war bonds. Yes, per the Constitution, the federal government could issue debt, but the history along those lines was quite modest. 

From the Republic's earliest days, when the federal government needed funds, it issued bonds. With every raise from 1789 to 1917, Congress authorized the amount and accompanying interest rate. Up until 1917, federal law provided nothing like a debt ceiling. 

Then along came Woodrow Wilson, and with the U.S. entry into the European war, fundraising began immediately. On April 24, 1917 – about three weeks after the declaration of war – Congress passed the First Liberty Loan Act; $5 billion was raised via 30-year bonds paying 3.5%. 

That was just the beginning of a Niagara-level of military spending. As you can imagine, the war, and of course, the Treasury, needed more. 

So on October 1, 1917, Congress passed the Second Liberty Loan Act, $3.8 billion of 25-year bonds paying 4%. Along with authorization to raise funds via bonds in this legislation, Congress set a ceiling of $15 billion of overall government indebtedness, the first debt ceiling in U.S. history.

Here’s what happened. Legislators who enacted this new statutory limit on borrowing were shocked at the rapid growth of federal obligations. Wilson’s war took government spending to unheard-of levels, with entirely unknown future effects on the national economy. 

For perspective, in the years immediately preceding U.S. entry into the war, the annual federal budget was under $1 billion. Yet as 1917 unfolded, federal debt expanded by an order of magnitude, from under a billion to well over ten billion dollars. 

War or not, Congress included at least a few members with a flinty, banker-like view toward exploding debt levels. Indeed, back then, everyone alive had come of age in a nation that routinely used hard money as currency, namely gold and silver. 

From the Civil War to 1900, the U.S. followed a monetary policy of bimetallism, meaning that silver and gold defined the national currency at fixed ratios. Then, in 1900, President McKinley signed the Gold Standard Act, which placed the U.S. squarely on the side of gold as the definition of American money. 

But on December 23, 1913, President Wilson signed the Federal Reserve Act, establishing a U.S. central bank. This new entity was to issue currency by fiat, meaning book entries of money unbacked by ounces of gold or silver. In other words, the Fed gave the U.S. what people called an “elastic” currency. 

The idea of the elasticity of money supply meant that the central bank could expand or contract the amount of currency in circulation to meet the needs of the country’s business cycles. If there were an agricultural crash in one place or an industrial crash somewhere else, the banking system could function with loans or another financial backstop from the Fed.

As fate would have it, though, in 1914, the first major challenge to the newly created Federal Reserve was to finance a global war that began in August of that year, “the Great War,” as it was called, now known as World War I. 

By the end of 1914 and into 1915, the Fed rapidly expanded the money supply. It issued billions of dollars in new credit to support the massive trade growth in war-related materials and machinery, moving from the U.S. to France and Britain. 

It would be a stretch to say that anyone at the time really saw what was coming. Nobody had, or has, that kind of crystal ball. 

But as events unfolded, the earliest, formative days of the Fed brought an explosion of money creation. And not classical, gold standard money; no, it was fiat and mere bookkeeping entries from the Fed to banks that then issued letters of credit to pay for wartime goods and services. It was an unprecedented way to make vast claims on real wealth.

This brings us back to the debt ceiling law of 1917, which was part of the Second Liberty Loan legislation. 

In essence, a few members of Congress applied their quaint notions of hard money to the new cascade of spending and debt. They created a debt ceiling as part of national law because they wanted at least a semblance of legislative control over federal outlays, and certainly outlays financed by the issuance of wartime bond debt.

The Ever-Growing Federal Debt

In 1918, the U.S. passed two more Liberty Loan acts as the war unfolded, in April and September; these raised a total of $11 billion in 10-year bonds at between 4.15 and 4.25%. Then, the First World War ended on November 11, 1918.

Through it all, the federal government enlisted celebrities to travel across the nation to urge people to buy bonds. For example, movie stars like Mary Pickford and a young Charlie Chaplin gave talks to promote the bonds. And even the Boy Scouts got into the act, urging fellow Americans to support the effort.

Boy Scout hands “Sword of Preparedness” to Lady Liberty; National Archives.

After the war, the U.S. still needed vast sums of money to pay ongoing obligations. It raised another $4.5 billion via “Victory Loan” bonds, 4-year term at 4.75%, payable in gold, no less.

The U.S. government’s war indebtedness topped out in August 1919 at just over $25.5 billion, comprised of Liberty Bonds, Victory Notes, War Savings Certificates, and various other government securities.

The next question was how to pay down these obligations.

Indeed, the peacetime question of how to repay the country’s wartime debt came home with a vengeance after a massive recession (some say depression) in 1920-21. Where was the wealth, let alone the tax mechanism, for the government to raise funds and pay down such immense debt? 

Another intriguing, if not astonishing, angle to this looming lack of tax revenue was the 18th Amendment, which came into effect in January 1919 and led to the era of Prohibition, which banned the sale of alcoholic drinks.

In turn, this led to a massive loss of formerly considerable and predictable tax revenue flows to the federal treasury and most states’ treasuries. Prohibition put many firms out of business and led to job losses for hundreds of thousands of workers across the land, from winemakers, brewers, and distillers to farmers, barrel-makers, drivers, saloonkeepers, and many more.

Financially, banning booze was a national disaster. 

In the 1920s, in Washington, D.C., under Presidents Harding and Coolidge and with no less than the formidable Andrew Mellon as Secretary of the Treasury, it was apparent that the war bonds would not be paid in full within the scheduled life of four, ten, twenty-five, and thirty years. 

And in another aside, this government financial quandary was behind 1920s-era efforts to limit spending on arms, notably a series of conferences and treaties that limited naval battleships. 

Getting back to the Liberty Loans for the war, and to make a long story short, the solution was simply to roll them over at maturity, to issue new bonds for old.

That worked throughout the 1920s until the Crash of 1929. Then the Great Depression came along and upended the entire edifice of federal finance. 

In 1933, Franklin Roosevelt became President. Almost immediately after taking office, he “called in” the nation’s gold and revalued it. Then came the government repudiation of elements in wartime bonds that referred to repayment in gold.

The matter was resolved through the Gold Clause cases, which went before the Supreme Court and relieved the government of any liability.

This brings us to the past eight decades of government debt, now growing in a manner that looks hyperbolic, if you believe the Federal Reserve Bank of St. Louis:

U.S. federal debt. Courtesy Federal Reserve Bank of St. Louis.

The big debt roll-up began in the 1970s and continued into the 1980s and 90s. Since 2000, it’s been up, up, and away. 

This brings us to the present, to the political battle over raising the debt ceiling to conform with the underlying requirements of the Second Liberty Loan Act of 1917. 

During World War I, people worried about raising a few billion dollars; today, the fight is over trillions, with more to come. The goal is for Uncle Sam to continue spending far more than he takes every year. We’re looking at a runup of national debt from $36-something trillion to about $38 trillion, give or take, in the next nine months or so. 

And if the debt ceiling doesn’t change, the U.S. Treasury cannot legally borrow more money, the stock market will crash, and all hell will break loose. Or so they say. 

Well, we’ll see. No doubt, the politicians will do something. After all, they want their paychecks next week, too, the same as everybody else. 

But as it all unfolds, think back to World War I, Woodrow Wilson, the use of patriotism as a club to beat people into giving their gold-backed money to the government, all to fight a war on another continent. And we’re still doing it. 

Yeah… As I said, I hope you had a good Memorial Day long weekend.

That’s all for now… Thank you for subscribing and reading.