The blood was barely dry in the streets outside of the Bastille when the brand-new government of revolutionary France started confiscating assets.
It was November 2, 1789. And by a margin of 508 to 346, France’s fledgling legislators– on both the Left and the Right– voted to nationalize all of the real estate owned by the Catholic church. And that was a LOT of property.
Between the confiscated Church assets, plus the land they had just expropriated from the king only a few weeks earlier, the revolutionary government had seized roughly one-third of France’s entire land mass in less than a month.
But they didn’t stop at asset confiscation.
Remember that France was completely bankrupt at this period in its history; France’s national debt was so high that there wasn’t enough money in the Treasury to even make interest payments, let alone fund normal government operations.
So almost immediately after seizing church lands, the Legislative Assembly hatched a new scheme to bring in much-needed cash: they created a special type of government bond called assignats, which would pay a 5% interest rate and be secured by the confiscated properties.
This idea of an interest-bearing government bond, secured by real estate, proved extremely popular with investors and financiers, and the first issuance of assignats sold out almost instantly.
That first bond sale brought in 400 million livres, which was considered a substantial sum of money at the time. However relative to the size of the French national debt, it was just a drop in the bucket.
(To put this figure in context, 400 million livres would be comparable to the US government raising about $1.5 trillion today– a significant amount, but tiny compared to the $35 trillion national debt.)
France’s politicians swore that the assignat issuance was a one-time thing, with a hard limit of 400 million livres. But naturally it was only a matter of months before they issued another 800 million… then another 400 million, then another 600 million.
You get the idea.
Now, the first issuance was hard. Assignats were considered controversial, and there was a lot of debate and argument among the politicians.
But with each passing issuance, it became easier and easier to authorize more. Eventually there was almost no debate about the dangers of issuing more debt, and the majority of the French government became blind to the risks.
It took less than two years for the amount of assignats in circulation to vastly exceed the value of all the real estate which supposedly backed them. And then something very predictable happened.
The thing about assignats is that they became a type of currency in France; rather than use traditional coins like the silver ecu or copper sou, French people began to use assignats as a form of paper money.
The government even formally made assignats legal tender in April 1790.
So naturally as more and more assignats surged into the French economy, inflation rose rapidly and soon became a full-blown crisis.
Now I’ll pause here for a moment to highlight the many similarities between this monetary experiment in Revolutionary France and today’s financial system.
In 1789, assignats were technically debt. But they were also a form of money. That is true today as well.
The US government is the largest debtor in the history of the world with a $35 trillion national debt. But its debt securities (i.e. Treasury bonds, notes, and T-bills) are also a form of money.
Obviously, no one buys a coffee at Starbucks with T-bills. But governments and central banks around the world do hold US Treasury bonds as form of savings. Banks and major corporations consider the US government bonds they own as “cash equivalents”. And many large financial transactions are settled by swapping US government bonds.
So, there is still a close relationship between debt and currency.
We can also see the link between debt and inflation; just like the French engineered major inflation in the 1790s by issuing more and more debt, the US government created the highest inflation in 40 years by issuing trillions of dollars of debt during the pandemic.
Another key point is that, just like assignats represented a claim on French government assets, modern debt securities also represent a claim on government assets.
When investors buy US government bonds (or realistically any sovereign bond), they are ultimately investing in the government’s authority to tax, seize, or otherwise commandeer virtually everything in the economy.
In theory if the government were unable to make interest payment or pay back the debt, they would be able to hike tax rates, nationalize businesses, etc. to satisfy creditors.
But as the French case shows, the authority to tax an economy and seize its assets is not infinite; there is a limit on how much an economy can produce… and how much the government can tax and confiscate.
In good times this is rarely a concern. When government debts are low, no one worries about its ability to repay– the claim (i.e. total debt) is trivial relative to the size of the economy.
But as government debts spiral out of control, the claim begins to exceed the value of the assets.
France reached that level in the early 1790s. The US may be reaching that level very soon… which is a major reason why we anticipate the US dollar losing its reserve status over the next few years.
It’s important to understand these financial relationships:
- Debt and currency (including inflation) are closely linked
- Debt ultimately represents a claim on the government’s authority to tax the economy
- That authority is not infinite
- Risks pile up when the level of debt exceeds the claim on the economy
This is all somewhat of a technical explanation of why it makes so much sense to consider owning real assets as a hedge against inflation and a ballooning national debt (which, again, are closely linked).
Debt, and hence currency, ultimately represent a claim on economic resources. But when both debt and money supply are out of control, it’s much safer to directly own the economic resource, rather than the claim.
We’ll discuss this more later in the week.
