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Making Economic Sense
by Murray Rothbard
(Contents by Publication Date)

Chapter 47
The Salomon Brothers Scandal

Financial scandals are juicy, dramatic, and fun, especially when they bring down such arrogant and aggressive social lions as Salomon Brothers head, John Gutfreund and his crew. And even more so when they elevate, as the rugged Nebraskan in the white hat riding in to Wall Street to try to save the day, Mr. Integrity, billionaire Warren Buffett (coincidentally, the son of my old friend, the staunch libertarian and pro-gold Congressman, the late Howard Buffett). But when we have stopped exhilarating in Mr. Gutfreund's grievous fall, we might ponder the matter a bit more deeply.

In the first place, what did Salomon Brothers do that merits all the firings and the stripping of epaulets from the shoulders of the top Salomon executives? That they finagled a bit to get around rules on maximum share of government bond issues, doesn't seem to merit all this hysteria. Why should Salomon have cleaved solemnly to rules that make no sense whatever? But Salomon might have cornered the market temporarily on some new Treasury issues? So what? Why shouldn't they make some money at the expense of competitors?

The only thing clearly beyond the pale done by Salomon Brothers was to sign its customers' names to bond orders without their knowledge or consent. That, surely, was fraud and merits censure; but, again, it needs to be pointed out that such chicanery would not even have been considered were it not to evade the silly maximum purchase regulations imposed by the Treasury.

If much too much is being made of Salomon's bit of hanky-panky, does this mean that nothing is wrong on the government bond market? Quite the contrary. This fuss was made possible by a much more deeply-rooted scandal which no one has denounced: the fact that the U.S. Treasury has, for decades, conferred special privilege upon a handful of government bond dealers, whom it has picked out of the pack and designated as "primary dealers." Then, instead of selling its new bond issues at auction in the open market, the Treasury sells the great bulk of them to these primary dealers, who in turn resell them to the rest of the market.

In the meanwhile, there is cozy and continuing conferring by the Treasury with these privileged big bond-dealers, who are grouped together in an influential lobbying cartel called the Public Securities Association (once named the Primary Dealers Association).

The Treasury, of course, claims that it is more efficient to deal with these designated primary dealers, and it can thus finance its bond issues more cheaply. But surely the cozy closed partnership and the conflicts of interest it conjures up, more than makes up for the alleged benefit by bathing the entire proceedings in what looks very much like cartel privilege. The small group of large dealers benefits at the expense of their smaller competitors.

Moreover, the problem in the government bond market is even deeper. Once a small and relatively insignificant part of the capital market, the Treasury bond market now looms massively, casting its blight on all credit and capital. The total U.S. public debt now amounts to $3.61 trillion, of which no less than $117 billion of securities changes hands every day. But a flourishing government bond market means a market starved for private capital and credit; it means that increasingly, private savings are being siphoned away from productive investments and into the rathole of wasteful and counter-productive government expenditures.

It is doubtful, therefore, whether we really want a smoothly running and efficient government bond market. On the contrary, a government bond market in difficulty is a market where less of our savings is poured down a rathole, and more is channeled into productive investment that will raise our living standards.

We need, in fact, to do some long, hard thinking about the blight of government debt on our capital markets. Wouldn't it be better if such debt were to disappear altogether? One beneficial reform would be to return to the route of Britain in the 19th century, where much government debt was due not in six months, or five years, or twenty-years, but was permanent debt, or "consols," that never came due at all.

The permanent consol paid perpetual interest, and was never contracted to pay its principal. If the British government wanted to reduce the public debt, it could use its fiscal surplus to buy back and cancel some of the consols. Replacing our current debt with consols would mean that the government would not have to keep coming back to the bond market, redeem principal, and refloat the debt; the crowding out of private credit and investment would be far smaller. Of course, the government would then have to pay higher interest since the principal would never be redeemed; but that would be a small price to pay for lifting so much of the debt burden from the capital markets.

Alternatively, and more radically, we could even ponder the old drastic Jeffersonian solution: simply repudiating the debt, and  writing it off the books. Undoubtedly, repudiation would be a severe blow to American bondholders; on the other hand, think of the burden that would be lifted from U.S. taxpayers! Think of the spur to savings and productive investment! It might be replied, however, that, upon such a stark declaration of bad faith and bankruptcy, no one would lend money to the Treasury for a long time thereafter. But wouldn't this be a blessing? Surely a world where people refuse, for one reason or another, to trust or invest in the operations of government, would be a world happily inoculated against the temptations of statism.

Congress, in its wisdom, is trying to decide whether the Salomon Brothers scandal merits more severe regulation of the bond market. It should look first, however, to removing government privilege, from that market, such as the primary dealers' cartel and the vast scope of the government bond market. As in other parts of the economy, and as in the Communist countries seeking freedom, the best course for government, far from coining new plans and regulations, would be to get itself out of the way, as quickly as possible. Once again, the best way for government to benefit the economy is to disappear.

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