Could 2009 be the year the United States of America starts to go subprime? Just as subprime mortgages wrecked the economy in 2008, 2009 might be the year we begin to see problems associated with the debt that funds our nation’s $10-trillion deficit. If we look to Civil War history we may be able to avert the looming problems.

Although the Federal Reserve did not cause the subprime crisis, it was the ultimate source of excess money for subprime home mortgages as well as much of the money used to finance our national debt. The Federal Reserve creates money out of thin air, with a few strokes of a computer keyboard, and uses the money for U.S. banking operations as well as financing the federal debt and various economic stimulus programs. If you and I were to create money, it would be called counterfeiting. When the Federal Reserve creates money, it’s called monetary policy.

The Fed’s monetary policy has been to create money, to crank up its “printing press.” As the Fed creates money, each dollar in circulation eventually falls in value. Prices then rise to compensate for the falling dollar. The purchasing power of the dollar has declined 87 percent since 1957, according to Niall Ferguson in his new book, “The Ascent of Money.”

In light of the Bush and Obama stimulus packages and growing deficit, it looks like there’s no end in sight to the Fed’s dollar-creation policy. Rather than paying off our national debt and cutting spending, we continue to create deficits and borrow money to finance the imbalances. We borrow from ourselves and foreign governments. The biggest domestic owner of federal-debt instruments, U.S. Treasury Bills and Bonds, is the Federal Reserve, which pays for these investments largely with its printing press. Foreign governments now hold about $3 trillion in U.S. debt obligations with China and Japan accounting for approximately 47 percent of that amount.

Can you see the problem brewing here? Even though the dollar has strengthened a bit lately, would you want to loan the U.S. federal government money at today’s paltry rates of one to three percent if you thought there was a good chance you would lose money due to the Fed’s monetary policy? Fortunately, foreign nations have been willing to loan us funds, but how long can we count on them in light of monetary risk?

We have to give bondholders a better deal. History may be our guide.

Niall Ferguson tells the Civil War-era story of the startup Confederate States of America and their “cotton bonds.” In order to entice Europe to loan it money to conduct the war, the South sought to assure its creditors that it would repay them with something of value rather than paper money that could be printed like Monopoly cash. The rebels backed their bonds with a valuable commodity: cotton. Because cotton was in high demand, the bonds doubled in value at one point during the war. With the Union’s blockade of New Orleans, the South couldn’t export its cotton and the value of its bonds, and its ability to sell more of them, plummeted. The South resorted to the printing press to pay for its goods and hyperinflation set in. Ferguson says that the North’s success in blockading the port of New Orleans was more important than its decisive victory at Vicksburg in bringing down the South.

In addition to the economic strategy of winning the Civil War, there’s something else of value in this story. Bonds backed by a revenue stream redeemable in a valuable commodity give investors additional incentive for loaning money.

The Obama administration may want to consider the consequences of paying our creditors with dollars that are likely to fall in value. At the rate that the Federal Reserve has been expanding the money supply over the past several years, those dollars could decline in value quickly.

The new government may want to be prepared to issue a new type of bond, a debt security backed by our vast untapped resources of oil and new sources of energy. A strategy could be worked out that would allow private industry to thrive while generating energy-related revenue to fund the debt securities. Such a plan would also help to keep our dollar strong, generate high-paying private sector energy jobs, tax revenue and reduce our reliance on foreign energy. Would any administration seriously consider this idea? Probably not. But it’s not a bad idea to be prepared if foreign countries shun our current form of debt.

We need to pay our creditors with a currency that holds its value. As we look forward to a happy new year, let us consider history to bring about a bright future.
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Lee Wishing is administrative director of The Center for Vision & Values at Grove CityCollege.