On November 22, 1798, the US Navy suffered its first true defeat when the USS Retaliation yielded its colors without firing a single cannon. What made the event truly noteworthy was to whom its commander, William Bainbridge, was surrendering. Having first mistaken two French warships for Brits, Bainbridge realized his error too late.
That might seem backward given the timeframe. The French had been indispensable allies during our revolution against the British, yet a mere fifteen years after the Treaty of Paris had ended it in the US’s favor, America’s new fighting ships were fighting their former French comrades.
Skirmishes continued into the following year. On February 9, the USS Constellation defeated L’Insurgente in a quick battle after severe weather had damaged the latter’s sailing capacities. It was a successful retaliation after L’Insurgente had been one of the pair which had made a prize of the, um, Retaliation.
The French weren’t at war with the United States, though they were sure mad America refused to join France in another of its seemingly perpetual conflicts against the British. Under George Washington’s direction and then John Adams, the fledgling government pledged to remain neutral.
Not to mention France wasn’t the same ally after suffering its own terrorizing revolution.
American neutrality wasn’t merely a principled stand, of course. Business was booming and not in the way things are often said today. Trade with England had become more robust than ever, so much so many in London began to believe they’d actually won the war with their former colonists; the British could now sit back and enjoy an ever more profitable commercial relationship freed from all the political headaches.
The French weren’t too keen on the win-win. Taking the position that their enemies should have been our enemies, the Revolutionaries in Paris declared anyone doing business with those enemies would make them France’s enemies and become fair game, including the massive flotilla of US merchant ships sailing around the Caribbean.
This Quasi-War, as it came to be known, was one fought by Americans far more against privateers than the major French ships-of-the-line. Constellation like Retaliation had been stationed in the warm southern waters for that reason, to ward off the numerous sanctioned pirates of the Caribbean as best as they might.
Every once in a while, they’d fight France if push came to shove.
Declared or not, this conflict was massively expensive to both sides (all three if we include the British). It takes quite a lot of money to raise sailors, build ships, then fund their extended commerce-protecting voyages. Not long after having done so, the Adams Administration found itself facing enormous fiscal difficulties.
It had been John Adams, too, who had unofficially negotiated loans from the Dutch before the Revolutionary War had even ended. As such, the second President was enormously confident he’d be able to find the money again. After all, unlike 1782, the US was a full-on recognized nation which had defeated (with assistance) the mightiest of the world’s empires.
Instead, Adams was absolutely stunned when he was told the interest cost on new debts in 1799 were going to be substantially higher than seventeen years before despite the huge upgrades to the country’s credit profile. Below is an excerpt from Jim Grant’s excellent 2006 book John Adams: Party of One:
“Yet now, as Treasury Secretary Wolcott insisted, the United States had to pay 8 percent – this after the winning of the Revolution, the ratification of the Constitution, and the visible germination of American prosperity. The issue came down to the demand for, and the supply of, capital, Wolcott tried to explain. America, a land of opportunity, afforded innumerable outlets for investment.”
This was more than a century before Knut Wicksell would formalize this fundamental feature of finance as the natural rate of interest. When times are good, even the best credits have to compete for loans. In fact, the better the times the more the competition sends interest higher.
Those rising rates do nothing to choke off or even slow down prosperity, either. It is a fact lost in this ignorant modern age of Greenspan Keynesianism. Maybe Adams took the comparatively higher cost as a shock to his pride, whatever he might’ve been upset about the economics was solid.
It works both ways, too. Consider what could’ve happened had the French been able to undertake more direct initiative and had really disrupted American-British commerce. There’s no certainty, of course, but the hit to the economy could’ve been severe enough especially in trade-heavy regions that a sharp reversal to fortunes would then have favored the US government’s debt opportunities.
Without nearly as much commerce to finance, America’s moneyed interests would’ve instead competed to lend their free cash on safe(r) investments including a failed naval effort, driving the government’s interest costs down for that very failure!
Far better for everyone including the administration to have to pay relatively higher rates.
Then why, you might ask, are today’s government and its presumed monetary agents so determined to drive borrowing costs for everyone up? An even better question, why isn’t it working?
A disgusting yet large part of that Greenspan-ism, one which comes from the “maestro” himself, purports that the Federal Reserve like any modern, developed world central bank actually controls interest rates. The guy even said so in testimony, under oath, to Congress in February 2005 (his “conundrum”). This is an unquestioned article of faith espoused by every single mainstream source.
And it is as entirely untrue today as it would’ve been in 1799 (had Alexander Hamilton gotten his way with a Bank of the United States).
We are witness to even more rounds of conclusive proof right as I type these words. There are several quantitative tightening efforts to go with tremendous levels of benchmark rate hikes. The latter should have been enough on their own had the “maestro” any idea how money and markets really work.
He declared bond yields little more than a series of one-year forwards, a convention still somehow in widespread use (come to think of it, this explains so much about the 21st century). The central bank raises a short-term benchmark and all the forwards from there down the whole curve merely fall right in line.
It is believed to be a linear process, too: a 400-bps rise, for example, in the short-term rate leads to an equivalent increase everywhere else on the bond curve.
Quantitative tightening should only amplify the process, make it work better and bigger. After all, as we’ve heard time and again during quantitative easing episodes, who will buy all these bonds once the Fed stops? Treasury Secretary Wolcott gave the answer to John Adams over two centuries ago, in an inverse format.
The numbers are profoundly conclusive (just as they were during the last QT, and the one before that the forgotten first QT back in 2010-11). Since last June, the Fed has run off nearly $670 billion in UST securities. At the same time, it has raised its fed funds range by 400 bps.
Yet, longer-term UST rates have barely changed. Those closer to the front of the curve have gone up more, though still nowhere near the policy benchmarks. If the rate hikes themselves didn’t raise much, then just how useless does that make QT?
It doesn’t matter which parameter you examine: type of asset or central bank engaging in the silliness. Sticking with the Fed and its third attempt to QT the MBS space, mortgage rates are barely higher now than when it started despite just over $200 billion run off the Fed’s mortgage bond holdings.
That’s because the market, the same Treasury market unbothered by its own QT, is what sets mortgage rates, not whatever irrelevant policy from the central bank.
The Europeans have joined the humiliation, too. For its part, the ECB began its own QT much later in March 2023. The initial pace was set at €15 billion per month to the end of June, with the central bank reinvesting any proceeds from maturities above that level. Beginning with July, the ECB will not be reinvesting anything.
And just like USTs, the effect on European bond markets has been less than minimal. Rates there as here have been sideways to lower despite the runoff on top of additional rate hikes, not to mention the constant threats of more.
All of it proved without any doubt Alan Greenspan was just wrong about interest rates, how markets really work, and what the Fed really does. And you’ll never ever hear any of this in the financial media. Not even the sliver of a doubt.
Which in reality goes some way to explaining why. Doubt and uncertainty play a huge role in depressing commercial instincts. Unsure about economic opportunity whether due to truly monstrous global recession risks or from French pirates, don’t risk your money. Keep it safe and keep it liquid. Increasingly certain the Fed knows nothing about money and markets, doubly so.
That was the irony of Adams’ effort. Had it been thought a failure, it would’ve benefited the government’s interest rate though only when trade died off and risk-taking disappeared.
Thus, this unquenchable bid for government bonds and similar today is the marketplace saying QE and previous attempts from the Fed and feds weren’t anywhere close to successful (or inflationary). The intermediate future is widely believed far more than downbeat enough (and this goes way beyond a 2023 recession) to keep those rates low no matter how much authorities perversely wish they would go upward.
If Jay Powell truly wants higher rates, then he should start by asking why he’s not getting them. We all want this to happen only organically not through some backward, ill-conceived package born of historical and economic obliviousness. We would all prefer to see Joe Biden have to confront what John Adams did, having nothing to do with party or politics.
It's always been economics.
