Huerta de Soto: how to clear the public debt


(Original publication: Mises Italia, Mises Canada)

A recent editorial by Alberto Alesina and Francesco Giavazzi in the Italian newspaper Corriere della Sera has spurred me to illustrate a proposal to reduce the public debt put forward by Professor Huerta de Soto. Since Alesina and Giavazzi’s article is the same old statist story, discussing it would be a waste of time and space were it not for the fact that it so perfectly represents the non-thought of those statists who consider themselves and inexplicably are considered to be ‘liberals’ because they are in favour of ‘privatization’. Huerta de Soto’s proposal is not immune from criticism, but it offers an opportunity to see what it means to think in economic terms outside the intellectual boundaries imposed by political power (in other words, what it means not to be a megaphone for the regime); what it means to reason about problems in terms of their structural causes rather than their effects; and finally what it means, in this intellectual desert of the so-called “élites”, to have ideas. For these reasons, and because overall I consider it to be a good proposal (though improvable), I think it worthwhile to call attention to it and discuss it.

1 . The same old statist story

Alesina and Giavazzi begin their article by citing the fact that the Italian public debt, which will reach 133% of GDP by the end of 2013, has increased by 30% (in relation to GDP) over the last ten years. This datum needs to be read bearing in mind that these last ten years have been characterised not just by a level and a type of increasingly exorbitant tax burden (and, partially in consequence, by practically non-existent growth when not outright decline) but also by extraordinarily and (though the two journalists do not acknowledge this) artificially low interest rates. After stating this essential premise, they go on to affirm that there are only two ways to reduce the debt: a wealth tax and ‘privatizations’, and use the rest of the article to eulogise the latter.

Before we go any further, a couple of clarifications. First of all, the two journalists speak of a wealth tax as though at present one did not exist, yet in Italy we already have a variety of wealth taxes: from the property tax on home-owners to stamp duty on financial investments. What they are referring to is an additional “one-off” property tax of extraordinarily high proportions. However, apart from the fact that, as we unfortunately know but have not yet fully absorbed, “there is nothing more permanent than a temporary government program”[1] (Milton Friedman was right about that at least), the difference would be quantitative, not qualitative. Furthermore, as those who consistently view economics as the science of human action know, there is no substantial difference between a tax on capital and an income tax because capital produces income. In the words of Pascal Salin, “an economist knows that there is an equivalence between income and capital. Indeed, income is nothing more than what capital yields per period … Capital is the source of income, and moreover its value is calculated on the basis of the income flows it makes it possible to obtain over time. This is because there is no income without capital. …  From this absolute equivalence between capital and income it follows that it is a matter of indifference whether one or the other is taxed, provided that both of them are affected correctly”[2]. Therefore the distinction between wealth tax and income tax is nothing more than the usual media gimmick to which those who hold political power resort (aided by the swarm of ‘intellectuals’ at their service) in order to sow confusion and justify the escalating plunder of property by the state machine.

That said, the first thing that immediately strikes the reader of articles like this one by Alesina and Giavazzi is the care they have taken to avoid mentioning any of the structural causes of the continued growth of the debt and thus of the size and functions of the state. No mention is made of the privileges of monetary and credit manipulation (legal tender, fiat money, fractional reserve banking, the printing of money and the arbitrary fixing of interest rates by the central banks), nor to what limits of principle should be applied to the functions of the state. No mention is made of the replacement of the Law[3] by ‘law’[4], and thus to the replacement of legitimacy (respect for the former) by legality (compliance with the latter). Not a word is spent on answering the question: What would happen after that? Once the debt and GDP had been reduced (for the sake of argument) by an additional property tax or the debt alone had been reduced by ‘privatizations’ (which the authors themselves admit would not, even in the best and most unrealistic of cases, be remotely sufficient to bring the debt/GDP ratio below 100% ), what would prevent the debt from not just beginning to grow yet again but to grow even faster than before? Silence.

The second thing that strikes the reader is the assertion that there are only two ways to reduce the debt: another wealth tax (in addition to those already in existence and to income tax) which would have increasingly depressionary economic effects, and ‘privatizations’ which (where this term did not mean confining the state inside a cage formed by the only function compatible with an imperfectly free and prosperous society: the defence of the sovereignty of the Law) would have an impact on the debt similar to that of a water pistol on a moving train. If these really were the only two ways to reduce the public debt, it could never be reduced. Fortunately, that is not the case: even without considering an explicit default, partial or total (a respectable option[5], albeit with complex practical implications) other ways of reducing the debt do exist. One of them is precisely that proposed by Professor Huerta De Soto, which we shall now discuss.

2 . Professor Huerta de Soto’s Proposal

The premises of De Soto’s proposal are well-known. In a nutshell: through the privileges of monetary and credit manipulation (which, let’s not forget, is made possible by the fact that ‘law’ has replaced the Law: fractional reserve banking being nothing more than embezzlement and the printing of money nothing more than counterfeiting), the state and the banking system have managed to legally and illegitimately create rivers of fiat ‘money’ out of nothing, in this way progressively and silently expropriating the private resources of the citizens. This fiat ‘money’ is what makes possible the continual expansion of the state and the expansion of credit beyond existing savings. The continual expansion of the the state machine (and thus of interventionism) plus the artificial expansion of credit have created distortions in the productive structure of the economy (and even in people’s psychology) whose effects include ever worsening cyclical crises followed ultimately by collapse. The economic crisis is a positive thing insofar as it is an attempt by the economic system to cleanse itself of the economically unsustainable investments produced by interventionism in general and by monetary and credit manipulation in particular. However, the longer monetary and credit manipulation barrels ahead, the more severe the crisis necessary to repair the consequences of this manipulation will be. The problem today is that states and the banking system tied to them have pushed monetary and credit manipulation so far that the crisis required to repair the damage they have produced would (will) have catastrophic dimensions: a sort of withdrawal so severe that it kills the addict. Under these conditions, where the alternatives seem to be either catastrophe or catastrophe, how can the addict be saved or actually got back into shape?

Certainly not by giving him ever larger doses of poison (i.e. taxes, interventionism, and monetary and credit manipulation) as is happening now, nor by giving him a glass of water (the ‘privatizations’ advocated by Alesina and Giavazzi). Huerta de Soto proposes to significantly reduce the debt (and possibly even clear it) by abolishing fractional reserve banking and thereby acting on the banks which, by means of this privilege, have “gradually expropriate[d] wealth from the whole of the rest of society”[6].

To put an end to this privilege, De Soto proposes that every bank transfer (that is, be obliged to transfer) its assets (those above its net worth) to a mutual fund and that people with current accounts (or other deposit accounts, where the money deposited remains available to them), be given the possibility of choosing between the following two options:

1 ) maintaining their deposit accounts. In this case, as we shall see, a 100% reserve would be guaranteed, meaning that any money deposited would have to be held in custody by the bank and could not be loaned out, which in turn means that the deposit would not produce a rate of interest contra naturam but would have a market cost for the account holder.
2 ) replacing their deposit accounts with shares in the mutual fund described above, receiving a number of shares proportional to their deposits. This would mean, of course, that a) the nominal value of these shares would not be guaranteed: it could equally rise or fall, and b) when the account holders who chose this option required cash, they might have to sell some of their shares and possibly deposit the cash into a deposit account.

In this way, the distinction between a loan (where one loses the availability of one’s own funds) and a deposit (where one maintains it) would be restored. It is likely that, for each bank, a portion of the deposits would be converted into shares in its mutual fund and consequently another portion would not be converted. For the non-converted portion, the problem of the 100% reserve would remain and to overcome this problem De Soto suggests that the central bank print (!) the required amount of fiat money and give it to the banks. This printing of money “would not be inflationary in any way, since the sole purpose of this action would be to back the total amount of demand deposits (and equivalents), and each and every bank would receive banknotes for a sum identical to its corresponding deposits. In this way a 100-percent reserve requirement could be established immediately, and banks should be prohibited from granting further loans against demand deposits”[7] that is, from creating money out of thin air by lending out the deposited money.

De Soto points out that both Hart and Rothbard (!) have suggested that these banknotes printed by the central bank be given away to the banks, though fortunately he acknowledges that this would be rather too bitter a pill to swallow because, as already pointed out, if anybody has profited illegitimately from the privilege of fractional reserve banking, it is the banks. Since giving away this ‘money’ to the banks “would allow them to keep the assets they have historically expropriated from society”[8], De Soto suggests that these assets (or activities) of the banks be used for other purposes: first and foremost, for the reduction of the public debt[9]. In particular, De Soto proposes that shares in a nation’s treasury bonds be exchanged for shares in the mutual funds (those into which the assets of the banks have been channelled) that had not been allocated after the reform: “The idea is simple enough: the holders of treasury bonds would, in exchange for them, receive the corresponding shares in the mutual funds to be established with the assets of the banking system. This move would eliminate a large number (or even all) of the bonds issued by the government, which would benefit all citizens, since from that point on they would no longer have to pay taxes to finance the interest payments on the debt. Furthermore [apart from the banks, who would see the government bonds in their possession (an enormous quantity today) simply cancelled[10], ed.] the current holders of treasury bonds would not be adversely affected”[11] [and even if they did, it would hardly be a tragedy, also because these negative consequences would be far less severe than those they ought to have known were highly likely when they invested in the debt of implicitly bankrupt countries, ed.].

It must be emphasised that this proposal is only an intermediate stage within a broader, five-step proposal that would lead to the abolition of legal tender, the abolition of the central banks, the abolition of monetary and credit manipulation in all its forms and, more generally, the re-establishment of freedom and legitimacy in the monetary sphere.

3 . Some general criticisms

I do not think that this proposal is exempt from criticism from a free market perspective (Phillip Bagus provides an interesting critique in this regard in the article cited in footnote 9), but since it is a feasible strategic proposal which focuses on some of the causes of the problem and not on its effects, I believe it can be a good starting point for a serious discussion (not restricted to a few isolated academic circles) about how to reduce the public debt that could counter the usual monolithic statist thought.

Here I will express a perplexity and a criticism. My perplexity concerns its gradualist approach: as I have said, the proposal is only part of a five-step proposal that would lead to the abolition of the central banks, which in this phase, however, to cite just one example, are necessary to print the banknotes that would serve to cover the deposits not converted into shares in the mutual funds. While it is true that a gradualist approach has its merits (if a healthy leg has been immobilized in a cast for a long time, suddenly removing the cast without providing temporary support and rehabilitative physiotherapy may not be ideal), it also has its shortcomings, both in moral terms (would it be right to argue that slavery be abolished gradually?) and at a strategic level: in the words of William Lloyd Garrison,  “gradualism in theory is perpetuity in practice[12]. In other words, one of the limits of this proposal, for those who defend the free market, is that it is more than a little interventionist and since it shares the logic of interventionism (even though it aims at eliminating interventionism), it risks becoming tangled up in it. Perhaps, it would be better to start from the objective itself and, as Ron Paul argues, abolish the central banks (“End the Fed”) as well as legal tender, fractional reserve banking and cancel the public debt immediately: after a brief period of adjustment, the market left to its own devices would, as always, find the best solution (and let’s not forget the fact that it has already found an ingenious one for the current situation in the form of  crypto-currencies like Bitcoin).

My criticism is that it is insufficient. De Soto himself acknowledges that monetary and credit manipulation are the product of legal positivism (i.e. the ‘law’ understood as the particular measure). Legal positivism implies:

a) the absence of a separation of powers, that is, between political power (the power to approve particular measures) and legislative power (the power to defend general rules of individual conduct, like those which affirm that embezzlement and counterfeiting are illegitimate actions), and

b) the non-subjection of political power to legislative power or, more frequently, the elimination of the latter: in other words, legal positivism necessarily implies the limitlessness of political power.

To be effective and sustainable, De Soto’s proposal (as well as the non-gradualist proposal of an immediate abolish ion of interventionism and public debt) in my opinion needs to be supplemented with a parallel strategic proposal for the limitation of political power. Otherwise, assuming De Soto’s proposal were realised, what would prevent us from immediately returning to the point of departure, if not worse?

4 . Proposals for the limitation of political power

Hayek put forward an institutional proposal to limit political power[13]. His proposal has a number of advantages, the most important being the possibility of depriving anyone who receives or has received ‘public’ money in any form of the right to vote for the assembly that exercises political power (but not for the assembly which exercises legislative power).  This would effectively resolve the conflict of interests of voters that lies at the heart of the system of vote-buying called ‘democracy’ today. Despite these advantages, however, Hayek’s proposal has the disadvantage of being impossible to put into practice because it lacks the necessary structure of incentives. I have personally put forward another proposal[14], of a non-institutional kind, not as an alternative to Hayek’s proposal but as an intermediate step towards its realisation. My proposal has the disadvantage of not resolving the voters’ conflict of interests and also of being gradualist, but in compensation its advantages include the real possibility of being put into practice. In fact, in my proposal the separation of powers is not the result of the good will and foresight of politicians and of the preliminary spreading of the culture of liberty among people. Instead, it is the result of a structure of incentives. In the same way that Bitcoin doesn’t replace fiat money but exists side by side with it, my proposal doesn’t call for ‘law’ to be replaced by the Law but positions the latter alongside the former. Just as Bitcoin, which is a private experiment that, if successful, will destroy fiat money, so my proposal is a private experiment which, if successful, may help to gradually and peacefully dismantle the ‘law’, thereby restoring liberty and the rule of Law. On a strategic level, I believe that political theory has a lot to learn from Bitcoin. After all, non-fiat money and the Law have a great deal in common: they are both spontaneous orders and they are both non-arbitrary limits to arbitrary political power.


As part of a wider proposal aimed at eliminating monetary and credit manipulation in general, Huerta de Soto solves the problem of public debt and that of fractional reserve banking by cracking down on the banks. To statists this may seem like a form of expropriation analogous to the one communists demand for the ‘rich’. It is of course the opposite: unless proved to be criminals, the ‘rich’ have not become ‘rich’ by violating the Law, but the banks have prospered precisely because they have violated it.

In my opinion, a non-gradualist approach would be better, both from a moral and a strategic point of view. Given that this is not possible (or for as long as it remains impossible) I consider De Soto’s proposal to be a good one. However, in order for it to be effective and sustainable, in my opinion it must be combined with a strategy for limiting the political power that today is limitless.

Money and Law, both spontaneous orders, are two sides of the same coin: switching from fiat ‘money’ to Money cannot be done without switching from fiat ‘law’ to the Law, that is, from the sovereignty of legislators to the sovereignty of the Law, in whatever way one wishes to attempt to do so.


[1] Cited in Facco L., 2013, Il Micropensiero Libertario (Libreria San Giorgio, Milan).

[2] Salin P., 1997 [1985], La tirannia fiscale (Liberilibri, Macerata),  p. 70, italics in the original.

[3] By Law (with a capital “L”), I mean the abstract principle; the general rule of individual conduct; the non-arbitrary limit on political power; and the powerful press that compresses first the functions, then the dimensions of the state.

[4] By ‘law’ (in inverted commas) I mean  the special measure, the arbitrary decision of those who hold political power, the instrument of that power, the spring that expands first the functions, then the dimensions of the state.

[5] See for example Murray N. Rothbard’s argument in favour of repudiating the national debt.

[6] Huerta de Soto J., 2009 [2006], Money, Bank Credit and Economic Cycles (Mises Institute, Auburn AL), p. 794.

[7] Ibid., pp. 793-794, in italics in the original.

[8] Ibid., p. 795.

[9] But also for the reduction of other liabilities such as, for example, the public pension systems, which recently, in the Italian case, have rightly been compared to a Ponzi Scheme.

[10] In the following article (Note 31: link) Phillip Bagus rightly points out a problem with this point: the government bonds held by banks are part of the assets that would be channelled into the mutual funds, therefore cancelling them would mean diminishing the value of the assets and thus of the shares held by the holders of the mutual funds (the account holders who have replaced their deposits with these shares). The problem can be easily overcome, however,  if the fact that all government bonds held by the banks would be cancelled is taken into account when the mutual funds are established.

[11] Huerta de Soto J., Ibid., p. 796-7.

[12] Cited in Rothbard M. N., 2002 [1982], The Ethics of Liberty New York University Press, New York and London, p. 260.

[13] Hayek F.A., 1982 [2003] , Law, Legislation and Liberty (Routledge, London & New York), Vol. 3, Cap. 17.

[14] A very concise outline in English of my proposal can be found here: link.

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