In order to face China, budget shortfall can be solved by a well-established financial route.
As a period of heightened risk of conflict with China begins, the US Navy faces a People’s Liberation Army Navy whose fleet has more than tripled in size since 2000, with 400 battle force ships projected by 2025. To challenge the Chinese Communist Party’s (CCP) erosion of the rules-based international order at sea, the 297-ship U.S. Navy must necessarily recapitalize and expand to confront the maritime coercion of its allies and partners and to deter high-end warfare at sea.
The Navy needs many things to meet this challenge—but chief among them is money. Naval bonds offer one of the few proven, practical, and politically feasible ways to make this happen in the short term. As a public-private partnership, they would allow industry and America’s wealthiest people to make a moderate return on financial investment in exchange for supporting the Navy that has underwritten the free flow of global commerce since the end of World War II and enabled their profitability.
The closest model of the peacetime recapitalization necessary for the Navy to compete with China is the 600-ship Navy initiative of the 1980s under then-President Ronald Reagan. Following the Soviet invasion of Afghanistan and the debacle of the Iran hostage crisis, Washington awakened to the need to rebuild the so-called hollow force that followed the Vietnam War in order to confront the looming threat of Soviet expansionism. Over Reagan’s two terms, the Department of Defense’s budget averaged 6.3 percent of GDP. In comparison, the department’s budget during the post-9/11 wars averaged 4.1 percent of GDP from 2001 to 2016 and actually decreased as a proportion of GDP during the supposed rebuilding of the military under former President Donald Trump—with most of it focused on the land combat in Afghanistan, Iraq, and other conflicts.
In contrast, the presidential budget request for defense for fiscal year 2022 was approximately half of what it was during the Reagan administration when measured as a percent of GDP, equating to a deficit of nearly $600 billion using fiscal 2020 GDP and dollars. Given the scale of the shortfall, it is clear that the money will not be coming through the traditional budget, authorization, and appropriations process. However, there is another way.
During the world wars, Congress authorized the sale of defense debt securities, variously known as Liberty and Victory bonds, to defray the costs of rapid military mobilization, modernization, and expansion. Offering a comparable rate of return to traditional bonds, the government marketed these bonds not only as investment opportunities but also as an opportunity for individuals and organizations to demonstrate their patriotism. Series E bonds, introduced on May 1, 1941, were sold at 75 percent of face value and had a 2.9 percent interest rate, compounded semiannually and initially matured at 10 years, though higher denominations were extended to 30 to 40 years. American defense bond programs were a resounding success. During the United States’ involvement in World War I from 1917 to 1918, Liberty Bonds yielded approximately $300 billion (in fiscal 2021 dollars). Then, during World War II in the early 1940s, 85 million Americans purchased Victory Bonds (E Bonds), raising $2.7 trillion in today’s dollars.
It is important to note that recognizing the clear and present danger of the Axis powers and the extended timeline necessary for a significant military buildup, Congress authorized defense bonds before the United States’ official entry into World War II. Granted, conflict with China now is far less certain—and the U.S. public is far less engaged—than during World War II, but well-designed and well-marketed naval bonds should be able to capture at least a fraction of the capital investment that earlier defense bonds did, giving Congress a powerful new revenue stream with which to fund naval recapitalization. Given current realities of America’s strategic competition and the looming possibility of a CCP invasion of Taiwan by 2027, it’s time for members of Congress to make the same preparations their predecessors did.
While naval bonds would be open to individual small investors, pension funds, and wealthy allied and partner nations such as Saudi Arabia and Japan, the target demographic would be extremely wealthy individuals and Fortune 500 companies, such as Walmart and Lockheed Martin, whose business models and profitability depend on the free, open, and unimpeded flow of maritime commerce.
Significantly, until the adoption of the income tax in 1914, American commercial interests bore primary responsibility for funding the Navy through the payment of customs duties that constituted the bulk of federal revenues. Thus, issuing naval bonds should appeal to the conservative preference for originalism while appealing to progressive sensibilities by having big business and the rich pay more of their fair share. Additionally, by authorizing the issuance of naval bonds, progressive politicians could finally fulfill the bumper sticker slogan of holding a “bake sale to buy a bomber.”
Naval bonds, specifically earmarked for naval recapitalization, could also be a way around perennial debt ceiling brinkmanship. Such differentiated bonds are in common use by federal agencies, and Congress regularly authorized them until World War I. Additionally, states and local governments commonly issue municipal bonds to finance capital improvement projects that offer investors the opportunity to invest in specific projects based on their own interests, with the revenues often exempt from state and federal taxes. As of last year, there was an estimated $3.9 trillion in outstanding debt on municipal bonds. Naval bonds should allow conservative politicians to assent to the financing of additional public debt in a politically acceptable manner.
If Congress can find a way past the partisan gridlock paralyzing Washington to issue naval bonds, the political return on investment would be significant for both sides of the aisle. The top priority should be fully funding the long-overdue overhaul and upgrade of the Navy’s four public shipyards in Hawaii, Washington, Virginia, and Maine. However, the shipyard capacity necessary to support the scope and scale of naval recapitalization necessary would quickly exceed the capacity of the Navy’s seven prime contractor construction shipyards and would no doubt induce some of the nation’s other 447 private shipyards to compete for Navy prime, sub, and supplier contracts. This represents a potential economic and employment windfall to 41 states.
The resulting modernized capacity should not only prevent costly production breaks in naval construction but could also create a virtuous cycle of increased competitiveness for the entire industry. Once rejuvenated, attention should then focus on the recapitalization of the U.S. Merchant Marine, an irreplaceable strategic capability currently kept on life support by the Jones Act and other protectionist measures.
Given the obvious benefits to the Navy and the nation, the question that remains is: Will the market buy naval bonds? Unprecedented levels of stock buybacks seem to indicate that companies are running out of opportunities to reinvest in growth initiatives. With tax-sheltered profits and explicit patriotic appeals, naval bonds should entice the investment of at least some of the over $2 trillion in cash currently held by S&P 500 companies in revitalizing the navy that guarantees the freedom of commerce that they rely on for their profitability.
Additionally, large corporations, very wealthy people, and politicians know far better than the average taxpayer that the contemporary American way of life is largely dependent on the freedom of the seas, namely the cheap goods that float upon them. With real wages for the average American worker barely keeping up with inflation since the 1970s, a significant enabler of the American middle class’s ability to maintain its standard of living has been access to cheap, foreign-manufactured finished goods, transported to the United States by sea for retail via the local big-box store or Amazon fulfillment center.
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As the current container shortage highlights, increased shipping costs are quickly passed on to the consumer, significantly eroding their purchasing power. If the CCP were to impede the free flow of commerce through the South China and/or East China seas, the American public would be subject to similar disruptions of product availability and unpredictable shortage-induced price spikes. Should voters start to experience these hardships, then the public would start asking hard questions and demanding solutions from industry and politicians.
If competitively structured naval bonds (with slightly higher returns than standard treasury securities) land in the market with a thud, then it should be a wake-up call to U.S. policymakers regarding industry’s stomach for armed competition or conflict with China. After two decades of economic entanglement, American companies have come to rely on the CCP to provide both low-cost supply chain and access to the largest consumer market in the world.
Similarly, a lack of buyers for naval bonds could indicate that the market has already priced in the erosion of the rules-based international order at sea, which would make investing in a strong U.S. Navy superfluous. In any case, a lack of interest in naval bonds should trigger a significant review and revision of America’s strategic end state with respect to China and the federal government’s relationship with industry. In full-spectrum competition, the United States cannot hope to prevail against an adversary that blurs the line between military and civil sectors as a matter of national strategy without the robust support of the whole of American society.
The naval historian Thayer Mahan argued that the Navy exists largely to safeguard the free flow of U.S. commerce upon the seas. If that commerce has decided that it makes better economic sense to pay tribute to the CCP, it is far better to know now, before spending hundreds of billions of dollars of American treasure to recapitalize the Navy, much less the expenditure of American blood in defense of the rules-based international order at sea.
