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'False crisis' over the federal debt?
"False crisis" is the way Treasury Secretary Jack Lew characterized the federal debt yesterday. Is this true? Well, it depends on what the meaning of "false" is. There were probably some in Rome who thought it was a "false crisis" when word reached them that the barbarians had crossed the Rhine bridges. After all, they weren't at the gates of the city...yet.
In order to see if we have a "false crisis" it is useful to see what the "crisis" is. I.e., what is happening to the federal debt? There are two ways to measure the federal debt: gross federal debt, which includes all obligations, and federal debt held by the public, which subtracts the debt in the trust funds. Since the trust funds will have to be made good, it is useful to look at gross federal debt, which is what we do here.
The most useful way to look at federal debt is as a percent of GDP, since that lets very different historical periods be compared. So, what does gross federal debt as a percent of GDP look like over time? Chart I shows it from 1929 through 2013 (estimated):
Debt as a percent of GDP (Debt/GDP) was 16% in 1929, the last year before the Great Depression. The vertical green line (there is no significance to the colors) is 1932, the last year of the Hoover administration. By that time Debt/GDP was 37%., i.e., it had doubled. The primary reason for this increase was a decrease in the denominator -- GDP -- unprecedented before or after in its magnitude. Between 1929 and 1932, GDP declined by an unimaginable 44%. That is where all those grainy photographs of the Great Depression come from.
We move through the Roosevelt administration and get to the red line, which is 1942. After we were hit at Pearl Harbor, which was half-way through fiscal 1942 (fiscal years ended in June at that time), Congress floored the accelerator. It took a few months for us to get organized, and then we blew the top off spending for the next three years. Debt/GDP exploded from 50% in 1942 to 123% in 1945. Very likely no AT readers personally remember this, but those of us not from Rio Linda will have seen newsreels or pictures of Hollywood stars making bond drives around the country. That was part of the effort to fund this debt. (That was when Hollywood was on our side.)
Why is all this important? Because there has been a lot of foolishness in the public discussion of the Debt/GDP issue that we don't have a problem now because after all, in 1945, Debt/GDP was 125% (actually 123% on the chart) and it is "only" 100% (actually 108% on the chart) now. Warren Buffett has made this argument. We can only hope he doesn't run his companies on the same logic.
Why? Because World War II was a one-time-only project! It had a beginning and most importantly, an end. It was in the nature of a huge investment that once made, did not have to be made again. So its cost could be amortized over the indefinite future. This is not true of current Debt/GDP increases which are the capitalization of operating expenses that will grow for the indefinite future. We are selling bonds to buy toothpaste.
We never paid off the debt from World War II. Of course, we rolled it over many times, but it was never paid down. Basically no country ever pays back its debt. It rolls it over and hopefully develops the economic strength to support it. That is what we did after World War II. Government spending was prudent, we had an era of prosperity, and Debt/GDP dropped from 123% in 1945 to a low of 33% in 1981.
This is clearer in Chart II, which eliminates the pre-war period:
The blue line (again, no significance to the colors) on Chart II is at 1981, the low point of Debt/GDP post-World War II. It is 33%. Recall this is down from 123% in 1945.
After 1981, as the welfare state grew and the defense budget couldn't shrink further as a percent of GDP, deficits grew and so did Debt/GDP. The only exception to this was the second half of the 1990's when Debt/GDP declined. Yes, the Clinton administration, although also the Newt House.
The orange line is 2008, the end of the Bush administration and the beginning of the Obama administration. In 2008, Debt/GDP was 70%. This year, 2013, it is projected to be 108%.
How high is too high? We won't know until we hit the wall. The "crisis" is that we can't go on like this. It is not as if the administration has a plan to bring the budget back into balance, or to cut the deficit to where Debt/GDP will level off. For the administration, the very modest sequester this spring was extreme. The effort of Republicans to bring spending under control, or even on a path to being under control, before raising the debt ceiling this fall is creating a "false crisis," at least in the mind of Jack Lew.
The charts tell the story.
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