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Debt Be Not Proud: The Sorry Tale of America’s Out-of-control Spending

Monday, September 7, 2009

How the richest country in the history of the world got into a position where its debt is spiraling out of control.

At the end of fiscal 2008, which came on September 30 of last year, the American national debt stood at $9.6 trillion. That sum is, perhaps, quite beyond the imagining of most people. It is, after all, 250 million times the average per capita income. Even the total fortunes of the entire Forbes 400 list add up to less than 15 percent of it. To use a journalistic measure that dates back to the late 18th century—when the British national debt had become a major political issue in that country—if you laid 9.6 trillion silver dollars end to end, they would reach to the sun and back, with enough left over to wrap around the Earth more than 1,700 times.

But while that is a nice little bit of mathematical calculation, it still does not tell us much that is useful, for the size of a national debt in absolute terms is meaningless. Only when it is measured against the size of a country’s GDP do we get a sense of a national debt’s real size, just as a bank looks at a family’s income to determine how large a mortgage it is willing to give.

And the United States’ economy is so large that the seemingly titanic sum of $9.6 trillion is only 60.8 percent of American GDP. The national debts of France and Canada are  similar, with France at 68.1 percent of GDP and Canada at 63.8 percent. Italy’s debt, in contrast, is over 100 percent of its GDP, while Japan’s is a staggering 173 percent. The world’s two emerging economic giants, India and China, have sharply different debt loads. India’s national debt is 61.3 percent of its rapidly rising GDP, while China’s is a mere 16.2 percent.

So the United States' national debt is not out of line with those of other major countries and has been much higher in the past. At the end of World War II, the debt was nearly 130 percent of GDP.

The budget deficit for fiscal 2009 is estimated to be a staggering $1.6 trillion, larger than the entire national debt as recently as 1984.

That’s the good news.

The bad news is that the debt is rapidly rising, both in absolute terms and relative to GDP, thanks to the current recession, the stimulus effort to end that recession, and the bailout of the country’s financial system. The budget deficit for fiscal 2009 is estimated to be a staggering $1.6 trillion, larger than the entire national debt as recently as 1984. It is the largest peacetime deficit (measured as a percentage of federal revenues) since 1936, when the country was still in the throes of a far worse economic downturn. The deficit will cause the ratio of debt to GDP to rise to over 80 percent by the end of fiscal 2009. That will be the highest it has been since 1950.

Worse, the Obama administration is projecting unprecedented annual deficits over the next ten years if its political agenda of cap and trade, universal healthcare, and other expensive programs is enacted. According to the non-partisan Congressional Budget Office, these programs will average more than 4 percent of GDP each year and total $9.3 trillion over the decade. That would mean a doubling of the national debt in absolute terms and at least a 50 percentage point rise in the ratio of debt to GDP, taking us back nearly to where the debt was at the end of World War II.

And that, of course, assumes a quick recovery from the current recession and an economy expanding at a rate averaging 2.5 percent a year beginning in 2010. If the economy were to continue to lag or the country face a serious crisis, such as a major war, or if the Obama agenda is enacted and turns out to be more expensive than estimated—as government programs usually do—the result could be a debt load that not even the United States could sustain. The only alternatives would then be a tax rate that would cripple the economy, radical reductions in government spending, or a deliberate policy of inflation that would send interest rates soaring.

If the economy were to continue to lag or the country face a serious crisis, or if the Obama agenda is enacted and turns out to be more expensive than estimated, the result could be a debt load that not even the United States could sustain.

How did the richest country in the history of the world—and one with great international financial responsibilities—get into a position where its debt might easily spiral out of control? A little history explains a lot.

*     *     *

The U.S. debt exploded in the last half-century from a fateful intersection of 1) a national economic trauma; 2) a fundamental change in the prevailing economic theory; 3) ill-considered political fund raising reforms after Watergate; and 4) reforms in Congress that made spending impossible to control.

The trauma was the Great Depression. In three and a half ghastly years between 1929 and 1933, GDP was cut nearly in half, the stock market fell by 90 percent, and unemployment went above 25 percent. Prosperity did not fully return until the Second World War.

Before the Great Depression, the first fiscal duties of the federal government had always been to balance the budget if possible and to pay down any accumulated debt. In 1916 the national debt was so small ($1.225 billion) that John D. Rockefeller, the richest man in the country, could have paid it off all by himself.

Since the Great Depression, however, the first fiscal duty of the government has been to avoid another Great Depression. If that meant not paying off the debt or even increasing it to maintain prosperity, then so be it.

And before the 1930s the dominant economic theory was, basically, that expounded by Adam Smith in The Wealth of Nations. In it, Smith advised that, “What is prudence in the conduct of every private family, can scarce be folly in that of a great kingdom.”

Congress has proved over the last 35 years that it is utterly incapable of fiscal discipline over the long term. And the president does not have the power to impose it. So what to do?

When Franklin Roosevelt first ran for president he still echoed Smith. “Let us have the courage to stop borrowing to meet continuing deficits,” he said in a radio address in July 1932. “Revenues must cover expenditures by one means or another. Any government, like any family, can, for a year, spend a little more than it earns. But you know and I know that a continuation of that habit means the poorhouse.”

Roosevelt, in office, quickly accepted the need for “passive deficits,” those resulting from the poor economy. Then in 1936 John Maynard Keynes published The General Theory of Employment, Interest, and Money. Keynes argued that while supply and demand must balance in the long run, in the long run, as he famously quipped, “we are all dead.” In the short run, Keynes thought aggregate supply can outstrip demand (producing depression) or vice versa (producing inflation).

Keynes argued for “active deficits”—deliberate spending in deficit to increase demand and bring the economy into balance in times of depression. Keynes also argued, of course, that when the economy overheated, the government should be in surplus to soak up excess demand.

Economists took to Keynesianism immediately. It is not hard to see why. First, it gave economists a powerful new analytical tool. Second, it greatly increased the power and influence of economists. Before Keynes, presidents had not needed economists any more than they had needed astronomers. But if government was now to be the engineer of the national economic locomotive, revving and braking through Keynesian means as needed, then government needed experts to guide it.

The reinstatement of the president’s power of impoundment would give the president much the same power as a line-item veto and would certainly be constitutional.

The politicians were a little slower to get on board, but not much. In 1946 Congress passed the first Full Employment Act, which mandated that the government pursue policies that would generate full employment (defined as unemployment no higher than 4 percent). Still, in the 14 years between 1946 and 1960, the federal budget was in deficit seven times and in surplus seven times. It is interesting to note that two of those surplus years were during the Korean War. As late as 1957, Secretary of the Treasury George Humphrey dismissed Keynesianism, saying “I do not think you can spend yourself rich.”

The advent of the Kennedy administration began to change that. Kennedy’s chief economic advisor, Walter Heller, talked of “fine tuning” the economy and argued for a “full employment budget,” in which government spending would match what government revenues would be if there were full employment.

It worked during the great prosperity of the early 1960s. But when Lyndon Johnson tried to have both guns, with the Vietnam War, and butter, with the Great Society, the federal budget deficit began to spiral out of control.

Members of Congress like to spend, as that helps them get re-elected. Bringing home the bacon, after all, is part of their job. And the easiest way to accomplish that is to promise to vote for other members’ bacon if they will vote for yours. And the Keynesian prescription for preventing depression had given them a great excuse to spend in deficit. But the Keynesian prescription for preventing excess boom—cutting federal spending—has gotten very short shrift.

Unfortunately, the president, the only official in Washington—besides the constitutionally powerless vice president—who is elected by the entire country, has little power to control spending. Lacking what 44 governors have, a line-item veto, the president is forced either to veto an entire spending bill or accept a lot of parochial spending he disapproves of.

The adoption by Congress of a limit on total spending, so that it could only increase to reflect population growth and inflation, unless a two-thirds majority agreed to suspend the limit, would force Congress to make the hard choices it now works so hard to avoid.

Instead, presidents from Thomas Jefferson forward have used “impoundment,” simply refusing to spend moneys the Congress appropriated. In 1966, Lyndon Johnson impounded no less than $5.3 billion out of a total budget of $134 billion, including such politically popular items as highway funds, agriculture, housing, and education. As a Democratic president with a Democratic Congress, he was able to get away with it.

But when Richard Nixon vetoed a $6 billion water pollution bill and impounded the money after Congress overrode his veto, Congress reacted angrily. As Nixon’s power slipped away in the Watergate scandal, Congress passed the Budget Control Act of 1974, which outlawed impoundment and created the Congressional Budget Office.

Further, after the election of that year returned large Democratic majorities in each house, it was decided to junk the seniority system for determining committee chairmen and have them elected by the majority caucus. In other words, chairmen had to keep their caucus happy to ensure remaining chairmen, and that usually meant acceding to a lot of individual spending demands.

Campaign finance reform after the Watergate scandal brought the political action committee system into being, making, in effect, lobbyists major funders of political campaigns. Naturally the lobbyists were interested in federal spending, not federal fiscal restraint.

The budget and the debt exploded. Like an alcoholic trying to quit drinking, Washington tried to reform itself with a series of budget deals and “summits.” None of it worked, as Congress, like the alcoholic, kept making one-time exceptions to the rules. Finally, in 1994, when a disgusted public—like a family “intervening” with an out-of-control family member—threw out the long Democratic majority in the House and Senate, real reforms became possible. The House Speaker was given the power to name committee chairmen and their terms were limited. The new Republican majority, with its “Contract with America,” restrained spending. It even gave a Democratic president a line-item veto, although the Supreme Court threw it out as unconstitutional.

In the great prosperity of the late 1990s, the budget even went into “surplus” for four years. (In fact, the so-called surpluses were nothing of the sort. They resulted from phony bookkeeping in which borrowings from the Social Security trust fund were counted as revenues. The national debt rose in every one of those “surplus” years.)

Taking away the power of Congress and the president to decide how to keep the government’s books would be a big step in the right direction and require only congressional action.

More importantly, the debt declined as a percentage of GDP from 68.91 percent in 1994 to 57 percent in 2001. But with the collapse of the dot-com bubble in 2000, the attack on New York and Washington in 2001, the subsequent brief recession, and the decay of Republican Party discipline as members became more interested in individual re-election than collective fiscal restraint, debt began to rise again. When the “Great Recession” of 2008 hit and the most liberal administration since Lyndon Johnson took office, the floodgates of debt opened.

*     *     *

Congress has proved over the last 35 years that it is utterly incapable of fiscal discipline over the long term. And the president does not have the power to impose it. So what to do?

A line-item veto designed to avoid the Supreme Court’s specific objections to the 1996 act might pass muster with a more conservative Supreme Court than was in place in 1998. This would make the president a major player in budget battles as he could use the threat to veto individual items to line up congressional support for general spending restraint. But the Supreme Court might well decide that a line-item veto is inherently unconstitutional. A constitutional amendment would then be necessary but the chances of two-thirds of each house agreeing to such a restraint on congressional power are small.

However, the reinstatement of the president’s power of impoundment, taken away by the Budget Control Act of 1974, would give the president much the same power as a line-item and would certainly be constitutional.

Only when it is measured against the size of a country’s GDP do we get a sense of a national debt’s real size.

Taking away the power of Congress and the president to decide how to keep the government’s books would also be a big step in the right direction and require only congressional action. Wall Street recognized more than 100 years ago that corporate managements could not be trusted to keep honest and transparent books and neither can the managers of governments because, like corporate managers, they are human and therefore self-interested.

An independent accounting board, modeled on the Federal Reserve (which keeps the power to print money out of the hands of Congress) would accomplish that. It should have the power to set the rules of accounting for the federal government, “score” the costs of new programs (which the Congressional Budget Office does now), and monitor all federal programs for cost-effectiveness (something Congress often forbids government agencies to do, obviously fearing what it might learn).

Finally, the adoption by Congress of a limit on total spending, so that it could only increase to reflect population growth and inflation, unless a two-thirds majority agreed to suspend the limit, would force Congress to make the hard choices it now works so hard to avoid. Several states have similar provisions in place, and these are the states suffering the least from the downturn in revenues due to the current recession. California’s budget began to go out of control in the early 1990s precisely because it effectively repealed such a law.

Only necessity will force Congress to control long-term spending on its own. And unless the body politic forces the needed changes, that necessity in the form of overwhelming debt is inescapable.

John Steele Gordon is the author of Hamilton’s Blessing: The Extraordinary Life and Times of Our National Debt; a revised edition of it will be published in early 2010.

Image by Darren Wamboldt/Bergman Group.

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