Running Header: The U.S.

National Debt 1

CLA 2: The U.S. National Debt

Robert Raisbeck

Westcliff University
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Right of the bat the U.S. began with a multi-million-dollar debt. Before the constitution

was ratified in 1776 more than $75 million was owed from the Revolutionary War. At this time

the Continental Congress had no money to finance the war since it had no power to collect taxes.

Financing the war was the option taken in order to secure independence from the British. In the

following years between 1791-1849 there were 36 years of surplus and 23 of deficit culminating

with $60 million of surplus and all debt repaid in 1836.

During the civil war $2 billion were borrowed and in the years following there were 21

years of surplus and 14 of deficits. By the early 1900s the U.S. was $2 billion in debt with 13

years of surplus and 17 years of deficit. A common pattern found before the great depression was

the fact that war drove debt up and in the years following the war fiscal responsibility slowly drove

debt back down.

After the 1930s there have been more years of deficit than of surplus. Only 11 years of

surplus between 1930 and 2012! There are various reasons for this, including two world wars, the

elimination of the gold standard, Regan, Bush, Obama and the Troubled Asset Relief Program,

better known as TARP. It is important to note that during WW2 the country’s debt to GDP ratio

was higher than it was today. Between 1982 and 1990 Social Security and Medicare expenses

ballooned due to an aging population. The Baby Boomers at that time was the largest and most

voluminous age group in the U.S. population and they were retiring and using more health services

than ever.

Many supporters of Regan consider the large increase in national debt in his presidency

worth it since the arms race was attributed to bankrupting the Soviet Union. In his presidency

between 1980-88 Ragan cut taxes for the wealthy as an incentive for them to spend more in what

became known as his famous trickle-down economy. In this economy the excess spending of the
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rich would “trickle-down” the social ladder. His arms race increased the national defense spending

from $157 billion to $303 billion. Towards the end of Regan’s presidency and after the fall of the

Iron Wall, inflation adjusted military spending was at the lowest point since WW2.

Both George H. W. Bush and Clinton were fiscally responsible as Bush created a pay as

you go program to curb discretionary spending and during Clintons administration there were two

years of surplus. These surpluses were mostly due to unexpected capital gains tax since the

economy and the stock market were performing very well. When George W. Bush entered the

White House, he cut taxes for the rich, and after September 11 2001, increased military spending.

Tax revenue was poor since the economy wasn’t performing well and this elevated the national

debt. By 2005 over $239 billion of deficit was added to the national debt.

Sub-prime loss in 2007 hit the country’s financial system leading to the collapse of Lehman

Brothers in September 2008 among many other firms. The automotive industry was on the brinks

of collapse, as well as other financial firms, including AIG. It was the biggest financial crisis since

the Great Depression, which led to the creation of a discretionary package called the Troubled

Asset Relief Program (TARP). The crisis began while Bush was still in office and a bailout in the

form of a loan was agreed during his presidency which continued under Obama for automakers

such as GM and Chrysler, as well as over $160 billion for AIG. Bush engaged fiscal policy to

stimulate spending in the form of tax rebates. Nondiscretionary fiscal policy kicked in high gear

in the form of welfare (unemployment, food stamps, Medicaid) and attempted to dampen the initial

impact of decreased demand. Bush worked with congress where Obama was present to plan the

giant stimulus package known as TARP and spending surged bringing the deficit past $1 Trillion

for the period.

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TARP disbursement began in 2009 and the stimulus added $787 billion in government

spending. Since congress had to approve TARP it fell under discretionary fiscal policy by

definition. The $787 billion stimulus package included 38% in tax cuts, mostly to individuals,

39% in spending, and 23% in aid, of which half went to individuals as Medicaid and a quarter in

unemployment. At the same time the FED engaged in the most expansive monetary stimulus in

history. The FED’s portfolio of assets tripled between 2008-2013 making more money available

to the banking system and allowing a dramatic increase in loanable cash at near record low interest

rates for the whole period.

Economists differ in view as regarding to the effectiveness of the stimulus package. Many

say that by the time TARP was disbursed the worst part of the crisis had already passed. Others

argue that the amount was too little and had very little impact on the economy. While others argue

that the increase in national debt was worth it since without it things would have been worse.

While the recovery was slow and wages were stagnant form nearly a decade, we can be certain

that GM and AIG would have sunk without the life saver the government gave these firms. The

bankruptcy of AIG would have left thousands more unemployed and the financial repercussions

would have worsened.

Obama left office leaving the national debt at nearly $20 trillion. It is important to clarify

that part of the spending began while Bush was in office and neither party can take all the blame

for increasing the national debt. With a debt to GDP ratio at around 105% and close to the levels

it had right after WW2 it is important to mention some of the consequences a large debt can have

on a country. In general terms a large debt to GDP ratio causes a central bank to have a tight

monetary policy and increase interest rates, which deteriorates savings and private investment.

Since companies have less capital to invest and expand this is accompanied by lower productivity.
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Additionally, high debt can pressure government to spend less and tax more, both policies that

were lethal for Greece’s economic recovery since both drove demand down.

Economists from Universities in Slovak Republic (Belgrade), Serbia, and Czech Republic

in a study of 13 EU countries found a linear relationship between debt to GDP decrease and GDP

growth. These findings concluded that a debt to GDP ratio smaller than 64% was connected to

GDP growth. Debt to GDP ratio between 64% - 113% had little effect on GDP growth and 113%

or more of debt to GDP ratio was associated with negative economic growth.

A 2013 study of the University of Massachusetts came to a different conclusion and found

no tipping point in debt GDP ratio. Although data gathered between 1946 and 2009 saw that 20

advanced countries had more growth under lower debt. However, the study clarifies that

correlation does not mean causation. Ultimately the study found the debt problem to be more

country specific than just a debt to GDP ratio issue. The fact that Greece had no monetary control

and could not print their own currency to devaluate and gain more favorable debt payments gave

them little control to maneuver out of the crisis. A unified monetary policy but separate fiscal

policies is something Europe will have to consider and perhaps reform in the near future.

Could the U.S. default on its debt with its debt to GDP ratio on the rise? The consequences

of higher debt were discussed above and this is an issue that has to be tackled eventually. In the

meantime, it is important to clarify that there is little chance of a default since most of the debt

held by the U.S. is in U.S. dollars. Since the debt is in the countries own currency the FED can

always print more money to pay debt. Printing more money can increase inflation and add to the

debt, but the country cannot default since it can always “create” money to pay for the national

debt. Below are some quotes of top level economists regarding their views on the possibility of

defaulting.
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"The United States can pay any debt it has because we can always print money to do that.

So, there is zero probability of default." Alan Greenspan.

“In the case of United States, default is absolutely impossible. All U.S. government debt is

denominated in U.S. dollar assets.” Peter Zeihan, Vice President of Analysis for STRATFOR.

“There is never a risk of default for a sovereign nation that issues its own free-floating

currency and where its debts are denominated in that currency.” Mike Norman, Chief Economist

for John Thomas Financial.

Paul Krugman won a Nobel prize for economy in 2008 and has been very outspoken against

austerity. He believes the answer to improve the economy today lies in acquiring more debt. He

sensibly argues that the British government have a solid economy and have been in debt for more

than three centuries, an era spanning the Industrial Revolution, victory over Napoleon, and more.

Many economists coincide with Krugman and argue that the economy needs a sufficient amount

of public debt out there to function well. M.I.T.’s Ricardo Caballero argues that “the debt of stable,

reliable governments provides “safe assets” that help investors manage risks, make transactions

easier and avoid a destructive scramble for cash.”

Given the fact that the United States infrastructure is obsolete and suffers from obvious

deficiencies in roads, rails, water systems, airports and more it seems like a great time to invest in

these items and take advantage of historically low interest rates. This is a very good time to be

borrowing and investing in the future, and as Krugman points “it is a very bad time for what has

actually happened: an unprecedented decline in public construction spending.” Krugman has the

following analogy regarding debt as an additional point of why it’s not as bad as people think “An

indebted family owes money to other people; the world economy as a whole owes money to
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itself… Because debt is money we owe to ourselves, it does not directly make the economy poorer

(and paying it off doesn’t make us richer).”

On the other side of the coin, austerity in Europe resulted in an environment in which

reducing debt ratios was difficult and reduced spending combined with increased taxes halted

economic growth and helped decrease the demand for goods and services. In this environment

inflation fell and deflation took over, making economic growth even harder. The U.S. who

increased their debt and “spend” their way out of the resection recovered faster than Europe who

attempted to increase tax revenues and reduce governments spending in an effort to lower debt to

GDP ratios.

Tax increases and decreased spending or a combination of both are common strategies for

reducing debt. Although the consequences of reduced spending where discussed above we can

conclude that debt in itself is not as bad as many would think. I would conclude that it is best not

to leave millions unemployed through untimely government policy and by not taking advantage

of the opportunity cost involved in acquiring more debt at historically low interest rates.
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References:

Guell, Robert C. (2015). Issues in Economics Today, 7th edition. Pg. 150-154, 176-178.

Bartlett, B. (2012, June 12). The Fiscal Legacy of George W. Bush. New York Times.

Sulikova, Veronika. Djukic, Mihajlo. Gazda, Vladamir. (2015, Sep 9). Asymetric Impact of Public

Debt on Economic Growth in Selected EU Countries. Ekonomicky casopis. Pg. 944-956.

Hervey, John T. (2012, Sep 10). It Is Impossible For The US To Default. Forbs.

Krugman, P. (2015, Aug 21). Debt Is Good. New York Times.

Krugman, P. (2015, Feb 9). Nobody Understands Debt. New York Times.