Much of the economic wreckage inflicted on the USA version 1 in recent years arises from the failure to use ordinary household economics at the national level. In 2011, I wrote the following in response to the media’s ecstasy of praise for the fiscal wisdom of President Obama, in settling for a few spending cuts rather than the budgetary increase he had requested:
Suppose you are the head of a small household, struggling to get by on $4,000 per month take home pay. You sit down, total up an average month’s spending, and realize that you spend $7,028 per month. The astute reader will recognize that this is $3,028 more than our hero has available to spend. You say to yourself, “Self, this can’t continue.” So, you think really hard and come up with $71 in budget cuts – you know, brownbag a few times a week, watch less pay-per-view, that kind of thing. Now you’ve got your monthly deficit all the way down to $2,957. Having satisfied yourself that you have done all that could possibly be expected of you, you retire to the local eatery for a (modest) celebratory meal to appropriately acknowledge your newfound solid fiscal footing.
When put this way, doesn’t it all seem rather moronic? I certainly applaud the cuts—they’re better than nothing, and certainly better than the spending increases our Dear Leader asked for, but since the cuts for an entire year are on the order-of-magnitude of our weekly deficit, a grown-up might be tempted to say, “If it was this hard to get this little, how much more can we expect out of this current crew of self-important morons?” Even Ryan’s budget proposal, strong though it may be, is insufficient to truly right our fiscal ship.
I also note that all my numbers here were rounded so as to make the cuts appear larger than they actually were, proportionally. The economist Herb Stein famously said, “If something cannot go on forever, it will stop.” Anyone who pays off his Visa bill using his MasterCard must understand that this is, at best, a short-term strategy!
And yet, at the Federal level, we go on and on with trillion-dollar annual deficits projected as far as the eye can see, believing that somehow the national debt fairy will rescue us from this insanity at some point. As I write this, the official “national debt” has passed 30 trillion dollars – $30,000,000,000,000; more than $90,000 for every citizen of the US (debt per taxpayer is nearly $210,000). The worst of it, though, is that this only counts the money we have already actually borrowed – it doesn’t count the money that we have promised to spend in the future, regardless of whether or not there will be tax revenue at that time to support it. If the Federal government were to be accounted for using normal accounting principles, it would likely be currently $141 trillion in debt (corresponding to $919,000 in debt per taxpayer – other estimates are even higher). The Federal government of the United States is likely the “brokest” single entity in the history of the world.
Options for USA version 1
The following tools are historically available (alone or in combination) for dealing with national debt:
- Growth – that is, keep spending level (or reduce slightly) and enact policies that encourage economic growth to reduce the deficit (by raising the tax base, not the rate), and eventually produce a (usually modest) operating surplus, which is then used to pay down the debt over some time.
- Empire – either colonize another country to increase your tax base or allow yourself to become a client state of another empire. The former is frowned upon these days (and in any event it’s a short term fix – eventually an empire becomes a fiscal drag on the central economy, even if it’s a boost in the beginning) while the latter has obvious downsides (and isn’t available when you’re the world’s largest economy without going off-world).
- Debasement – either devalue or inflate your currency so as to be able to repay the debt with greater ease. This is only helpful for the government, though, as the citizens are harmed in the process (the wealthy have their wealth devalued, and the poor are priced out of basic necessities). Thomas Sowell: “Inflation is a quiet but effective way for the government to transfer resources from the people to itself, without raising taxes.”
- Default/repudiation – the national equivalent of bankruptcy. Obviously, this makes it really difficult for you to borrow in the future (even at a modest, cash-flow management level) and is a real kick in the teeth for the bondholders (who frequently are the nation’s own citizens).
- Austerity – a sharp drop in spending to reduce the deficit and move towards a surplus to be able to pay down the debt. Your citizens who were counting on that spending will NOT be happy about this.
The obvious least-painful choice is Growth, but note that Reinhart and Rogoff in This Time is Different, show that, historically, a debt level above around 90% of GDP is associated with under-performing growth* – that is, the debt itself seems to make it difficult to grow your way out of the debt. USA version 1 passed this threshold in 2010 and the ratio has continued to climb since (including the truly horrific 128% pandemic year in 2020).
There are historical parallels (see here for raw data on this subject: historical data on 187 countries from 1800-2015) for growing out of our current debt-to-GDP ratio levels, but, as time goes on and the ratio gets ever higher, there are fewer and fewer relevant historical examples. At the tail end of World War 2, the US debt-to-GDP ratio was 121% and we grew our way out of that (66% a decade later) but there were special postwar circumstances there (pent-up demand from the austere war years producing huge growth in many sectors, as well as a sudden stop in the underlying cause of the debt). There are a few other examples of this level of debt being resolved, but nearly all involve either some fairly severe social upheavals/wars (Australia 1905, New Zealand 1933) or special circumstances causing the debt which was then able to be resolved when the circumstances resolved quickly (Argentina 2002, Brazil 1884).
However, unless the public demand for entitlements from the public treasury suddenly recedes, I see no way to reduce spending in the near future and thus no way to grow out of the current debt level. Since we likely can’t find the political will for the modest spending reductions associated with a “Growth” solution, I am afraid that “Austerity” would produce straight-up revolution. As “Empire” is off the table these days, that leaves only “Default” (unlikely) and “Debasement” (already started) as live options. For these reasons, I am very much afraid that the inflation kicked off by the Biden administration will be with us for a very long time. As an alumnus of the Carter years, I don’t recommend it, but no one asked me**
Recently, an approach to macroeconomics (or maybe an “approach” to “macroeconomics”) called Modern Monetary Theory (governments can issue as much fiat currency as they like, essentially without consequence, so taxation and bond issuance are unnecessary except as policy tools to achieve some other goal) has arisen, which appears to me to be simply wishful thinking wrapped in pseudo-economic gibberish. It’s clearly false in extremis (society cannot function if the government simply pays everyone welfare in fiat currency – some members of society must be productive and incentives must be provided for this) and its advocates give no hint (that I can see) of how to derive any sort of boundary to the monetary regime they advocate that would exclude this failure point. However, I regard myself as simply a well-educated amateur in economics, so I was gratified to see an actual economist, Noah Smith, have a similar take on it. I don’t see how MMT is an actual option for dealing with the debt, except as the first step of an “underpants gnome”-type strategy.
Advice for USA version 2
Given the range of options for getting out of debt, the best advice I can give to USA version 2 is: DON’T TAKE ON DEBT!
As with household debt, it’s SO much easier to avoid debt than to get out of it. Small amounts of cash-flow management debt are fine, but keep the overall debt low relative to GDP. A structural approach like Switzerland’s “debt brake” is likely to be of benefit (it’s worked well for Switzerland in the nearly 2 decades since it went into effect; their debt-to-GDP ratio declined slightly right after it was enacted, then has remained flat ever since).
Resources
None of what I am saying here should come as a surprise to anyone who took (and stayed awake in) a macroeconomics course in, say, the last 50 years (Friedman’s Money Mischief, the source of his well-known aphorism that “Inflation is always and everywhere a monetary phenomenon,” was full of well-established facts, and it was written 30 years ago). Even Keynesians of various stripes never advocated (that I’m aware) for the levels of deficit spending that are now routine in this country. As I said above, I am not optimistic for the likelihood of USA version 1 winding the current debt down to manageable levels within the lifetime of my grandchildren, but perhaps an understanding of these issues will help USA version 2 avoid the fiscal trap of reliance on deficit spending to keep the welfare state afloat.
In case resources are necessary for this, here is a modest list of starting points for further research:
- Dan Mitchell: “Historical Evidence on Reducing Large Debt Burdens.”
- Adam Tooze: “Putin’s Challenge to Western Hegemony,” an article discussing how, even though Russia should be at a huge economic disadvantage vis-à-vis the West, the fact that Putin began his rule by drastically reducing Russia’s debt makes Russia competitive where it otherwise would not be.
- Cullum Clark: “A Historical Look at National Debt.”
- Reinhart & Rogoff: This Time is Different, mentioned earlier.
- IMF Working Paper (Eichengreen, ElGanainy, Esteves & Mitchener): “Public Debt Through the Ages.”
- Adam Vicari: “America is Approaching Financial Doomsday.”
- David Sukoff: “MMT is Dead. It Must Now Be Buried for Good.”
Postscript: after writing this post, I happened upon this well-constructed graph giving a good sense of the recent state of affairs regarding the USA version 1 “debt borrowed so far.”
Further Postscript: here is an even-more-recent FEE article by Pepperdine economist Gary M. Galles making many of these same points.
* Yes, I am aware that that Reinhart and Rogoff made a few errors in the book (and the papers that support it), but even so, the raw data makes it clear that there is a general negative correlation between debt level and growth, even if the “90% cliff” isn’t as sharp as they asserted. Their fundamental point is that extremely high levels of debt are, generally speaking, a drag on growth, and correcting their errors doesn’t really affect this. Note, for example, that this critique of Reinhart and Rogoff contains this corrected graph:
I would simply point out that, while the strength of the relationship between debt level and growth varies by decade, it’s nearly always there (only the 1980s looks flat to me), and always in the same direction.
** Actually, I suspect that “Biden inflation” will be much more painful than “Carter inflation” because of the debt level. During “Carter inflation,” interest rates were high, thus there were ways for investors to more-or-less keep up with inflation without taking on much risk. With “Biden inflation,” sovereign debt is so high that interest rates cannot be allowed to rise much without debt service blowing up the deficit further (I suspect even the press, which is pretty much a wholly-owned subsidiary of the Democratic Party these days, would notice that). Thus, there won’t be any way to hedge against inflation other than relatively risky equities, likely in the middle of a recession.