Budget Deficits And The National Debt:
Causes, Consequences And Cure!
Dr. Judd W. Patton
On July 8, 2004 the national debt, to the penny, stood at
$7,262,737,835,501.71.1 We’ll round it to $7.3 trillion dollars
to save keystrokes. That
represents more than $26,000 dollars for every man, woman, and child in
As Saddam might say, the “mother of all” national debt is the
budget deficit – the amount by which government expenditures exceed its
revenues. The accelerating nature of these deficits was very striking
the last four decades. The
combined deficits for all of the 1960s averaged $5.7 billion per year; $35
billion per year in the 1970s; $156 billion per year in the 1980s, but $134
billion per year in the 1990s due to surpluses totaling $195 billion in 1998
After $364 billion in surpluses in 2000 and 2001, the trend
to larger deficits has resumed with deficits of $158 billion and $375
billion respectively for 2002 and 2003. The Congressional Budget Office
estimates Federal deficits of $477 billion for 2004 and $363 billion for 2005.
The above statistics, though, surely suggest that the United States
government has had a severe case of economic A.I.D.S. disease – Acquired
Immunity to Deficit Spending.
In spite of the Gramm-Rudman deficit reduction act, budget
resolutions, and all the political promises to balance the budget, deficits
and the national debt skyrocketed in the latter half of the 20th
century. Thanks to the World Wide Web and Internet “Revolution” the
economy boomed in the 1990s expanding government revenue to the point of
creating budget surpluses.
Will this $7.3 trillion national debt harm the long-run health of our
nation? Has the economic A.I.D.S. disease returned?
Frankly, there is a diversity of opinion on these matters.
Some economists suggest that “we owe it to ourselves” – that
the national debt is essentially a transfer of money from one group of
Americans (taxpayers) to another (bondholders).
The economic effect is thereby supposedly neutralized.
Others point out that if the national debt is adjusted for price
inflation or considered as a percentage of GNP, it is not at alarming,
On the other side of the debate are economists who express great
alarm over past deficits and national debt and fear the return to big
government with its economic A.I.D.S. disease.
To them the debt represents “living beyond our means” and capital
consumption. The consequences
include declining living standards and the possibility of more price
Who is right? Are
“we” mortgaging our children’s future?
Just what are the economic consequences of deficits?
Why did they become a way of life?
Before considering these questions, consider the origin and an
historical overview of U.S. deficit spending.
It all started in
1777. The Continental Congress
tried to raise tax revenue to buy needed supplies for the war against
Britain. Unsuccessful, it
resorted to printing “paper money” (the Continental dollar) and debt
financing. By 1783 the new nation had borrowed over $8 million.
From 1790-1812 the government incurred some additional debt but
promptly repaid it. However,
the unpopular War of 1812 raised the national debt to over $129 million by
1816. But fearful of rising
debt, U.S. leaders used budget surpluses to eventually pay off the national
debt by 1835.2
From 1835 to 1860 the national debt reappeared, notably induced by
the Mexican- American War (1846-48). Just
prior to the Civil war it reached $65 million.
But the Civil War (1861-1865) was essentially financed by printing
unbacked “greenbacks” and incurring $2.6 billion in debt!
Again, fearing public debt, the debt was reduced about 60% in thirty
years to $1 billion in 1895. It
stayed in this $1 billion range until World War I when it exploded. By 1920 the national debt exceeded $24 billion.
Following historic precedent, the government ran surpluses during the
1920s and thereby reduced the national debt to $16 billion by 1930.3
But the 1930s Great Depression and the advent of Keynesian
macroeconomic ideology changed everything.
Deficits and “easy money” became “tools” to manage the
economy. The economic A.I.D.S.
disease was contracted. Thus, by 1940 the national debt approached $43 billion.
Then the Keynesian influence and World War II combined to explode the
national debt to $259 billion by 1945, a 500% increase in five years.
By 1960 it had grown to $285 billion.4
The 1960s, with its “Great Society” programs
and Vietnam War, caused the debt to reach $370 billion by 1970.
Another $544 billion was added to the total debt in the decade of the
1980s. When President Reagan
came into office in 1981 the national debt was nearly $1 trillion.
By 1990 it had tripled to $3 trillion!
A brief summary statement would be that the historical accumulation
of the national debt reflected war financing followed by a gradual repayment
until the 1930s when Keynesian economic analysis legitimatized deficit
spending as a means to manage the economy, and in the process, expand big
National Debt And
It is important to
understand that the U.S. national debt consists of U.S. Treasury bills,
notes, and bonds. As of 2001, 50% of U.S. debt was owned by private
institutions or investors – banks, corporations, insurance companies, etc.
Federal agencies, like the Social Security Administration, owned
41% while the Federal Reserve owned 9% (This figure is important because
it drives new injections of money into the economy when the Fed purchases
government securities). Finally,
almost 21% of the national debt was held by foreigner investors –
foreign governments, banks, corporations, and individuals.5
Another interesting fact concerns interest on the national debt.
For fiscal 2003, the interest expense was $318 billion. It
had reached a peak of $361 billion in 2000.
As the Federal
deficits balloon in the first decade of the 21st century, expect this
expense to balloon as well.
Notice also the federal budget expenditures for 2003 in the Table
below. Social Security
accounts for 21% of the budget; National Defense for 36%; net interest for
7%; Medicare for 12%; Medicaid for 8%; and Income Security Payments
(Unemployment, Disability, and other income security payments) for 14%. Total transfer payments (redistribution),
adjusting for income receipts of $102 billion, were 59% of the total budget. Robin Hood is
alive and well!
Confusion over the
effects of deficits is eliminated by distinguishing between productive debt
and consumptive debt. A
productive debt is incurred by a borrower for the purpose of earning income.
Clearly most business debt is productive.
Such debt is self-financing; it is paid off out of earnings. However, consumptive debt is incurred with no purpose to earn
income; it uses up income and must depend on another source of income to pay
it off. Consumer borrowing for
an auto loan or home mortgage are examples of consumptive debt.
Productive debt is a major source of economic growth and progress. Through it firms acquire the money capital needed to
accumulate machinery, equipment, and new technology to expand productive
capacity. The loan’s
principal and interest are paid off out of the revenue the investment
Unemployment, Disability and Income Security
|6. Net Interest
On the other hand, consumptive debt is not a means to economic
growth. Surely the use of the
new car or new home provides enjoyment and benefits to the owner.
But it was productive investment that was the essential means to
create the car or home in the first place.
Productive debt and investment, not consumptive debt, is the means to
a higher standard of living.
Virtually all government debt, with few exceptions, is consumptive,
even their so-called capital investment.
Government programs and activities are rarely intended to be
self-financing, even when user fees are sometimes charged.
(The U.S. Postal Service generally runs deficits, for example).
All consumptive activities rely on a productive source.
Logically, then, government deficit spending must be at the expense
of the private economy. It must
crowd out private production. There
is no such thing as a free lunch! The
cost or burden of deficit spending is what the money could have produced in
the private economy.
Deficit spending is, by straight-forward logic, a triple burden on
the private economy. First,
private consumption and production is replaced by government resource-using
programs. Secondly, there is an
additional burden (sacrifice or cost) in the future when the government either borrows again,
raises taxes, or prints money to pay interest and principal. Thirdly, the nation’s standard of living must be lower than
it otherwise would have been as private productive activities are diverted
to government consumptive activities.
In other words, the U.S. deficits of the last forty years have
diminished productive debt (a source of wealth creation) in favor of
consumptive debt (an action that uses up wealth).
This is known as crowding out – crowding out private investment and
deficit spending and the national debt did reduce our nation’s standard of
living compared to what it would have been had not consumptive debt
crowded-out productive debt. Fortunately, foreign saving through investment
into the U.S. “saved the day,” so to speak, and made possible continued
The oft quoted cliché
that the growth in the national debt is not a serious problem because “we
owe it to ourselves” can now be seen for the obvious fallacy that it is. Truly the national debt represents a transfer of money from
some Americans to other Americans, from
lenders to the beneficiaries of the government spending and from taxpayers
to bondholders to pay interest. But
this “transfer” is not neutral to the economy.
It represents a change in how economic resources are used by
diverting savings from primarily productive purposes (productive debt) to
consumptive purposes (consumptive debt).
Thus the national debt should be a serious concern for all Americans.
It signals the consumption of economic resources for political ends.
It represents factories not built, businesses not initiated, and jobs
not created. It represents a
transfer of land, labor and capital from wealth-creating ventures to
wealth-using activities. Surely
deficits and debts do matter to the nation.
Another mischievous argument is that past deficits and national debt
are not at alarming proportions when adjusted for price inflation or when
taken as a percentage of GNP. Truly the depreciation of the dollar (now worth about 5
cents of the 1933 dollar) is itself a great evil and is caused, for the most
part, by past deficits that have been monetized.
That is, deficits are financed by selling securities in the open
market. To the extent the
Federal Reserve purchases these U.S. Treasury securities, new money is
created. But this monetization
of the national debt causes price inflation, not to mention a redistribution
of income and wealth to the favored recipients, and the business cycle!
To claim that national debt is not at historic levels – because of
price inflation – is to be blind to the fact than monetized deficits cause
price inflation in the first place. These
economists then use the inflation index to deflate the national debt figure
to demonstrate their argument. Incredible!
The argument that the national debt should be considered as a
percentage of GNP also misconstrues the real economic concern over deficits
and debt. Deficits consume
savings and hinder productive debt. An
appropriate ratio would be the percentage of the nation’s saving taken by
government debt (the debt/savings ratio).
It is this latter ratio that rose sharply in the 1980s and early
1990s as individual and business savings dwindled while deficits skyrocketed.
Remember this point for the future: economic growth depends on
savings and successful investment. As the 21st century
return to record deficit spending, and should the “government debt/savings
ratio” increase significantly, the economy will decline through capital
consumption, regardless of the debt/GNP ratio.
And Debts Do Matter
Loose U.S. fiscal
policy, along with a “now generation” attitude, has caused our nation to
live beyond its means. Foreign
savings or investment have “saved the day” so far.
But this can’t be expected to last forever.
The consequences of our past deficits and national debt have been
higher interest rates and capital consumption than our nation otherwise
would have had. It has meant higher inflation rates as well as the Federal
Reserve was pressured to monetize a good portion of the deficits. And since
monetary inflation causes the business cycle, we can anticipate a major
downturn in the economy and stock market in the future.
Americans must learn the lesson that living beyond our means via
loose fiscal and monetary policy will eventually mean living below our means
tomorrow. A day of reckoning will come.
Many solutions were
tried and found wanting during the “high deficit” 1980s and 1990s: the
Gramm-Rudman-Hollings Act and periodic increases in the national debt ceiling. Lively
discussions during this period addressed the possibility of passing legislation for either a balanced budget Constitutional
Amendment and/or giving the President line-item veto power in the budget
process. However, the budget surpluses of 1998-2001 quieted the debate and
public concern. Still, with record deficits now looming the economic A.I.D.S.
disease appears to have returned with a vengeance. Are there any new ideas
for thwarting this economic disease?
The U.S. national debt
had been the product of war financing and the advent of Keynesian economics
in the 1930s that justified deficit spending as a means to (supposedly)
manage and stimulate the economy in downturns.
The Keynesian legacy is an intractable economic A.I.D.S. disease and
accelerating national debt that is consuming the nation’s substance by crowding out private
Nevertheless, there is a cure to the economic A.I.D.S. disease - a
new idea perhaps. The American people must embrace a change in
thinking and values. Collectively
they must pull their hands out of the public treasury.
That is, they must initiate a benefit rebellion, not a tax rebellion.
They must once again prefer to earn income in the marketplace by
serving others, not by seeking political income through consumptive policies
of dependence – transfer payments and redistributive schemes.
Then expenditures can be slashed and the budget balanced easily year
Government deficits and debt do matter greatly.
Let’s be a part of the solution and not a part of the problem.
the U.S. Treasury Web site at http://www.publicdebt.treas.gov/opd/opdpenny.htm.
2Bradley R. Schiller, The Economy Today (New York: McGraw-Hill,
Inc, 1991), pp. 259-260.
3Ibid., pp. 260-261.
4Ibid., p. 261.
5James Gwartney, Macroeconomics (Fort Worth, TX: The Dryden
Press, 2000), p. 506.
billion seconds = 32 years
1 billion minutes = 1903 years
1 billion hours = 115,000 years
time it takes for the Federal Government
in 2004 to spend $1
billion dollars = 3 hours 37 minutes!
Historian Alexander Tytler (1747-1813) wrote a book entitled, The
Decline and Fall of the Athenian Republic. His words are still
thought-provoking for Americans today. He wrote: “A democracy cannot exist
as a permanent form of government. It can only exist until the voters
discover that they can vote themselves money from the Public Treasury. From
that moment on the majority always votes for the candidates promising the
most benefits from the Public Treasury with the result that a democracy
always collapses over loose fiscal policy always followed by dictatorship.
The average age of the world’s greatest civilizations has been 200 years.
These nations have progressed through the following sequence:
to spiritual faith;
from spiritual faith to great courage;
from courage to
from liberty to abundance;
from abundance to
from selfishness to
complacency to apathy;
from apathy to
from dependency back
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