How Dangerous Is the Public Debt?
by LEO BARNES
PEOPLE are beginning to worry about the consequences of our huge national debt. More than half the cost of World War II has been met through borrowing. Despite Japan’s earlier than expected surrender, our public debt will be in the neighborhood of 300 billion dollars before the financial balance sheet of this war is closed. That will be more than seven times the New Deal’s top debt of 40 billion dollars, and twelve times the First World War peak of 26 billions.
Plain citizens, businessmen, and politicians alike view this prospect with alarm. How large a public debt is dangerous? Will the debt expand? Will it be reduced? Will it be repudiated? Will inflation be the post-war heritage of “war on the installment plan”? What will happen to the war bonds and stamps 85 million Americans have bought? Recurring questions like these call for the widest possible public understanding of the economic realities underlying the national debt.
For years, economists, fiscal experts, and journalists have vigorously debated the question whether a large national debt is a catastrophe or a blessing. In itself, a national debt of 300 billion, 500 billion, or even a trillion dollars is neither a menace nor a benefit. It is simply an instrument for future good or evil. We the people, our government, and our business system can choose to use that fiscal instrument. Whether we use it well or badly will depend on our economic literacy.
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OUT of the argument between debt optimists and debt pessimists, eight points have emerged which may help to clarify our understanding of the public debt.
1. The term public debt is a “weasel” phrase which induces a one-sided approach to fiscal problems. Because every debtor has a creditor, because government bonds are assets as well as liabilities, it would be equally correct and much more encouraging to speak of the 300-billion-dollar national credit instead of the 300-billion-dollar national debt. Actually, the public debt is no more a sign of public poverty than war bond certificates are tokens of public wealth.
This simple linguistic distortion has probably been responsible for more loose thinking about the public debt than any other one factor. It is at the heart of the prevalent misconception that increasing the public debt somehow makes a nation poorer, while decreasing it makes a nation richer. As we shall see, precisely the reverse is usually true.
8. The public debt is a public burden, even though “we owe it to ourselves.” Exuberant debt optimists like Alvin Hansen and Stuart Chase insist that the public debt, no matter how large it is, cannot be a burden to the nation as a whole because we who owe the debt also own it. They point out that as taxpayers all of us amortize the principal and pay the interest on the national debt; while as bondholders most of us receive the interest and principal when due.
Conservative economists have justifiably poked fun at this argument of debt liberals. Actually, the point is superfluous to the liberal position. For the burden of the public debt does not have to be denied. It is enough that, for most of us, its burden is negligible compared to its benefits.
3. The public debt is a burden not because of its size but because of its carrying costs. If the public debt were to be retired by means of extra-heavy taxes or through a capital levy, then the larger the debt, the greater its burden would become. Actually, only once in world history has any considerable part of a large national debt been legitimately retired rather than repudiated. That happened in the nineteentwenties under Harding, Coolidge, and Hoover.
By contrast, most economists do not expect any large-scale debt retirement to take place after the present war. Nor do they anticipate repudiation. Debt maintenance and expansion are the probabilities we face. Significantly, President Truman’s twenty-one-point post-war program presented to Congress in September contained not a word about reducing the public debt.
Discounting substantial debt retirement, the burden of our post-war debt will consist almost exclusively in paying interest and other carrying charges. At the present average interest rate of less than 2 per cent, annual carrying charges on a 300-billion-dollar debt would be around 6 billion dollars. This would mean an actual post-war debt burden of about $160 per family per year, or roughly $40 per person — not the $8000 which would be each family’s theoretical share of the total debt.
In the long run, the real debt burden will probably be even less than 6 billion dollars. Interest rates paid by the government have been dropping steadily. The current average of under 2 per cent is less than half the First World War figure. After the present series of war bonds owned by individuals have been redeemed, they are likely to be partly replaced by securities financed through banks at lower rates. In this way, the over-all average interest charge may eventually fall to about 1 per cent. Such a reduction would halve the burden of the present debt. Alternatively, it would permit that debt to double without increasing the burden for the taxpayer.
4. The burden of the public debt is relative to national income; the greater the national income, the less the burden of a given debt. Obviously, a debt burden of $160 per year is less onerous for a family with an income of $10,000 than for one with an income of $5000. Similarly, it is much easier for the country at large to carry an annual debt burden of 6 billion dollars when its income is 150 billions than when it is 75 or 100 billions.
Accordingly, the burden of a public debt is best expressed as the percentage ratio of the annual debt interest charge to the annual national income. This means that the burden of a 300-billion-dollar debt, financed at 2 per cent for an interest charge of 6 billion dollars a year, would be 6 per cent of the national income when the latter is 100 billions, 5 per cent when it is 120 billions, 4 per cent when it is 150 billions, and so on.
5. In an economy operating at less than full employment, raising the public debt usually increases real national income, and thereby decreases the debt burden. This is the most startling principle of the modern concept of the public debt. It is valid only when economic resources are not being fully utilized; once full employment is achieved, it is no longer true. Moreover, Point 5 applies to real national income—that is, money income translated into units of constant purchasing power.
This fact is important; for inflation, which is essentially increasing money income without increasing real income, can also ease the burden of public debt. However, because the economic and social evils of inflation far outweigh its incidental benefits to debtors, we must concentrate on raising real national income rather than content ourselves with the illusory satisfaction of reducing the debt burden by inflating money income.
Point 5 stems from world-wide experience with what opponents call “deficit spending” and what advocates have renamed “compensatory finance.” In this country, the depression showed that, increasing the national debt by, say, one billion dollars boosted national income by more than a billion — usually by two or three billions. Economists call this expansion the “multiplier” effect. In other words, when government injects more money into the national income stream by spending than it takes out of it by taxing, that extra money will be spent and respent several times by consumers and businessmen.
Since the burden of the public debt is relative to national income, any increase in the total debt which raises national income by more than the boost in the debt will actually reduce the debt burden. Because this point is all-important, let us examine in some detail a possible situation.
Suppose the government is considering a compensatory-spending program to restore full employment. Such action is what the Wagner-Murray Full Employment Act proposes. Suppose too that the public debt is 300 billion dollars, the annual debt charge at a 2 per cent average interest rate is 6 billions, and the national income is 150 billions. The debt burden would then be the ratio of 6 billions to 150 billions, or 4 per cent.
The government now proceeds to spend 10 billion dollars more than it expects to raise in the current year by taxation, thus boosting the national debt 10 billions, to 310 billion dollars. At the average rate of 2 per cent, the annual debt interest charge also rises .2 billions to 6.2 billion dollars. However, as a result of the “multiplier,” 10 billions in deficit spending would probably increase national income by at least 20 billion dollars, to 170 billions or more. Simultaneously, the debt burden would actually have declined from 4 per cent to 3.6 per cent (the ratio of 6.2 billions to 170 billions). Even if the national income were raised by only the exact amount of deficit spending, to 160 billion dollars, the debt burden would still have declined from 4 per cent to 3.9 per cent (the ratio of 6.2 billions to 160 billions).
Debt pessimists will be quick to point out that the increase in national income ordinarily produced by raising the public debt is frequently temporary, while the increased carrying charges are likely to be permanent. The basic reason is that, sooner or later, the “multiplier” effect of any given boost in the public debt dies out and national income tends to drop back to where it was before the debt was increased.
Moreover, businessmen who distrust deficit spending may curtail their expenditures, thus offsetting the expansionary effect of government deficits. Whatever the cause, the result is the same. Compensatory spending frequently does not “prime the pump” of private enterprise, and a continuous flow of it seems to be needed to maintain national income at high levels. This is undoubtedly the most serious objection against deficit spending.
Of course, everyone would be happier if real national income could rise continually or at least remain high without deficit spending. But when the choice is between a falling national income and a rising public debt, the latter is by far the easier horn of the dilemma. Point 5 tells us why. As long as more than frictional unemployment exists, compensatory spending almost always pays for itself—either by raising national income or by preventing it from falling as far as it otherwise would.
6. In an economy operating at less than full employment, reducing the public debt usually decreases real national income, and thereby increases the debt burden. This is the opposite of Point 5. When unemployment exists, wiping out part of the national debt by greater taxation or reduced government spending is the surest way to magnify the burden of the remaining part. The “multiplier” works in reverse. A billion dollars more in taxes or less in government spending would mean several billion dollars less in total expenditures for goods and services. Cutting the debt by one billion dollars would thus almost certainly mean a larger slash in national income, so that the relative debt burden would be greater than it was before.
One striking example of this principle will be remembered by many readers —the “recession” of 1937-1938. From June 30, 1937, to March 30, 1938, the Treasury’s books showed a cash surplus of about 100 million dollars. That was the last time the Federal government balanced its budget. It was the only time the New Deal ever did. This retreat from deficit spending was accompanied by one of the swiftest industrial declines in American history.
7. Only in a full employment economy may debt expansion be harmful and debt contraction beneficial. Points 5 and 6 are not to be construed as arguments for increasing the public debt ad infinitum. Expanding (or contracting) the debt is beneficial when it raises real national income, and harmful when it does not.
When a nation’s economy is operating at full employment, its real income is already af high as the skill of its labor force and the development of its technology permit. Under such conditions, additional deficit spending cannot increase real income. In fact, whenever deficit spending does not serve either to bring idle economic resources into use or to prevent economic resources from becoming idle, it is an inflationary rather than an income-creating force. With total public and private spending increasing faster than the total output of goods and services, real income would decline because prices would be rising faster than money income.
In this situation, contracting the public debt is the beneficial measure. This may be done either by curtailing government spending or by increasing taxes. If the cut in the debt is drastic enough, prices will fall faster than money incomes, and real incomes will go up.
8. Expansion or contraction of the public debt should be determined by its effects on real national income, not by the size of the government’s budget. Points 5, 6, and 7 culminate in this basic operational principle. Public debt management should be an instrument for keeping the real national income at the highest possible level. Any decision to increase, to maintain, or to reduce the debt should be made primarily for this purpose.
From this point of view, the size of the public debt is the net result of the government’s participation in economic life, the final score of its financial activities. A government has five fiscal instruments by which it can influence production and consumption, saving and investment, employment and unemployment, the distribution of wealth and the level of prices. These are: taxing, borrowing, spending, lending, and selling. By different combinations of these devices, the government can help to determine the real national income. Whether the national debt will rise or fall in any given year will depend on the government’s decision as to whether the economy must be stimulated or given a sedative.
More and more economists are coming to agree that a technologically developed economy like ours needs government stimulation much of the time to avoid depression and stagnation. After the war, achieving and maintaining high employment levels will accordingly require fairly continuous large-scale government spending. Such spending will mean a constant or a rising public debt.
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THIS economic compulsion to avoid depression will determine what will happen to the public debt. It will be the crucial factor in shaping the techniques for redeeming the war bonds of 85 million Americans. It will also largely decide how the rest of the public debt will be handled in the decades ahead.
There is no doubt that every single war bond will be paid in full when it falls due. So will every other Treasury obligation. A modern state, equipped with the high-powered weapons of income taxation and central bank financing, does not need to default on its debts. But the necessity of preventing depression will compel the Treasury to replace almost all war bonds as they mature with other government bonds or notes. Debt refinancing, not debt retirement, will be the order of the day.
Why this will be so is not hard to see. Most war bonds sold to individuals have a ten-year maturity period. They will therefore fall due, at a rate of half a billion dollars or so a month, between 1952 and 1957. By that time, the post-war replenishment boom will probably have petered out. As Point 6 shows, to retire large amounts of government debt when economic stagnation threatens would almost surely send the economy into a tailspin. The downrush of 1937-1938 would be mild by comparison.
Shortly after 1950, accordingly, Americans will find themselves being urged to exchange their war or defense bonds for a new kind of “peace” or “prosperity” bond. Conceivably, devices may be worked out for converting war bonds into additional life insurance, unemployment insurance, or old-age pensions, thus supplementing regular social security benefits. Not only would this spread out repayment dates for the Treasury, but it would also provide income when the recipients most needed it, and when it probably would have a beneficial effect on the national economy as a whole.
Apart from mild social pressure, any type of war bond conversion will be optional. Bondholders who want cash will get it when they ask for it, for the government will have other outlets for refunding. Banks, insurance companies, and trust funds will be as eager to invest their assets in government securities in the nineteen-fifties as they have been throughout the New Deal and the Second World War. The Treasury will always be able to refinance its bonds at a lower interest rate through institutions than through individuals.
Individuals’ war bonds, of course, represent only a small portion of the public debt. What can be expected to happen to the major part of the debt not owned by individuals? I erpetual renewal is probable for this portion of the debt also.
Indeed, the United States institutional debt is already well on the way to being transformed from a conglomeration of securities with assorted maturity dates into a unified, revolving, perpetual fund. Most bond contracts between the government and financial institutions even now contain clauses under which the Treasury, in order to facilitate its refunding operations, may call in the bonds at any time before maturity.
It is but a short step forward to an even more effective device: that of recognizing the public debt as the permanent economic fixture it is by issuing most if not all government bonds as “perpetuities” or “consols.” These are marketable bonds which contain no fixed expiration dates. Instead, they would be subject to unlimited call at the option of the Treasury. In this way, the national debt could speedily be expanded or contracted as over-all economic conditions required.
From now on, the logic of events will probably impel the government to move toward compensatory finance whether it wants to or not. I have pointed out some of the economic advantages that lie in this direction. There remains the vital question of political and social consequences.
Do deficit spending and a large public debt inevitably lead to fascism, as journalist John T. Flynn strenuously maintains? Are they a speedy short-cut to serfdom, as economist Friedrich Hayek more studiously avows? By skillful arguments from German and Italian analogies, both authors present cases which many of their readers have found reasonable and persuasive.
These writers overlook one basic truth. It is the fact that free men can shape social instruments to their own purposes. Democracies can employ some of the economic tools fascist nations have also used, without embracing fascism. Actually, in peace and in war, deficit financing by democratic governments has done infinitely more to prevent and destroy fascism than to establish it.
The real choice America must make is not. between a controlled and a laissez-faire economy. Our choice today is rather between control techniques which involve considerable regimentation and those which do not.
Compensatory spending is a device that offers maximum economic results with a minimum of social upheaval. If used in accordance with the eight principles explained in this article, the resulting public debt, however large, will not be dangerous. The public debt can thus serve us as a vehicle of peaceful, democratic change along the highroad to permanent prosperity.