Learning to Love the National Debt
Devoting the surplus to paying it down could be bad for the economy
Feb 21, 2000, Vol. 5, No. 22 • By DAVID FRUM
IF AMERICANS do things his way, President Clinton vowed in his State of the Union, "We will pay off our national debt for the first time since 1835." This promise is now being treated as an unequivocally good thing. Alan Greenspan has endorsed it. Republican John McCain has adopted the Clinton debt-repayment as his own, down almost to the last comma, while George W. Bush is buying ads in South Carolina to emphasize that he'll devote more than four times as much money to debt repayment as to tax reduction.
Somebody should ask -- So, how'd things go after 1835, the last time the sovereign debt of the United States was retired? The answer is: Not so good. Within two years of the 1835 debt repayment, the country plunged into the worst economic crisis of its first half-century of independence. And while debt repayment was not the sole culprit, it certainly made matters worse. Debt repayment is deflationary; and that is as true today as it was 150 years ago.
As Alexander Hamilton realized when he pointed out that a moderate public debt could be a public blessing, federal obligations function as money. Somebody who has a $ 1 million Treasury bill feels just as rich as somebody with $ 1 million in cash. The bill is virtually as liquid as cash. When the government takes money from people in the form of taxes and then uses those taxes to buy up and extinguish its bills, it is shrinking the money supply just as surely as if it made a bonfire of $ 100 bills on the Mall.
How fast would the money supply shrink? The U.S. public debt now stands at about $ 5.7 trillion. In comparison, the total amount of U.S. currency in circulation is only about $ 500 billion, of which rather less than half is probably held inside the country. In other words, the Clinton administration is now proposing to eliminate the equivalent of the entire currency supply -- and then to eliminate it again next year, and again the year after that, every year for a decade. No wonder the bond markets have been jittery all week.
Defenders of the Clinton plan express hope that this monetary squeeze will reduce interest rates. It very well might. But low interest rates are not an end in themselves: They are valuable because they promote growth. If we achieve low interest rates in a way that depresses growth more than the low interest rates stimulate it, we haven't really achieved anything -- just ask the Japanese, who have been slumping for a decade despite interest rates that are close to zero. The same thing could happen in the United States.
This may sound counterintuitive. Mistrust of public debts and the bankers who finance them is strongly felt. Public-spirited citizens pay large sums of money to erect electronic "debt clocks" on street corners, on traveling flatbed trucks, and now on the Internet, to keep track of the ruin into which they perceive the country slipping, minute by inexorable minute.
But what has always mattered most is not the size of the debt in dollar amounts, but the size of the debt relative to the country's ability to pay. Look at what happened to the World War II debt, for example. In the summer of 1945, the United States was burdened by the most staggering debt in the nation's history: nearly $ 260 billion, which actually exceeded the country's gross domestic product. By the end of 1960, that debt had grown somewhat, to $ 290 billion. But as a percentage of GDP, it had plunged to almost half its level 15 years before.
The alternative method, the one tried in the 1830s, did not work nearly so well. By overtaxing the economy to repay the debt as rapidly as possible, President Andrew Jackson triggered a financial panic, which settled into a prolonged recession. The debt so laboriously discharged in 1835 mushroomed after 1836: By 1843, the United States had amassed a debt nearly as big as the one it had in 1832, when Jackson determined to drive the debt to zero. The experiment was never repeated.
Nor should it be repeated now. Repaying the debt will not do what President Clinton promises (and John McCain imagines) it will. It will not reduce the burden of America's Social Security obligations -- they will remain as large as ever. It will not bolster the country's ability to pay those obligations -- that depends on the speed at which the U.S. economy grows over the next 15 years, which in turn is affected very greatly by the tax rate on productive activity.
Overtaxing Americans to repay the national debt will actually lower the capacity of the United States to honor its commitment to Social Security. How does that make any sense?
David Frum, a contributing editor to THE WEEKLY STANDARD, is the author of a new history of the 1970s, How We Got Here (Basic).