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George Washington William H Harrison Checks Balances By Robert E. Wright

“Today,” President bond rating and additional upward pres- predicament was the (1993–2001) said on January 6, 1999, “I sure on interest rates. Many (1929–1933, strictly speaking). That massive am proud to announce that we can say believe that more dangerously destabiliz- downturn, and the policies and economic the era of big deficits is over.”1 Clinton’s ing political squabbles over taxes and theories it spawned, shattered the gov- pronouncement was profoundly prema- social programs are forthcoming, with ernment’s longstanding commitment to ture, a fact underscored by the debt ceiling results that no one with a decent respect peacetime balanced budgets and thereby impasse and Treasury bond downgrade of for the intricacies of and econom- laid the foundations for its current budget- 2011. Unless the US economy improves ics dares to predict. ary woes. faster than even the most optimistic econ- How and why did Clinton’s optimism The of the US government’s omist now forecasts, huge federal deficits turn so quickly to such despair? It is management of its budget can be divided will be in America’s future for many years easy for Republicans to blame the poli- into three great epochs, each of which is to come. That means the national debt, cies of (2009–present) and depicted graphically in the accompanying already at almost $15 trillion and 100% of for Democrats to blame those of George figures. During the first, the age- ofsur GDP, will continue to grow, putting more W. Bush (2001–2009) but the ultimate pluses, which lasted from the administra- downward pressure on the government’s cause of the government’s current fiscal& tion of (1789–1797)

A of the often worthless fractional currencies issued by banks, businesses and municipalities in lieu of coin. These notes proliferated during the Panic of 1837 with the emergency suspension of specie (i.e., gold and silver) payments by New banks on May 10, 1837. The artist broadly attacks President Van Buren’s pursuit of predecessor Andrew Jackson’s hard-money policies as the source of the crisis.

20 Financial History | Fall 2011 | www.MoAF.org William McKinley Checks Balances Three Epochs of Federal Budget Management

through that of (1923– Alexander , perhaps the most Van Buren’s presidency (1837–1841). It reg- 1929), the federal government ran large pro-debt policymaker of the first epoch, istered only .80% of GDP and was caused deficits (>2% of GDP) only in wartime and argued that a national debt was a blessing in large part by a 50% reduction in federal paid down the resulting national debt by only if it was not “excessive.” Presidents revenues following a financial panic and consistently running peacetime surpluses. virulently opposed to peacetime deficits, economic contraction. Nevertheless, it cost During the second, the age of transi- including Thomas Jefferson (1801–1809) Van Buren considerable political clout. tion, which began during the adminis- and Andrew Jackson (1829–1837), did Two subsequent deficits, in 1838 and 1840, tration of (1929–1933) everything in their power to run surpluses also hurt Van Buren, who found his fiscal and lasted through that of and were generally successful at doing so. policy difficulties excoriated in political (1969–1974), large deficits were tolerated Thanks to a string of post-War of 1812 sur- cartoons and commentaries. poli- during recessions or, under the influ- pluses interrupted by only three years of tician William C. Rives (1793–1868), for ence of British economist John Maynard small deficits, Jackson was able to retire the example, asked a correspondent if there Keynes (1883–1946) and his followers, national debt entirely at the end of 1834. ever existed “a cooler piece of hypoc- were encouraged in the name of mac- The largest peacetime deficit in real or risy” than a Van Buren speech preaching roeconomic stabilization. The ostensible percent of GDP terms in the first epoch “economy, in the face of the most lav- &goal of those administrations was to bal- took place in 1837, the first year of Martin ish expenditure of the public Treasure by ance the budget across the business cycle rather than across the war- cycle. During the third epoch, the age of defi- cits, which began during the administra- tion of (1974–1977), deficit finance became a structural part of the US economy. To justify persistent, large deficits began to point to the costs of fighting minor wars, establishing or maintaining and stimulat- ing economic growth. Political cartoon criticizing James Buchanan, whose administration The US government ran consistent ran deficits in three years including peacetime surpluses during its first 140 the largest nominal peacetime years because everybody wanted it to. Even deficit prior to 1894.

www.MoAF.org | Fall 2011 | Financial History 21 William Taft Woodrow Herbert Hoover Franklin Roosevelt Harry Truman

himself — to deprecate and denounce a (1841–1845) also ran three small deficits Buchanan’s relative fiscal profligacy played public debt, when he is the only President and also paid for it politically, though “His only a small role in his ouster. who ever created one, in time of peace.”2 Accidency,” as Tyler was dubbed, prob- After the , the federal govern- Nicknamed the “Little Magician” and the ably would not have won re- even ment ran surpluses for almost three con- “Red Fox of Kinderhook” (, his if his administration had run surpluses. secutive decades, even during economic hometown) in recognition of his consider- Another despised one-term President, downturns. By the early 1890s, however, able political prowess, Van Buren was nei- James Buchanan (1857–1861), also ran defi- the surpluses had shrunk from generally ther sly nor magical enough to overcome cits in three years, including, in 1858, the robust ones in the double and triple digits the political burden of having resurrected largest nominal peacetime deficit ($27.5 to just a few million dollars. When revenues the national debt. Although he managed million) prior to 1894. The Panic of 1857 collapsed in the wake of a financial panic, to receive almost 47% of the popular vote was mostly to blame for the large shortfall from $385.8 million in 1893 to $306.3 mil- in 1840, Van Buren handily lost to William because federal revenues fell from $74 mil- lion in 1894, a fairly sizeable deficit of .43% Henry Harrison (1841) in the electoral col- lion in 1856 to just $46.7 million in 1858. of GDP occurred despite a simultaneous lege, 234 to 60. More controversially, Buchanan increased retrenchment in government expenditures After Harrison died just a month expenditures from $69.6 to $74.2 million of some $16 million. Deficits continued to into his term, his successor John Tyler over the same span. Like Tyler, however, dog the second administration of Grover

Epoch I The Age of Surpluses

4 War of 1812 Civil War WW I

2

0

-2

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De cit as a % of GDP -6 Mexican Spanish American American -8 War War

-10 1790 1795 1800 1805 1810 1815 1820 1825 1830 1835 1840 1845 1850 1855 1860 1865 1870 1875 1880 1885 1890 1895 1900 1905 1910 1915 1920 1925 1930

22 Financial History | Fall 2011 | www.MoAF.org Dwight Eisenhower John Lyndon Johnson Richard Nixon Gerald Ford

Cleveland (1885–1889; 1893–1897) and the growth meant that by 1916, the last full year The Depression did happen, however, first three years of the presidency of his before US military involvement in World and has been paying for it ever successor, William McKinley (1897–1901). War I, it stood at a mere 2.47% of GDP, since. The rhetoric of balanced budgets Tellingly, however, McKinley ran a surplus its lowest level since the Civil War. The remained virulent for a long time. Both heading into the 1900 election, which he government ran a large deficit in 1919 due Herbert Hoover (1929–1933) and Franklin won, only to be assassinated the following to engagements entered into before the Roosevelt (1933–1945) repeatedly stated year. war ended in November 1918, but true to that in peacetime the government should With the national debt almost extin- form it enjoyed surpluses averaging .85% at least balance the budget if not run sur- guished in real terms, dropping under of GDP throughout the 1920s. By 1929 the pluses. But the reality was different. After 5% of GDP in 1902, Presidents Theodore national debt stood at only 16.34% of GDP running surpluses in 1929 and 1930, the Roosevelt (1901–1909), William Taft and about $17 billion, down from 32.53% Hoover administration ran slightly into (1909–1913) and (1913– and $25.5 billion a decade earlier. Had the the red in 1931 at .6% of GDP, a 1921) found it politically expedient to run a Great Depression not occurred, the US occurrence during recessions as described few, small peacetime deficits. The national government would have continued run- above. In 1932, however, Hoover busted debt grew slightly in nominal terms during ning surpluses and paying down the debt all previous records with a peacetime defi- their presidencies, but continued economic until World War II. cit of $2.7 billion or 4.66% of a rapidly

Epoch II The Age of Transition

4 WW II War

2

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De cit as a % of GDP -6

-8

-10 1929 1931 1933 1935 1937 1939 1941 1943 1945 1947 1949 1951 1953 1955 1957 1959 1961 1963 1965 1967 1969 1971 1973

www.MoAF.org | Fall 2011 | Financial History 23 George H.W. Bush Bill Clinton Barack Obama

shrinking GDP. A precipitous drop in (4.38% of GDP) one in 1948. Thereafter, But the track record of the Presidents revenues from $3.1 to $1.9 billion was the however, surpluses became smaller and during the second epoch was downright primary culprit, but Hoover in his final less frequent. Wars in Korea and Viet- fiscally conservative compared to that of year also increased government spending nam, other obligations, the the Presidents since Nixon. In only one from $3.6 to almost $4.7 billion. Roosevelt space race, and the continued growth of year during the administrations of Gerald ran deficits every year of his presidency, and New Society entitlement Ford (1974–1977), Jimmy Carter (1977– an average of 3.84% of GDP through 1941. programs stymied all attempts to balance 1981), Ronald Reagan (1981–1989) and By then, federal revenues had rebounded the budget. Dwight Eisenhower (1953–1961) George H. W. Bush (1989–1993) was the to $8.7 billion but expenditures grew even managed it only three years, and the last deficit less than 2% of GDP. Reagan ran more quickly, to $13.6 billion, partly due time only barely. The administrations of the two biggest in real terms, in 1983 and to New Deal programs and partly due to John F. Kennedy (1961–1963) and Lyndon 1985. During his first term in office, Bill military mobilization. Johnson (1963–1969) were in deficit every Clinton (1993–2001) and an increasingly After the war, the US national debt year, though only once, in 1968, at more buoyant economy sliced the deficit from stood at an unprecedented 122% of GDP. than 2% of GDP. Richard Nixon (1969– 3.83% of GDP to just .26%. In his second After demobilization was complete in 1946, 1974) managed only one small surplus, in term, the government ran the only sur- Harry Truman (1945–1953) ran several sur- 1969, but two years later put the govern- pluses of the third epoch. Deficits returned pluses, including an impressive $11.8 billion ment in the red by over 2% of GDP. during both of » continued on page 36

Epoch III The Age of Deficits

4

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De cit as a % of GDP -6

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-10 1975 1977 1979 1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009

24 Financial History | Fall 2011 | www.MoAF.org Checks and Balances continued from page 24

George W. Bush’s terms, however, and Security became the third rail of US poli- and continued high levels of government half of them were over 2% of GDP. Under tics, a program often expanded but only expenditure. So while the effectiveness Obama, government deficits have topped occasionally and marginally retrenched. of Keynesian is hotly debated 10% of GDP, twice those recorded under ’s connection to the Depres- among academics, no President is likely to Reagan and completely unprecedented in sion was less direct but no less real. Dur- move significantly toward a balanced bud- peacetime. ing the Depression, the government disas- get when the economy is on the skids. This Partisans naturally want to blame their sembled the nation’s first health insurance de facto Keynesian policy consensus has political enemies for this stark disintegra- system, which was dominated by low cost precluded serious consideration of alter- tion of federal fiscal discipline, but clearly mutuals and pre-paid medical care pro- native tax regimes. Contingent or standby long-term forces were at play. During viders compensated for curing patients taxes that would kick in when large defi- the third epoch government expenditures rather than just seeing them. In its place, cits loomed were briefly employed -dur grew in nominal terms every year but the government encouraged the creation ing the Reagan administration, but the revenue growth was much more sporadic of a new system based on for-profit insur- 18th-century notion of directly taxes and sometimes negative. Revenue growth ers, employer-provided insurance and a to expenditures in peacetime has largely exceeded expenditure growth in 20 out pay-for-service model. All three innova- been lost and is unlikely to be resuscitated of the last 36 years, but total expenditure tions encouraged continual cost increases as long as policymakers continue to think growth over the period outpaced total to satiate stockholders and healthcare of deficit financing as a key macroeco- revenue growth by some 50%. The cause providers. By the 1960s, many older nomic stabilizer. of chronic deficits was therefore two-fold: Americans found it increasingly difficult So the next time you want to bash your expenditures increased faster than rev- to obtain or pay for healthcare. Rather favorite political enemy over the head, enues on average and revenues were much than try to reduce costs, the government think about blaming the Great Depression more volatile than expenditures. provided retirees with a heavily subsi- instead. Maybe then we can work together Both of those problems can be traced to dized healthcare program that actually to actually end the age of deficits. the Great Depression. Nominal govern- accelerated healthcare cost pressures in ment expenditures have increased every myriad ways. Those costs, which continue Robert E. Wright is the Nef Family Chair year since 1965 because entitlement pro- to rise faster than inflation, combined with of Political Economy at Augustana Col- grams like Social Security and Medicare increases in longevity mean that Medicare, lege and the director of the Thomas Will- grow ever larger due to demographic not Social Security, is currently considered ing Institute for the Study of Financial changes (e.g., an aging population), gen- the nation’s biggest budget buster. Markets, Institutions, and Regulations. eral inflation and runaway medical costs. The variability of government revenues He is also the author of numerous books, Social Security was of course a New Deal is a by-product of Keynesian econom- including most recently Fubarnomics program. Its biggest fault was that it pro- ics, another Depression-era innovation. (2010), and is on the editorial board of vided a permanent solution to a tempo- According to Keynesians, governments Financial History magazine. rary problem, the growth in the number of should increase spending during reces- Sources the aged indigent. Before the Depression, sions in order to stimulate the economy. the elderly were no more likely to live in (Output equals consumption plus busi- Hormats, Robert. The Price of Liberty: Paying poverty than members of any other age ness investment plus government spend- for America’s Wars (New York: Henry Holt, group were. As their wages declined as ing plus net exports. Increases in govern- 2007). they aged, most Americans compensated ment spending, Keynesians claim, can Morgan, Iwan. The Age of Deficits: Presidents by investing in financial (e.g., annuities), offset decreases in the other three, espe- and Unbalanced Budgets from Jimmy Carter real (e.g., rental houses) and familial (e.g., cially investment.) Of course government to George W. Bush (Lawrence: University working children) assets. revenues drop during recessions, so the Press of , 2009). The Depression temporarily depressed increased spending Keynesians call for Wright, Robert E. One Nation Under Debt: all three income streams, leaving many must be financed by borrowing. Although Hamilton, Jefferson, and the History of What retirees destitute. Instead of seeing them few describe themselves as Keynesians, We Owe (New York: McGraw-Hill, 2008). through the crisis and allowing the pri- most postwar US Presidents have increased vate security system to continue to evolve, government spending during recessions. Wright, Robert E. Fubarnomics: A Light- the government instead enacted Social Revenues turned negative during three of hearted, Serious Look at America’s Economic Security, in part to prevent the passage the last four recessions, but expenditures Ills (Buffalo, N.Y.: Prometheus, 2010). of even more radical plans like that of continued to grow and even accelerated Notes Francis Townsend (1867–1960). Forced to during the last two. Roosevelt’s failed save through Social Security, many post- attempt to balance the budget in 1937, 1. http://archives.clintonpresidentialcenter. war Americans allowed the private secu- which according to Keynesians caused that org/?u=010699-speech-by-president-on- rity safety net to wither and thus became year’s recession, was invoked as recently the-surplus-for-fy.htm increasingly reliant on the government to as the Great Contraction of 2008–9 to 2. Emphasis in original as quoted in Wright, provide for their retirement. Soon Social justify various economic stimulus plans One Nation Under Debt, 274.

36 Financial History | Fall 2011 | www.MoAF.org