When it comes to managing the U.S. Federal budget, Republicans talk a good game about smaller government, balancing the budget, paying off the deficit, and rescuing the Social Security trust fund. And yet they have never succeeded in realizing those goals.
In fact, only one President in U.S. history has ever succeeded in paying off the national debt: Andrew Jackson. According to that article, the national debt was paid off in 1835 and everyone in Washington celebrated. But a year later the United States was borrowing money again. And we have never stopped borrowing money since.
There are three ways to pay off a national debt:
- Allocate enough tax or other revenue to pay it off
- Default on the obligations (fail or refuse to pay)
- Print enough extra money to pay off all obligations
A History Lesson about the U.S. Debt, Economics, and Finance
So how did Andrew Jackson do what other Presidents before or after him could not? He sold off a lot of government-owned land to generate additional revenue and he vetoed as many spending bills as he could. After six years of stiffing the American public’s land heritage and stifling the government’s infrastructure investments, he paid off all the national debt.
In addition to his voracious appetite for killing debt through national austerity Jackson refused to support a renewal of the charter of the (Second) Bank of the United States. Why did the U.S. need a national bank? Well, it started with all the debt. The 13 states that formed the Union had all accrued large amounts of debt during the War for Independence. The federal government, after some debate, stepped in and assumed all those debts (about $75 million in 1790 dollars).
But how was the United States supposed to pay those debts? There was no income tax at the time and the federal budget was rather small. Worse, there was no national currency at the time. Every state had its own bank that issued its own “bank notes”. Alexander Hamilton proposed the creation of a national bank that would stabilize the economy, generate revenue, and help build the nation’s infrastructure. Congress created the First Bank in 1791 with a 20-year charter. In 1811 the House of Representatives chose not to renew the bank’s charter, so it shut down. In 1816 President James Madison (Dolly Madison’s husband) signed a law establishing the Second Bank of the United States.
Andrew Jackson and his political supporters felt that national banks were unconstitutional. When the time to renew the Second Bank’s 20-year charter approached, Jackson’s political opponents attempted to renew the charter before it had expired. In 1832 Congress passed a bill that Jackson immediately vetoed. There were not enough votes to override his veto. With the issue decided, the Second Bank spent its last four years transferring funds and business to state banks.
With no national debt there was no need for a national bank, so the U.S. government disbursed its surpluses to the various states.
Meanwhile, the various state banks continued to issue their own “bank notes”. All that money fueled speculation in land, which drove up prices. President Jackson decided to fix the problem by requiring that all land sales be completed in gold or silver, which most people did not possess. Jackson’s tight fiscal policies create a 6-year depression that forced the U.S. government to borrow money again, and this time there was no national bank to manage the fiscal process.
Why Does the U.S. Need to Keep Borrowing Money?
Since 1836 the United States has fought many wars, experienced several depressions, and invested in both infrastructure and social programs. Everything from healthcare to education to law enforcement has received money from the federal government for 100 years or more. Historically the United States has always made social investments (socialist policies) and only rarely have anti-Socialists like Jackson had the means to reverse course.
Each crisis, whether economic or military, forced the government to increase spending. And it wasn’t long after Andrew Jackson left office that the United States went to war with itself. The Civil War lasted from 1861 to 1865. Not only did the war force the U.S. government to take on a lot of debt, more than 600,000 men were killed or died from battlefield wounds. Historians estimate that several hundred thousand civilians also died as a result of the war. And the southern states’ infrastructure was nearly completely destroyed, including factories, railroads, and plantations.
The U.S. economy experienced severe, extended deflation from about 1865 to 1895, and there were several recessions during that time frame. The Long Depression (originally called the Great Depression) lasted from 1873 to 1896 (most economists say the depression ended in 1879). The government need to borrow money during these decades to compensate for insufficient revenues. And then the Spanish-American War came along, followed within a generation by the First World War, which was followed ten years later by the Great Depression, which was followed by the Second World War.
Through all those those years, even with revenues raised by income taxes, the government could not pay its bills. Congress authorized the first income tax in 1861 but allowed it to lapse in 1872. Congress passed another income tax law in 1894 but the Supreme Court ruled it unconstitutional in 1895. Only in 1913 did the modern income tax system come into being, and that has never raised sufficient income to pay off the national debt.
How the National Debt Affects Consumers
First and foremost, everyone is required to pay an income tax to subsidize the federal budget. Many states and some cities also levy income taxes. If all our government bodies paid off their debts they could, in theory, reduce the taxes of the average citizens. That is the theory behind “balanced budget” economics. If a government doesn’t operate in the red then it doesn’t need to borrow money and therefore it needs less tax revenue because it’s not paying interest on the debt.
But there are upsides to governments incurring debt. Especially during recessions, governments can put people to work by hiring more employees, issuing contracts for private services, and building new infrastructure – everything from government buildings to dams and schools and highways. When a government needs money, it borrows that money to fund new programs.
But economists also say that government debt – created by selling bonds, bills, or notes – also reduces the money supply. During times of high inflation a government can borrow more money, thus taking it out of the economy. In theory prices should fall, cooling off the inflation.
And yet by the same token, all that government debt competes with private industry for investment capital. Companies may have to pay higher interest on the bonds they sell to raise money to attract investors. That corporate debt may force companies to make hard choices, such as laying off workers or raising prices for their goods and services.
Corporate debt can be good for the economy because it gives companies the leverage they need to build more infrastructure (factories, warehouses, or stores), to buy more equipment and vehicles, and to acquire valuable assets including land, land-use contracts, and even other companies. But when corporate debt becomes too expensive fewer companies turn to that method of raising capital.
The U.S. Treasury Dept adjusts the yield or interest rate on the securities it sells to make them more or less attractive to investors. These interest rates are closely associated with the interest rates that banks charge to consumers and businesses. In fact, the U.S. Federal Reserve Board, which oversees the current national banking system, also mandates minimum interest rates that banks must charge each other for overnight or short-term loans. So if the Treasury and the Federal Reserve both raise interest rates, consumers can be hit hard.
Can the U.S. Government Ever “Default” On Its Debt?
In theory the U.S. government can walk away from its financial obligations at any time. Every year the Treasury must ask Congress for authority to raise more debt to cover the budget deficit. If Congress fails to act there is a chance the Treasury department would miss some interest or repurchase goals. Of course, the government has faced this type of crisis many times. Congress has even passed laws forcing some government agencies to cut back on expenses if no new spending authority is approved.
Investors and economists always speak in terms of “how likely” or “how close” the U.S. government is to defaulting on the national debt. Some smaller foreign governments, such as Venezuela, have indeed defaulted on debt obligations. There is historical precedent for nations refusing to pay their obligations as well, even when they still had the means to do so.
When national governments go into default on sovereign debt they find it difficult to trade with other nations, or to ask other nations for economic help. One of the most severely impacted countries in recent times was Greece. In order to bail out the Greek government and economy, the European Union imposed strict austerity requirements on Greece. The Greek economy went into a long recession because of the austerity measures but other nations contributed enough money, credit, and loan deferments that Greece was able to pull through after several years.
The United States would not be able to turn to other nations for help if it defaulted on its sovereign debt. There is no other nation on Earth that is wealthy enough to help us.
A New Idea Has Emerged
If you have never heard of Modern Monetary Theory don’t be surprised. You’re not alone. But what may surprise you is that MMT (as it’s usually called) has been around for about 100 years. One of the basic tenets of MMT is that the U.S. government could pay off its debt at any time. As that article explains, there is even recent historical precedent for the simple mechanism that would do the job.
The current U.S. debt level is about $21 trillion. In order to pay off that debt instantly the government only need declare that it has $21 trillion more than it did previously. It’s as simple as changing a few numbers in a computer. They did this during the Great Recession of 2008 when the government loaned immense amounts of money to the banking system.
Proponents of MMT argue that as long as newly created money is put to work increasing Gross Domestic Product, you won’t see hyperinflation as happened in countries like post-WWI Germany, post-WWII Hungary, 1990s Zimbabwe, or Venezuela today.
Not every country can benefit from Modern Monetary Theory. The fact that some nations do default on their debts or go into hyperinflation proves that this is not a miracle cure. Instead, advocates say, the country must first issue its sovereign debt in its own currency. If the sovereign debt is issued in some other nation’s currency (and many countries tie their currencies to the U.S. dollar), then they cannot simply “print more money” to get out of debt. They need to raise more money in whatever base currency their economies run on.
Venezuela has been selling off its gold reserves to raise “hard currency” (U.S. dollars) to continue making payments on its debt. But at the same time the country continues to create more Venezuelan Bolivars (their national currency) as millions of people flee the country. The Venezuelan economy has all but come to a standstill. In other words, Venezuela is not increasing production.
Venezuela’s situation proves how dangerous it is for a country to continue borrowing money and printing money at the same time without increasing Gross Domestic Product. The United States is not in any danger of becoming another Venezuela. If push comes to shove, all Congress needs to do is muster the political will and issue enough new money to pay off the national debt. They could do this all at once or over a period of several years. If the creation of new currency for the sake of paying off the debt were tied to growth in Gross Domestic Product, the government should be able to avoid any economic crisis. Also, extending the program over several years would make it easier for the government to measure the success and impact of the measure and, if necessary, cut back or stop creating money for the sake of paying down the debt.
In time, the national debt could be eliminated, possibly for good. Because once there is no more debt the government would still have the option of creating new money. That should be safe to do as long as production continues to grow.
See Also …
U.S. News & World Report: How the National Debt Affects You
CBS News: How Our National Debt Hurts Our Economy