Attention! Deficits Disorder

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“To
contract new debts is not the way to pay old ones.”

~
George Washington, letter, April 7, 1799

If
the history of United States federal budgets – and the debts that
grow out of them – tells us anything, it is this: the dollar’s in
it up to its eyeballs. Today’s level of debt and continuing deficit
spending is only the visible portion of that problem; beneath the
surface we face an unavoidable day of reckoning for our great national
past-time: spending money.

Long
before Lord Keynes opened his mouth in the 30s, the attitude in
Washington, and among academics, has been that we don’t really have
to ever repay debt. It can be carried indefinitely for future generations
to worry about. Most people today would claim that debt “doesn’t
matter” or even that it is a wise policy to spend more than you
bring in. The mind boggles.

Early
on in U.S. history, Americans learned from British ancestors that
empires could be built on a foundation of debt – and continued indefinitely.
In the early part of the 18th century, Sir Robert Walpole introduced
an innovative system for financing Britain’s colonial expansion
and ever-growing military might.

Government,
Walpole demonstrated, is able to create a revenue stream by issuing
bonds and other debt instruments. The interest is paid regularly
and eventually, upon maturity, the face value is paid off – and
for every maturing bond, a new one is issued. This simple means
for the expansion of revenue through debt was the venue by which
Britain built its empire, from the 1720s through the next 100 years.
Among those who observed this phenomenon of “endless debt financing”
was the first Secretary of the Treasury of the United States, Alexander
Hamilton.

In
the early days of the American nation, a host of fiscal problems
faced Hamilton and the other Founders. The War for Independence
left a large debt; there was no unified currency and each state
issued its own money; the currency itself was of dubious value and
inflation made it difficult to imagine how the young nation would
even survive.

Hamilton’s
view was that growth and expansion would be possible with the use
of debt. “Hamilton’s rationale for a perpetual public debt included
his belief that it would help keep up taxes and preserve the collection
apparatus,” writes Scott Trask on the Mises.org site, “He believed
Americans inclined toward laziness and needed to be taxed to prod
them to work harder.”

Not
everyone agreed.

Thomas
Jefferson argued: “It was unjust and unrepublican for one generation
of a nation to encumber the next with the obligation to discharge
the debts of the first. After all, the following generation cannot
have given their consent to decisions made by their fathers, nor
will they have necessarily benefited from the deficit expenditures.”

During
the 19th century, American debt did not grow substantially. When
he began his presidential term, Jefferson had an $83 million debt,
mostly left over from the costs of the war. During his term, Jefferson
reduced the debt to $37 million even after spending $15 million
on the Louisiana Purchase.

In
Madison’s term of office, the ill-fated War of 1812 ran the national
debt up to $127 million by 1816. Monroe and John Quincy Adams were
both able to reduce the debt during their terms of office and by
1829 the debt had fallen to $58 million. And then, during Andrew
Jackson’s presidency, the national debt was entirely paid off. For
the first time in its history (and the last) the United States had
no national debt.

Over
the next decade, the country ran up $46 million in new debt and
by 1848 it rose to $63 million. However, in all fairness, one advantage
of this was that the Mexican War resulted in U.S. expansion all
the way to the Pacific and the acquisition of the entire southwest
and California. Under the Pierce administration, the debt was paid
down to $28 million; but it never got that low again.

The
Civil War exploded the national debt up to $2.8 billion, or 100
times higher than in had been in 1857. Per capita debt in 1860 was
$2 per capita; at the end of 1865, it was $75. The temporary tax
measures in place during the war were repealed and, by the end of
the 19th century, the debt had been reduced to $1.2 billion, less
than half of its 1865 level.

Given
the vast expansion of U.S. territory and the wars the country fought
to create and then hold together the United States, this does not
seem a large debt level. In fact, in its first 110 years of history,
the United States had shown its ability to fund expansion while
reducing debt over time. And this was accomplished without an income
tax. In fact, in 1869 and again in 1895, the Supreme Court ruled
federal income taxes unconstitutional.

The
story was quite different in the 20th century. By the end of World
War I, the national debt had risen to $26 billion. Even though the
debt level had been reduced over the next decade, the Great Depression
caused further deficit spending and FDR’s New Deal tripled debt
levels up to $72 billion.

World
War II created even higher debt levels. By 1945, the country owed
$260 billion – small by today’s standards, but gargantuan in its
time. But one outgrowth of that war was a new one, the Cold War.
Military spending took the national debt up to $930 billion by 1980
and under Reagan’s administration, in rose to a staggering $2.7
trillion. In Clinton’s eight years, the debt tripled to $6.9 trillion.
Estimates as of 2005 are that the debt will reach $10 trillion by
2008.

In
other words, the national debt is growing exponentially. We may
blame the War on Terror, the inheritance of the Cold War, or the
new international market and its competitive forces, or a combination
of these realities. In any event, it is clear that the levels of
debt reach new records, virtually on a month-to-month basis.

We
make a distinction in reviewing all of this history, between debt
levels and deficit spending. Many people are confused about the
differences here and some, even experts, use “debt” and “deficit”
interchangeably.

A
“debt” is the amount of money owed. A “deficit” is the shortfall
in a current budget. For example, if we begin the year with a $6
trillion national debt, and in the following year we spend $1 trillion
more than we bring in, we are running a deficit of $1 trillion.
At the end of the year, that deficit will increase the debt to $7
trillion.

Why
does the government need to spend more than it takes in? After all,
in most of the 19th century there were no income taxes (except during
the Civil War). And the debts the nation incurred were paid down
time and again. Even by 1900, the debt level was manageable…not
so today. And since 1980, the debt has exploded to levels that are
inconceivable.

If
a currency reflects a nation’s economic health, as the quaint classical
economists believed, the current bull run in the dollar is but a
correction in a long-term bear market and an opportunity to sell.

May
18, 2005

Addison
Wiggin [send
him mail
] is the author, with Bill Bonner, of Financial
Reckoning Day: Surviving The Soft Depression of The 21st
Century
. This
article is taken from his soon-to-be released new book, The
Demise of the Dollar…and Why It’s Great for Your Investments
.

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