THAT POST-WAR FEDERAL DEBT WHY IT MUST NOT EXPAND LIMITLESSLY

By John T. Flynn in Harper’s Magazine July 1942

I am NOT saying I agree with this. I just wanted it out there for posterity as much of older economic work is getting harder to find. – Josh

Nine years ago we were introduced to an experiment in recovery which was called pump-priming. The pump to be primed was the capitalist enterprise system. The assumption was that the pump was out of whack and needed a few repairs and the infusion of a few billions to set it working again. By the summer of 1939 we had poured roughly 28 billions into that pump. By this time the notion got round that the pump worked only so long as the priming continued. Certain gentlemen in Washington came to the conclusion that we had on our hands a pump not merely out of repair but wholly inadequate to the demands on it. They decided that we had been treating as a crisis what was a permanent condition. Now they have decided that we need two pumps—the private-industry pump supplemented by a government pump as a permanent institution.

The people who have savings must use them or lend them to others to use to produce goods. The funds thus used are turned into wages, profits, fees, etc. These make up the income of the nation. Before there can be income, therefore, there must be investment. But private investment is no longer adequate to absorb all of the nation’s savings. The government, therefore—so these gentlemen in Washington argue—must become an investor—must borrow what private business cannot borrow. To state the matter differently, after the war we must have a WPA upon a grander scale than ever as a permanent part of what is to be henceforth known as the Dual Consumption System.

This is a brief outline of the basic principle of this new order. This must not be confused with certain hurried programs of public works to cushion the shift from a war to a peacetime economy. It means a program of government borrowing and spending—and hence of debt—upon a colossal and continuing scale. Government debt is to be used as an instrument for controlling the national economy. The proposal runs counter to all those “strict maxims” of public credit of which Hamilton spoke. Hence the proponents of this new dual system assure us that these ancient maxims are the children of ignorance and superstition. “It seems not unlikely,” says Mr. Rexford Tugwell, “that less than a generation will be required to kill such a fetish as that of an annually balanced budget.”

This program is destined to take form as the most discussed subject in our midst when the war ends. It may well become the major measure of some political party. It is being put forward now by a group of men of the highest political influence in Washington. It is well to stress the fact that this plan is offered to support the economic life of the nation when the war ends. Nothing said here, therefore, has any reference to the fiscal problems of the war. Obviously the war must be supported even at the cost of dislocating the economic life of the country. However, since the public credit is to become the central instrument for making our economic system work when the war is over, it is essential that we have a clear idea of what the public credit will be at that point.

The President has warned that victory will require at least two or three years. Others have made less roseate estimates. Let us accept, however, the more favorable view. The government has committed itself thus far to an expenditure of 162 billion dollars. It has, however, given notice of its intention to ask for another 35 billions. Here is a sum already very close to 200 billions. We have spent to date 20 billions of this, leaving 180 billions to be laid out. The national debt as I write is 76 billions. Up to the present we have paid with taxes for only one-fourth of what we have spent on the war. If we pay with taxes for a third of what is to be spent in the next two years we must raise 60 billions that way for war alone. I see no evidence that anyone contemplates that. But if we borrow only two-thirds of the presently contemplated sums we shall add another 120 billions to the debt—making a total of 196 billions. If the war should end by the summer of 1944—in two years—there is no reason to suppose that expenditures would stop. The heaviest spendings in World War I were made in 1919, the year following the war. It is, therefore, I submit, a fair estimate that we shall have a total debt of 200 billions if the war should last only two years. This is based on the supposition that prices will not rise, which no sane man can admit. What the debt will be if the war lasts three years or more no one can predict.

We have to keep in mind, therefore, that, as we embark on a program of recovery through public borrowing, we must begin at a point where the national debt will be already at least 200 billion. As we set about whipping depression in the future we must do so, under the plan we are discussing, by piling more debts on top of those contracted to whip the wars and depressions of the past.

This debt will require interest. The average rate on our interest-bearing bonds now is 2.518 per cent. We must be optimists indeed if we suppose that if we owe 200 billions when the war ends we can still borrow money at that rate. We must look forward, therefore, to an annual interest bill of from five to six billion dollars as we begin the new dual system of making the capitalist system work by means of public debt.

I have said that this more or less officially sponsored program of abundance through public debt contemplates continuous borrowing and spending and a limitless rise in the public debt. In some of the popular presentations of this theory this aspect of the matter is purposely obscured. At least the impression is created that debt is rather to be used as a regulator—that in times of boom government debt will be reduced, while in times of depression the debt will be increased. It is fair to say, however, that the champions of this program do realize the nature of the plan they present in sugar-coated form for popular consumption. They admit that the plan involves continuous federal debt-making over long periods. “The notion,” says one of them, “that government spending can be resorted to only as a temporary emergency device must be abandoned. A program must be developed which recognizes the necessity for permanent public investment.” At another point the same writer says: “We advocate a long-term program of government investment financed through borrowing of savings which would otherwise go to waste.” Dr. Alvin H. Hansen, of Harvard and the Federal Reserve Board, the foremost apostle of this theory, says quite frankly that there is little likelihood “of ever seeing the federal budget balanced for any considerable period.”

Along with this goes the twin proposition that government debts need never be paid. Most people, we are told, “take it for granted that a government debt, though internally held, is essentially like a personal or business debt and that, in just the same manner, it must be repaid. This is erroneous.” In fact the notion of paying government debts is called an “outworn superstition.”

As a matter of fact the theory at the very base of this program necessarily excludes the idea of either a reduction in the public debt or a halt in its rise. That theory asserts that the present system of private enterprise, for reasons carefully set out, can no longer absorb the savings of the community or produce adequate purchasing power. Therefore we must have what they call a dual system in which the government will become a permanent borrower and spender in order to make up the deficiency in national income produced by private business. The need for this grows out of a flaw inherent in the present system that cannot be corrected, but that must be overcome by the government’s collaboration in the function of producing income or purchasing power. What we have to look forward to, therefore, is this: that when the war ends and we have a debt of 200 billions and an annual interest charge of five or six billion dollars, we shall embark upon a long-range program of borrowing and spending; for continuous deficits and for a great rise in the public debt.

And so we are bound to ask—at what point will the limit to this debt be reached? Dr. Hansen admits that there is a limit. There must be, he says, a reasonable ratio between national income and debt. If, therefore, we continue to borrow we shall arrive at a level where the debt will be quite out of proportion to the national income. At that point, surely prudent men will say that borrowing must cease. But this will not be possible. We shall still have the same free enterprise system, still incapable of producing adequate purchasing power. This being so, there will be no course open to the government save to borrow once again and still again or face a collapse. With each successive deficit the ratio between national income and debt will be still further distorted. At what point, then, will the spenders step forward and cry “Hold! Enough!”? When the debt is five hundred billions? A thousand billions? But why ask? It makes no difference how high the debt goes, it must ever go higher. The choice will always be—borrow or be damned. There is in fact no point at which we can stop.

The size of the public debt is not a matter of concern to the social reformers of this school because they insist that a public debt is not a burden upon the people. The burden, if any, they explain, is the annual interest charge. But this is no burden because the government collects it from the people in the form of taxes and pays it back to the people in the form of interest on its bonds. There is of course no doubt that the funds to pay the interest are drawn from the people’s pockets. But certainly the interest payments do not go back into the same pockets. The notion that the people as a whole, either directly or indirectly, hold the government’s bonds is without any basis in fact. It is not possible in a brief space to examine this subject here. A mere facet of it, however, may illustrate the point. Practically one-half of all the direct obligations of the government is owned by commercial banks and the Federal Reserve banks. It is true that investments of commercial banks are made with funds belonging to depositors. But the investments do not belong to the depositors though they represent a security for the deposit; and the interest payments on them do not go to depositors. They go to the bank corporation which belongs to the stockholders. And there are about 700,000 bank stockholders in the country—or were in 1933. The government must each year take enough money in taxes from the population to pay interest to commercial banks and Reserve banks (which belong to the commercial banks) on one-half the direct obligations of the United States government.

Great numbers of people have an interest in the interest payments made to insurance companies and savings banks, but first of all these hold only about 18 per cent of government paper and there are other factors involved in these investments which affect this whole question. And moreover there are tens of millions of people who have no interest in either insurance or savings bank security holdings, however widespread these may be.

The mistake arises out of assuming that the national income finds its way into a vast reservoir from which the government ladles out taxes, pouring them back again into the same reservoir. The national income flows in greatly differing quantities into innumerable containers of differing sizes. The government takes amounts of taxes out of all these containers and pours them back again in the form of interest into some of the containers and in amounts quite different from those which were extracted.

III

We now come close to the heart of this problem. The point is made that the public debt wisely managed can never become a burden. It will be no burden to pay since it will never be paid. It will be no burden to pay the interest because a flood of a billion of borrowed funds will create several billions in national income. Certainly, therefore, we are told, it will be no hardship on the nation to pay out of that, let us say, 30 million dollars in taxes for interest.

To see clearly all of the implications of this argument it is necessary that we pause long enough to have a quick glance at the career of a government dollar in the field of income. Let us assume that the government borrows a dollar to create income and pays that dollar to a workman on a project. The workman, in spending the dollar, starts it on its way to be used in buying goods and services, in paying debts. As that dollar passes from hand to hand it creates additional income at each move, but also a little of it is saved here and there; here one person saves a few cents of the dollar while he has it, there someone else does. Finally enough cents have been saved along the line to add up to one dollar; all the little driblets of savings out of the dollar are sufficient to make a dollar that has dropped into the pool of savings. Presumably the only way for this dollar to get out of the pool will be for the government to borrow it again, or for someone to loan it to a private business or invest it in a private business, and thus put it to producing income again.

Estimates vary as to how many moves such a dollar makes before it has entirely disappeared into savings. A high estimate is that it goes through from ten to twenty moves and takes from two to four years to do it and that in the process it creates from $2 to $5 income. That seems a very high estimate, but for the sake of clarification let us accept it and assume that such a dollar will create $2 of income the first year, $1.50 the second, $1.00 the third and 50 cents the fourth, and nothing the fifth year, or a total of $5 in five years. Of course the progress of the dollar back into savings does not follow so tidy a pattern but a change in the figures would not alter the principle we can now observe.

Now let us assume the government decides to borrow and spend a dollar a year for five years. The dollar spent the first year creates two dollars of income under our assumption, and by the fifth year it has completely ceased to produce any such effect. The dollar spent the second year will create two dollars’ income in that year, plus a $1.50 of income created by the first dollar, but by the sixth year the second dollar will have reached the end of its income-producing ability. This will be the life history of each new dollar spent in each succeeding year. Therefore it is necessary, if the government is to get any results out of this policy, that it continue these infusions each year.

The following table illustrates what will happen over a period of six years, on the assumption that in the sixth year the spending is stopped:

Thus we see that although a new income dollar each year is poured into the economic system, there comes a time—the fifth year under the assumption we have made—when there is no longer any increase in income; when, in fact, the income levels off despite the fact that this new dollar is imported into the economic stream each year; when, to put it differently, it is necessary to continue each year the government dollar, not to increase income, but to keep it at the level attained. For we can see in the table above that if spending is stopped in the sixth year the income produced will fall to only $3, and with each succeeding year will be further decreased until it is back at the point at which it started.

Thus we can conclude that, once government spending is adopted as a means of infusing income into the national stream of purchasing power, such infusions must be repeated each year on the same scale, but after a given number of years the income levels off unless the government contributions are increased. And if they are ended or decreased the general level of income will gradually shrink to the point at which the experiment began. Of course this economic force of government borrowing and spending, as it makes its way through the economic organism, is complicated in its impacts and cannot be described in figures representing so simple and equal a rhythm as those used here. But whatever figures we use, the difference will be in the number of moves of the spent dollar, the amount of income it produces, and the number of fractions into which it splits as it journeys on; not in the essential principles depicted here.

The soundness of these views is supported by our own recent experiment in spending. Below I give a table showing the increase or decrease in national income for the years indicated and the increase or decrease in the national debt:

Up to 1932 national income had been shrinking progressively and disastrously as private investment dried up. In 1932 President Hoover began some spending and in 1933 President Roosevelt increased it and launched a spending program. In 1933 the decline in income was checked. In 1934 national income rose. It increased each year to 1938 as national spending continued. However, several facts are obvious from these figures. One is that in only one year did national income rise twice the amount of the debt incurred. Second, the rise in income continued as long as the increase in spending continued. In 1937 spending of borrowed funds was tapered off and in 1938 was practically ended. Instantly the national income dropped in 1938 by over five billions. The program had to be resumed the next year. And after this event all notion of any abandonment of borrowing and spending departed from Washington. It was at that moment that the theory of the permanent deficit was born.

It is necessary to observe that no accurate deductions on the relationship between debt and income can be drawn from this experience. It was directed by men who understood literally nothing of the economic theories at its base, and its effect was diluted and confused by the objects upon which the money was spent as well as by some of the counter-irritant tax policies. But the experience does serve to illustrate certain general aspects of the problem as set out here.

With all this in mind we can see the fallacy of the argument that, because the new debt creates a great flood of national income from which the interest can be extracted painlessly, the interest charge creates no burden. We can see clearly enough that, while the debt produces a flow of income for a few years, the interest charge remains literally forever. Moreover, each year as we pile on more debt we pile on more interest. And, as each year we continue the debt increase, there comes a time when these increases will not further increase the national income unless we step up the debt increases. The income benefit is temporary; the interest burden is enduring and cumulative. The 16 billion dollars of the First World War debt created great streams of income. But those streams have vanished. The interest remains with us. The 28 billions of depression debt up to 1939 produced a heavy flow of income. But it has all disappeared—while the interest charge lingers on. The imperious demands of war drive us to another 150 billions of debt—billions which will enrich the income stream for a few years and then cease to flow. But the interest will be perpetual.

When the war ends the interest charge will be around five billions. This is more than we have ever collected in any one year in income taxes in all our history until this year. To say that such a volume of taxes collected for interest alone would not be a burden to government and nation alike is to adopt blindness as a defense against facts.

It is a fact that the champions of this debt school contemplate government deficits of ten billions a year when the war ends as a permanent program. This, indeed, is one of the lower estimates. As we begin we shall have an interest load from the past half as big as the borrowing program. Such a tax would be deflationary. The authors of this plan tell us that reducing the debt in the rare event of a runaway boom would be deflationary, since it would take by taxes portions of the national income. For the same reason interest payments of five billions a year would be as deflationary as debt reductions of that amount. We should find ourselves in the contradictory position of collecting deflationary taxes of five billions at the very moment that we must make loans of ten billions to expand the income. If we borrow ten billions a year for ten years we shall have a public debt of 300 billions and an interest charge of seven to nine billions. The prospect is terrifying.

There is no doubt that there must be a continuous flow of credit into the capitalist system. Proponents of the government debt school make the mistake of saying that there must be a continual expansion of debt, which is quite a different thing. Debt is the consequence of credit. As debt expands—public or private—the depressive burden on the system increases. However, it is possible to have a continuous flow of credit, which means a continuous lending of money. If this is a flow of private credit to private borrowers a considerable percentage of the debt thus created can be wiped out each year through defaults and losses without crippling the system. In fact these losses are essential to the system. But unfortunately government debt cannot be wiped out in this way. It must be paid or hang on forever until the situation becomes so bad and destructive of the whole economy that the government is forced to resort to the violent process of either inflation or repudiation.

In 1929 the total net public and private debt in the United States was 172 billion dollars, after a century and a half of development. We now face a condition where the government debt alone will presently be greater than all the public and private debts of the nation at the highest period of its prosperity—and this sum will be utterly incapable of being paid or extinguished by default.

IV

However, when these gentlemen insist that debt will be no burden for the various reasons examined here they mistake the whole nature of the form and incidence of debt as a government burden. It is a misconception to think of debt as a burden merely on the nation as such—something due by the nation to the nation. This overlooks completely the interposition of the government between the citizen taxpayers and the citizen bondholders. The load of the debt rests primarily on the government. And the government is not the nation. The government is an organism, a recognizable entity set up by the people to perform certain public functions. Our federal government is only one such corporate entity. The government has no funds with which to meet its interest obligations. It must extract such sums from the people. But its power to extract those sums is limited in a very real manner. The powers of government return in a sense every two years to the people. They can refuse to elect representatives who continue to squeeze interest taxes out of them. The power to borrow is not unlimited. The lenders can refuse to lend. This is not a totalitarian government. It cannot coerce, save under war powers, either taxpayers or lenders; because if it attempts coercion beyond the public endurance the public can oust the government. Thus a huge debt involving immense interest charges can affect gravely the vitality of all the energies of government, impairing and even paralyzing them. The debt itself can and inevitably will become a problem surpassing in gravity the problems it was invoked to cure.

At the basis of this theory is the assumption that it is a plan to save the system of private enterprise, but that private enterprise needs a partner—a collaborator in producing purchasing power with which the public can buy the consumer goods which private enterprise produces. It will develop into what they call a “dual system” with a private-enterprise sector and a public sector. The private-enterprise sector will produce practically all the goods the nation demands. And it will produce from 75 to 80 per cent of the purchasing power. The government will merely produce whatever additional purchasing power is essential to make buyers for the products of industry. This is a dangerously alluring program. But we must keep in mind that the private sector is supposed to be the biggest producer of income—the bigger income pump of the two. Of course there is no doubt that setting the government pump to work will produce income. But this additional government-created purchasing power will be of no avail if, in producing it, we succeed in crippling the private—and bigger—pump; if we actually curtail the production of income by the more important of the two sectors. Yet that is precisely what this plan will do. It would be impossible to devise a program better adapted to the systematic undermining of the private-enterprise system and the hastening of the final catastrophe than this one.

Much is said of the ease with which the nation, having created a billion or ten of income, can dip into that flood and remove any amount of it by means of taxes. But the incidence of taxes is a very serious matter in a private-enterprise economy. In such an economy all production depends on continuous investment in production equipment. And this investment will not occur unless it is profitable. Of course in a form of investment that involves very little risk a small profit will suffice. But such investment can be obtained only in established corporations, with a long history of wise and profitable management. Investment in new industries cannot be had unless the return is large enough to compensate for the risk involved.

If this dualist plan is adopted, in a very short time this nation will be confronted with a tax bill for interest alone so great that every man must hand over a considerable fraction of all he earns to the government. Take the man with a $20,000 income. Let us suppose he has accumulated $10,000 to build a house or a small plant. The interest at 6 per cent will give him $600. His income is already $20,000. The tax rate on that additional $600 will be 45 per cent—based on this year’s figures. Hence $270 would be extracted from the $600 by his partner, Uncle Sam, leaving him only $330. The man who would lend money on a mortgage at 3.3 per cent return to himself would be a fool. Even the benevolent Uncle Sam will not do that. If this investor is in the $50,000-a-year income class the tax rate will be higher—the tax will be $366 and his own share will be $234. A $10,000-a-year man would do a little better but not enough to entice him into such loans. More risky enterprises would be literally stopped forever by private individuals. Adopt this system and we shall never see another dollar loaned on mortgages by private individuals. And as mortgage money is the very base of the whole construction industry—the largest sector of investment—that industry would fold up. To keep it going the government would have to take it over. Sooner or later the government would have to take over one sector of investment after another as it withered away under the debilitating effect of this dual system. The private-enterprise pump would grow smaller and smaller; the government pump would grow larger and larger. The system which this plan is offered to save would die at first a little slowly, but finally with a resounding crash. That is all right if the object be to put an end to the capitalist system. It is not all right if the prescription is sold as a means of saving that system.

V

The gravely disquieting nature of this program, in the presence of dollar figures upon a scale so vast as to defy comprehension, has induced the proponents of the plan to seek support in some authority which even the most conservative critic might respect. They have therefore gone to the very holy-of-holies of conservatism and invoked the imprimatur of no less a saint of sound finance than Alexander Hamilton. The great Treasury minister, we are told, did not fear “the growth of what for his day was a huge public debt.” He urged, we are reminded, “a vigorous use of the public credit within appropriate limits, not merely for government ends, but also to achieve certain economic objects.” Indeed the statement has been made that Hamilton said that “a public debt is a public blessing.”

To finance the Revolution the central government borrowed from citizens and foreign governments. The States also incurred large debts. When the new government was formed under the Constitution Hamilton fought for the assumption of the revolutionary debt of the revolutionary government and the assumption of the debts which the States had made for the same purpose. The only formidable opposition to these proposals was encountered by the plan to have the federal government take over the pre-Constitution State war debts. Hamilton favored this because, as the holders of the bonds would look to the federal government for payment, they would have a strong financial interest in supporting the central government. Assumption and funding of the central government’s war debt was a matter of honor. Hamilton was dealing with a problem very different from that which we are considering to-day. He was fighting to fund honor debts already contracted. The Debtists to-day are proposing a long-range program of fresh borrowing while insisting that debts once contracted need never be paid or reduced.

In his first report to the House in January, 1790, after outlining his funding plans, Hamilton said: “It will be the truest policy in the United States to give all possible energy to public credit, by a firm adhesion to its strictest maxims, and yet to avoid the ills of excessive employment of it, by true economy in the public expenditures, by steadily cultivating peace, and by sincere, efficient, and persevering endeavors to diminish present debts, prevent accumulation of new, and encourage the discharge within a reasonable period of such as it may be a matter of necessity to contract.” It is interesting to find him adding to this sentence the admonition that “it will be wise to foster private credit by an exemplary observance of the principles of public credit.” On another occasion he said that “a funding of the public debt is a blessing,” adding that “it is a quite different thing from maintaining as a general proposition that a public debt is a public blessing.”

Conjuring the ghost of Hamilton to support the orgiastic fiscal policy involved in these proposals is, to say the least, surprising in a school of thought that seems to look with disdain upon what is scornfully referred to as “sound finance.” The balanced budget has come to symbolize the Tory mind. To scoff at it gives to a certain type of social reformer a feeling of superiority over the bourgeois soul of the business man who holds to the Main Street superstition of paying bills.

Certainly a powerful argument can be made against the capitalist system of society. It has beyond doubt grave flaws. It is a human institution. And these flaws must be corrected or the system itself must be junked. I can follow the logic of the man who says it is too full of flaws and ought to be ended. But I cannot understand the men who denounce it as uncivilized, say it is unworkable, and then offer a collection of remedies to cure it which are designed not to save but to kill the patient. I do not defend capitalism. I do not know whether it can be saved or not. I wonder if the capitalist groups most interested in its perpetuation will ever permit it to be saved. But if it is to be saved the remedies must be designed to work in accordance with the genius of the system of private ownership. In that system the central idea is private ownership working for private profit. The dynamic element in it is private investment. Private investment is now stalled and has been since 1933. I do not believe that it is impossible to revive the capitalist system and make it work far better than it has ever worked before, though I do not think it can be made to produce “abundance” for everyone—nor do I think any other system now known will do this. But the central element in the system which must be repaired and set to operating again is private investment. A group of reforms is conceivable that will do this. But the one thing that can be counted on, not only not to do this, but to kill off private investment finally, is the proposal to invoke the dangerous and destructive device of government borrowing upon a limitless and continuous scale.