Debt Derangement Syndrome: Saving Our Grandkids from Wall Street

By William K. Black
October 24, 2016     Quito, Ecuador

Pete Peterson is back, and his message and rhetoric are always the same.  The federal budget deficit is a disaster and – any day now – will produce massive inflation.  Peterson has written his 20,000th version of this fantasy in the NYT with Paul Volcker.  The first rhetorical game that Peterson plays is to assert that it is bad for a sovereign nation to run budgetary deficits because they are not “sound and sustainable.”  Except that the U.S. has run deficits for most of its existence without ever suffering hyper-inflation.  For a nation like the U.S. with a sovereign currency, a federal budgetary deficit is not unsound and it is not unsustainable.  Federal budget deficits can, depending on the circumstances, be the very definition of “sound” fiscal policy – a policy that is often essential for “sustainable” recovery and growth of the economy.

Peterson asserts that his latest warning of fiscal disaster might, for the first time in his career be correct.  Peterson claims that this time his warnings are real because the “widely respected” Congressional Budget Office (CBO) says its model predicts a growing deficit.  The CBO is not “widely respected” by economists.  It uses macroeconomic models that produce nonsense results.  Economists know that the CBO models cannot predict reality because they were constructed out of ideological nostrums that have repeatedly been proven false by reality.  The CBO has gotten credit in the past from Democrats because it declined to use even more flawed “dynamic scoring” models favored by many Republicans that falsely predict that tax cuts lead to magical, spectacular growth.

The ultra-right-wing Republicans that control Congress chose an ultra-right-wing fanatic to run the CBO who has a track record of being spectacularly wrong.  He is the opposite of “widely respected.”  Even before his appointment, the CBO functioned as a barrier to the vigorous stimulus policies that we have known for over a half-century to be essential to respond to a Great Recession.  The result was a much slower and weaker recovery.

The financial markets price the risk of Peterson’s repeatedly promised, imminent hyper-inflation.  They price that purported risk as essentially zero.  Japan is praying for exceptionally low inflation (it suffers from deflation) despite budget deficits roughly three times larger than Peterson is warning about.

The Grandchild Guilt Gambit (G3)

Peterson knows he cannot win the economic argument because he is zero for 20,000 in his predictions of hyper-inflation in the United States.  Instead, his second rhetorical game is to infuse parents with guilt about the fate of our grandchildren.  Here is one problem with the G3 – and it comes from Peterson’s own attempt to induce grandkid guilt.  Peterson warns that:

[T]he national debt [will be] about 75 percent of the gross domestic product, a ratio not seen since 1950, after the budget ballooned during World War II.

Why Peterson Does Not Discuss the Great Depression or World War II Deficits

The reasons why Peterson did not analyze either the Great Depression or World War II deficits is that studying either would destroy his G3 myth.  The grandkids of the economists and bankers who advised running budget surpluses during the Great Depression had their lives brutally diminished by that economic malpractice.  Further, they did not escape budget deficits because attempts to run a budget surplus made the Great Depression far worse and added to the deficit.

Peterson did not discuss the World War II deficits because they falsify his arguments to an even greater extent.  The U.S. ran very high, in historical terms, budget deficits in World War II.  Further, inflation was likely to be more of a problem than in peacetime because critical real resources (labor and material) were in fact desperately short to support the unbelievable production levels of material for the war effort.  Women played a vital role in this success, reducing greatly what would have been devastating bottlenecks.  FDR’s generation of officials chose to run massive deficits in order to fight and win World War II.  It was the grandkids of FDR’s generation who fought World War II.  A journalist famously labeled them our Greatest Generation.

Should we have surrendered to Germany and Japan instead, rather than face the terrible fate of nations that run budget deficits?  Would surrender have been preferable for our grandkids?  Did those budget deficits in the 1940s and 1950s crush our economic growth in those years?  The result of the war time expenditures was such a sharp increase in demand due to vastly increased government spending that the economy quickly recovered and operated at levels far above what conventional economists would have considered “full employment” without generating harmful levels of inflation.

But even more importantly, the deficits were essential to win the war against the Axis.  That was superb for the grandkids.

To help win the war, the U.S. adopted price controls – and put John Kenneth Galbraith in charge – the ultimate nightmare of neoclassical economic ideologues.  What they will never forgive Galbraith for was his contribution to the success of the war effort through a program that was anathema to their dogmas.  More generally, planning proved essential and effective in developing the arsenal of democracy and in operations such as D-Day, causing von Mises and von Hayek to gnash their teeth.  The Soviet Union was able, with substantial aid from the U.S., but overwhelmingly from its own troops and resources, to develop what many consider the world’s best main battle tank (the T34) and to inflict the decisive losses on the Nazis.

During the few years where FDR actually adopted significant stimulus the economy recovered rapidly from the Great Depression.  Government programs brought hope and jobs to millions of Americans, reduced malnutrition, and developed tens of thousands of public gems we continue to enjoy 80 years later.

After the war, President Truman created the Marshall Program that was critical to the economic and democratic revival of much of Europe.  A Republican President, Eisenhower, led the U.S. to fund a stupendous infrastructure program, the interstate highway system, that transformed the Nation.  The GI bill began the process of making university educations for their children the normal aspiration of middle class parents for the first time in our history.  Scientists at U.S. universities, many of them immigrants, dominated the Nobel Prizes in science and medicine.

Instead of harming their grandkids, the huge budget deficits devised by their grandads and great-great-grandads during World War II were critical to their grandkids’ lives and accomplishments.

  • The grandkids were harmed when Hoover and FDR tried to run budget surpluses and instead made the Great Recession far more severe and led to unintentional deficits.
  • The grandkids’ lives were helped immeasurably when FDR deliberately ran budget deficits and provided social programs during the Great Depression.
  • The grandkids’ lives were helped immeasurably when the deficit spending during World War II rocketed the economy to full recovery from the Great Depression.
  • The grandkids’ lives (and the lives of hundreds of millions of people globally) were helped immeasurably because we spent vast amounts of money to defeat the Axis powers. Had the Axis forces won the results would have been horrific.  Yes, it was the sacrifice of blood by the grandkids that made this possible, but they could not have gone to Europe and Asia to shed their blood without the U.S. government providing the financing.
  • Hundreds of thousands of the grandkids’ lives and limbs were saved during the war because the U.S. funded such vast amounts of men, material (much of it given to Allies), and intelligence. Without that vast funding of resources our service members would have gone into battle in situations where they would have lost or prevailed only through catastrophic levels of injury and death.

Peterson ignores the brilliant successes made possible by the large federal budget deficits during World War II because they would falsify his G3 myth by proving the opposite.

A Brief Historical Note on Federal Deficits in the 1930s-1950s

As Brad DeLong explained in his 1998 article on fiscal policy in the shadow of the Great Depression, the Hoover and Roosevelt administrations sought to run “balanced budgets” in response to the Great Depression, but a severe depression dramatically reduces tax revenues and produces involuntary budget deficits.  FDR went through three stages on his approach to fiscal policy as I explain briefly below.

DeLong was writing during a period when he was hostile to government deficits, so his article is congenial to Peterson at a number of points.  DeLong explains that President Hoover heaped scorn on his own economic team as a group of do-nothings who thought the Great Depression was a healing storm that would “liquidate” economic poisons such as unions.  Hoover’s economic advisors told him not to act.  Hoover believed that it was vital for him to act to combat the Great Depression – by trying to run a budget surplus!  Hoover asked Congress to approve a raft of new taxes.  Hoover’s economic malpractice was a double failure – it deepened the Great Depression and failed to even come close to balancing the budget.  Hoover was enraged that the Federal Reserve refused to deliberately produce serious deflation.  Had the Fed done so, it would have materially worsened the Great Depression.

FDR was, by instinct, a great believer in austerity.  He campaigned against Hoover’s “failure” to balance the budget.  FDR’s early efforts to balance the budget were doomed for the same reason that Hoover’s efforts were doomed.  Eventually, as DeLong put it, the Roosevelt administration decided to make a virtue out of necessity and stress the benefits of government spending to the recovery.

Once FDR embraced fiscal stimulus the recovery from the Great Depression became robust.  Unfortunately, Treasury Secretary Morgenthau, who detested budget deficits, convinced FDR to reverse course and inflict austerity in 1937.  Austerity did not balance the budget because it crushed the recovery and hurled the economy back into an acute phase of the Great Depression.

The economists’ malpractice in the 1930s did not simply fail to protect the grandkids – it brought economic terror to the parents, kids, and grandkids.  G3 has always been cynical propaganda that produces disastrous austerity policies whose principal victims are our kids and grandkids.

Indeed, it was the malpractice of austerity that helped produce World War II by bankrupting Germany and discrediting its democratic leaders.  John Maynard Keynes famously warned that such economic malpractice would lead to economic ruin and enrage the German people.  The grandkids of those European leaders who inflicted ruin on Germany were the ones who died by the tens of millions in World War II.  It is common for those who share Peterson’s dogmas that purport to be protecting our grandchildren to be the ones savaging our grandchildren.  Peterson is another in a long line of pretended protectors of our grandkids who actually advance economically illiterate policies that prey on our grandkids.

When Should We Run a Budget Surplus?

There are times when we should run a budget surplus, but they are unusual times for an economy like the U.S. with a sovereign currency that is very likely to continue to run substantial balance of trade deficits.  We could achieve an economy running so “hot” that many millions of Americans who dropped out of the labor force reentered and employers were looking so aggressively for scarce workers or scarce resources such as rare minerals that prices for such workers and rare minerals rose sharply.  Alternatively, demand could so outpace supply that the general price level rose sharply and produced harmful levels of inflation.  Running a budget surplus could be an excellent idea shortly before either condition arose.  None of those conditions is true in the U.S. today as we can see every day by observing the data for inflation, federal interest rates, and labor force participation rates.

The circumstances in which a Nation like the U.S. that has a sovereign currency, borrows solely in that currency, and allows the value of its currency to freely “float” needs to “balance” a budget or run a budget surplus are historically rare.  As we have seen from the horrific errors of the 1930s under Presidents Hoover and Roosevelt, the grotesque pattern of economic malpractice in the eurozone of inflicting austerity in response to a Great Recession, and the slowing U.S. recovery once Obama and the Republicans began to inflict austerity, it is critical for everyone’s welfare, particularly our kids and grandkids, not to inflict austerity except when it is really needed.

Even extremely conservative central bankers now admit that modest inflation is desirable.  The U.S. and the eurozone have failed to provide sufficient demand to achieve even the Fed and ECB’s modest inflation targets.  Moderate inflation, in nations with functional governments, does not lead to hyper-inflation.  Moderate inflation does not cause significant harm to an economy.  We should have been so lucky to have experienced moderate inflation in the last ten years, it would have meant a superior economic environment.  But the same is not true of disinflation (negative inflation rates).  Even modest deflation poses a material, albeit far from inevitable, risk of pushing an economy into a long-term recession or locking it into a long period of weak growth.

Economists now broadly recognize that the problems of disinflation versus inflation are not symmetrical and it is essential to adopt macroeconomic approaches that put far greater weight on avoiding modest disinflation than modest inflation.  This means we can and should err on the side of not inflicting austerity for the purpose of preventing inflation that has not even become modest.

This also means that the third major rhetorical gambit that Peterson launched is false. Peterson claims it is an “immutable” fact that delaying inflicting austerity always makes life “more painful and difficult.”

Delaying action now will make the needed changes only more painful and difficult later on, while also increasing the risk of financial crisis before the reforms are even made.

Austerity, when inflation is already too low, when many millions have dropped out of the labor markets, when there are no real resource constraints to stimulus, and interest rates are often negative is a dogmatic act of economic malpractice.  The deficit was brought down too far and too fast by President Obama and the Republicans’ embrace of austerity, slowing the recovery.  Peterson’s proposal to inflict still more damaging austerity on our kids and grandkids poses a serious risk of forcing our economy into recession.

Delaying running a balanced federal budget or a fiscal surplus has long proven to be desirable in U.S. history.  Trying to run budget surpluses is highly associated throughout U.S. history with producing economic crises, not preventing them.  Trying to run a surplus, as Presidents Hoover and Roosevelt discovered, often failed because it exacerbates the economic downturn and increases the deficit over the course of the business cycle.

Peterson is a direct ideological inheritor of the economists of the 1930 and 1940s.  That generation of economists convinced presidents Hoover and Roosevelt to commit what was economic malpractice even in the 1930s, but Peterson’s failure to learn from reality puts him into a special category of malpractice.

Peterson is a Wall Street billionaire.  He has admitted that his dream is to privatize Social Security.  Privatization would mean Wall Street obtaining hundreds of billions of dollars in fees administering private savings schemes that would put our retirements at serious risk.  His op ed calls on us to support Wall Street’s goal of unravelling the safety net by making what he euphemistically refers to as unspecified “adjustments” to reduce Social Security benefits.

9 responses to “Debt Derangement Syndrome: Saving Our Grandkids from Wall Street

  1. Ray LaPan-Love

    Excellent article, I especially appreciate the refresh on the history of an all important period.

    My only critique is on the claim that the US allows … “the value of its currency to freely “float”. This may have been true before 1973, and perhaps that is what is being said here, but since 1973 the US dollar has been structurally manipulated by the petrodollar arrangement and other efforts to keep it out of the Forex. Naturally, the US could not run a trade deficit for the last 41 years straight and still maintain a strong dollar without mechanisms to keep dollars from piling up in the Forex, so maybe the word ‘manipulation’ needs to come with some explaining. But to say that it floats freely is not quite true.

  2. Roger Erickson

    uh … this is common sense in Biology-101, and physiology, and ecology …. and also in Peasant_Logic-101 (aka, Common Sense)

    but is also set up well even in eCon, by:

    John Atkinson Hobson …..
    In 1889, Hobson published with co-author Albert F. Mummery the work – Physiology of Industry – which carried the sub-title “Being an Exposure of Certain Fallacies in Existing Theories of Economics”.

    more commentary at

    According to NeoLiberal superficial thought: “if consumption fell away (and saving rose), firms would just gear up to satisfying investment goods production instead of consumptions goods production – the rise in saving would increase the flow of funds into the loanable funds market and drive down interest rates and stimulate investment.”

    RGE: Except that that people can’t maintain reproductive rates, and cultural development, on “investment goods” as opposed to their ability to survive on “consumptions goods.”
    No eat, no live.
    No education, no cultural evolution.

    see also:
    The Evolution of Modern Capitalism: A Study of Machine Production
    Hobson, J.A. (1894)

  3. Thanks for the history. Exactly right. I’d add the MMT insight that the money *is* “debt.”

    If you sell your lawnmower at a garage sale, then accept an IOU from the neighbor who buys it, then use that IOU to pay for something else… the IOU has become a “money thing.”

    Most bank account holders are familiar with this. That bank account is the depositor’s asset, but the bank’s liability (debt). Writing a check assigns the bank’s debt to the payee. Currency is simply checks on the Federal Reserve (bank) made out to cash in fixed amounts. The “debt” *is* the money! Withdraw money from circulation and you crush the debtors. (See Federal “debt” is completely unlike household debt because…they make the money!

    Unfortunately, my (Democratic) congressman is, wilfully or not, ignorant of that and has literally sponsored a “budget workshop” put on by Peterson’s Concord Coalition. Fiscal Responsibility [tm] is a synonym for austerity.

  4. Great piece, Prof. Black, but all we need do with regard to any debt clearance is to halt the carried interest (private equity types like Peterson was, and hedge fund people, who claim their normal salary as capital gains and pay considerably lower tax rates would conservatively save this country $100 billion annually, as there are a whole bunch of those types who do this!

    Also, with regard to Peterson:

    2003: With the influence of Peter G. Peterson (Blackstone Group,Peterson Institute, etc.), Timothy Geithner would be appointed president of the Federal Reserve Bank of New York, essentially the (Wall Street) control element of the Federal Reserve.

    When long-time FRBNY advisor, Prof. Robert Shiller (“Irrational Exuberance”), advised the new Fed president that it might be sensible to program into their mortgage models the possibility of falling mortgage prices, President Geithner promptly replaced Prof. Shiller with Catherine Mann from the Peterson Institute (founded by Peter G. Peterson of Blackstone Group and David Rockefeller).

    The legal advisors in the creation of the Mortgage Electronic Registry System — or MERS — were the attorneys at Covington & Burling, the same law firm from which Eric Holder, President Obama’s choice for attorney general to contain the banker meltdown, came from.

    It turns out that MERS is completely illegal from the get-go; they were and are often listed as the mortgagee, and sued on various foreclosures (really, they were all fraudclosures) even though they weren’t a party to the original contract — which violates basic contract law, the principle of privity.

    Also, due to the US Supreme Court decision in 1873 (Carpenter v. Longan), the mortgage or deed of title, and the note, cannot be separated, which indeed they were on every occasion.

    Add to those illegalities the fact that the mortgages and notes weren’t physically transferred to the trusts (REMICs) which invalidated both the securitization contracts (pooling and servicing agreements) and tax law!

    All the mortgage securitizations — thus everything from that point on — were illegal!

    All those MBSes, CDOs, and endless variants on them, were therefore not legal and those credit events which invoked credit default swaps weren’t valid, as illegal securitizations had zero worth. And certain people became billionaires and multi-billionaires based upon this deceit!

    Beyond the fraudclosures (which involved massive mortgage fraud, massive securities fraud, massive false affidavit fraud, massive false court document filings fraud, massive tax fraud (invalid REMICs), massive contracts fraud, massive notary fraud) which involved the commission of millions upon millions of crimes — everything connected with those mortgage securitizations was illegal and invalid — and everything which followed had zero legal basis, and therefore was also illegal!

    And the then CEO of Fannie Mae, the fellow who promoted the large-scale adoption of mortgage securitizations, James Johnson, had a longstanding relationship with David Rockefeller and Henry Kissinger; Johnson was the business contact for the American Friends of Bilderberg, Inc. (directors: David Rockefeller, Henry Kissinger, Richard Perle, et al.).

    So Covington & Burling, which has long enjoyed a strategic partnership with Kissinger Associates, was the legal advisor of record, and their man, Eric Holder, was appointed by the president to insure no bankers were prosecuted, and this entire criminal conspiracy would not be exposed. President Obama also appointed Judith (“Jami”) Miscik, then president and vice-chair of Kissinger Associates, to his Intelligence Advisory Board.

    2013: Blackstone Group purchases 41,000 fraudclosed homes, making them the number one landlord in America, and they announce they will begin issuing rent-backed securities (credit derivatives).

    Presently, Hillary Rodham Clinton’s top advisor is Cheryl Mills, on the board of directors of BlackRock, an offshoot of the Blackstone Group (Blackstone . . . . BlackRock . . . . get it?).

  5. Also, if Peterson was so darned concerned about the budget deficits, he could have helped out the tax base immeasurably by not scamming the taxpayers of America when he took Blackstone Group public, and instead of paying corporate tax rates which he normally should have, he paid off some members of congress and was allowed to continue paying at capital gains rate because he sold shares in “units” instead of stocks?!?!?

    Anybody wish to call this anything other than purely corrupt?

  6. It’s good that Dr. Black can write about this for educated sectors of the population. We also need to find people who can write about this at the 8th grade reading level– to the audience who end up being the majority of the victims of Debt Derangement Syndrome– most of the people whose votes resulted in the current GOP domination of state legislatures, governorships, both Houses of Congress, and SCOTUS until Scalia died.

    Hillary ain’t perfect, but she’ll be better than Trump/Pence on this– especially if Bernie and other progressives will demonstrate in the streets to demand that she pursue progressive policies.

    Obama sure made a mistake appointing a Republican FBI director though. Comey has hurt Hillary’s chances, as well as affecting down ballot races in a Republican direction. I wish Obama hadn’t tried to be a uniter. One can’t do that without any cooperation from the other side.

    • Roger Erickson

      “Hillary ain’t perfect, but she’ll be better than Trump/Pence on this”

      That’s a helluva assumption. It took a Clinton Dem to repeal Glass-Steagall, something even the GOP didn’t dare contemplate.

  7. Ray LaPan-Love

    The Democratic Party, or what remains of our progressive movement, is not as much constrained by debt-related issues, as it is the dilemma of ‘appearing’ to be the party concerned about wages and inequality and etc, while also being the party that supports high levels of immigration. It is folly however to pretend that the laws of supply and demand pertaining to the labor markets might somehow be ignored.

    We have long history of labor market dynamics that show how high demand for labor drives up wages. During each of the World Wars for example, and after the 2nd World War up until the Immigration Act of 1965, and so on.

    There is also an historical pattern showing that low wages, which accompany inequality, lead to drops in consumption which then trigger economic collapses. In 1929 for example, just months before the Crash, the Dept. of Commerce released a paper which put poverty at 71%. This of course also being at a time when there were no programs to provide aid to the poor, and when most of those living below the poverty line were employed to some degree, but wages had been stagnant throughout the 1920s, and, with… relatively high price-inflation. This also followed a period when immigration levels had been at an all-time high so as to meet the labor demands of WW1. Then too, the soldiers returning from the war added to the supply of labor. Thus, labor values remained stagnant as the cost of living rose sharply for a decade.

    Naturally too, our recent downturn also came after a long period of wage stagnation and historically high levels of immigration, and so obviously, the system relies on consumption levels rising in step with growth and wages etc; but wages never rise when the labor markets are over-saturated, however, inequality does. This all being inescapable proof that if the Democratic Party had any intention of supporting labor-related issues…their positions on all types of immigration would not be the opposite of what the clear historical pattern shows to be necessary for wages to rise.