The Five Worst Reasons Why the National Debt Should Matter To You: Part Two, the Record Since 1930

By Joe Firestone

In Part One, of a critique of the most important of “Fix the Debt’s” reasons for “Why the National Debt Should Matter To You,” I asserted that high debt levels haven’t caused high unemployment in the United States, and that, if anything causation was in the other direction. I didn’t want to disturb the flow of the argument there with a relatively lengthy survey of some of the numbers in the historical record since the 1930s. But let’s test the idea that High debt causes fewer jobs and lower wages in the United States by looking at that record now.

Hoover, FDR, and Truman

During the early 1930s, in the presidency of Herbert Hoover, unemployment spiked up first; then the deficits, funded by debt issuance, followed. In fiscal 1933, which began in July 1932, unemployment peaked at 24.9%, while the debt-to-GDP ratio reached 39.1%, up from a low of 14.9% in 1929.

During FDR’s first two terms, the increases in the debt-to-GDP ratio level off. But, unemployment declines steadily to 9.9% in 1941, with an exception coming in 1938, the year following his misguided attempt to cut the debt. During WW II, the public debt skyrockets, but unemployment declines to a historically low level of 1.2%, another contradiction to the idea that high debt levels cause fewer jobs and lower wages.

Nor are the Truman Administrations any kinder to this first “fix the debt” myth. During these eight years the debt-to-GDP ratio declines steadily from 112.7% to 60.2% with one exception in fiscal 1949. Meanwhile, unemployment rises until driven down by Korean War spending beginning in Fiscal 1951.

Eisenhower and Kennedy-Johnson

How about the Eisenhower and Kennedy-Johnson Administrations? Again, all the evidence contradicts the “Fix the Debt” myth. Levels of the debt-to-GDP ratio continue to fall while unemployment rates vary cyclically, but generally average a full point higher than in the Truman Administration, and more than three points higher than at the height of wartime full employment. In short, decreasing levels of the debt-to-GDP ratio do not appear to cause more jobs and higher wages than the higher debt-to-GDP ratio levels during WWII and the Truman period.

In 1969, the debt-to-GDP ratio falls to 28.5%, a drop of nearly 3 points from the year before. The budget surplus is 0.3% up from a deficit of -2.9 in 1968. Unemployment is down to 3.5%, a low water mark for the Kennedy-Johnson period. But in FY 1970, unemployment spikes up to 4.9% and continues “high” for the rest of the Nixon-Ford Administration, reaching 8.5% in FY 1975, even as the level of the debt-to-GDP ratio declines to 24.6% in 1974, and then goes up to 28.1% in 1976 before resuming its downward track for a few years.

Nixon – Ford and Carter

The Nixon-Ford Administration, marks a break in the currency system, since in August of 1971 Nixon withdrew from the Bretton-Woods agreement and both ended the convertibility of dollars to gold on the international exchange, and allowed the value of the dollar to float freely on the international exchanges. Since then, the US has had a fiat currency system, rather than a commodity-based system. However, the US has continued to act domestically as if it was still on the gold standard, continuing to issue public debt even though the rationale for borrowing back money created under its authority, and which can be created in unlimited amounts, at will, is based on the idea of a Government Budgetary Constraint (GBC) that no longer exists; and also on the need to “sterilize” excess reserves produced by deficit spending, because these are falsely assumed to be more inflationary than new securities would be.

In spite of the change in the currency system, and the change in political party control of the White House, the Carter Administration was not able to break the pattern of economic stagnation that characterized the Nixon-Ford Administrations, probably because it received bad advice from economists, who did not understand the significance of the shift to a fiat currency system. The general levels of unemployment remained similar over the two administrations.

The mean annual employment rate during the Nixon – Ford period is 6.3%. During the Carter Administration, it increases to 6.65%. We’ve already seen that the decline in the debt-to-GDP ratio reached 24.6% and then increased slightly. The Carter Administration began to reduce it again, but never reached the Nixon low point, and ended at 26.3%.

There’s no noticeable relation here between high debt levels and unemployment. The debt-to-GDP ratio hit a low level and was varying slightly higher than that level after 1974 through 1981. Unemployment, on the other hand, varied cyclically, but was trending upward, with apparently no direct relationship to high debt levels.

Reagan-Bush

The Reagan-Bush years are remembered as prosperous years. But the mean unemployment rate was 7.1%, a half point higher than under Carter and 0.8% higher than in the Nixon-Ford years, and the period ended at 6.9%. So, many people weren’t prospering.

On the other hand, the Reagan-Bush years saw a substantial rise in the debt-to-GDP ratio which increased from 26.3% at the end of Carter’s Administration’s to 49.5% at the end of Bush 41’s. A level that high had last occurred 35 years before in 1958, during a period when unemployment had averaged 4.9%. Comparing the two, note 1) the level is nowhere near the historic high of 112.7% and 2) the level of the ratio is apparently compatible with both relatively low and relatively high unemployment levels, again refuting the idea that “high debt levels = fewer jobs and lower wages.”

Clinton and Goldilocks

The period of the Clinton Administration has been characterized as the period of “the Goldilocks Economy,” and is also considered by many as a time of “fiscal responsibility.” The economy grew at the most rapid rate since the 1960s, but did so in the presence of trade deficits, and decreasing budget deficits, finally ending in Government surpluses.

With GDP growing rapidly and public debt growing slowly, and actually shrinking through four consecutive years, of surpluses, the debt-to-GDP ratio fell throughout the period FY 1994 – 2001, declining from 49.5% to 32.5% in 2001. This happened simultaneously with steadily declining unemployment rates, reaching 4.0% in 2000, before increasing again to 4.7% in 2001, when a new recession, in reaction to the surpluses and the credit bubble of the 1990s began to bite. The unemployment rate over the whole goldilocks period averages 4.93%, the lowest average since the Kennedy-Johnson and Eisenhower Administrations.

Why isn’t the Clinton Administration a confirmation of the claim that high debt causes fewer jobs and lower wages? Well first, the data show the debt-to-GDP ratio falling, along with unemployment, not the ratio rising while unemployment increases. But even if one wants to claim that a falling debt-to-GDP ratio increases employment and wage levels, the data show unemployment falling much faster than the debt-to-GDP ratio, which doesn’t begin declining appreciably until the unemployment rate has declined from 6.9% in 1993 to 4.9% in 1997.

Also, when unemployment rises again in 2001 to 4.7% from 4.0%, the fall in the debt-to-GDP ratio continues, suggesting a lag relationship between unemployment and a falling debt-to-GDP ratio. What would explain this? The answer is the automatic stabilizers. When people go back to work, they cease to draw as much, or at all on the safety net, and they also pay taxes. So, tax revenues increase, government deficits decrease, and GDP increases, meaning that the debt-to-GDP ratio falls.

But a mystery remains, why did the goldilocks economy appear? Why did it create an apparently strong recovery with decreasing unemployment and higher wages, without the assistance of large government deficits, and with the disadvantage of increasingly substantial trade deficits. The answer is that the goldilocks economy was driven by the Fed’s decision to maintain low interest rates, and easy bank credit, and by the increasing willingness of the private sector to run a deficit, and run down its net financial assets, accommodating the Government’s desire to run a surplus.

The private sector balance went into deficit in 1997 when the Government’s deficit declined to -0.3%. Then the four years of Government surplus: 1998, 1999, 2000, and 2001, were all years of aggregate private sector deficit in which the private sector, looked at as an aggregate, lost net financial assets. While this was going on, the “dot com” bubble was bursting and the economy fell into recession, accompanied by the increase in the unemployment rate in 2001, followed by the increase in the debt-to-GDP ratio, as the automatic stabilizers, along with the beginning of post 9/11 homeland security deficit spending, kicked in with a return to deficits in 2002.

So, it turns out that the primary causal factor in the Goldilocks economy and its increasingly low unemployment rate wasn’t deficit reduction, as claimed by many Clinton partisans, and debt hawks, but the credit bubble blown by the Federal Reserve, the banks, Wall Street, and an increasingly optimistic private sector. The economy boomed in spite of deficit reduction, and was itself the primary cause of deficit reduction, and not vice versa. This is another refutation of the narrative behind the theory that high debt levels cause high unemployment and low wages, because the boom was due to a credit bubble that drained net financial assets from the private sector and then burst at the end of the period.

Later, the blowing of another bubble under Bush 43, restored a modicum of prosperity, but only increased the chances for a more serious crash in 2008. Had the expansion of the 1990s been based on much larger government deficits, the recession at the end of the Clinton-Gore period would have been avoided, because the expansion would have been based on a permanent transfer of new net financial assets to the private sector, and not on bubble-generated paper assets that are gone with the wind when the inevitable collapse of a credit bubble occurs.

Bush 43

That brings us to the Bush 43 Administration. In 2002, the Government went back to deficit spending. But the Government deficit was small enough that, given the size of the demand leakage due to the trade deficit, it kept the private sector in deficit. Deficit spending increased in 2003, along with war spending, but since the trade deficit was rising to 5% it wasn’t large enough at – 3.4% to compensate for the trade deficit. Over the next two years, the private sector balance varied around zero, sometimes in deficit, sometimes showing a small surplus.

But beginning in 2005, as the trade deficit rose eventually to 6%, and the Government deficit again was lowered first to -2.6, and then to -1.9 and -1.2% in 2007, the private sector was again in substantial deficit for three consecutive years. Altogether, beginning in 1997 under Clinton and ending in 2007 under Bush, the private sector went through 11 years without ever having a substantial private sector surplus, and for 6 of those years the private sector lost more than 2 – 4 % of GDP in net financial assets, because private sector activity was funded by private sector credit bubbles rather than by government deficits that were high enough to compensate for the Trade deficit.

In other words Government deficit spending wasn’t too high under the Bush 43 Administration, as we hear in conventional economic and political analysis. But rather, it was far too low to sustain a decent level of economic activity without relying on the credit bubble-fueled housing bubble that burst in 2007, and led to the crash of 2008.

No wonder the Bush 43 period had the highest average unemployment rate (5.83%) since the Bush 41 Administration (6.7%). Neither Government deficit spending, nor the private credit bubble were large enough to drive unemployment down to the levels seen in the Clinton period, and unemployment was mostly over 5% hitting 5.8% in 2008, and then in the transition 2009 fiscal year, between the Bush 43 and Obama Administrations, rising to 9.3%. Meanwhile, the debt-to-GDP ratio slowly rose nearly 4% from 32.5% between 2001 and 2007, and then jumped sharply to 40.5% in 2008 and to 54.0% in 2009, as unemployment was rising and safety net spending accelerated.

So, during Bush 43, we see a sharp rise in the debt-to-GDP ratio in 2008 and 2009. But, it’s not this rise in debt levels that causes unemployment, because the sharp increases in unemployment were a result of the financial crash caused by the lengthy attempt over two administrations to fuel economic expansion through increasing private sector debt facilitated by the Fed, the banks, and Wall Street. That attempt led us back to the boom-bust cycles that were prevalent prior to the New Deal and the reform of the banking system — reforms that were largely repealed in the Clinton and Bush Administrations.

The sudden growth in debt in 2008 and 2009 appeared because the rise in unemployment caused by the Great Crash, led to increases in Federal deficit spending resulting from the automatic stabilizers, and the beginning of the economic stimulus provided by the American Recovery and Re-investment Act of 2009. So, once again, job loss came first, and was then followed by higher debt levels, rather than vice versa, another contradiction with the theory that high debt levels cause higher unemployment and lower wages.

The Obama Administration

From 2009 until the present, the results of the sharp spike in the unemployment rate on the debt-to-GDP ratio are apparent. The ratio has increased by nearly 20 points in 2010, 2011, and 2012 to 72.6%, while the unemployment rate has declined from 9.3% to the present 7.4%. So, increases in the debt-to-GDP ratio are inversely correlated with the unemployment rate, yet another contradiction of the austerian theory. Meanwhile, the reduction in unemployment and the increase in both GDP and tax revenues is driving the 2013 deficit toward 4% of GDP, down from 10.1% in 2009.

This result, while touted as good news by the Obama Administration, and nearly everyone else in sight, resulting in a veritable Versailles happy dance, is bad for the economy. While the trade deficit is down to close to 2.5% now, a projected Government deficit of 4% for 2013 is too small to provide for more than a 1.5% of GDP surplus in private sector net financial assets. Most of this is likely to go to continue to repair private sector balance sheets that were damaged so much during the 11 year debt binge over the Clinton and Bush Administrations.

That means there won’t be new private sector financial assets sufficient to support increasing aggregate demand. And this, in turn means that the economy will continue to stagnate or heal only very slowly, or perhaps even turn back to recession, provided there’s no substantial private sector credit expansion to fuel demand. But, so far at least, one can’t see such an expansion getting under way, and without it there’s no substitute for the Government deficit spending that the Administration and Congress are so intent on reducing.

Where’s the Evidence?

It’s astonishing how people just make up stories to support policies they favor. Even though I have the background to use rigorous modeling or statistical analysis methods, and have used them many times in past years, my look at the record hasn’t involved them, because, this is, after all, a blog post meant to be read more widely than a statistical study, and I think the raw numbers since 1930 continuously and conclusively refute the causal theory advanced by the “Fix the Debt” group that high debt or debt-to-GDP levels increase unemployment rates.

Falsification of any theory can never be certain, but the evidence in this case never contradicts the idea that high unemployment comes first, and high debt levels come afterward as an effect of high unemployment, assuming, of course, that deficit spending is accompanied by debt issuance. Given the data, I think one has to reasonably conclude that High debt levels ≠ fewer jobs and lower wages, as the “Fix the Debt” group claims.

If the “Fix the Debt” group disagrees, and thinks that I’ve interpreted the data incorrectly, or that more rigorous analysis expanding the set of variables and using more sophisticated techniques shows that the evidence doesn’t refute their theory, then I challenge them or others in the Peter G. Peterson Foundation-funded network of organizations to produce such an analysis. Until they do, I think we have to continue to ask “Where’s the evidence”?

And we also have to ask whether a theory amounting to no more than a plausible narrative about what causes unemployment, contradicted by many other plausible causal narratives can serve as the basis for a Federal fiscal policy of deficit reduction that will hurt many millions of American citizens for generations? I think not! I think the very idea is ludicrous, and that it’s time to laugh the “Fix the Debt” campaign off the public stage.

In Part Three, I’ll cover the other four “worst reasons” why the national debt should matter.

Data Sources:

Budget deficits/surpluses, 1940 – 2018.

Unemployment rates, annual averages, 1923 -1942.

Unemployment rates, annual averages, 1940 – 2008.

Unemployment Rates, annual averages, 1947 – 2012.

Sectoral Financial Balances.