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After the last budget surplus ended in 2001, Bloomberg stated it was the longest period of surplus since 1927 -1930.

Prof. Fred Thayer wrote this before the surpluses of the late 90’s:


Here’s part of the intro:

From the origins to World War II

In its first 150 years, the government periodically undertook systematic multi-year reductions in the national debt by taking in more revenues than it spent.

Each of six such sustained periods led to one of the six major depressions in our history. The last three of these crashes were the truly significant depressions of the industrial era.

This is the record:

1. 1817-21: In five years, the national debt was reduced by 29 percent, to $90 million. A depression began in 1819.

2. 1823-36: In 14 years, the debt was reduced by 99.7 percent, to $38,000. A depression began in 1837.

3. 1852-57: In six years, the debt was reduced by 59 percent, to $28.7 million. A depression began in 1857..

4. 1867-73: In seven years, the debt was reduced by 27 percent, to $2.2 billion. A depression began in 1873.

5. 1880-93: In 14 years, the debt was reduced by 57 percent, to $1 billion. A depression began in 1893.

6. 1920-30: In 11 years, the debt was reduced by 36 percent, to $16.2 billion. A depression began in 1929.

There have been no such multi-year budget surpluses and debt reductions since World War II and, significantly, no major new depression. The record suggests that reducing the debt never sustained prosperity, even when the debt was virtually wiped out by 1836. The highest deficits were those of World War II, ranging from 20 to 31 percent of Gross National Product. For a few years following the war, the debt was greater than GNP, the only such case in history. The wartime borrowing and spending actually ended the Great Depression.


7 Responses

  1. Warren,

    A big picture question for you. If the U.S. were to adopt a persistent fiscal deficit to offset the international appetite to save in USD financial assets, how would that eventually end?

    Would inflation be the most likely consequence, or a declining dollar, as the USD savings are eventually spent on US exports?

    When I explain your approach, some of my colleagues instinctively find the idea of a persistent fiscal deficit to be unsustainable. My own thought is that the foreign savers of USD financial assets are likely to be disappointed, and that will turn out to be their problem (radical notion–financial assets can decline in value). As they hoard dollars now, they drive up the dollar, and when they go to spend them later, they will have the opposite effect. They are “legging” the trade, rather than using the dollars they currently earn to boost current consumption.

    Many reactions to the idea of a persistent US fiscal deficit are that it will eventually be repudiated via inflation. Randall Wray does a good job of countering that argument over at TPMCafe, but it still seems likely.

    And it doesn’t have to be that the dollars are worth less–if the U.S. increases the economic capacity and production of the country via the deficit spending, then foreign USD savings can ride along on the improvement in the U.S. economy. In addition, the demographics of some countries (Japan) suggest that as they age, they will become net importers and consumers.

    In other words, foreigners face the same tradeoffs as non-govt domestic entities. Both want to currently net save in order to consumer later (e.g., retirement). The whole thing looks messy, in terms of demand leakages, and sub-optimal resource utilization, etc.

    And it doesn’t help my ability to address these questions when many of the questions are heavily rooted in the gold-standard paradigm.

    Interested in your thoughts about how to address the instinctive reaction against persistent fiscal deficits, and answer the basic “And then what?” questions about the long-term consequences of these persistent fiscal deficits.


  2. J- it should over time, but there’s a lot of ‘off balance sheet’ deficit spending that often goes on, like the cb buying fx, or ‘investment’ by ‘state and local govt’ that doesn’t ‘count’ etc, so you have to look at actual public sector ‘cash flows.’

    Roger, it doesn’t need to ‘end’ for any particular reason. Japan and China probably would have been more than happy to keep collecting $ indefinately, for example.

    Yes, when it goes the other way it can be ‘inflationary’ as we define inflation, but ‘inflation’ per se doesn’t alter the real wealth of a nation.

    What can happen is our real terms of trade can go against us and hurt our real standard of living. That’s why we shouldn’t be in any hurry to end it, and instead try to nurse it along.

    will check out the tpmcafe- haven’t seen it

  3. will check out the tpmcafe- haven’t seen it
    Some good discussions in the comments section. Dr Wray and Dr F were commenting.

  4. FYI, as I’ve noted before here, my paper at cfeps.org on “interest rates and fiscal sustainability” goes directly at the “repudiate debt via inflation argument.” The latter relies on the loanable funds framework in which interest on the national debt is set by private mkts, which is obviously false under flex fx. A powerpoint version is posted to the epicoalition site.

  5. That said, enough deficit spending will cause ‘inflation.’

    No denying, for example, giving everyone $1T would drive up prices a lot!

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