A History Lesson: US GDP and Federal Debt

(Posted 2/10/2010) - Like many older Americans I'm fiscally conservative. I tend to invest in things I understand and don't believe one can (or should) sustain profits without producing something of capital value. Like many of my generation I do not spend beyond my means.

Our family and our parent's families have always adhered to non-deficit spending policies with regard to the family budget. Doesn't it make sense that governments should follow the same common sense strategies? Well, maybe yes, and maybe no -- read on.

I've come to believe that governments may need to operate under different rules than family households. Ideas currently touted by some fiscal conservatives, while unemployment is in double digits and businesses struggle to find markets for their consumables, are potentially quite damaging to our national well being. Laissez-faire conservatives believe government should adopt policies which reduce social services (like support payments and credits to under employed families; health-care subsidies; education reimbursements; and job-training programs, among others). The argument goes that as revenues (GDP) available for taxes contract because of lost jobs and commerce, the government services supported by tax dollars from lost enterprise must shrink correspondingly. After all isn't this precisely what families do on an individual basis? Well, again, yes and no.

Families that become destitute often turn to saftey-net services provided by relatives, philanthropic organizations, local, state, and/or federal government agencies. When government's cash flow falls on hard times (during economic downturns) it can borrow on its economic engine's future returns to get through a rough patch. We are experiencing such a downturn right now.

What should be considered when trying to prioritize government spending in a time of economic stress are those expenses that can be shed or deferred without impacting the economy (Military Occupations come to mind; though it is certainly non-trivial for a nation to extricate itself from such committments in a timely way - think of the British Empire's occupation of India for example; or more recently the Occupation of Iraq. As a point of information, it currently costs the US taxpayer an additional $1 million per year in logistical support for each soldier deployed to Iraq and Afghanistan). Reference Link Here

Historically deficit spending has been part of every recession's economic recovery strategy. So borrowing is not in and of itself a bad thing. If the monies borrowed can be expected to be repaid over time as the economy recovers and aggregate tax revenues surpass pre-recession levels then such a strategy appears to be reasonable.

A natural question to ask is "what amount of deficit spending is prudent during a downturn?" An historical way of looking at this question is to compare the annual deficit as a percentage of the Gross Domestic Product (GDP) during various recessions, (and during major wars).

Most of us probably don't have any idea what a 'good' deficit percentage of GDP might be. To that end, let's look at the US GDP vs. annual operating deficits for the last 110 years (1900-2010). Click Here for a chart and associated table showing year by year GDP and the percentage of borrowing that took place that year by the federal government.

If one continually borrows without paying off the majority of past debt one will have to pay an ever increasing percentage of one's revenue to service the accumulating debt. Therefor it is equally important to look at the federal government's total debt as a percentage of GDP. Click here to view that information.

We also need to know when our economy has experienced recessions (ie, 2 or more consecutive quarters in which the GDP contracted). Click here to view all US recession data. The list on the linked website allows you to look at all US recession years and associated data.

With these data one can clearly see how our national debt has evolved over the last 110 years and observe how our politicians have reacted to recession using debt financing. Maybe we can even form some opinions about what levels of borrowing are rational given our current recession?

A key variable is that no one knows how our economy will evolve as we move forward. In a rapidly growing economy (GDP rising), it becomes easier to retire debt because of tax surpluses. In a stagnate or recessionary economy it becomes virtually impossible to retire debt. So, while we can make educated guesses about future rate of GDP growth, and about the value of the US dollar the reality will affect the nation's ability to retire debt.

Here is my own take on the referenced data - I've grabbed three images to help make the analysis more transparent ... Click on an image to get a larger version.

From 1900 till 1918 the government appeared to operate without any significant deficits -- but maintained a debt ratio of about 20% of GDP. Then the post WW I recession hit and from 1917 - 1919 (Wilson was president) the government borrowed massively (deficit high was 16.9% of GDP in 1919). The debt as a percent of GDP doubled to almost 45%.

From 1920 - 1928 the economy hummed along (Warren Harding, and upon his death Calvin Coolidge both Republicans held office). The government experienced small budget surpluses each year, and GDP grew by about 15%. The national debt was reduced from 45% to near 34% of GDP.

From 1929 - 1932 Herbert Hoover (Republican) was president. The great depression took off in 1930. GDP fell off the table dropping over 40% to around $56 billion by the time Franklin Roosevelt came to office. National debt soared to over 70% of GDP and Hoover's administration averaged over 3% annual deficit spending.

From 1933 till 1946 (the FDR / Truman years in office) the great depression and WWII produced massive borrowing in each year (deficit min 2.75% - max 28% of GDP each year) with accumulated debt reaching a whopping 121% of a GDP of $222 billion in 1946. During the next 35 years the debt was reduced (as GDP continued to rise) so that by the time Reagan took office (1981) the national debt was around 44% of GDP (then $3,127 billion).

The Reagan administration treated the cold-war as though it were a traditional hot-war, borrowing massively (deficit min 2.6% - max 5.9% of GDP each year); the national debt under Reagan went to 67% of GDP (even as GDP continued to rise dramatically during those 8 years by 80%).

Bush I continued Reagan's borrowing strategy, but had the misfortune to be hit by a recession that kept GDP from growing. During his four year tenure the national debt rose to 80% of a $5,800 billion GDP.

From 1993 - 2000 the Clinton administration used deficit spending in the first four years, and experienced surpluses in the last three. The GDP rose by over 60% (to $9,951 billion). The national debt was reduced to 72%.

From 1999 - 2001 the Bush II presidency presided over surpluses averaging over 1.75% of GDP. GDP was also growing -- however, in the remaining 5 years, 2002-2008 there were average deficits over 3% and borrowing which raised the debt to 88% of a $14,400 billion GDP.

Obama's administration owns the 2009 numbers, which show a GDP fallen to $14,237 billion, a stimulus and bailout that pushed deficit spending to 9.9% of GDP - and an increase in the debt ratio to 104% of GDP. Obama's administration also placed the cost of the Iraq and Afghanistan occupations 'on the budget,' where Bush II had kept the cost of the wars off-budget. The reality is that the cost of these two occupation efforts, if recorded, would have pushed the last term deficit percentage of the Bush II administration closer to the current Obama debt ratio.

Now that we've organized the data what conclusions can be drawn? The first one is that the national debt has grown from approximately $12.7 trillion to $14.8 trillion over the last year. But with 140K troops in Iraq and 34K in Afghanistan that off-budget item adds 173,000 times $1 million dollars, or $173 billion to the Bush II war debt for each year of financing. This extra trillion in borrowing that was off-budget is now on-budget and is being carried openly in the $14.8 trillion Obama budget. The net 'new debt' then is less than $1 trillion dollars. Taken as a percentage increase, our debt has gone up by less than 7%.

This additional borrowing was largely targeted at stimulus and bail-outs to keep the economy from falling off a cliff into a 1930's style depression. I'd say we are still a ways from economic bankruptcy, despite the hysteria from the fiscal conservatives about burdening our future tax payers with too much debt. If the GDP grows we can pay our debt down over the coming decades; if we don't borrow massively for wars or new programs with little direct benefit to the economy. Remember we successfully reduced our debt after WW I and after WW II.

But, if the economy stagnates for a decade or more we will have to adjust our debt service somehow. Look to the former USSR, Japan, or more recently Argentina to get an idea how economic contractions and collapse affect policy and politics of nations. Let us hope we can keep our country economically sound and pay down our debt over the next 40 or so years :-)