TOPICS > Economy

America’s Historical Struggle With Debt and the Role of Federal Government

November 27, 2012 at 12:00 AM EDT
Between paying now or paying later, Americans have just about always preferred debt to taxes. Paul Solman talks to Simon Johnson of the MIT Sloan School of Management about his new book "White House Burning," which chronicles the history -- including the whys and whererfores, virtues and vices -- of U.S. debt.

JEFFREY BROWN: And we return to the great debate over budgets, deficits, taxes and spending with yet another viewpoint, this one with some historical perspective.

NewsHour economics correspondent Paul Solman is on the case, part of his ongoing reporting Making Sense of financial news.

PAUL SOLMAN: Our allegedly tragic trillion-dollar annual budget deficits, swelling our supposedly unsustainable $16 trillion national debt. More borrowing, it’s said, means the proverbial road to ruin.

Some think then that the fiscal cliff, slashed spending and hiked taxes, is not the horror of horrors, some sort of economic suicide, but the very opposite, the last resort for avoiding a fatal whirlpool of debt.

So what about more debt? Will it destroy us or won’t it? How bad would it be to barrel over the cliff?

Enter former IMF economist Simon Johnson of MIT. He’s written a book, “White House Burning,” on the history of U.S. debt, all 225 years of it, its whys and wherefores and — get this — its considerable virtues.

We asked if he could provide a TV version. The answer was a mobile history lesson, starting at the museum where every 15 minutes they reenact the dumping that helped make a town famous and a group of contentious colonies united.

So, to begin, you’re in Boston. What’s your fundamental thesis?

SIMON JOHNSON, MIT: The American republic is born partially in a tax revolt. This is the tea party site where they threw the tea over because they didn’t like the tax system. So this has been a fundamental debate and argument from the beginning of the American republic. And we come back today to exactly the same sorts of issues.

PAUL SOLMAN: Well, not exactly the same.

The tea parties of yore included tea smugglers protesting England having lowered the tax on tea, threatening their contraband business.

But, hey, as between legend and fact, legend usually wins.

And the fact is, as between paying now or paying later, Americans have just about always preferred debt to taxes, debt to pay the very first army, for example.

This is the spot on the Cambridge Common where, legend has it, General Washington first amassed his troops under a now dead elm and faced the basic question of government economics.

SIMON JOHNSON: How is going to pay them? How is he going to feed them? How is he going to clothe them? Where are they going to get their shoes? That’s the question we’re still trying to answer.

How do we tax ourselves and what’s a reasonable amount of federal government spending and on what?

PAUL SOLMAN: What did America in the making do? We didn’t much tax ourselves. Instead, we began to borrow, as a new united country.

SIMON JOHNSON: It was the idea primarily of Alexander Hamilton, who was the first secretary of the treasury under George Washington.

Hamilton realized you needed to have strong federal fiscal authority, ability to tax, and the ability to issue debt and manage debt and bring debt down.

PAUL SOLMAN: We also stiffed creditors back then, too.

SIMON JOHNSON: Absolutely. The United States was born in default. We defaulted on many obligations to foreign creditors and to our own soldiers.

PAUL SOLMAN: OK. So America was born and swaddled in debt. Then, about four score and seven years later, when the country threatened to break in two, it was borrowing that distinguished the winners from the losers.

SIMON JOHNSON: In the Civil War, the North financed itself by issuing bonds and by developing a tax system. Nobody was very happy about that. But it worked.

The South financed itself by printing money and got a hyperinflation, destabilizing — further destabilizing its economy. So, those are two different ways to finance a big ramp-up in government activity.

And the North won in part because they had a better approach, the Hamilton approach, to public finance.

PAUL SOLMAN: And that approach was to print IOUs, bonds, and come up with a way to market them, mainly in Europe, to people who had the money and thought, hey, I’m going to get it back with a good rate of interest.

SIMON JOHNSON: They also sold them to what we now call retail investors. They made the bonds relatively small denominations and had a big marketing push, the first time anybody in this country or almost anywhere else had tried to sell bonds to ordinary, regular people. Big success.

PAUL SOLMAN: And so it was, says Johnson, whenever America found itself at war, peaks of debt as a percent of national at the peak of every conflagration from the Revolution through the War of 1812 and the Civil War to World War I.

The next big bump in debt added a new reason to borrow. It came during peacetime, new debt to combat the Great Depression of the 1930s that hit America and other market economies.

SIMON JOHNSON: Massive slump in GDP and output, and conventional economics and standard economic practice just didn’t work for turning these economies around.

PAUL SOLMAN: Now, had you been born, you would have been in England at the time. And that was when John Maynard Keynes became most famous for his prescription, spend, spend, spend. That’s how you get the system up and moving again, by pouring money into it.

SIMON JOHNSON: Yes, when you’re in a depression.

So, in that situation, Keynes said that more government spending could help push the economy, restart the private sector by having the government lead the way.

PAUL SOLMAN: And when J.M. Keynes talked, people listened, among them, Johnson’s academic predecessors.

SIMON JOHNSON: People working here at MIT Department of Economics and in other leading universities became convinced that the government could play a different role and a more helpful role in the economy and supporting the macroeconomy, compared to what the previous orthodoxy had been before the 1930s.

PAUL SOLMAN: But that meant going into more and more debt. And that’s a good thing, then, you say?

SIMON JOHNSON: It meant being careful with the debt still. It meant that deficit spending was something that could be very useful to you in terms — when the economy needs some help.

PAUL SOLMAN: Very useful and, of course, borrowing proved very necessary when World War II broke out. Total U.S. debt soared to 120 percent of GDP. But, after the war, the U.S. economy soared too.

And by the late 1960s, economic growth had whittled the percentage down near 40 percent of GDP, despite new wars on poverty and Vietnam. Again, debt had delivered us from evil and, it seemed, into prosperity.

Then came the 1980s and the tax cuts of Ronald Reagan combined with greater defense spending leading to hugely higher annual deficits covered by borrowing, and thus again a swelling national debt, but with no wars at all.

Then, under Presidents George H.W. Bush and Bill Clinton, we took action. For a while, both parties agreed, says Simon Johnson.

SIMON JOHNSON: And there was a bipartisan agreement to raise revenue and put something of a damper on spending. So, that’s an important moment. In the bigger picture, of course, that was just a small hesitation on the path to a much larger national debt.

PAUL SOLMAN: Because, in the bigger picture, a president just can’t accomplish very much if he’s cutting spending and won’t raise taxes, and so, yet again, more borrowing under Presidents George W. Bush and Barack Obama, higher deficits and debt that, because of the graying baby boom, are fated to get even worse.

SIMON JOHNSON: The population was always going to age. The baby boomers were going to retire. They were paying a lot of Social Security contributions in the 1990s. They’re drawing pensions today. We were always going to shift into structural deficit for that reason.

PAUL SOLMAN: And that’s why, even though we have been in deeper hot before as a percentage of the economy, this time really may be different.

With the baby boom hanging it up, increasing our debt load now presents a clear and future danger, and thus this era’s key questions.

SIMON JOHNSON: Do you want to keep Social Security? Do you want to keep Medicare? And if yes, how are you going to pay for it?

And I don’t suggest the answer be, well, sell more debt to the Chinese. You have got to pay the taxes to support the social insurance programs, if that’s what you want to keep.

PAUL SOLMAN: But Americans do not want to pay higher taxes.

SIMON JOHNSON: No one wants to pay higher taxes. Actually, everybody is happy to have someone else pay higher taxes. They don’t want to pay higher taxes themselves.

And this is where we come to in the conversation. What do you want government to do?

And we have got ourselves into this mind-set of, well, the government can give me stuff, but someone else can pay for it. That is incredibly dangerous. That is what has broken many governments and many countries. It’s never been the American problem, but it is the American problem today.

PAUL SOLMAN: Last stop, back to Cambridge Common. Last point, some people think going over the cliff won’t be all that catastrophic. But economist Simon Johnson thinks it would be a disaster. You don’t just change course overnight.

SIMON JOHNSON: If you go over the cliff in a disorganized way, with mass amount of political confrontation, that could be very bad for us and absolutely — and much worse for the world. We need to make some fiscal adjustments.

Some of those things include higher revenue and bringing spending under control. So, I’m in favor of that, but charging off a cliff as we struggle at each other’s throats, very bad.

PAUL SOLMAN: Very bad, perhaps, but not, as things now stand, impossible to imagine.