ratio that high was not seen again in U.S. history until the 1930s when the Great Depression led to large federal deficits and increases in the debt at the same time the gnp was collapsing.
The national debt reached a high in 1804, when the Louisiana Purchase added $11.25 million to it in one transaction. But aside from this extravagance, the administrations of Jefferson and James Madison were noted for fiscal frugality. Although some of the old Federalist taxes were cut in those years, Treasury Secretary Albert Gallatin was nonetheless able to cut the debt nearly in half between 1804 and 1811. Another notable event in the history of the debt was its elimination in 1835 and 1836, an occurrence unprecedented in the history of modern nations. This was during the administration of Andrew Jackson who, like his Jeffersonian predecessors, was fiscally frugal. But the main reason was the rapid economic growth that swelled federal tariff and land-sale revenues.
Much of the rest of the history of the national debt before 1930 can be generalized as following a pattern of rapid expansion in times of war and gradual reduction in times of peace. Reliance on debt financing during wars can be justified in economic theory by treating war expenditures as investments (in national survival or territorial expansion, for example) benefiting later generations who ought to help pay for the benefits by servicing the debt. A more likely explanation is one of expedience: wars call for rapid increases in expenditures, but equally rapid increases in compulsory taxation would be less popular than borrowing.
The pattern of wartime debt expansion can be seen in the War of 1812 when the national debt nearly tripled between 1811 and 1816, in the Mexican War era when the debt more than quadrupled between 1845 and 1851, in the Civil War when the debt increased forty-two-fold between 1860 and 1866, in the Spanish-American War era when the debt rose 50 percent between 1893 and 1899 (although the larger part of this increase occurred before the war), and in World War I when the debt increased twenty-one-fold between 1914 and 1919. World War II also fit the pattern: the debt increased nearly sixfold between 1939 and 1946.
The longest sustained period of debt reduction occurred after the Civil War, from 1866 to 1893, when the federal government ran a budget surplus every year and cut the debt to about a third of its initial value. On the whole, this was a positive development for the U.S. economy, as the government freed up funds for private investment and high levels of investment at some of the lowest interest rates in U.S. history fueled rapid economic growth. But debt reduction was controversial because it resulted from administrations, mostly Republican, that combined fiscal frugality with high tariff rates, producing revenue surpluses while protecting American manufacturers from foreign competition. The administration of Grover Cleveland was embarrassed in the late 1880s when, having retired all the callable federal bonds, it had to enter the market and buy up government debt at prices well in excess of par. Some modest debt reduction occurred between 1899 and 1914. The last sustained reduction came in the 1920s when the debt was reduced to less than two-thirds of its 1919 level. This was a favorite policy of Treasury Secretary Andrew Mellon, a conservative banker.
The year 1930 represented a watershed in the history of the national debt. Since that date the debt has never been reduced for more than a year or two in peacetime or, of course, in wartime. In the depressed 1930s the collapse of the gnp led to federal fiscal deficits and debt growth. World War II, as can be seen in the figure, saw the debt rise to by far its highest level in relation to gnp in previous or subsequent experience. The national debt peaked at 128 percent of gnp in 1946. After the war, although the debt continued to rise, the gnp until the 1980s rose much faster, so that by 1979–1981 the debt/gnp ratio was only 33 percent. From 1981 to 1988, the policies of the Reagan administration – tax cuts and increased defense spending – coupled with Congress’s and the administration’s reluctance to cut spending on inflation-swollen entitlement programs, produced large deficits that raised the debt/gnp ratio to 53 percent, its highest level in U.S. history apart from the World War II era, with no end to the rise in sight as of 1991. This trend disturbed many Americans, and federal deficits and rises in the national debt once again became major national issues. Even in 1988, however, the debt/gnp ratio was no larger than it was during the period 1943–1961.
Various strategies for marketing the debt have been followed through the years. The funded national debt of 1791 was created by exchanges of various Revolution era obligations for long-term bonds payable, principal and interest, in hard money. Before the Civil War, when new funds had to be raised, the Treasury usually relied on loan contractors to buy large amounts of new securities at negotiated prices and resell them to state and local governments, institutions, and wealthy individuals. Secondary trading markets emerged, allowing holders of the debt continuously to buy and sell their holdings of federal securities. Since much of the debt was held in Europe, arrangements were made to make it payable in European centers. Thus, $6.25 million of the Louisiana Purchase loan was made payable in London and $5 million in Amsterdam.
The Civil War brought sudden financial requirements and uncertainties that were too great for the old system of debt marketing. Jay Cooke, a private banker, contracted with the Treasury to place large war-debt issues with small investors throughout the Union. Cooke relied on heavy advertising expenditures and patriotic appeals to sell bonds. The newly created National Banks also bought large amounts of wartime issues, against which they could issue national currency. Jay Cooke’s techniques of mass marketing Treasury debt within the United States introduced many Americans to ownership of paper wealth – a major development in the history of U.S. financial markets.
Cooke’s techniques were employed again when the debt soared in World Wars I and II. Then, however, a central bank, the Federal Reserve System, was present to aid Treasury financing by creating new money to be exchanged for federal debt. Nonmarketable savings bonds were introduced, but they never became a major part of the total debt.
Today, the marketing of the national debt is almost continuous, with new issues of Treasury bills, for example, being sold every week. New notes and bonds are issued quarterly. Many new issues simply replace old ones, but in the 1980s a great deal of new money had to be raised to finance the large Reagan era federal deficits. In 1988, U.S. government agencies, trust funds, and Federal Reserve banks owned about 30 percent of the debt, private financial institutions held nearly 40 percent, and the remainder was owned by state and local governments (11 percent), U.S. individuals (7 percent), and foreign/international holders (13 percent).
Robert Heilbroner and Peter Bernstein, The Debt and the Deficit (1989).
Richard Sylla
EXERCISES
Exercise 1. Words and expressions. Provide Russian equivalents.
obligations
outstanding debts
bonds
fund the government’s obligations
notes
securities
bills
defer payments
lend money to the government
interest rates are below the market rate
per capita
the depreciated Continental bills
purchasing power
were funded at less than face value
the debt stands at $2 bln
par (value)
borrower
use them as collateral for bank loans
lender
federal deficit
apply for a loan
transaction
interest payments
fiscal policy
principal repayments
tariff and land-sale revenues
debt/gnp ratio
to increase forty-two-fold
the issue of $2 million of bills of credit
budget surplus
indebtedness
revenue surpluses
arrears