History of National Debt

• http://www.publicdebt.treas.gov/history/history.htm
• http://www.uwsa.com/us-national-debt.html
• http://www.treasurydirect.gov/govt/reports/pd/histdebt/histdebt.htm

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Debt in the 19^th century

• The U.S. has had debt since its inception. Records show that debts incurred during the American Revolutionary War amounted to $75,463,476.52 by January 1, 1791. http://www.publicdebt.treas.gov/history/history.htm
• The National Debt in 1816 was $127 million
• Andrew Jackson reduced the National Debt to zero (or virtually zero) in 1835
• The National Debt in 1839 was $10 million
• The National Debt in 1851 was $68 million
• The National Debt in 1866 was $2.77 billion
• By 1891 the National Debt had fallen to $1.546 billion (the lowest it was from the Civil War to World War I)

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Debt in the 20^th century

• The National Debt in 1919 was $27.4 billion
• The National Debt in 1930 was only $16.2 billion
• By 1946, the National Debt was $269.4 billion
• 1957 was the last year – in the data set examined in class – the National Debt fell. It was $270.5 billion that year.
• 1963: $305.9 billion
• 1972: $427.3 billion
• 1975: $533.2 billion
• 1982: $1.14 trillion
• 1986: $2.13 trillion
• 1992: $4.06 trillion
• 2000: $5.67 trillion

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Debt in the past decade

• 2001: $5.8 trillion
• 2002: $6.2 trillion
• 2003: $6.8 trillion
• 2004: $7.4 trillion
• 2005: $7.9 trillion
• 2006: $8.5 trillion
• 2007: $9.0 trillion
• 2008: $10.0 trillion
• 2009: $11.9 trillion
• 2010: $13.6 trillion
• TODAY: $14.7 trillion

What Causes the national debt to rise?

• Debt occurs when government revenue (primarily from taxes) is less than government spending.
• Therefore debt will rise whenever..
• revenue falls: this happens when the economy goes into recession and when we decide to cut taxes
• spending increases: this can happen when we go to war

Taxes of the Federal Government

• http://www.ustreas.gov/education/fact-sheets/taxes/ustax.shtml
• The income tax was instituted in 1913
• The social security tax was instituted in 1935

Recent tax history

• Effective tax rates from 1979 to 2007
• http://www.taxpolicycenter.org/taxfacts/displayafact.cfm?Docid=456
• Marginal tax rates from 1913 to 2011
• http://www.taxfoundation.org/publications/show/151.html
• In recent years taxes in the United States have declined.

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The U.S. is a relatively low tax nation�Consequently… debt is also used to finance the government�

YOU ARE NOT A GOVERNMENT!�OR… WHY THE NATIONAL DEBT MAY NOT BE AS IMPORTANT AS PEOPLE CLAIM!!!

• Because you plan to stop working at some point, you must eventually consume less than you earn. In other words, individuals have to save. Governments do not retire. So they do not have to save.
• In other words…government debt is ongoing, but individual debt must eventually be repaid.
• Because government never retires and always earns an income, markets may be willing to lend at very low rates. This is especially true for very rich countries (like the U.S.). The current interest rate on U.S. debt is close to 0%.

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MORE ON HOW GOVERNMENT DEBT IS DIFFERENT

• Government can print money to pay off debt. Although this is not generally a good idea, people – and some nations – do not have this option. And when this option does not exist, debt can become a very big problem.
• As we will see… most of the government’s debt is internal debt, or debt owed to the government (yes, the government owes money to itself) or to its citizens.
• Paying interest on internal debt redistributes income, but does not cause a net reduction in income of the average citizen.

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OWNERSHIP OF THE DEBT�FROM DAVID COLANDER

17-11

THE DEBT TO GDP RATIO

• The household analogy doesn’t work (again, you are not a government). But thinking of households does offer some insight.
• Imagine a household borrows $200,000. Is this a good decision?
• If a person only earns $10,000 a year, then no.
• If a person earns close to $100,000 a year, then this is not a bad financial decision.
• Key point: We need to consider income – or GDP – in evaluating the national debt.

BACK TO WORLD WAR II

• From 1940 to 1946, the national debt increased from $40 billion to more than $260 billion. So debt went up 6 times (debt has increased about 6 times from 1987 to 2011).
• The Debt-to-GDP ratio in 1946 was 1.21 (or 121%)
• What happened to this debt? From 1946 to 2011, the national debt has only declined 5 times and we only reduced the amount by $23 billion. In other words, we never paid the debt from World War II.
• So what happened?

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WHY DEBT MAY NOT MATTER OVER TIME

• From 1946 to 2011, nominal GDP has increased from about $220 billion to nearly $15 trillion.
• That means our debt from World War II is simply insignificant compared to the size of our national economy.
• Remember what we said before…

Economic Growth in the 19^th century�(from EH.net)

Economic Growth in the 20^th century� (from EH.net)

Growth Happens!!

• Real GDP per-capita has increased in every decade in U.S. history.
• Growth was faster in the 20^th century (relative to the 19^th century).
• Average annual growth in the 20^th century was about 2% per year.
• For the past 100 years….
• Real Gross Domestic Product has increased (on average) 38.4% in each decade
• Real GDP per capita has increased (on average) 22.5% in each decade

Here is the 21^st Century (assuming growth continues as it has for the past 100 years)�AND YES, that is $102 trillion in 2070 with average income above $150,000!!�How much will $15 trillion in debt matter if Real GDP passes $20 trillion? Or $50 trillion? Or $100 trillion?

U.S. DEBT AS PERCENTAGE OF GDP�FROM DAVID COLANDER (AS OF 2008 OR SO)

Debt as Percentage of GDP

1800 1840 1880 1920 1960 2000

100

75

50

25

17-19

PUTTING U.S. DEBT INTO PERSPECTIVE: HISTORY OF DEBT IN THE UNITED KINGDOM

U.S. DEBT COMPARED TO FOREIGN COUNTRIES’ DEBT�FROM DAVID COLANDER (AS OF 2008 OR SO)

The U.S. debt does not appear so large when compared to the debts of some other countries

17-21

how much U.S. Debt does china have?

• Debt held by China:
• US debt holdings: $1.173 trillion
• http://www.treasury.gov/resource-center/data-chart-center/tic/Documents/mfh.txt
• In other words, China owns about 8% of the U.S. national debt.
• Japan holds about 6.3% of our debt. The United Kingdom is third on the list, with 2.4% of our debt.
• Why do these nations hold our debt? These nations hold U.S. debt for the same reason anyone else holds U.S. debt: U.S. treasuries are a very safe investment and a very liquid investment.

Where did our current debt come from?

• The driving factors behind our current debt include
• the recent recession (tax revenues declined, while expenditures like unemployment compensation increased)
• Tax cuts under President Bush
• Wars in Iraq and Afghanistan
• Stimulus package
• Without these factors, national debt would not be growing much over the next 10 years.

Future Debt issues

• What will debt look like in the future?
• http://cbo.gov/ftpdocs/122xx/doc12212/2011_06_22_summary.pdf
• According to the Congressional Budget Office, it depends on the policies we enact. If we maintain current law (i.e. allow Bush tax cuts to expire, implement the Affordable Care Act, etc…) the CBO projects a debt to GDP ratio that is fairly similar to the current ratio in 25 years.
• If we continue with tax cuts, this ratio may be will over 200% in 25 years.

Tax cuts vs. Increases in spending

• Imagine the government decided to increase the pay of Professor Berri (because he is so wonderful). This is an increase in government spending.
• Imagine the government decided to cut the taxes of Professor Berri (because he is so wonderful). This is a decrease in taxes.
• Both policies put more money in Professor Berri’s pocket. And if that money is spent, both policies will stimulate the economy.
• When does government want to stimulate the economy?
• What happens if the government keeps trying to stimulate the economy?

What is the impact of government borrowing on an economy at full-employment?

• If an economy is at full-employment (and we are not at the moment), then a large national debt crowds out private investment.
• This increases interest rates and depresses the economy.
• Hence, we don’t want the government borrowing large sums of money forever.
• Yes, as the economy grows, debt doesn’t matter. But if the government is borrowing large sums in a fully employed economy, you won’t stay fully employed for long.
• In sum, government debt can have adverse consequences. But it is not the case that it will destroy the nation.
• So DON’T PANIC!!!

How markets evaluate U.S. Debt

• from Ezra Klein… “The “yield” on Treasury debt is how much the government pays to borrow money. The “real yield” is how much it pays to borrow money after accounting for inflation. When the “real yield” turns negative, it means the government isn’t paying to borrow money anymore. Rather, the situation has flipped, and the government is getting paid to keep money safe.”
• When the current real yield is negative, markets are saying that government debt is willing to give money to the government for free.
• Why would they do this?