Barron's on Government Debt (and a Mention of Financial Armageddon)

History has clearly shown that governments take to debt like a fish to water.

One reason, of course, is that politicians can make expensive promises today that generally won't become due and payable until years later (i.e., after they've left office).

Eventually, though, the illusion ends -- and a day of reckoning begins.

That is at the heart of a column by Barron's editorial page editor Thomas G. Donlan, "A Penny for an Old Book" (which also happens to mention Financial Armageddon).

You were warned: the warning said that in a certain year, ". . . the United States of America, as we know it today, will cease to exist. That year, the country will have spent itself into a bankruptcy from which there will be no return. What we once called the American Century will end, literally, with the end of the American way of life -- unless you and I act now to pull ourselves and the country back from near-certain oblivion."

That certain year of disaster, however, was 1995. Harry E. Figgie Jr. first issued the warning in Figgie International's 1985 annual report. Government debt, he said, was growing out of control. The trend would culminate in 1995, when all the tax revenues of the federal government would not suffice to pay the interest on the national debt.

Figgie repeated his warning many times, buttressed with calculations provided by an economist, Gerald J. Swanson. People listened. Figgie and Swanson published Bankruptcy 1995, which enjoyed more than nine months on best-seller lists in 1992 and 1993.

Used-book listings on Amazon show that Bankruptcy 1995 is widely available for a penny, plus $3.99 shipping.

We have been warned before. Thomas Jefferson, who spent $27 million to purchase Louisiana but was frugal enough to reduce the national debt from $83 million to $57 million in eight years, said that public indebtedness was "the greatest danger to be feared."

The War of 1812 seemed a greater danger to his successor, James Madison, and the country survived having a debt of $123 million. Real danger only appeared when the country freed itself from its debt during the administration of Andrew Jackson.

Post-war arrangements to pay off the debt included the sale of public lands that had cost the government nothing. Purchasers' payments were financed by bank loans on easy terms, since everyone knew that vast profits could be made on the resale of land to new immigrants, new cotton planters and new developers of new towns. Payments for land deposited to the Bank of the United States helped retire the national debt, putting liquidity in the hands of former bondholders, many of them bankers who could then lend for more speculation in land. The phrase "doing a land-office business" entered the American language at this time.

On Jan. 1, 1835, the United States was officially debt-free. This happy condition lasted two years and a bit -- five weeks longer than Jackson's presidency. The Jacksonian boom of development and real-estate speculation accelerated, further fueled by foreign capital and foreign creditors. It came to a crashing end in the Panic of 1837. The conversion of bank currency into gold was first dubious, then made mandatory, then suspended, then made irrelevant by a wave of bank failures.

Historian Edward M. Shepherd summarized the situation in his biography of Martin Van Buren, the unlucky president who followed Jackson and received the blame for the ensuing depression:

"Fancied wealth sank out of sight. Paper symbols of new cities and towns, canals and roads were not only without value, but they were now plainly seen to be so. Rich men became poor men. The prices of articles in which there had been speculation sank in the reaction far below their true value."

The United States did not go out of business in the Panic of 1837 and the following depression, nor in the cyclical panics and depressions and recessions that followed through the decades. Each time, individuals suffered dispossession of their homes and the loss of what they imagined was their monetary wealth.

The development of the United States continued. Immigrants did not stop setting up farms and businesses. Miners did not stop mining, traders did not stop trading and, most importantly, capitalists did not stop investing.

John Jacob Astor, who had made a good-sized fortune in the fur trade, sold out in 1834. He had gold when others had paper, so he was able to buy Manhattan properties for cash. He leased them back to the sellers for 5% of the purchase price per year. Such transactions saved the sellers' homes and businesses and made Astor one of the richest men in the country. Other capitalists also made their fortunes in distressed real estate in other cities.

Capitalists also rose to the occasion or the bait, in the other panics. The Great Depression was the first in which government attempted to impose solutions, and it lasted longer, with worse pain, than any other.

Even in the 1990s, capitalists were at the center of the solution. The Clinton administration acquired a healthy fear of "bond-market vigilantes."

Interest rates fell even as the national debt was piling up. Figgie and Swanson had projected a $6.5 trillion national debt in 1995 with interest payments of $619 billion. The debt was only a little lower than their ferocious projection -- it came in at just under $5 trillion -- but interest expense in 1995 was only $332 billion.

The government had increased taxes and slowed the growth of spending for a time, and investment capital, foreign and domestic, flowed into U.S. stocks, corporate debt and government bonds. The returns on capital were reinvested in a more productive economy, and taxes on investment profits were reduced, not raised. A few years after the expected disaster, the U.S. very nearly ran a real surplus, and did report budget surpluses for three years.

Running a surplus, however, merely encouraged higher spending and lower taxes. By 2004, after tax cuts and war spending, Swanson was back with a new book, America the Broke, and other authors joined the doomsday chorus. Financial Armageddon, by Michael J. Panzner, spread scorn all over the mortgage-backed securities market in 2006, a year or more before most financial writers knew what CDO stood for.

This year, the national debt is on track to surpass $10 trillion, not counting another trillion or two of mortgage debt that won't be paid back unless the federal government does it, or allows capitalists to pick up the pieces of a shattered market.

You have been warned. Again.

Comments

[Independent Accountant]

I've been saying things like this for 28 years. Eventually the dollar will hyperinflate out of existence and the US will see the rise of an American Napoleon. Just wait.

[Aaron Krowne]

Figgie and Swanson were right. Or should have been.

Figgie didn't count on Greenie making reserve requirements obsolete and the Japanese implementing a ZIRP just in time for 1995 to roll around. They scraped to the bone and pulled unrivalled levels of liquidity into the US at that time.

The result is visible in any inflation adjusted chart of major US markets spanning the last 20 years... a gigantic dollar, stock, and real estate bubble starting almost exactly in 1995.

In effect it has all been a supernova blow-off phase of economic binging dating back to the collapse of Bretton-Woods.

We're just now starting to get the hangover.

[Debtus Maximus]

Well there seems to be one industry that's recession proof:
http://www.liveleak.com/view?i=0ab_1207948795

[dearieme]

Cheer up; if you start The American Century at 1945, there's still more than 30 years to go.