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Todd Buchholz draws parallels to the World War II era and proposes solutions for avoiding a fiscal cliff

Todd Buchholz draws parallels to the World War II era and proposes solutions for avoiding a fiscal cliff

The United States today not only looks ill, but dead broke. To offset the pandemic-induced “Great Cessation,” the US Federal Reserve and Congress have marshaled staggering sums of stimulus spending out of fear that the economy would otherwise plunge to 1930s soup-kitchen levels. The 2020 federal budget deficit will be around 18% of GDP, and the US debt-to-GDP ratio will soon hurdle over the 100% mark. Such figures have not been seen since Harry Truman sent B-29s to Japan to end World War II.

Assuming that America eventually defeats COVID-19 and does not devolve into a Terminator-like dystopia, how will it avoid the approaching fiscal cliff and national bankruptcy? To answer such questions, we should reflect on the lessons of WWII, which did not bankrupt the US, even though debt soared to 119% of GDP. By the time of the Vietnam War in the 1960s, that ratio had fallen to just above 40%.

WWII was financed with a combination of roughly 40% taxes and 60% debt. Buyers of that debt received measly returns, with the Fed keeping the yield on one-year Treasuries at around 0.375% – compared to the prevailing 2-4% peacetime rates. Ten-year notes, meanwhile, yielded just 2%, which actually sounds high nowadays.

These US bonds, most with a nominal value of $25 or less, were bought predominantly by American citizens out of a sense of patriotic duty. Fed employees also got in on the act, holding competitions to see whose office could buy more bonds. In April 1943, New York Fed employees snapped up more than $87,000 worth of paper and were told that their purchases enabled the Army to buy a 105-millimeter howitzer and a Mustang fighter-bomber.

Patriotism aside, many Americans purchased Treasury bonds out of a sheer lack of other good choices. Until the deregulation of the 1980s, federal laws prevented banks from offering high rates to savers. Moreover, the thought of swapping US dollars for higher-yielding foreign assets seemed ludicrous, and doing so might have brought J. Edgar Hoover’s FBI to your door.

While US equity markets were open to investors (the Dow Jones Industrial Average actually rallied after 1942), brokers’ commissions were hefty, and only about 2% of American families owned stocks. Investing in the stock market seemed best-suited for Park Avenue swells, or for amnesiacs who forgot the 1929 crash. By contrast, a majority of American households own equities today.

In any case, US household savings during WWII were up – and largely in bonds. But Treasury paper bore a paltry yield, a distant maturity, and the stern-looking image of a former president. How, then, was the monumental war debt resolved? Three factors stand out.

First, the US economy grew fast. From the late 1940s to the late 1950s, annual US growth averaged around 3.75%, funneling massive revenues to the Treasury. Moreover, US manufacturers faced few international competitors. British, German, and Japanese factories had been pounded to rubble in the war, and China’s primitive foundries were far from turning out automobiles and home appliances.

Second, inflation took off after the war as the government rolled back price controls. From March 1946 to March 1947, prices jumped 20% as they returned to reflecting the true costs of doing business. But, because government bonds paid so much less than the 76% rise in prices between 1941 and 1951, government debt obligations fell sharply in real terms.

Third, the US benefited from borrowing rates being locked in for a long time. The average duration of debt in 1947 was more than ten years, which is about twice today’s average duration. Owing to these three factors, US debt had fallen to about 50% of GDP by the end of Dwight Eisenhower’s administration in 1961.

So, what’s the lesson for today? For starters, the US Treasury should give tomorrow’s children a break by issuing 50- and 100-year bonds, locking in today’s puny rates for a lifetime.

To those who would counter that the government might not even be around in 50 or 100 years, it is worth noting that many corporations have already successfully auctioned long-term bonds of this kind. When Disney issued 100-year “Sleeping Beauty” bonds in 1993, the market scooped them up. Norfolk Southern enjoyed a similar reception when it issued 100-year bonds in 2010. (Imagine, buying century bonds from a railroad.) And Coca-Cola, IBM, Ford, and dozens of other companies have issued 100-year debt.

Notwithstanding the fact that many institutions of learning have been compromised by the pandemic, the University of Pennsylvania, Ohio State University, and Yale University also have issued 100-year bonds. And in 2010, buyers even grabbed Mexico’s 100-year bonds, despite a history of devaluations stretching back to 1827. More recently, Ireland, Austria, and Belgium all issued 100-year bonds.

To be sure, a longer duration will not be enough to solve the debt problem; the US also desperately needs to reform its retirement programs. But that is a discussion for another day.

Finally, what about the post-war experience with inflation? Should we try to launch prices into the stratosphere in order to shrink the debt? I advise against that. Investors are no longer the captive audience that they were in the 1940s. “Bond vigilantes” would sniff out a devaluation scheme in advance, driving interest rates higher and undercutting the value of the dollar (and Americans’ buying power with it). Any effort to inflate away the debt would result in a boom for holders and hoarders of gold and cryptocurrencies.

Unlike military campaigns, the war against COVID-19 will not end with a bombing raid, a treaty, or a celebrations in Times Square. Rather, the image we should bear in mind is of a ticking time bomb of debt. We can defuse it, but only if we can win the battle against policy inertia and stupidity. This war won’t end with a bang, but it very well could end in a bankruptcy.


Todd G. Buchholz, a former White House director of economic policy under George H.W. Bush and managing director of the Tiger Management hedge fund, was awarded the Allyn Young Teaching Prize by the Harvard Department of Economics. He is the author of New Ideas from Dead Economists and The Price of Prosperity. Copyright 2020 Project Syndicate, here with permission.

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12 Comments

I'm not sure what to say after reading that lot, except, I hope there's someone in charge of the books that has a better idea of what to do than what's suggested above (and that isn't much!).
The sad fact, though, is ...there isn't.

To be sure, a longer duration will not be enough to solve the debt problem; the US also desperately needs to reform its retirement programs.
Hmmmmm......

The rebound isn’t being very bouncy, for one thing, no matter how many gigantic gobs of purported “stimulus” has been thrown at the economy. It ain’t stimulating. The number of jobs still being lost this late into it is unthinkable; historic.

I wrote a couple days ago about another key factor which appears to be what the productivity estimates have revealed; the terrifying possibility that though there’s been more job losses than at any time in history there may not yet have been enough of the longer-run variety to balance business perceptions of far lower post-GFC potential.

Before even getting to July, this divergence between hours and headline payrolls had already suggested that companies may have been holding on to more workers than the decline in output would’ve demanded. In other words, the level of output and actual work performed had declined more than the reduction in headcounts, by a lot more, leaving us to suspect businesses were holding back a sort of reserve of their own workers (who were still on the books but idle nonetheless) having them at-the-ready for when reopening got started.

Those are both (unemployment and productivity) relatively familiar numbers. Now along comes the IRS, of all places, to put even more disturbing emphasis on this idea. The government’s tax collector is preparing itself for severe, and permanent, shrinking in the labor market.

Yesterday, the agency released its estimates for Publication 6961 (h/t Bloomberg). And the update to that release will make your blood run cold (while oddly explaining the NASDAQ).
Link

“Ticking Time Bomb of Debt”. Globally, both an individual and government level. And the answer...... drum roll....... More Debt!!! We are all being led down the dead end one way street of debt with no plan by any government or central bank anywhere in the world to get us out of it. When governments and individuals are up to their necks in debt your choices are limit. Take what is on offer or drown.

We will not get out of this by just doing more of the same. We need very smart, innovative businesses. Banks need to lend to these businesses. The government and the Millionaires/ billionaires of NZ need to show their support by offering to guarantee and fund these new businesses. Without it we are dead in the water. Selling houses to each other will not to allow us to grow. It’s an old trick which has worked for the last 30 years but the associated debt burdens will cripple us unless we change.

In essence, you've probably hit the nail on the head.
The answer is, more productive enterprise and less speculative.
There's nothing wrong with speculation IF it's done with the excess returns from proceeds of productive effort, and if you lose it YOU lose it. Want to buy a second house as a speculative asset? Go right ahead - with your own savings and not new debt.
There's nothing wrong with debt per se IF it returns more than it costs from productive effort ( and today, even at 0%, it doesn't, and making debt cheaper just exacerbates the problem)
We should have learned all this 100 years ago, and we did. It's just that we forgot the lessons; thought we knew better with all the risk minimisation tools that we have available today, and that 'things are different'.
The answer is easy; make debt productive and not speculative. But doing that now is nigh impossible.

I agree 100%. Well said.

Dated, but what's changed for the better since 2017?

For most of the 20th century, stock buybacks were deemed illegal because they were thought to be a form of stock market manipulation. But since 1982, they were essentially legalized....Now, I have some theories on why stock buybacks have gotten so out of control. Mostly, I think it’s because we’re in a period of massive technological disruption. New industries like cloud computing, electric cars, and streaming video are rapidly changing the world. But in my opinion, older companies like HP have been too slow to adapt, and rather than investing in research and development (or simply holding onto cash) the corporate boards of legacy businesses are bolstering stock prices the only way they know how: playing defense and buying back stock.
Buybacks are supposed to be funded with excess cash that the business doesn’t need for innovation or expansion (not even more debt).

https://www.forbes.com/sites/aalsin/2017/02/28/shareholders-should-be-re...

China and Russia have been slowly pulling out of trading with the USD for years. The clock is ticking on the USD being the worlds reserve currency, time is running out for America in more ways than one. Weapons of war are no longer required when you can use the financial system and just wait for the USA to implode on its own.

Problem is, what will be the viable replacement?

The USA could recover some of its reputation by replacing Trump and moving toward more stability over time. The Euro looks a bit shaky as a viable replacement. The yuan suffers from the CCP and its reputation.

The NZ peso perhaps? Bitcoin?

Why we should worry about America's growing debt, when the Americans themselves don't.
If it gets too out of control, they can always nationalise Google, Apple, Amazon and Tesla and pay off the world and the Chinese who have lent them the most.

Or start to sell of their oil reserves which they dominate as the bigest producer in the globe.

Individuals and businesses can become bankrupt but sovereign currency issuing governments cannot. They can in fact only borrow back what they have previously created through their spending. Spending occurs first and borrowing back happens afterwards, where else can US Dollars come from but the US Government?