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Time to Worry
James Grant

It took the United States 193 years to accumulate its first trillion dollars of federal debt. We will add that much in the current fiscal year alone.

America’s deteriorating public credit is the cold-button issue of the 2018 midterms. With rare bipartisanship, Democrats and Republicans compete to pretend that the country isn’t going broke. In 1992, the third-party presidential candidate Ross Perot likened the widening gap between federal receipts and federal spending to “the crazy aunt tucked away in the room upstairs nobody talks about.” The old gal’s dottier than ever.

It took the United States 193 years to accumulate its first trillion dollars of federal debt—the gross debt, as it’s called. We will add that much in the current fiscal year alone. All told, the government owes $21.5 trillion, give or take a few careless tens of billions—that works out to $65,885 for each American. It’s the ease of borrowing that drives the growth in federal IOUs.

The remote political cause of this predicament is the ideology of statism. In Washington, this takes the form of tax and tax, spend and spend, elect and elect; on Wall Street, it’s found in too-big-to-fail, a virtually socialized mortgage market, and an overreaching, manipulative central bank.

The remote monetary cause of our troubles is the closing of the gold-standard era in 1971, or what little remained of it by then. It was the breakdown of the fixed monetary order that opened the floodgates. From Alexander Hamilton to Richard Nixon, the dollar was an IOU, a promise to pay gold or silver at a fixed rate. It subsequently became a thing unto itself, an IOU nothing. In consequence, for the past several decades, federal liabilities have grown faster than the national income with which to service them. Ultra-low interest rates have cheapened the cost of this profligacy and hidden the looming dangers.

The sophists and economists who contend that we ought to borrow because, at an interest rate only slightly over 2 percent, we can hardly afford not to borrow, have a point of a kind. In 1988, on a debt of $2.6 trillion, the Treasury paid net interest of $152 billion. In the just-ended fiscal year, on $21.5 trillion of debt, the Treasury paid net interest of $371 billion. Thus, over the past 30 years, the debt jumped by 727 percent, the cost of servicing it by just 144 percent. To the casual question, “What’s the harm in the Treasury’s availing itself of the market’s over-generous hospitality?” there is no casual, tweetable answer.

Common sense dictates that debt ought not to be easily incurred, but common sense is not an unfailing guide to federal finances. Even the $21.5 trillion gross debt (so called because it encompasses the obligations that one branch of government owes another) is only slightly larger than a single year’s GDP. If the voters chose, they could elect politicians to erase the debt in its entirety, as Thomas Jefferson tried to do, as Bill Clinton talked about doing, and as Andrew Jackson, in 1835, actually did. (“An unprecedented spectacle is thus presented to the world, of a Government . . . virtually without any debt,” Jackson’s secretary of the Treasury, Levi Woodbury, boasted.) Or the government could sell its assets, applying the proceeds to debt reduction. What might the Grand Canyon fetch in an honest auction?

But the 21st-century Treasury is under no pressure to take such actions. Its creditors, for now, seem perfectly happy. Though the supply of government securities on offer this fiscal year, from all sources, including the Federal Reserve, is projected to be the greatest, as a percentage of national output, since World War II, interest rates have risen only by enough to rattle President Trump and (at this writing) the stock market; the government is still easily financing its $3.9 billion or so of daily new borrowing needs. The dollar-exchange rate likewise signals complacency. In the worldwide laundromat of fiat money, the dollar is the cleanest dirty shirt.

Certainly there is no audible clamor for debt reduction, let the Committee for a Responsible Federal Budget, the Concord Coalition, and Grant’s Interest Rate Observer scold as they might. Still-elevated stock prices and a 49-year low in the unemployment rate are not the kind of data to instigate financial anxiety, and the projected depletion of the Social Security and Medicare trust funds’ surpluses in 2020 is too contingent, and too distant, an event to prompt a professional speculator to dump Treasury bonds.

The Democratic party, from Jefferson to Grover Cleveland to the fleeting moment in 1999 when Clinton dangled the prospect of a national mortgage-burning in the year 2015, was the party of hard money and a presentable balance sheet. Up until the 1960s, there was a predictable rhythm to the movement of the national debt in proportion to output. It rose in wartime and fell, or at least stopped rising, in peacetime. During the War of 1812, Albert Gallatin, secretary of the Treasury under James Madison (and under Jefferson before him) went so far as to urge that military operations be subordinated to fiscal considerations, rather than the other way around. The frugal Gallatin was guilty of bean-counting for the sake of bean-counting.

In the 20th century, the Republican administrations of Warren G. Harding, Calvin Coolidge, and Dwight D. Eisenhower nobly emulated the early Democratic examples, not necessarily to extinguish the debt but to keep it manageable. Now neither major party espouses the old-time fiscal and monetary canons, let alone seeks to restore them.

America was born indebted in 1789, and Hamilton famously called those Revolutionary War obligations, if properly funded, a “national blessing.” But there was a codicil. “[T]he creation of debt should always be accompanied with the means of extinguishment,” he said. Here was the “true secret for rendering public credit immortal.”

If you attended the same undergraduate economics classes I did in the 1960s, you learned that the debt was immortal. And so it should be, said the Keynesian at the blackboard. When a bond falls due, the Treasury will simply issue another one; somebody will buy it at one price or another. You learned, too, that the public’s debt is unlike anyone else’s. It’s not really an encumbrance but an instrument of macroeconomic stabilization. Federal spending, with dollars procured by borrowing, stimulates business activity, according to this worldview. There was, however, nothing said about the utility of a trillion-dollar deficit in a time of supposedly bounding prosperity. The silence on that point foreshadowed a great fiscal truth. The truth is that in the absence of monetary or market constraints, federal borrowing begets more federal borrowing.

If statism is the debt-facilitating doctrine of the left, “growth” is the debt-rationalizing ideology of the right. Pro-growth conservatives preach, correctly, that only a strong economy can produce the goods and services with which to meet tomorrow’s vast entitlement bills. But these happy fiscal warriors forget that the government has a balance sheet as well as an income statement. They carelessly overlook the risk that the worsening federal finances themselves could undermine economic growth.

The bulge in capital-gains tax receipts during the 1998-99 stock-market bubble helped to produce the first federal budget surplus since 1969. With it came a lively debate over what to do with the unspent funds. Invest them, urged the left. Return them to the taxpayers, countered the right. There was no gainsaying the correctness of the proposition that the money belongs to the people, not to the state. Nor was it clear, as the editors of the Wall Street Journal observed, that paying down the debt would have positive effects: “In the high-growth 1950s, federal debt as a percentage of gross domestic product ran almost double what it did during the low-growth 1970s.” But the Journal pushed its argument past the breaking point. “Debts and deficits and surpluses are accounting identities,” the editors wrote. “They are not the actual engines of economic growth. Not all that long ago, paying down national debt was considered a quaintly archaic notion.”

Quaintly, the Founders themselves, finding sanction in the ideas of Blackstone, Montesquieu, and Pitt the Younger, established a special fund—a sinking fund—to do just that. In truth, the sinker was a kind of gimmick, albeit a purposeful one, its purpose being to erase the public debt, “that wasting canker of the nations,” as Martin Van Buren later put it. The sinking fund retired its last government security in 1960.

More significantly, the Founders established a dollar defined as a weight of precious metal: first of silver, later of gold and silver, finally of gold alone. Writing in 1830, Gallatin asserted that the Constitution afforded “a complete security against the danger of paper money” and that if further authority on the monetary utility of the precious metal were required, a skeptic could consult the Book of Genesis.

From 1789 till 1971, with time out for the Civil War, America’s bank notes were convertible under law into precious metal at a fixed and statutory rate. By the time the sand ran out on the gold standard, only foreign governments enjoyed the right to exchange their promises to pay (a dollar being a note, or debt obligation, a promise to pay as opposed to money itself) for gold at the then-fixed rate of $35 an ounce. And when the foreigners sought to exercise their rights more vigorously than the depleted American gold store could bear, Nixon ordered the Treasury to suspend payment. Henceforth, the dollar would be just as good as paper or, subsequently, a digital representation of paper; the date was August 15, 1971.

Modern economists, their heads turned neither by the Constitution nor the Old Testament, contend that the gold standard is an anachronism that, if reinstituted, would tie the government’s hands and consign the nation to deflation. They are wrong about that, although, admittedly, there is something anachronistic in the image of a willful political class subordinating its electoral interests to the higher cause of the integrity of the dollar. Then again, there is nothing so very new about the money-printing alternative, either. John Law invented “quantitative easing” in France 300 years ago, from which followed a legendary boom and a gaudy bust. Anyway, not even the flower of the Harvard economics department would deny that the discipline of a convertible currency checks a government’s ability to overspend and overborrow. It was to buy guns and butter and to establish a schedule of perpetual entitlements that the administrations of Lyndon Johnson and Richard Nixon found it necessary, first, to loosen the fetters of the Bretton Woods system (the halfway gold standard put in place after World War II) and, in 1971, to abandon any idea of a monetary anchor. Thus was born the Ph.D. standard, the system of monetary management by former tenured economics faculty that reached its apogee under Dr. Ben S. Bernanke in the wake of 2008. Under the Bretton Woods regime, there could have been no wasting canker such as the one that gnaws today.

The second trillion dollars of gross federal debt came on the books in 1986, four years after the first. Five trillion was the grand total in 1996, $10 trillion in 2008, and $20 trillion in 2017. Since the suspension of dollar convertibility in 1971, growth of the debt has outpaced growth in GDP, a rough and ready expression of the nation’s ability, if not its willingness, to pay. The debt has registered compound annual growth of 8.8 percent, the GDP of 6.3 percent. On current trends, GDP will be hard-pressed to close the gap.

Under the Ph.D. standard, the dollar has become America’s greatest export. It costs us nothing to produce, and only we may lawfully print it. The Google or Coca-Cola of monetary brands, it passes for value the world over. Spending it, we may—and we do—consume much more than we produce, putting the balance on the tab.

Under the true-blue gold standard, nations settled up accounts in commercial bills exchangeable into gold or, less frequently, in the metal itself. To get money, you dug it out of the earth or attracted it with high interest rates or fetching investment opportunities. Some gold-standard-bound nations, of course, were more powerful than others (Britain ruled the roost until 1914), but the system inherently advantaged no one participant over the others.

The post-1971 regime advantages the United States. Or, rather, it confers on us an advantage that we may regret having availed ourselves of. Possessing a currency that doubles both as America’s money and the world’s, we’ve been able to run up deficits domestic and foreign, to “acquire without paying,” as the French economist Jacques Rueff put it in 1972. We pay with our magic dollar-printing press, allowing, as Rueff observed, “deficits without tears.”

Just how long this dry-eyed state of being may last is, of course, the great question. Analysts at Bank of America Merrill Lynch suggest that, at the least, America is trading on her might and majesty rather than plain arithmetic. They add our budget deficit to our trade deficit (technically, the deficit on the current account) and then divide that sum by our forecast GDP. The answer—the twin deficits as a percentage of anticipated national output—comes out to minus 7.3 percent. It places the United States 41st in a field of 45 countries, behind South Africa and ahead only of Argentina, Turkey, Brazil, and Pakistan. Singapore is tops, at positive 18.5 percent.

Again, according to projections by the International Monetary Fund concerning the 36 member states of the Organisation for Economic Co-operation and Development, only the United States, Turkey, South Korea, and Chile will register a rising percentage of gross government debt to GDP over the next five years. It’s American exceptionalism, all right, though perhaps not the kind that the Founders were thinking of.

Shortly after the 2002 midterm elections, Dick Cheney was overheard to say, “Reagan proved deficits don’t matter.” If those were Cheney’s words, and if by “matter,” the vice president was alluding to the sensitivity of interest rates to shortfalls in federal revenue against federal receipts, he was as right as rain. Under Ronald Reagan, the public debt more than tripled but interest rates (at their extreme high and low readings) were sawed in half. When Cheney made his remark the 10-year Treasury note was being quoted at 4 percent. But interest rates continued to push lower, such that on July 8, 2016, the 10-year security yielded less than 13/8 percent, the lowest recorded on an obligation of a leading global sovereign borrower in 743 years, according to a study prepared for the Bank of England.

Franklin D. Roosevelt ran for president in 1932 on a balanced-budget platform, but proceeded to run up deficits that seemed immense at the time. There are three things to say about these Depression-era shortfalls. They did not restore prosperity, they did not raise long-term interest rates, and they did not come close to setting modern peacetime borrowing records. In 2009, the first year of the Obama presidency, the deficit reached 9.8 percent of national output; Roosevelt’s maximum effort was 5.8 percent, in 1934.

Perhaps what the borrowing records of Reagan and Roosevelt illustrate is not that deficits don’t matter but that the forces that drive the movement of interest rates are more complex than the condition of the balance sheet of even a great power. In obedience to laws nowhere spelled out, interest rates have tended to rise and fall in long cycles. Thus, in America, they were down from the 1870s till 1900, up till 1920, down till 1946, up till 1981, and down till 2016. And now, perhaps, they are going up.

Steven Mnuchin can only hope that they’re not, or at least not very fast. This fiscal year, a 1 percentage-point rise in net borrowing cost, to 3 percent or so, would cost taxpayers an extra $163 billion. As recently as the 1990s, the Treasury paid an average cost of 6.6 percent. Apply that rate to this year’s projected debt, and net interest expense would top $1 trillion. For perspective, in the just-ended fiscal year, Social Security outlays totaled $977 billion.

The thoughtful citizen, no less than the professional speculator, would like to know when to worry. There have been many false alarms—the first $1 trillion of gross public debt seemed scary, too, in 1982.

It is important to realize that the financial future is unpredictable, the pretensions of the Wall Street forecasting profession notwithstanding. The nil public debt that Bill Clinton projected for 2015 turned out to be $18.2 trillion instead. War, politics-as-usual, and a pair of recessions, including the Great Recession, took him by surprise—as they did so many others. There’s no reason to think that bearish forecasts are likely to prove any more prescient than bullish ones.

But we do know some things and may plausibly speculate about others. For instance, we know that if the debt keeps growing at a faster rate than GDP, there will be a debt crisis.

We know, thanks to John F. Cogan’s 2017 study The High Cost of Good Intentions, that in 2015, 55 percent of American households received a check from one or more of the major federal entitlement programs. In a contest between the entitlement constituency and the federal balance-sheet-improvement constituency, the balance sheet will surely come in second.

We know there is no magic threshold of gross debt to GDP below which a government is safe and above which a government is in jeopardy. Japan, though 238 percent encumbered, has near-zero interest rates and complacent creditors (notably its captive central bank). Italy, though 132 percent encumbered, has restive creditors. The United States, at 106 percent, is, like Japan, seemingly at peace with its lenders, though sentiment can change. Just the other day, the Wall Street Journal reported that overseas buyers of U.S. government securities had invested only half as much in the first eight months of 2018 as they had in the same period of 2017.

And we know that since 2016, interest rates have been rising. We know that the Federal Reserve has stopped buying bonds and begun selling them. We know that sooner or later, there will be a recession and that in a moderate downturn, a $2 trillion deficit may well be in the cards (there’s a $1 trillion deficit on tap in today’s boom).

Finally, we know that America’s credit record is not unblemished. The government defaulted on domestic bondholders in 1814 (it happened to be the year that the British burned down the public buildings in Washington). By devaluing the dollar against gold, it defaulted in 1933-34 and again in 1971. Suffering the Great Inflation, it defaulted in all but name in the 1970s, when creditors received dollars much less valuable than the ones they had lent.

As recently as 2011, Barack Obama’s chief political adviser, David Plouffe, speaking on the eve of that summer’s threatened government shutdown, dismissed as “inconceivable” the idea that if push came to shove, the government would pay creditors before pensioners. “The notion,” said Plouffe, “that we would just pay Wall Street bondholders and the Chinese government and not meet our Social Security and veterans’ obligations is insanity and is not going to happen.” It is not inconceivable that the chief political adviser to an Elizabeth Warren or Bernie Sanders White House would say the same. Credit, ultimately, is an opinion, and America’s creditors may wake up one morning and change their minds about either the ability or willingness of this country to meet its obligations.

Therefore, taking one thing with another, I would advise worrying now.

Might we do anything else? Long-term solutions to the problem exist. We could, for instance, raise federal revenue by broadening the tax base while lowering and flattening the rate. Steve Forbes has been pushing the idea for years. We could—arguably, we must—replace the Ph.D. standard with a 21st-century variant on the classical gold standard, as the monetary theorist Lewis E. Lehrman has long espoused. No, we would not all carry $20 gold pieces in our pockets. We would continue to pay with our plastic, and our phones, but the money on which we draw would finally be convertible into grams of that tangible, ductile, eternal precious metal. And while we’re at it, we could get the Federal Reserve out of the business of manipulating long-term interest rates, which, after all, are prices and ought not to be under the government’s thumb. Let them be discovered in the market, like the price of corn and soybeans.

Each of these propositions will sound farfetched. Steve Forbes is not president, and the pure paper dollar is the only dollar that most Americans have known. Monetary habits, even the unwholesome ones, die hard, as the so-far-unsuccessful Citizens to Retire the U.S. Penny can attest.

Better to begin with the humble hope that someone, maybe a Republican or a Grover Cleveland Democrat, says something about the scandal of the national balance sheet. It is no opinion, but an arithmetic truism, that our debts are growing faster than our means to discharge them. It strains credulity to think that our creditors are unaware of the fact. Some of us fret about foreign hackers tilting American elections with lies. We should all spare a worry about hackers causing a bond-market crisis by spreading the truth.

Auntie in the attic needs our help.

James Grant was born in 1946, the year interest rates put in their mid-20th century lows. He founded Grant’s Interest Rate Observer, a twice-monthly journal of the financial markets, in 1983, two years after interest rates recorded their modern-day highs.

Born in New York City and raised on Long Island, he had thoughts, first, of a career in music, not interest rates—french horn was his love. But he threw it over to enter the Navy. Following enlisted service aboard the U.S.S. Hornet, and, as a newly minted, 20-year-old civilian, on the bond desk of McDonnell & Co., he enrolled at Indiana University. There he studied economics under Scott Gordon and Elmus Wicker and diplomatic history under Robert H. Ferrell. He graduated, Phi Beta Kappa, with a Bachelor of Arts degree in economics in 1970. Next came two happily unstructured years at Columbia University that produced a master’s degree in something called international affairs but, more importantly, the privilege of studying under the cultural historian, critic and public intellectual Jacques Barzun.

In 1972, at the age of 26, Grant landed his first real job, as a cub reporter at the Baltimore Sun. There he met his future wife, Patricia Kavanagh, and discovered a calling in financial journalism. It seemed that nobody else wanted to work in business news. Grant served an apprenticeship under the longsuffering financial editor, Jesse Glasgow. He moved to Barron’s in 1975.

The late 1970s were years of inflation, monetary disorder and upheaval in the interest-rate markets—in short, of journalistic opportunity. It happened that the job of covering bonds, the Federal Reserve and related topics was vacant. In the mainly placid years of the 1950s and 1960s, those subjects had seemed too dull to care about. But now they were supremely important—even interesting—and the editor of Barron’s, Robert M. Bleiberg, tapped Grant to originate a column devoted to interest rates. This weekly department, called “Current Yield,” he wrote until the time he left to found the eponymous Interest Rate Observer in the summer of 1983.

Grant’s books include three financial histories, a pair of collections of Grant’s articles and three biographies.  The titles are these: “Money of the Mind” (Farrar, Straus & Giroux, 1992), “The Trouble with Prosperity” (Times Books, 1996) “Minding Mr. Market” (Farrar, Straus & Giroux, 1993), “Mr. Market Miscalculates” (Axios Press, 2008) and “The Forgotten Depression, 1921: the Crash that Cured Itself” (Simon & Schuster, 2014), which won the 2015 Hayek Prize of the Manhattan Institute for Policy Research.

Also, “Bernard M. Baruch: The Adventures of a Wall Street Legend” (Simon & Schuster, 1983), “John Adams: Party of One” (Farrar, Straus & Giroux, 2005) and Mr. Speaker! The Life and Times of Thomas B. Reed, the Man Who Broke the Filibuster” (Simon & Schuster, 2011).  
Grant’s television appearances include “60 Minutes,” “The Charlie Rose Show,” Deirdre Bolton’s “Money Moves” program on Bloomberg TV and a 10-year stint on "Wall Street Week". His journalism has appeared in a variety of periodicals, including the Financial Times, The Wall Street Journal and Foreign Affairs, and he contributed an essay to the Sixth Edition of Graham and Dodd's “Security Analysis” (McGraw-Hill, 2009).

Grant is a 2013 inductee into the Fixed Income Analysts Society Hall of Fame. He is a member of the Council on Foreign Relations and a trustee of the New-York Historical Society.

He and his wife live in Brooklyn. They are the parents of four grown children.

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