The Corner

Economy & Business

Government Is an Efficient Debt-Producing Machine

We libertarians and conservatives tend to be very skeptical of government’s ability to do anything well. But there is one thing the government excels at producing: debt. In fact, Washington is the leader on this front. Granted, this is not a good thing, but we must nevertheless recognize the government’s skill at it. And just when you think it can’t do better (read: worse), it surprises you with an extra production of debt and deficit, just like that.

This time, Washington went above and beyond its usual accomplishment, as demonstrated by the latest Congressional Budget Office (CBO) projections. The report shows that federal debt held by the public (that’s foreign and domestic investors) will reach 76 percent by the end of 2016, a full two percentage points higher than 2014. It is also expected to grow from $14 trillion this year to $24 trillion by 2026. That’s probably an underestimate, since it is a projection based on the assumption that promises to cut spending and raise taxes will be kept. Based on Congress’s shameless termination of the sequester years ahead of schedule and its awful propensity to spend more and more each year, this is unlikely. The projections also assume that the economy will grow at current projected rates and without any recessions. This too is unlikely, since the country tends to go into recession every five to six years.

Here is a chart:

Notice how the debt went down after World War II. Don’t count on that ever happening on our current spending trajectory. For one thing, the debt levels in the ’40s were the product of significant increases in war spending and other factors. and thus they naturally went down after the war. Spending today is not projected to go down anytime soon. In fact, it is projected to explode. And unless we get a major breakthrough in technology or a life-altering discovery (which could happen, of course), I wouldn’t count on post-WWII growth levels.

Over at Cato, Chris Edwards makes another important point:

The post-WWII debt decline was partly due to strong economic growth, but mainly due to the government shafting bondholders with unexpected inflation. Inflation reduces the real value of outstanding debt, and thus imposes losses on creditors. The ability to cut real debt by inflation depends on the debt’s maturity and whether creditors expect inflation. If the average maturity is long, the government can reduce the real debt load with unexpected inflation.

That is what happened following WWII. As the chart shows, the debt-to-GDP ratio was cut almost in half between 1946 and 1955. Economists Joshua Aizenman and Nancy Marion found that nearly all that drop was due to the combination of inflation and long maturities on the debt at the time. In subsequent decades, maturities fell, so inflation resulted in less debt shrinkage.

Here’s the upshot: It is unlikely that the government would be able to shaft bondholders like that again, nor would that be a good idea.

Worth noting: Deficits are also going to go up to $544 billion from last year’s $439 billion. Over the coming decade, the size of the federal deficit will double to reach an almost annual gap of 5 percent of GDP. CBO predicts that deficits will total $9.4 trillion. That’s up $1.5 trillion from its August report. CBO blames in part the giant budget deal passed in December.

Nice job, Republican Congress. Granted, you were helped by Democrats, but are you not in charge? So much for the return of fiscal responsibility.

Veronique de Rugy is a senior research fellow at the Mercatus Center at George Mason University.

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