Attention! Deficits Disorder
The dollar just busted through its 200 day moving average. Time to buy? Not. With a brief tour through history, Addison Wiggin points out, never has a "reserve currency" been so overburdened by national debt. This bear market rally is an opportunity to sell…
"To contract new debts is not the way to pay old ones."
– George Washington, letter, April 7, 1799
If the history of United States federal budgets – and the debts that grow out of them – tells us anything, it is this: the dollar’s in it up to its eyeballs. Today’s level of debt and continuing deficit spending is only the visible portion of that problem; beneath the surface we face an unavoidable day of reckoning for our great national past-time: spending money.
Long before Lord Keynes opened his mouth in the 30s, the attitude in Washington, and among academics, has been that we don’t really have to ever repay debt. It can be carried indefinitely for future generations to worry about. Most people today would claim that debt "doesn’t matter" or even that it is a wise policy to spend more than you bring in. The mind boggles.
Early on in U.S. history, Americans learned from British ancestors that empires could be built on a foundation of debt – and continued indefinitely. In the early part of the 18th century, Sir Robert Walpole introduced an innovative system for financing Britain’s colonial expansion and ever-growing military might.
Government, Walpole demonstrated, is able to create a revenue stream by issuing bonds and other debt instruments. The interest is paid regularly and eventually, upon maturity, the face value is paid off – and for every maturing bond, a new one is issued. This simple means for the expansion of revenue through debt was the venue by which Britain built its empire, from the 1720s through the next 100 years. Among those who observed this phenomenon of "endless debt financing" was the first Secretary of the Treasury of the United States, Alexander Hamilton.
In the early days of the American nation, a host of fiscal problems faced Hamilton and the other Founders. The War for Independence left a large debt; there was no unified currency and each state issued its own money; the currency itself was of dubious value and inflation made it difficult to imagine how the young nation would even survive.
A History of Debt in America: Alexander Hamilton’s Rationale
Hamilton’s view was that growth and expansion would be possible with the use of debt. "Hamilton’s rationale for a perpetual public debt included his belief that it would help keep up taxes and preserve the collection apparatus," writes Scott Trask on the Mises.org site, "He believed Americans inclined toward laziness and needed to be taxed to prod them to work harder."
Not everyone agreed.
Thomas Jefferson argued: "It was unjust and unrepublican for one generation of a nation to encumber the next with the obligation to discharge the debts of the first. After all, the following generation cannot have given their consent to decisions made by their fathers, nor will they have necessarily benefited from the deficit expenditures."
During the 19th century, American debt did not grow substantially. When he began his presidential term, Jefferson had an $83 million debt, mostly left over from the costs of the war. During his term, Jefferson reduced the debt to $37 million even after spending $15 million on the Louisiana Purchase.
In Madison’s term of office, the ill-fated War of 1812 ran the national debt up to $127 million by 1816. Monroe and John Quincy Adams were both able to reduce the debt during their terms of office and by 1829 the debt had fallen to $58 million. And then, during Andrew Jackson’s presidency, the national debt was entirely paid off. For the first time in its history (and the last) the United States had no national debt.
Over the next decade, the country ran up $46 million in new debt and by 1848 it rose to $63 million. However, in all fairness, one advantage of this was that the Mexican War resulted in U.S. expansion all the way to the Pacific and the acquisition of the entire southwest and California. Under the Pierce administration, the debt was paid down to $28 million; but it never got that low again.
The Civil War exploded the national debt up to $2.8 billion, or 100 times higher than in had been in 1857. Per capita debt in 1860 was $2 per capita; at the end of 1865, it was $75. The temporary tax measured in place during the war were repealed and, by the end of the 19th century, the debt had been reduced to $1.2 billion, less than half of its 1865 level.
Given the vast expansion of U.S. territory and the wars the country fought to create and then hold together the United States, this does not seem a large debt level. In fact, in its first 110 years of history, the United States had shown its ability to fund expansion while reducing debt over time. And this was accomplished without an income tax. In fact, in 1869 and again in 1895, the Supreme Court ruled federal income taxes unconstitutional.
A History of Debt in America: In the 20th Century, Things Change
The story was quite different in the 20th century. By the end of World War I, the national debt had risen to $26 billion. Even though the debt level had been reduced over the next decade, the Great Depression caused further deficit spending and FDR’s New Deal tripled debt levels up to $72 billion.
World War II created even higher debt levels. By 1945, the country owed $260 billion – small by today’s standards, but gargantuan in its time. But one outgrowth of that war was a new one, the Cold War. Military spending took the national debt up to $930 billion by 1980 and under Reagan’s administration, in rose to a staggering $2.7 trillion. In Clinton’s eight years, the debt tripled to $6.9 trillion. Estimates as of 2005 are that the debt will reach $10 trillion by 2008.
In other words, the level of growth in the national debt is growing exponentially. We may blame the War on Terror, the inheritance of the Cold War, or the new international market and its competitive forces, or a combination of these realities. In any event, it is clear that the levels of debt reach new records, virtually on a month-to-month basis.
We make a distinction in reviewing all of this history, between debt levels and deficit spending. Many people are confused about the differences here and some, even experts, use "debt" and "deficit" interchangeably.
A "debt" is the amount of money owed. A "deficit" is the shortfall in a current budget. For example, if we begin the year with a $6 trillion national debt, and in the following year we spend $1 trillion more than we bring in, we are running a deficit of $1 trillion. At the end of the year, that deficit will increase the debt to $7 trillion.
Why does the government need to spend more than it takes in? After all, in most of the 19th century there were no income taxes (except during the Civil War). And the debts the nation incurred were paid down time and again. Even by 1900, the debt level was manageable…not so today. And since 1980, the debt has exploded to levels that are inconceivable.
If a currency reflects a nation’s economic health, as the quaint classical economists believed, the current bull run in the dollar is but a correction in a long-term bear market and an opportunity to sell.
The Daily Reckoning
May 17, 2005 — London, England
Addison Wiggin is the editorial director and publisher of The Daily Reckoning. Mr. Wiggin is also the author, with Bill Bonner, of the international bestseller Financial Reckoning Day and a frequent guest on national radio and television programs.
Addison Wiggin isn’t the only one who sees the slide of the dollar as an opportunity to profit…the esteemed Dr. Richebächer offers specific recommendations to play the dollar’s fall in his special report.
We know how it began – Mr. Greenspan and Mr. Bush conspired to create the biggest expansion of credit in history. We know also why it happened when it did – because both men hit the panic button after the events of 2001…the attack on Manhattan by a terrorist band and the recession that began that year. Bush cut taxes and increased spending; Greenspan pushed the Fed’s lending rate to negative territory and left it there for the next three years.
What we don’t know, of course, is what happens next. There is no analytical method to know. All we can do is look back at the phenomenological record of history. Has anyone pushed that button before, we ask ourselves? If so…what happened?
Every case is different. Input different circumstances and you get different outputs. The circumstance that has intrigued us lately is the fact that the United States bears a strikingly resemblance to an empire. The current state of the American economy also bears an odd resemblance to traditional imperial financial models. It is odd because it does not look like, say, the way Rome financed its empire…or the Mongols financed theirs…or even the way the English paid the bills when they were on top of the world. Still, we think a paternity test is in order. Perhaps the U.S. model is just missing a chromosone or something; it looks a bit like its ancestors; but a half-wit version.
America first stooped to empire in the late 19th century. She was able to straighten herself out for a few years…but the lure of it was there, which later became irresistible. Between 1917 and 1952, the country was transformed from a simple republic that mostly minded its own business, to a grandiose empire with imagined interests and real troops nearly everywhere.
In normal places at normal times people go about their normal lives earning a living the best they can and focusing their attention mostly on their private lives. But an empire changes the way people think. The common householder turns away from his own humble house and his own wretched wife and begins to think about the fair world beyond his own kith, kin and ken. He looks outward and sees how much better the world could be if he and his fellow citizens could run it their way. It makes them think they must play a greater role in global affairs…that they must walk upon the world stage, not as some bit player, but as the main character, the hero. They must play the role of the protagonist.
Instead of sticking to their looms, fields and factories, the imperial citizens begin to appreciate the financial logic of empire: they provide the world with a valuable service – order and protection. Surely the rest of the world should pay for it.
Gradually, they neglect their own commerce…and depend on their subordinates, lackeys, and loyal subjects to support them. While administrative commands, fashions, and proclamations flow from the center of the empire to the extremities, there is an important flow in the other direction, too. Rome brought in its wheat from Egypt…(Romans needed bread)…its gladiators from the Balkans (Romans wanted circuses)…its soldiers from Gaul and its money from foreign treasuries and tax collectors from Judea to Britannia.
What caught our eye this morning…and set us to thinking such big thoughts…was a chart showing the ownership of U.S. Treasury bonds. A modest republic pays its own way. In 1952, nearly 90% of the Federal government’s borrowings came from domestic investors. Americans saved their money and used some of it to support the programs of the Eisenhower administration. But the maturing empire of 2005 depends on a globalized debt market and the savings of foreigners. From below 5% of Treasury bonds in overseas hands in 1952, the total now approaches 45%, while the percentage of lending coming from domestic sources has been cut in half.
We still grow our own wheat, but the trucks to move it may be made in Europe or Asia, and the pans to cook it are probably made in China. We get our electronic paraphernalia from Taiwan, our clothes from Malaysia, and our automobiles from Japan. We get our scientists from India and our classical musicians from Korea. And from all over the Eastern Periphery comes the money we need to keep it all going.
Reading the history of empires we learn that the central power – the imperium – tends to weaken, as the periphery states grow stronger. Eventually, the subordinate states get tired of supporting the imperium. They stop paying tribute…and show up at the gates of Rome.
As we say, we don’t know what will happen next. But we are on the edge of our imported chair…
More news, from our team at The Rude Awakening…
Eric Fry, reporting from Manhattan:
"A big problem with both houses and spouses as investments is that neither can be counted on to deliver a reliable short-term profit. Indeed, a short-term commitment to either a house or a spouse can result in a significant loss of capital…"
Bill Bonner, back in London…
*** America’s real estate bubble threatens the real economy as well as the financial world. Richard Russell reports that 40% of new jobs created in San Diego last year were in the property sector. When the bubble pops, people will not lose only their "paper" profits – they will lose their homes and their jobs.
More than a third of the houses bought last year were not intended as primary residences. Nearly a quarter was for investment. Another 13% were vacation homes.
*** In the "Jumbo" category, nearly 50% of new mortgages in the United States are "IO" – interest only. Nearly 90% are ARMs – adjustable rate mortgages. Everyone seems to be speculating in real estate. Everyone wants to own property, but no one wants to pay for it. And everyone seems to like the new abbreviations. There is even a rising trend towards "neg-am" mortgages – where the amortization schedule actually walks backward and the principal grows larger. Neg-Am mortgages are popular now…they will probably become even more popular – until the homeowner walks backward into a ditch.
*** According to a report in today’s Daily Mail, no one in Europe much likes the French. They are too arrogant, say the Italians. They are too unruly, say the Swedes. They are obnoxious, say the English. They are cynical scofflaws, say the Germans. For their part, polls show that the French were much more gracious about their neighbors than the neighbors are towards them, with one major exception. The French dislike the British, whom they regard as pretentious, snobby, no-accounts.
(Here at The Daily Reckoning, we have lived amongst both groups – the cheeseheads and the limeys – and learned their ways. Both are disagreeable on occasion…but then, so are our own countrymen. The world’s nicest race, as near as we can determine are the Lapps of Finland. We have never met one; so, we have no reason to think poorly of them. Yet.)
Every group seems to want to make fun of some other group. To that end, the French use Belgians…just as Americans use Polish people or blonds.
"Why does a Belgian man put two water glasses next to his bedside – an empty one and a full one – before he goes to sleep?" asked our gardener, Damien, the other day.
"Because he doesn’t know if he’ll be thirsty or not when he wakes up."
Damien also posed a mathematical problem to us:
"Three Belgians check into a hotel…they want a room with three beds. The hotelkeeper charges them 10 francs each. Then, the hotelier feels he has overcharged them, so he sends a boy with 5 francs to return to them. The men realize that they can’t divide the 5 francs evenly between them. So, they each take one franc and give the boy two.
"What a minute, says one of the quick-witted Belgians. We started with 30 francs. But now, we have paid 27. And the boy has two. Where’s the other franc?"