Do Balanced Budgets Cause Depressions? (Part 2)

My prior post suggested that the initial events that lead to financial crises are more likely wars, not the periods of paying down the resultant debt. The following graph shows the federal debt held by the public during major wars since 1790:



The actual numbers and sources can be found at this link. The graph shows the federal debt as a percentage of GDP, as opposed to my prior post which deals with the current dollar amounts. The debt as a percentage of GDP gives a better measure of our ability to service the debt since the government receipts used to pay the interest have remained around 18 percent of GDP for the past 50-plus years (see the first graph at this link).

In any event, the graph shows that there was a tremendous growth in the debt during the Civil War, World War I, and World War II. The growth in debt was much more rapid than any paydown in debt after the war. The growth in debt during the Mexican-American War and the War of 1812 was much more modest but the paydown in debt immediately following those wars was even less. Hence, the graph does agree with the conclusions of my prior post. Looking at the debt as a percentage of GDP does make the paydown in debt appear much more substantial but it still, for the most part, appears to be just a paydown of the tremendous debt run up during war years.

The relationship between the debt and war years reminded me of a similar relationship that I had noticed years ago. The following graph shows the CPI (Consumer Price Index) and M2 Money Supply since about 1800:



The actual numbers and sources for this graph can be found at this link. As can be seen, inflation has tended to increase during major wars though it did not during the smaller Mexican-War War. In addition, the growth in the M2 money supply has tended to increase during major wars since at least World War I. In fact, there appears to have been a positive correlation between the growth in the M2 money supply and inflation since World War I though this relationship seems to have broken down somewhat since about 2000. I had a discussion about this with Rodger M. Mitchell (who I mentioned in my prior post) at this link. He felt that the use of ten-year spans to "smooth" the data had in fact "ruined" it. But, as I explain in my comment of October 11th, even the graphs using five or one-year spans (shown here) show a correlation.

I also mentioned in my comment of October 7th that Thayer's claim that the six financial collapses that he lists "have been the only major depressions in U.S. history" is questionable. As I pointed out, I have seen 1907 mentioned as a possible depression in several places, including this article. Another article mentions that the U.S suffered a serious economic downturn at the start of the 1920s. The list of recessions on wikipedia lists the Depression of 1920-21 and the Panic of 1907. It also lists the first five of Thayer's six collapses (1819, 1837, 1857, 1873, 1893) as Panics. The sixth collapse in 1929 is, of course, listed as the Great Depression.

The Panic of 1907 and Depression of 1920-21 are significant in another way. Treasury data shows that the Panic of 1907 was preceded by rising debt, with the debt increasing from 1898 to 1913. The huge debt run up during World War I did decrease from 1919 to 1930 but, as this article mentions, that was through the recovery. Hence, the Panic of 1907 contradicts the notion that all depressions are preceded by decreases in debt and the Depression of 1920-21 contradicts the notion that deficit spending is an absolute necessity for recovery.

In any event, the above graphs again suggest that the initial events that lead to many financial crises are wars, not periods of paying down the resultant debt. For that reason, it would seem that our higher priority should be to find ways to prevent wars and their resulting cost in lives and treasure.

Do Balanced Budgets Cause Depressions?

According to this link, Frederick C. Thayer, a professor of Public Administration at George Washington University, wrote an article titled "Do Balanced Budgets Cause Depressions?" for The Washington Spectator on January 1, 1996. Following is an excerpt:

Even though the sequence that begins with budget-balancing and ends with depression has been common in American history, the question of a linkage has been ignored. The following paragraphs include all the basic data:

1817-21: In a period of five consecutive years, the national debt was reduced by 29 percent, to $90 million. The first acknowledged major depression began in 1819.

1823-36: In a period of 14 consecutive years, the national debt was reduced by 99.7 percent, to $38,000, a virtual wipeout. This didn’t help either. A major depression began in 1837.

1852-57: In a period of six consecutive years, the national debt was reduced by 59 percent, to $28.7 million. A major depression began in 1857.

1867-73: In a period of seven consecutive years, the national debt was reduced by 27 percent, to $2.2 billion. A major depression began in 1873.

1880-93: In a period of 14 consecutive years, the national debt was reduced by 57 percent, to $1 billion. A major depression began in 1893.

1920-30: In a period of 11 years the national debt was reduced by 36 percent, to $16.2 billion. The sixth real depression -- the Great Depression -- began in 1929.

As opposed to many less important downward “business cycles” or recessions, these six collapses have been the only major depressions in U.S. history. The batting average is perfect -- six sustained periods of reducing the national debt followed by six major crashes.

Since 1791, these debt reduction crusades have colored 57 of the 93 years in which debt was reduced. The debt was increased in each of the 112 years, an indication that federal deficit spending has been anything but unusual. We have almost chronic deficits since the 1930s, and there has been no new depression since then -- the longest crash-free period in our history.

Other articles by Thayer from about the same time and containing the same numbers can be found here and here. According to this link, Thayer passed away in 2006 at the age of 82.

More recently, these same basic numbers have been posted by Rodger Malcolm Mitchell, author of the book "Free Money: Plan for Prosperity". Following is an excerpt from his website:

1817-1821: U. S. Federal Debt reduced 29%. Depression began 1819.
1823-1836: U. S. Federal Debt reduced 99%. Depression began 1837.
1852-1857: U. S. Federal Debt reduced 59%. Depression began 1857.
1867-1873: U. S. Federal Debt reduced 27%. Depression began 1873.
1880-1893: U. S. Federal Debt reduced 57%. Depression began 1893.
1920-1930: U. S. Federal Debt reduced 36%. Depression began 1929.
1998-2001: U. S. Federal Debt reduced 9%. Recession began 2001
2004-2008: Deficit Growth reduced 40%. Recession began 2008.

The first six sets of numbers are the same as Thayer's except that the second lists a debt reduction of 99% instead of 99.7%. In addition, he adds a 9% reduction in federal debt from 1998 to 2001 followed by the recession of 2001. It should be noted that this 9% reduction appears to be a reduction in the federal debt held by the public. Mitchell's figures link to this page which contains graphs showing Federal Debt Held by the Public (FYGFDPUN) and Federal Government Debt: Total Public Debt (GFDEBTN). According to the data for the series found here and here, the Debt Held by the Public went down by 11.3% but the Total Public Debt went up by 5.1% from 9/30/1998 to 9/30/2001. The difference is due to the fact that the Debt Held by the Public does not include the federal debt owed to Social Security and other federal trust funds. There are likely arguments in favor of using either of these two measures of debt. In any event, it's important to note the one that is being used.

Mitchell also adds a 40% reduction in deficit growth from 2004 to 2008. It is very interesting that he chooses to switch from "federal debt reduction" to "deficit growth" reduction. In fact, sticking with "federal debt reduction" would have resulted in data that would have run very much counter to his other data which shows depressions and/or recessions being preceded by reductions in debt. According to the figures for Federal Debt Held by the Public, the debt increased from $4303 billion on 09/30/2004 to $5814 billion on 09/30/2008, an increase of 35 percent in just 4 years!

In any event, following is a critique of Thayer's original numbers:

In order to evaluate Thayer's claim, one needs to look at all of the major changes in the debt during this period. The following table attempts to do that:

     FEDERAL DEBT (in millions of dollars) AND PERCENT CHANGE

   High Debt     Low Debt
---------------------------- Prior Low    High  Prior Low
Year     Debt  Year     Debt   to High   to Low    to Low Events
---------------------------------------------------------------------------------
1804    86.43  1812    45.21             -47.69           War of 1812 (1812-15)
1816   127.33  1821    89.99    181.65   -29.33     99.04 Panic of 1819
1822    93.55  1836     0.04      3.96   -99.96    -99.96 Panic of 1837
1843    32.74  1846    15.55  87184.08   -52.51  41352.78 Mex-Amer War (1846-48)
1851    68.30  1857    28.70    339.25   -57.98     84.56 Panic of 1857
               1861    90.58                       215.61 Civil War (1961-65)
1866  2773.24  1873  2234.48   2961.61   -19.43   2366.84 Panic of 1873
1879  2349.57  1893  1545.99      5.15   -34.20    -30.81 Panic of 1893
               1915  3058.14                        97.81 World War I (1914-18)
1919 27390.97  1930 16185.31    795.68   -40.91    429.25 Great Depression

Source: Treasury Department: 1791 to 1849, 1850 - 1899, 1900 - 1949

The first period that Thayer cites is the five years from 1816 to 1821, when the debt was reduced by 29 percent. What Thayer fails to mention, however, is that in the four years from 1812 to 1816 (which includes the War of 1812), the debt was increased by 182 percent. Hence, the debt in 1821 was still nearly double it's level when the War of 1812 began.

The second period that Thayer cites is the 14 years from 1822 to 1836, when the debt was reduced by over 99 percent, to $38,000. This is the one period that Thayer cites when a recently acquired debt was not simply being partially paid down. In fact, the debt was paid down to its lowest level on record.

The third period that Thayer cites is the six years from 1851 to 1857, when the debt was reduced by 58 percent. Once again, Thayer makes no mention of the fact that the debt had just increased 339 percent in the prior five years, driven largely by the Mexican-American War. Even after the 58% decrease, the debt was still 85 percent above where it had been just 11 years earlier.

The fourth period that Thayer cites is the seven years from 1866 to 1873, when the debt was reduced by 27 percent (19 percent by the Treasury numbers in the above table). Thayer makes no mention that this immediately followed the Civil War during which the debt increased by nearly 3000 percent! Even after the 19 percent decrease, the debt was still nearly 25 times its size at the beginning of the war.

The fifth period that Thayer cites is the 14 years from 1879 to 1893, during which the debt was reduced by 57 percent (34 percent by the Treasury numbers in the above table). In fact, this represented a further paying down of the tremendous debt run up during the Civil War. Even after this 34 percent decrease, the debt was still about 17 times its size at the beginning of the Civil War.

The final period that Thayer cites is the 11 years from 1919 to 1930, during which the debt was reduced by 36 percent (41 percent by the Treasury numbers in the above table). This followed another war which Thayer saw no need to mention, World War I. In the four years from 1915 to 1919, the debt had increased by 796 percent. Even after the 41 percent decrease, the debt was still over 5 times its size at the beginning of World War I.

Hence, four of the six periods of surpluses that Thayer mentions followed wars during which the debt rose far more than it was paid down during those periods. Another of the periods (1879 to 1893) was just a further paying down of the tremendous debt run up during the Civil War. Hence, only one of the periods represented a seemingly voluntary paydown of debt not recently acquired through war.

The above timeline suggests that the initial events that lead to financial crises are wars, not periods of paying down the resultant debt.