Nov. 14 (Bloomberg) -- The “fiscal cliff,” a combination of tax increases and severe spending cuts scheduled to kick in next year, is a product of multiple deceptions. Both the expiration date on the Bush-era tax cuts and the trillion-dollar “sequesters” that were enacted as part of last year’s debt-ceiling deal were designed to cover up an overarching problem: the country’s out-of-control debt.
The U.S. government today owes $16.05 trillion to bondholders and creditors, more than $51,000 for every American. This debt is already larger than the country’s annual economic output and threatens to cripple the economy for generations.
In its 235-year history, only twice has the country run up this big a tab: during the Civil War and World War II. Each time, though, the U.S. managed to dig its way back, regain its credit and emerge as the world’s leading economy. Both episodes offer lessons for today’s predicament.
To finance the Civil War, President Abraham Lincoln’s Treasury Department borrowed heavily. Public debt exploded between 1861 and 1866 to more than $2.75 billion from $90 million. Lincoln’s government also cheapened the currency through inflation, issuing more than $500 million in fiat paper dollars, or “greenbacks.”
By the time Robert E. Lee surrendered to Ulysses S. Grant at Appomattox Court House in April 1865, those greenbacks had lost two-thirds of their value (measured against gold), leaving the country with oceans of debt and a debased currency.
To regain solvency, four things had to happen. First, the government paid down the debt. Starting in 1867, the U.S. Treasury every month sold gold and bought bonds, slowly paying off creditors and strengthening the dollar. By 1878, it had lowered the debt by almost 25 percent and the country was able to return to its traditional gold standard. No more fiat paper.
Second, Congress kept up revenues with high taxes, in the form of protective import tariffs. These tariffs helped local businesses and allowed the government to afford programs like Reconstruction, farm homesteads, railroad land grants and westward expansion.
Third, the economy grew. The great industrial boom of the Gilded Age, a product of many causes -- wartime stimulus, corporate consolidation, government subsidies, immigration, new technologies and so on -- quickly made the lingering debt a shrinking portion of a booming economy.
Finally, the country showed patience in sticking with this plan over two decades and under three presidents: Andrew Johnson, Grant and Rutherford B. Hayes. The electorate didn’t shift course every Election Day.
Like the Civil War, World War II also forced the government to borrow heavily. The debt grew to more than $270 billion in 1946 from $50 billion in 1940, topping 120 percent of the country’s annual gross domestic product -- the highest level in U.S. history.
Again, the first step for bouncing back was to control debt. Between 1947 and 1960, the government ran seven annual budget surpluses and seven small deficits, keeping nominal debt essentially flat.
At the same time, taxes were set at levels sufficient to pay for, among other things, the Cold War, the interstate highway system and continuing New Deal programs.
And once again, the economy soared. Real GDP more than doubled during those years and continued to increase through the 1960s.
Finally, patience. Over 15 years, presidents as diverse as Harry Truman, Dwight Eisenhower and John F. Kennedy all stuck to the plan. By the time Kennedy was assassinated in 1963, the World War II debt had shrunk to less than 50 percent of GDP. By 1981, it would bottom at 32 percent.
The history is clear. With four things -- income, growth, discipline and patience -- the U.S. has climbed out of financial holes similar to the one it now faces. Since Election Day, President Barack Obama and House Speaker John Boehner have signaled the need for a bargain: cutting some $4 trillion in debt over the next decade. That’s the very type of disciplined, long-term plan that saved the country’s finances in the past.
(Kenneth D. Ackerman is the author of four books, including “Boss Tweed: The Corrupt Pol Who Conceived the Soul of Modern New York.” The opinions expressed are his own.)
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