On the Sophistry of Frederick C. Thayer
George H. Blackford (04/02/2015)
Index
Statistics that are supposed to prove that, somehow, surpluses cause depressions apparently come from a 1996, three page note by Frederick C. Thayer, Balanced Budgets and Depressions, published in the American Journal of Economics and Sociology. According to Thayer:
Since 1791, the earliest data available, the national debt has been increased in 112 years, decreased in 93 years. 57 of those balanced budget, debt-reduction years have been concentrated in six sustained periods of varying length. Also since 1791, there have been six significant economic depressions among the innumerable "business cycles." Each sustained period of budget balancing was immediately followed by a significant depression. There are as yet no exceptions to this historical pattern.
This is the record of six depressions:
1. 1817-21: in five years, the national debt was reduced by 29 percent, to $90 million. A depression began in 1819.
2. 1823-36, in 14 years, the debt was reduced by 99.7 percent, to $38,000. A. depression began in 1837.
3. 1852-57: in six years, the debt was reduced by 59 percent, to $28.7 million. A depression began in 1857.
4. 1867-73: in seven years, the debt was reduced by 27 percent, to $2.2 billion. A depression began in 1873.
5. 1880-93' in 14 years, the debt was reduced by 57 percent, to $1 billion. A depression began in 1893.
6. 1920-30' in II years, the debt was reduced by 36 percent,. to $16.2 billion. A depression began in 1929.
There has been no sustained period of budget-balancing since 1920-30, and no new depression, the longest such period in our history.
The question is whether this consistent pattern of balance the budget-reduce the national debt have a big depression is anything other than a set of coincidences. (Thayer, p. 211)
Thayer asks the right question: "[I]s . . . this consistent pattern . . . anything other than a set of coincidences[?]", but he doesn't answer it! And he doesn't actually say that those sustained periods of budget balancing caused depressions. Instead, he infers this through innuendo and leaves the answer to your imagination. He then rambles on about "economic myths" and "intellectual dishonesty" and quotes disjunctive statistics without citations as to where these myths or statistics are to be found. Rather than make a case, he leaves it to your imagination to fill in the gaps. As a result, any conclusions you draw from his facts or his analysis with regard to the way in which surpluses cause depressions are, in fact, simply a figment of your own imagination. There is nothing in either Thayer's facts or in his analysis that justifies any kind of conclusion in this regard. (See: It Makes Sense If You Don't Think About It.)
What do we find if we actually look at the numbers in the federal budget that Thayer talks about?
The Reality of Surpluses
Figure 1 plots the federal government's receipts, expenditures, and surpluses as a percent of GDP from 1800 through 2014:
Source:
Historical
Statistics of the United States (Ea584-587,
Ca9-19),
Office of
Management and Budget (1.1
10.1),
Bureau of Economic Analysis (1.1.5)
The first thing that jumps out from this graph is that, other than during the two major wars, prior to the 1930s the federal budget played a relative insignificant role in the economic system. Federal expenditures averaged only 1.6% of GDP from 1800 through 1860 leading up to the Civil War, and federal surpluses averaged only -0.02% of GDP. From 1866 through 1916 federal expenditures averaged only 2.6% of GDP and stood at only 1.8% in 1916 while federal surpluses average only 0.31% and stood at 0.12% of GDP. Even as late as the 1920s we find that federal expenditures averaged only 4.1% of GDP from 1920 through 1929 and stood at 3.1% in 1929 while surpluses averaged only 0.90% of GDP and stood at 0.79% in 1929.
It's not until we get into the 1930s with federal expenditures averaging 7.8% of GDP and surpluses averaging -2.9%, or into the 1950s where federal expenditures averaged 17.1% of GDP that the government begins to play an important role in the economic system other than during a major war, and even in the 1950s federal surpluses still averaged only -0.39% of GDP. It is clear form this graph that, prior to the 1930s, the federal budget played a relatively minor, if not insignificant role in the economic system compared to the role it plays today and, in particular, compared to the role played by the non-government sector of the economy.
This conclusion is reinforced by the history of federal debt since 1800. Figure 2 shows federal debt as a percent of GDP from 1800 through 2014:
Source:
Historical
Statistics of the United States (Ea584-587,
Ca9-19),
Office of
Management and Budget (7.1),
Bureau of Economic Analysis (1.1.5)
Here we see that from 1800 through 1861 federal debt was rather insignificant relative to the size of the economy. We also find that there were four periods from 1800 through 2014 in which the federal debt was either relatively stable or fell rather consistently relative to GDP: 1800-1860, 1866-1915, 1919-1930, and 1946-1973. As Thayer points out, there were three major depressions during the first period (1819, 1837, and, 1857), two during the second (1873 and 1893), and one at the end of the third (1929). It is also worth noting that there were no major depressions following World War II during the longest and most dramatic period of falling federal debt relative to GDP.
Figure 3 shows the absolute value of federal debt from 1792 through 1860:
Source: Historical Statistics of the United States (Ea584-587),
Here we see a 19 year period leading up to the War of 1812 in which there were no major depressions while the debt was either stable or falling. In addition, the debt fell almost continuously following the war, from 1815 through 1836, until it was virtually eliminated, and while there was a major depression in 1819, there was a 16 year period until there was another major depressions as the debt continued to fall rather dramatically. In addition, except for all but two years, 1821 and 1824, the federal budget was either balanced or had a surplus for the entire 21 year period from 1815 through 1836 leading up to the the major depression that began in 1837 as the federal government paid off its debt.
What does it mean for Thayer to say:
Since 1791 . . . there have been six significant economic depressions among the innumerable "business cycles." Each sustained period of budget balancing was immediately followed by a significant depression. There are as yet no exceptions to this historical pattern. (emphasis added)
in light of there being no depression during the 19 year period of balanced budgets and debt reduction with no depression leading up to the War of 1812 and the fact that the federal government managed to balance its budget and pay down its debt for a full 18 years following the depression that began in 1819 before this period of fiscal responsibility was "immediately" followed by a significant depression in 1837? These facts clearly contradict the impression Thayer is trying to create.
Next we have Figure 4 which shows federal debt from 1866 through 1915:
Source: Historical Statistics of the United States (Ea584-587),
Here we find an almost continuous 27 year period of falling debt from 1866 through 1893 (the exceptions being 1874, 1878, and 1879) followed by seven years of increasing debt then 16 years leading up to 1915 in which federal debt remained fairly stable at around $1.2 billion. And in spite of the fact that this 50 year period contained 44 years of falling or stable debt, it contained only two major depressions: one that began in 1873 preceded by seven years of falling debt and one that began in 1893 preceded by 13 years of falling debt. And we are supposed to conclude from this that sustained periods of fiscal responsibility on the part of the federal governments causes financial crises that are followed "immediately" by serious depressions? I don't think so!
Then we have Figure 5 which shows federal debt from 1919 through 1940:
Source:
Historical
Statistics of the United States (Cj870-889),
Office of
Management and Budget (7.1)
Here we see ten years of falling debt leading up to the crash of 1929, and because of the numbers Thayer cites and the history of federal budget and debt I have outlined above, we are supposed to just accept the fact that, somehow, the federal deficits that averaged 0.9% of GDP in the 1920s caused the Great Depression that followed and simply ignore everything else that was going on in the economy in the 1920s that might have caused this catastrophe to have happened? This makes no sense at all. The numbers Thayer cites are totally meaningless in the absence of a causal explanation as to how and why they have come into being, and Thayer offers no explanation of any kind as to how or why these surpluses are supposed to have caused a problem here.
Finally, there is Figure 6 which shows federal debt from 1945 through 2014:
Source: Office of Management and Budget (7.1)
Here we see an almost continuous and dramatic increase in debt from a mere $213 billion in 1945 to $10.3 trillion in 2014 with only one period of sustained decrease in debt from 1998 through 2001. There were no major depressions during this period until 2008, and there was no immediate serious depression following the sustained four-year period of falling debt following 1997.
Now when I look at the numbers in these graphs I don't see the definitive pattern that Thayer describes above to justify his innuendo to the effect that, somehow, federal surpluses cause depressions, and he provides no explanation of any kind as to why I should think there is a causal relationship in this regard. All he does in his note is babble gibberish about disjunctive numbers, economic myths, and intellectual dishonesty as he argues what appears to be nonsense through innuendo.
The Surpluses Cause Depressions Fallacy
The fact is, the government does not control its surpluses, its deficits, or its debt. What it controls is its monetary, fiscal, and other policy instruments. This means the government can control the rates at which it taxes, what and who it taxes, and the government can control what and how much money it spends. The government can also control the monetary base and the rate of interest at which it lends money to banks, and it can, through legislation and law enforcement, change the rules by which the economic system operates. And there are a number of policy instruments with regard to international trade and finance that the government can control. When the government changes these policy instruments it will have an effect on the government's deficit or surplus as the effects of these changes work their way through the economic system, but the government does not control what the deficit or surplus is because the deficit or surplus is determined by the interaction between the government and the rest of the economic system.
When the economy is booming it expands the tax base and thereby increases tax receipts even if the government makes no changes in the policy instruments it controls. A booming economy also has a tendency to reduce government expenditures through a fall in social welfare obligations. Thus, a booming economy has a tendency to decrease a deficit or increase a surplus as it increases tax receipts and decreases government expenditures.
The opposite is true when the economy is in a recession: Tax receipts fall as the tax base is eroded by the fall in income and output, and expenditures tend to increase as various kinds of social welfare emergencies arise as a result of the fall in income and output. Thus, a recession has the effect of increasing a deficit or decreasing a surplus as it decreases tax receipts and increases government expenditures in the absence of government action to keep this from happening, and even if the government attempts to keep this from happening there is no guarantee that it will be successful in doing so.
The point is that the surplus in the federal budget is simply the difference between the federal government's receipts and its expenditures. The federal government determines its tax and expenditure policies. Given those policies and the interaction between the government's policies and the rest of the economic system, the surplus simply comes into being as the system adjusts to those forces that determine what the surplus, along with all of the other variables in the system, will be. The surplus that results is an effect of the causal factors that determine the variable of the system. It is not a causal factor that determines the rest of the system.
Providing a scientifically meaningful explanation of what Thayer refers to as a "consistent pattern of balance the budget-reduce the national debt have a big depression" (Thayer, p. 211) requires more than a vague innuendo to the effect that balancing the budget and paying down the debt causes depressions. It requires an intelligible theory that explains the seeming correlations between federal surpluses and the depressions examined above, and, in fact, there is a very simple theory that can explain those seeming correlations—a theory that has nothing to do with the government trying to eliminate deficits and paying down its debt.
The alternative theory is that unregulated or poorly regulated financial systems facilitate the creation of speculative bubbles that lead to unsustainable levels of private debt. Defaults on this unsustainable privet debt that occur when a speculative bubble bursts lead to financial crises that causes the financial system to implode, and it is the resulting implosion of the financial system that causes the depression that follows these financial crises.
The government surpluses that occur leading up to financial crises do not cause the speculative bubbles or the crashes or the depressions that follow. The creation of speculative bubbles has the effect of stimulating the economy which, in turn, has the effect of causing government surpluses to increase and government deficits to decrease as the economy grows in the presence of a speculative bubble. The government surpluses that occur leading up to the crisis are caused by the underlying process that leads to the crash; they do not cause this process to come into being.
In other words, this theory says that the correlation, such as it is, between depressions and surpluses leading up to depressions described above is spurious: rising surpluses and economic booms are correlated with speculative bubbles, and it is the speculative bubble that causes the former, not the other way around. I have attempted to explain this theory in great detail in Where Did All The Money Go? with regard to how we ended up in the Crash of 2008. How well does this theory stand up in explaining the seeming correlation between depressions and surpluses that Thayer alludes to compared to his innuendo to the effect that surpluses caused the depressions?
The Crash of 1929 and the Great Depression
When World War I ended in 1919 (a war that created a dramatic restructuring on our economic system industrially, agriculturally, and financially) there was a huge drop in government expenditures that led to (i.e., caused) a major disruption in our economic system. The immediate result was a significant recession in 1920 and 1921, followed by a prolonged period of economic depression in the agricultural sector of the economy which had expanded and mechanize during the war and found itself in serious trouble when European farmers went back to work.
At the same time there were tremendous advancements in manufacturing as we switched from steam to electrically powered factories that implemented assembly-line techniques on a scale never seen before. New electrical powered consumer goods were created such as toasters, vacuum cleaners, power tools of various sorts to name just a few. Radio and Hollywood were booming, and all of this was accompanied by a major expansion in the utilities industries as electric, gas, and telephone companies grew at an incredible pace. And as these sectors of the economy were booming people were migrating from farms to the growing manufacturing centers.
This was also a time in which financial regulators were confident, over confident as it turned out, in the ability of the financial system to avoid financial crises as a result of having eliminated, through the creation of the Federal Reserve, the inelastic reserve problem that had plagued the financial system throughout the latter half of the nineteenth century and into the twentieth. Regulators refused to acknowledge the dangers endemic in the fraudulent practices that were being perfected and becoming rampant in the financial markets during that period, and a shadow banking system came into being that bypassed what little financial regulation that there was. In addition, the Federal Reserve based its policy on the Real Bills Doctrine which fed reserves into the financial system in a pro-cyclical manner. (Meltzer Pecora PBS)
All of these things combined with the incentives they created for people to take advantage of the institutions of the financial system in ways that caused speculative bubbles in real-estate markets from 1921 through 1926 as well as the speculative bubble in the stock market that led up to the Crash of 1929. In my understanding of what was happening during this decade, all of these factors also led to an increase in the concentration of income to the point that it became impossible to maintain the economic expansion that was taking place in the absence of an increase in private sector debt relative to income. This eventually led to (i.e., caused) a collapse of the financial system when the real economy began to falter in the summer of 1929, the stock market crashed in the fall of that year, and debtors began to default on their debts. I have explained all of this in detail in Where Did All The Money Go?, and I can’t see any reason to think that the surpluses in the federal budget that existed during this decade caused any of this to happen.
What's more, that surpluses weren't the problem becomes even clearer when we look at what the government was actually doing during the 1920s. Everything that we know about how the economic system works tells us that in order to eliminate the surpluses of the 1920s the government would have had to use the policy instruments that it can control to either to increase expenditures, cut taxes, increase the monetary base, or some combination of these policies. What did the government actually do with these instruments during this period?
When we look at the OMB’s official statistics in Figure 1 we find that while government expenditures remained relatively stable relative to GDP (which means they increased in nominal terms) from 1923 through 1930, the average of federal expenditures during that period as a percent of GDP (3.3%) was, in fact, almost 46% higher than the average leading up WW I (2.2%). In addition, there were five federal government tax cuts in the 1920s, one in 1921, 1924, 1926, 1928, and 1929. (Romer and Romer) Higher expenditures and lower tax rates are both policies that are supposed to have the effect of reducing surpluses and increasing deficits as they stimulate the economy. In other words, the government actually was doing the kinds of things that are supposed to reduce surpluses during the 1920s. What’s more, the Real Bills Doctrine which the Federal Reserve relied on at the time also had the effect of stimulating the economy which also should have the effect of reducing surpluses. (Meltzer)
The economy was booming in the 1920s with an unemployment rate of only 3% in 1929. It makes no sense at all to think that if the government had just done more of what it was, in fact, doing with its policy instruments and had been able to eliminate its surpluses and created deficits that we could have avoided the stock market crash and everything would have been just fine in the 1930s. Everything we know about how the economy works tells us that these sort of actions on the part of the government would have further stimulated a booming economy and would made the speculative bubbles worse, though probably not much worse given the relatively insignificant size of the federal budget at the time.
In the 1920s the federal government averaged only 3.7% of GDP and was equal to only 3% of GDP in 1929. The non-government sector controlled 96% of total spending on GDP in the 1920s. In addition, the federal surpluses averaged only 0.9% of GDP. How can anyone honestly believe that 0.9% surplus tail wagged 100% of our economic dog during the 1920s in such a way that from 1929 through 1933 those surpluses caused GDP to fall by 45%, the output of real goods and services to fall by 26%, 10,000 banks and savings institutions to fail along with some 129,000 other businesses as the unemployment rate soared to 25% of the labor force and 12 million people found themselves unemployed at the depth of the ensuing depression as if the non-government sector of the economy had nothing to do with this catastrophe in spite of the fact that the federal government controlled only 4% of GDP spending leading up to this disaster and the non-government sector controlled 96% of GDP spending? It was the non-government sector that caused the problems in the economy during the 1920s, not federal surpluses.
It is obvious to me, and it seems to me that it should be obvious to just about anyone who actually looks at the history of this era, that it was the lack of financial regulation that led to the speculative bubbles that took place during the 1920s, and that these bubbles allowed the concentration of income to increase to the point that that the economy could no longer grow in the absence of an increase in private debt debt relative to income. This situation was unsustainable, and when the private debt stopped growing the speculative bubbles burst, debtors defaulted on their loans, the financial system collapsed and initiated a vicious downward spiral that led us into the depths of the Great Depression. It also seems obvious to me that the federal budget had nothing to do with any of this. The government's contribution to the crash of 1929 and the subsequent depression is to be found in its failure to regulate the financial sector, not in its surpluses.
Not only is it obvious to me that the lack of financial regulation in the non-government sector of the economy was at the root of the problem, it was obvious to anyone who had any sense at the time who actually lived through the 1920s and into the 1930s. That’s why they put in place a financial regulatory system in the 1930s that kept that kind of pernicious nonsense from happening again for the next fifty years. They may not have understood how important federal expenditures had become in propping up the economic system in 1936 after federal outlays had gone from 3% of GDP in 1929 to almost 10% of GDP in 1936, but they did know what caused the financial collapse that led us into the Great Depression following the Crash of 1929. And it’s worth noting that it wasn’t until we started to unravel the system of financial regulation put in place in the 1930s that we began to see the likes of the commercial real estate and junk bond bubbles in the 1980s, the dotcom and telecom bubbles in the 1990s, and the mortgage fraud and housing bubbles in the 2000s reappear in our financial markets again—the same kinds of bubbles that had plagued the financial system throughout the nineteenth century and that led up to the Crash of 1929. All of this is explained in detail in Where Did All The Money Go?
And what do we find when we look at the depressions of the nineteenth century Thayer cites as being relevant to his surpluses cause economic catastrophes innuendo?
Surpluses and Depressions Before 1929
As is indicated in Figure 1, in 1800 the federal budget played a relatively minor role in the economy with federal expenditures amounting to only 2.1% of GDP, and the average federal expenditure to GDP ratio from 1800 through 1860 was only 1.6%. Thus, it is difficult to imagine how the three years of federal surpluses that precede the Crisis of 1819, or the twelve years of surpluses that proceeded the Panic of 1837 could have had much of an effect on the economy, especially in a situation where over 98% of GDP spending was beyond the control of the federal government. What's more, these catastrophes were preceded by periods of rapid economic development characterized by widespread speculation in cotton and land in 1819 and mostly in land in 1837.
We find a similar situation when we look at the Panic of 1857. Federal expenditures averaged only 1.5% of GDP in the seven years of surpluses leading up to the crisis and these surpluses averaged only 0.2% of GDP. At the same time, we find that the panic was preceded by widespread speculation in railroads and, again, in land.
Next we come to the Panic of 1873. Here we find that in the seven years of surpluses that preceded the crisis the role of the federal budget in the economy had doubled compared to what it had before the Civil War. This should not be surprising as it coincided with Reconstruction, the building of the Trans Continental Railroad, and the beginning of the Indian Wars in the west.[1] In any event, federal expenditures still averaged only 3.9% of GDP and surpluses less than 1% of GDP, and the period leading up to the crash was, again, one of rapid economic expansion accompanied by a huge speculative bubble in railroads that burst in 1873. And in spite of the increase in the size of federal budget following the Civil War, the non-government sector still controlled 96% or more of GDP spending leading up to the panic just as it had during the 1920s. The federal surpluses were also comparable to those that existed during the 1920s, averaging 0.8% of GDP for 1866-1873 compared to 0.9% for 1921-1930.
There is just no rational reason to believe these surpluses increased as a result of government actions leading up to the Panic of 1873 as opposed to as a result of what was going on in the non-government sector of the economy or that the surpluses, rather than the implosion of the financial system that resulted from the bursting of the railroad bubble, caused the ensuing depression.
Then there was the Panic of 1893. Here we find twenty-eight years of federal surpluses leading up to the crisis, from 1866 through 1893, which includes surpluses throughout the entire seven year depression following the Panic of 1873.[2] Clearly, not all of these surpluses were caused by economic booms as a result of speculative bubbles, but we do see a pattern in which surpluses doubled during the boom leading up to the Panic of 1873 and doubled again during the boom leading up to Panic of 1893. We also find that each of these increases were accompanied by railroad bubbles, and federal expenditures leading up to the Panic of 1893 were even less relative to the size of the economy (2.0% of GDP) than those leading up to previous crises (3.7% of GDP). The size of the surpluses were also about the same as those leading up to previous crises (0.9% of GDP), while the non-government sector was responsible for fully 98% of GDP spending.
Again, there is just no rational reason to believe that federal surpluses increased as a result of government actions leading up to the Panic of 1893 as opposed to as a result of what was going on in the non-government sector of the economy or that the surpluses, rather than the implosion of the financial system that resulted from the bursting of the railroad bubble, caused the ensuing depression.
Deficits Since 1929
Thayer points out that "There has been no sustained period of budget-balancing since 1920-30, and no new depression, the longest such period in our history." This is, of course, true, at least it was true until 2008, but the reason for the lack of major depressions since the 1930s is not because the federal government ignored the deficit and became fiscally irresponsible. In spite of the deficits since 1930, the federal government has managed its finances responsibly during most of the period to which Thayer refers. It was not until the Reagan Tax Cuts of the 1980s that the federal government began to throw caution to the wind in this regard.
The difference in major depressions before and after 1930 does not arise from the fact that the federal government failed to balance its budget since the 1930s. The difference is in the fact that the federal government put in place a comprehensive financial regulatory system in the 1930s that was able to keep in check the kinds of financial crises that plagued the system leading up to the crash of 1929—the kind of crises that began to reappear with the Savings and Loan Crisis in the 1980s, the dotcom and telecom bubbles in the 1990s, and the mortgage fraud and housing bubble in the 2000s as we began to systematically dismantled that system in the 1970s.
And the deficits we experienced from 1930 through 1980 were not the result of government profligacy. There was a huge increase in government expenditures during the 1930s as federal expenditures doubled from 4% of GDP in the 1920s to 8% in the 1930s and federal surpluses that averaged 0.9% of GDP turned into deficits that averaged 2.9% of GDP, but the increase in expenditures was funded by nine tax increases, starting with the Revenue Act of 1932. Most importantly, the deficits of the 1930s were associated with huge investments in roads, highways, bridges, dams, water and sewage treatment facilities, and public parks and other recreational facilities through the Civil Works Administration, Civilian Conservation Corps, Public Works Administration, Rural Electrification Administration, Tennessee Valley Authority, and Works Progress Administration.
As a result of the increases in these kinds of investments in public infrastructure, the unemployment rate fell by over 40% from 25% in 1933 to 14% in 1937 as GDP increased by over 60% and the output of goods and services increased by 40%. Employment and output then fell when federal expenditures were cut in 1937 and 1938 and didn't recover again until government expenditures were increased again. Meanwhile, the tax increases of the 1930s made it possible to stabilize the federal debt, which had increased from 16% of GDP in 1929 to 46% by 1935, and in spite of the federal deficits that had occurred during the 1930s, federal debt stood at 44% of GDP in 1941 on the eve of World War II. Most importantly, the investments in public infrastructure made during the 1930s led to tremendous increases in productivity in the years that followed and the tax increases greatly enhanced the financial stability of the federal government as we became the Arsenal of Democracy during World War II.
A similar situation prevailed following the war as federal expenditures doubled again from 8% of GDP in the 1930s to 17% in the 1950s; then increased to 18% in the 1960s as deficits averaged 0.6% of GDP during those two decades. But, as I explain in what is undoubtedly excruciating detail in Where Did All The Money Go?, it was not the deficits that led to economic prosperity during that era. It was the phenomenal increase in federal expenditures that built our Interstate Highway System and created the National Science Foundation, Space Program, National Institute for Health, and Center for Communicable Disease. It was the federal expenditures that expanded our educational systems through federal Grants in Aid and such programs as the GI Bill and National Defense Education Act along with our social insurance programs—Social Security, Medicare and Medicaid, Food Stamps, unemployment compensation, etc.—that that led to our economic prosperity in the 1950s and 1960s.
It was these kinds federal expenditures that increased productivity and contributed to the prosperity of the era, not the existence of deficits. And as I have explained in detail in Where Did All The Money Go?, it was this expansion of the federal government, combined with the 1) fall in the concentrations of income, 2) the financial regulatory system put in place during the 1930s, and 3) the tax increases that were put in place during the 1930s and World War II that were left in place until 1965 that led to the economic stability we saw during that era and that allowed us to reduce the federal debt ratio from 110% of GDP to 23% by 1974. It was not the existence of deficits that allowed us to accomplish these feats. (See: A Note on Managing the Federal Budget.)
The Bottom Line on Surpluses and Depressions
When I look at the actual numbers and the historical events that generated Thayer's numbers it is quite obvious to me, and I think it should be quite obvious to just about anyone who actually looks at these numbers and events, that it was not federal surpluses that caused the six financial crises and subsequent depressions that Thayer list. It was speculative bubbles that caused economic booms leading up to these crises that caused the federal surplus to increase, and it was the bursting of those speculative bubbles that caused the financial system to implode and the depressions that followed, not the existence of federal surpluses leading up to the financial crises.
It also it is quite obvious to me, and I think it should be quite obvious to just about anyone who actually studies the era of perpetual deficits following World War II, that it was not the federal deficits that led to prosperity and economic stability for thirty-five years following the war but the increase in government expenditures and taxes, the fall in the concentration of income, and the existence of an effective financial regulatory system that led to the prosperity and economic stability that followed the war. Deficits by themselves would have been disastrous following World War II in the absence of these other factors, just as deficits have proved to be disastrous over the past thirty-five years as they have been used as an excuse to cut taxes, unravel our financial regulatory system, and allow the concentration of income to increase beyond where it was in the 1920s, as I have explained in Where Did All The Money Go?.
[1] There is, however, an additional complicating factor that must be taken into consideration in examining the role of federal surpluses in the economic system following the the Civil War in that the National Banking Acts of 1863 and 1864 tied the total amount of currency that national banks could print to the amount of federal debt outstanding. This meant that when the federal government ran a surplus and paid off its debt it reduced the maximum amount of currency national banks could print and, hence, had the potential to reduce the stock of money within the economic system. This effect of the federal government running a surplus was not eliminated until the creation of the Federal Reserve System in 1913. (See Chapter 5 in Where Did All The Money Go? for a discussion of this problem and especially The National Banking System: A Brief History by Champ.)
In addition, there is a second complication that should also be taken into consideration if one is to truly understand economic realities during that era, namely, the fidelity with which nation states paid homage to the Gold Standard and the limitations on fiscal and monetary policies that this system imposed during its reign through 1973. (See: Brief History of the Gold Standard in the United States published by the Congressional Research Service for a discussion of the way in which the Gold Standard affected the monetary system prior to its disintegration in the 1930s and its formal abandonment in 1973.)
The fact is, the National Banking era was one characterized by a ridged monetary system, dramatic changes in international capital flows, deflation, long periods of economic stagnation, a great deal of civil disorder accompanied by violent suppression, and a rather ineffectual federal government. These factors undoubtedly contributed more to economic instability during this era than the federal budget other than during the Civil War.
[2] It should be noted that a budget surpluses does not mean a debt reduction in that the government can collect money it doesn’t spend, thereby increasing the amount of cash it holds without paying down its debt, and it can spend money in excess of its revenue without borrowing by reducing its holdings of cash. The government can also affect its cash/debt holdings by buying and selling assets that are, by definition, not included in its expenditures or revenue which determine its surplus or deficit. As was noted above, there were, in fact, three years of increasing debt during these 27 years of surpluses: 1874, 1878, and 1879. See the Bureau of Economic Analysis's Table 3.2 to see how asset purchases and sales enter into the national income and product accounts.