"Those who don't know history are destined to repeat it."

- Edmund Burke

A Brief History of Federal Debt

To determine whether or not the Federal Debt is growing to dangerous levels, let’s start with a look back at our country’s history.  The first Federal Government under the Constitution was formed in 1790.  It costs a lot of money to win a country’s independence, so on “Day 1” the Federal Government's Debt was equal to 29% of Gross Domestic Product (GDP = the market value of a country’s final goods and services made in a year).  We have run some level of Federal Debt in all but three of the subsequent 220 years.  

There are times when a high level of government debt is absolutely essential to ensure a country's survival.  For example, defense spending to fight World War II drove the Debt to 113% of GDP - a level we haven’t seen before or since.  We survived the experience, and no one could argue that we would be better off today if we had saved the money and lost the war.  Clearly government debt in and of itself is not the problem.  It’s when the Debt grows faster than the overall economy over an extended period of time that we run the very real risk of economic catastrophe.   

The United States has experienced five significant increases in Federal Debt as a percentage of GDP in the past 100 years.  For our purposes, a significant increase is defined as a continuous rise that resulted in at least a doubling of the debt level.  After three of these “spikes”, we were able to drive the debt back down before the next increase began. 

The first spike began in 1917 with the entry of the US into World War I 
It was driven by a huge increase in defense spending.  Overall federal spending rocketed from $700 million to $18.5 billion per year within two years.  The Debt climbed from 3% of GDP to 33%.  It took a decade of almost equal parts budget surpluses and real economic growth to drive the Debt back down to 15% of GDP just before the start of the Great Depression.  

The second spike started in 1929 and became the Great Depression
The next four years saw the Debt relative to GDP rise from 15% to 40% thanks to deficit spending plus a toxic combination of a 25% economic contraction and 20% deflation.  For the remainder of 1930’s through 1941, the Debt relative to GDP remained fairly constant with deficit spending and a bit of deflation offsetting an effective real economic growth rate of 10% per year.  There was no recovery from this spike before the beginning of the third...

America’s entry into World War II in 1941 created the third spike 
For three years, defense spending averaged 37% of GDP.  Compare that to about 4% today.  By the end of the war, deficit spending had driven the Debt to an all time high of 113% of GDP.  It took 12 years of real economic growth and inflation to drive it back below 50% of GDP in 1957.  It took another 17 years of inflation and growth to bring the Debt down to the post-World War II low of 25% in 1974.  This despite a return to deficit spending.

Deficit spending created the  "4th spike” 
From 1982 until the mid 1990’s, the Debt increased at an average rate of 2% of GDP per year until it reached 49.5%.  This increase was driven by an increase in deficit spending from 2.5% to 3.9% of GDP due to increased spending on entitlements and especially on interest on the Debt.  These factors were only partially counteracted by an effective annual inflation rate of 4.3% per year and an effective real growth rate of 2.1% per year.  Five years of a combination of economic growth, budget surpluses of 0.8%, and a bit of inflation brought the Debt back down to 33.3% by 2001.      

The current spike began in 2008
It began with the financial crisis which caused a contraction in GDP and drove down tax receipts while the Federal Government tried to stimulate the economy through increased deficit spending.  Since the beginning of 2008 (through 2011), we have added almost $7 trillion to the Debt - that’s a $21,566 increase for every man, woman, and child in the United States.  By 2011 it was 72% of GDP and rising with no end in sight.  By 2030 the Federal Government will spend $1.63 for every dollar it collects in taxes.  And the next 20 years will see $65,663 (in constant 2010 dollars) added to the Federal Debt for every US citizen alive today.

Take a look at the graph below to understand how debt as a percentage of GDP has changed over the past 100 years and to see what is going to happen if we stay on our current course.