By now most Americans have heard that our national economy is in deep trouble. With increasing frequency, articles are appearing discussing the steadily accumulating massive debt, the looming insolvency of Social Security, Medicare and Medicaid, the inability of our congressional leaders to rein in spending, an increase in pending bankruptcies of many municipalities and perhaps soon some states, and the overall impact of this crisis on our own personal finance and lifestyle. Yet for most of us, it seems completely abstract—more like a dream. Many simply ignore the facts, believing it will just go away. After all, we have all seen our prosperity exponentially improve over the past 60 years. Haven’t we?
These issues cannot be discussed in sound bites and superficial ways.
We all believe that our wages have risen, many of us have purchased houses, some more than one, constantly upgrading our lifestyles. We have been able to buy all the modern conveniences; flat panel televisions, computers, cars, cell phones. We have taken vacations, saved for retirement or received pensions, and constantly demanded and recieved increasing benefits like more vacation days, health, vision and dental coverage. Most of these are things that our parents and grandparents would never have dreamed of. We have had the government encourage us to live on credit, and all of us have been unequivocally assured that we need not worry about saving for any rainy day difficulties because the government could, and would, take care of all of us. We have been told that if we want the economy to improve we need to spend more—that saving is bad for the economy. Yet most of us have never questioned this assertion.
We need to look critically at the Clinton Budget Surplus and determine if it was both a true surplus and if the method employed to achieve this feat was good for the economy and the middle class.
So while we sit here in the middle of an economic disaster, few of us seem willing to acknowledge the problem, and even less willing to take on the task of addressing the underlying problem. We wonder how a nation like ours, with so much money, could be unable to pay for these things. Believing in the promise of American Exceptional-ism so fervently, we have never questioned how we could see a rise in the amount of money in the U.S. go from $500 billion in 1972 to over $16 trillion in 2008, an increase of thirty-five times. We have never asked if the real underlying value of the Nation also increased thirty-five times. We are America, of course it could. It had to, because there are Americans, who in 1972 were making a salary of $9,000.00 per year, who in 2008 were making over $350,000.00 per year—38 times as much. See we got richer! Some have made much more. Since the War on Poverty began in the mid-1960s, we have continued to increase spending to subsidize the needs of the poor. Clearly, we can afford this. After all today there are more poor than ever, but we don’t see them dying in the streets, most are able to get healthcare and there are lots of governmental agencies focused solely on providing things they need. We know that almost one-half of the population is getting some or all of their annual income from federally subsidized programs. We simply must have had these increases or we could not have paid for it—right? And if you look at the middle-class—well lets not really look at the middle-class—they just have to be doing alright, after all, they are the middle-class.
Repeatedly, over the past few days, the central political topic has shifted from the one fundamental issue that polls show the electorate is clearly basing much of their decision upon—the U.S. economic disaster, its effect on jobs, buying power, the middle class, and ultimately, our nation’s ability to compete in the world today. The tactic to avoid the debate has been to focus on changing the subject, to the war on women, the war on the middle class, the war in Afghanistan, the war on the poor, and the war on any other populist ideal. Not only is the continual derision getting tiresome, it is also starting to show in the polls. More, and more, likely voters are dragging the administration and the republican contenders back to their main concern—the economy. Clearly, “Who will be better for the economy?” is the underlying question of this election and perhaps many more to come.
Recently, the president, slipping in polls and running out of options other than divisiveness, which is not working, has hauled out the “big gun” of the democratic legacy, President Bill Clinton to support the fiscal policy of the current administration, despite the fact that President Clinton has been at odds with these policies more often than not.
Now that it appears the justification for four more years of the current administration is switching from the promise of “Hope and Change” to running on the Clinton presidency’s budget surplus record, perhaps it would be wise to analyze the Clinton Budget Surplus and determine if it was both a true surplus and if the method employed to achieve this feat was good for the economy and the middle class.
Unfortunately, we will have to have to dig a bit in the weeds of the policies and actions of the past 50 years in order to extract a few important points. The chart above will help show the cause and effect of much of what has driven our current problems.
From its inception, the United States of America’s currency, with only a few relatively brief exceptions, was based on its relative value to one ounce of gold. For the most part, the rest of the world followed the same principle to assure that all nation’s currencies exchanged goods for a fair valuation. The dollar value compared to gold, like other currencies, was a relative measure of work output based on the total value created by U.S. workers, divided by the total amount of money and that was divided by the total amount of gold in U.S. possession. In fact, throughout history, currency has always been nothing more than a relative measure of work and the value of that work to either the encompassing society or later between nation-states. The reason for the gold standard was to assure that increases in currency were backed by real, tangible, economic value. In other words, it was to prevent any nation, or trading partner from just printing paper to pay for their goods and defraud their trading partners of the underlying value (balanced by the price of gold). Currency was the real measure of the total value of a nation and therefore, the real representation as to the buying power of the citizens in that nation was based on that total national value, backed by its gold, divided by the total currency in circulation.
$100.00 in Gold, divided by 100 $1.00 bills yielded a real value of $1.00 of internationally trade-able gold per $1.00 bill. If a nation printed 200 $1.00 bills with the same amount of gold in the national treasury, then despite the face value of $1.00, other nations would only value it as worth 50 cents in gold.
If you look at the chart above, you will see that the solid black line represents the Total Currency in Circulation (CinC). You can see that the total CinC in 1900 was approximately $9 billion, in 1972 was $500 billion, and in 2009 was over $16 trillion. The chart also shows the various presidential administrations and party affiliations from 1961 to 2009 as well as some key events that had major effects on our economy. You will also see that both parties bear some responsibility for the current economic disaster but, it is also clear that some of the decisions made, likely with the best of intentions and for very valid reasons at the time, have had some very bad unintended consequences.
Looking just at the CinC line you can see the rapid effects of a number of our major policy decisions. For instance if you look at 1935 through 1945, you can see the beginning of the spike in amount of U.S. currency, driven by real tangible asset growth due to the war production and programs like “lend-lease” and “cash and carry” created by President Franklin Roosevelt as he endeavored to both help the allies win the war and recover the American economy. This chart tracks just currency growth and not expenses or trade deficit, so you see no impact from programs like social security here. The gold standard did not allow the printing of currency simply to pay for goods and as such, unlike today, the need for cash did not stimulate the production of new money. Hence, increases in spending did not have a “stimulative” effect on our economy. For the most part only production of tangible goods and services could stimulate the economy, not mere debt.
In 1965, President Lyndon Johnson expanded the Social Security Act of 1935, to include a new, initially restricted, safety net for seniors and sick and disabled individuals, dubbed Medicare and Medicaid. Johnson, initially had significant resistance from within his own party including very powerful democrats like Representative Wilbur Mills, considered the foremost expert on Social Security at the time. Mills felt that the nation simply could not afford such an expansion of Social Security. Mills felt the initial actuarial predictions were off by an order of magnitude and would by the mid-1970s put the country in a very bad economic condition. After the democratic sweep of congress in Johnson’s first election, Mills quit resisting the tide against him and, for the pragmatic purpose of continuing his career as a member of the House of Representatives, joined the bandwagon and pushed the legislation through the Ways and Means Committee that he chaired. Upon passage of the bill by the committee Mills famously told President Johnson on a conference call, “today I am giving you something we (democrats) can run on next year and every year thereafter.”(You can hear this exchange yourself by listening to the Johnson Tapes available on line) In less than a year, congress began the continual expansion of what started as a safety net, into the partly socially beneficial and partly economically problematic entitlement that we see today.
After World War II, the U.S. had accumulated a huge percentage of the world’s gold reserves, mostly due to President Roosevelt’s war supply policies. As a result, the U.S. economy began to drive up gold’s value, and the U.S. dollar became the world standard currency. As a result of the rising value of gold and the U.S. position of owning much of the world supply, the amount of dollars in circulation began a gradual and significant rise. The wealth of Americans was truly increasing. By the 1960s, however, much of the world was converting their U.S. dollars, accumulated as payment for trade goods, back into gold. By the early 1970s, the U.S. had only a fraction of the gold reserves still in its possession. The effect of the gold standard now worked in the opposite way—limiting how many new dollars we could print without a corresponding real gain in tangible work value. During this same period, a number of the core economic industries, like steel, mining, clothing, cotton production, food production, fisheries, and oil production, among others, began to be reduced, either because: the population no longer wanted such jobs, we were now concerned over the environmental impacts of such activities, or due to rising U.S. worker cost (wages & benefits) making America no longer a competitive producer. Additionally, Europe had rebuilt its own production capacity, lost during the war, and was no longer reliant on the U.S. as its principal supplier. America now more often a net purchaser, not a seller, was moving from a trading surplus into a trade deficit.
By the time President Nixon took office, Wilbur Mill’s prediction had come true. The U.S. had entered a period where the limiting effect on the production of new dollars had placed Nixon’s administration in the position that the government was simply running out of money due to the rising cost of entitlements like Medicare and Medicaid. Additionally, the cumulative effects of both the Korean and Vietnam War had further drained cash and gold from the U.S. coffers. By 1972, the now combined cash drain of the trade deficit, Social Security, Medicaid and Medicare, and the wars had left Nixon with insufficient cash reserves to pay federal expenses.
Nixon took what was at the time heralded as the bold step to remove the U.S. from the gold standard. Looking at the chart above you see that the spike in the increase in currency begins slightly before this step in 1970. The realities of the need for cash had driven the government to begin increasing currency supply prior to the removal of the gold standard restriction. Since the U.S. economy was the benchmark, for a short period this increase, and its effect was not very visible. In fact, it has been argued that if Nixon had not removed the gold standard in 1972, the U.S. economy would have collapsed shortly thereafter.
Having U.S. currency no longer tied to the ownership of gold, transformed the U.S. economy to one now based on the creation of Debt. Before this action, the amount of currency could only be created based either on the increase in tangible value of the U.S. economy (assets and production) to the total gold, or by an increase in the gold owned. Now currency in the U.S. was tied to the formula of fractional reserve lending employed by banks. The bank could create and led ten dollars of new money for every dollar of assets (including debt) shown on their books. This was the birth of the so called Finance, Investment, and Real Estate (FIRE) economy. This is where the increase in new currency begins its rapid rise.
A significant portion of debt, in the form of mortgages, was in the hands of Savings and Loans. S&Ls were not banks and therefore not able to create money at the rate of 10 to 1 like banks. So initially the rise of currency was limited because most of the leverage-able debt was only able to be leveraged based on a dollar for dollar future return on a loan, in other words, the mortgage plus interest paid back to the S&L throughout the life of the loan.
There was a change in accounting rules during this period that limited the S&L industry from using the full repayment amount for what they could lend out to only the amount that they could realize if the asset (home) was sold today. This is the so called “mark to market” rule that began during S&L deregulation in 1980 and culminated with FAS 115 in 1993. It is this, in conjunction with some tax reform legislation that reduced housing sales drastically, that spelled the death of S&Ls. Perhaps this was simply happenstance and not proscription but the bankrupting of S&Ls conveniently drove the asset value for mortgages from the S&Ls that could only get a 1 to 1 leverage, to the banks that could print new money against their newly acquired mortgage debt at the rate of 10 to 1. As the S&Ls collapsed, you see the beginning of the hockey stick in the rise of the amount of currency in circulation.
Still, as we will see in the later chart, the rise in new currency was not keeping up with the increase in costs due to the combined effect of both federal spending and the accumulating trade deficit. The U.S. Treasury was continually relatively short of cash. Even with the 10 to 1 leverage ratio afforded by the banks in creating this new money, it could not keep up. A number of individuals, driven by the Federal Reserve and the Banks, argued that the historical prohibition of banks participating in speculation through connection and ownership of investment banks was limiting the ability of the banks to absorb all the “bad” S&L mortgages. So the Glass Steagle Act was effectively overturned and Banks now had direct control over investment banks and Wall Street brokerages. With the cooperation of the Federal Reserve, the Banks took significant advantage and used this new power to create new classes of securities called derivatives. Since 10 to 1 leverage was not keeping up with the rising federal spending and trade deficit, then what we needed, according to the Fed and the Banks, was to be able to justify creating more money out of thin air.
In the 1990s the death of the S&Ls and easing of banking regulations allowed fractional reserve lending to rapidly grow from 10 to 1, to 100 to 1, and then to over 1,000 to 1.
With Debt growth capped by the restricted amount of people building and buying homes, we needed another accelerator. So the Banks turned to their new Wall Street subsidiaries, and mortgage backed securities were created. The home, and its underlying mortgage, could up till this point only create 10 times its value in new currency. As an example a $128,000 home would allow the bank to create only $1,280,000 in new currency. But, if we then package this mortgage with other mortgages, we can sell these new securities to 100 people. Now we create 1,000 times the original mortgage amount (10 to 1 times 100 equals 1000 to 1). This is why you see the huge increase in the rate of currency creation from 1994 to 2002. But by 2002, this was still not enough so the always creative Wall Street subsidiaries of our banks then packaged these mortgage-backed-securities derivatives into new packages of the same derivatives and sold them to 100 more people. Now we are at a ratio of 10,000 to 1. This is one of the reasons you see the additional spike in the curve in 2004. It is also the reason that some experts say the total amount of derivatives in the world, plus the insurance hedge, is in excess of $1.25 quadrillion dollars. (A quadrillion is one thousand million million)
Was all of this accidental? Who knows but the affect is still the same!
All went well till we arrived at 2008, when the housing market collapsed due to the government’s promotion of home ownership no matter what the cost or ability to pay. When these new home owners found that the increase in the numbers of dollars in salary, and home value was not directly translating into real purchasing power, the bust occurred. In retrospect, it was predictable. If you look at the dashed line you will see a trend analysis of what we would have had in our true value based economy if we had stayed on the gold standard. You see today we would have only about $6 trillion in currency in circulation in 2008, not the $16 trillion. What does this mean in English? It means that you may have made $150,000 dollars in income last year, and own a $330,000 home but, you actually only have about $94,000 in real worldwide purchasing power from your earnings, and your home is worth about $206,250.00 in real world asset value.
Now with this background, we may be able to finally have a more valid understanding of the Clinton budget surplus, how it came to be, and what impact its method of creation really had on people’s real net worth and the national economy.
The second chart focuses on the years 1960 through 2011 with hard data points, and estimated projections for 2012 and 2013. Again the various presidential administrations have been included and coded for the party in power. The same key policy decisions are again located in time as well as key events.
This chart displays a purple dotted line to again show the CinC. It shows three key indicators about our Federal Budget. The Green Columns show the total receipts, or income, to the federal government from taxes, fees, interest and other sources. The Blue Columns show the federal spending and the Red Line shows the balance of the budget with a surplus when the line is above the $0.00 base line and a deficit when the line is below the $0.00 baseline. Finally, the Yellow Line represents the cumulative balance of the trade deficit.
The most remarkable thing that one can see in looking at the federal budget related to the increase in currency is that the combined effect of federal spending and the cumulative trade-deficit actually offset the increase in currency. Other charts I have previously published (see President Obama’s Speech: Critical Question Continued) show that the healthcare spend is a point for point match to the CinC curve, indicating that the place that a large part of the newly created currency went, was to pay for entitlements. The other curve that matches the CinC point for point, is housing prices. Since mortgage debt is the creative force for the new currency, and healthcare and entitlement spending is where the money went, you would expect to see indicators like median home pricing leading the increase in currency, and the rising cost of total healthcare spending as following the increase in CinC and, that is exactly what you see.
Looking at the Budget Deficit line during Carter years, you see the beginning of an increasing deficit that continued into the first half of the Reagan years, rising to balance in the end of the Reagan second term. Once again the budget deficit increases during President H.W. Bush’s term building a historically negative trend. Clinton did, in fact, inherit a negative deficit curve, but so did Presidents Kennedy, Johnson, Ford, Carter, Reagan, G.H.W. Bush, G.W. Bush, and Obama.
What was it that President Clinton did that turned this curve around? Was it the rising net value of the U.S. economy? No! Looking at these numbers it becomes clear that since 1972 the U.S. economy was not based on the tangible value of our underlying work and assets. How could one even think it was based on real values when you look at the other items? No one in America today, economist or not, thinks that America increased our national net worth thirty-five times since 1972! Additionally, if you even came close to believing there was a real underlying increase in the value of America, then you would have to explain how the cumulative deficit (more money going out of the collective piggy bank than was going in) could have continued to offset any potential tangible increase in value.
Again, we need to critically understand the effect of the elimination of the gold standard as the basis for our currency. When we eliminated this restriction, the banks, due to debt based fractional reserve lending, could simply print more money. The additional money drove more purchasing, higher wages, higher home prices, more home purchasing, bigger mortgages, higher debt, and ultimately this cycle of just increasing currency. In effect it was a printing press tied to no real basis. While wages went up, tangible goods creation fell. While wages and benefits rose, real output value based on the world’s appetite for American goods went down. The more we purchased from other countries the less we sold to ourselves and the less the world was willing to buy what we were making.
The main thing that allowed President Clinton to generate his budget surplus was the rapid increase in currency that was begun under his monitory policy in 1993; not a real increase in the output value of the American economy and our underlying asset base. The strong acceleration of the growth curve in currency in circulation was no accident. Printing more money tied to nothing, faster than we were initially spending it for a short term, pushed the curve into the surplus category. All now must realize however that it was really nothing more than a temporary gain. More spending in the economy, would require more currency, which required maintaining rapidly rising housing prices to underlie the basis for the mortgages that backed up the new money. In retrospect, this simply could not sustain itself—particularly when as a nation we were now not just borrowing from the American institutions but from our prime international suppliers as well. Rapidly the debt owed to foreign nations was outpacing the leverage-able debt we owed to ourselves.
In conclusion, the constant refrain of the Clinton Budget Surplus is a simple myth. It is an international game of Three Card Monte that we have been playing since 1972. When we were the ones controlling the cards and moving them on the table, rapidly and unobserved we were able to continue the charade. Like people that kite checks to defraud banks, as long as we deposited the supposed increase in currency just in advance of the need for the money, and we kept the underlying values off the table, we succeeded. Unfortunately, the game worked not just on the international economy, it worked on ourselves as well. But just like the check kiter, if anything delayed that deposit of new currency into our economy then the Three Card Monte House of Cards came crashing down. That is precisely what happened in 2006-2007. Now the rest is history!
During this debacle, in 2006, one assumes by pure coincidence, the Federal Reserve decided it was no longer a good idea to calculate one of the key economic measures of the total amount of currency in circulation, called the M3. Today there are numerous organizations that have been continuing to calculate the M3 for years. Even the St. Louis Federal Reserve Bank, continued to produce a similar statistic called the MZ. The numbers for the CinC used in this article are those that are produced by the outside organizations. The St. Louis Fed number in 2008 was about $10 trillion as opposed to the $16 trillion of the other institutions. Regardless, while the sizes of the numbers are different the actual curves are identical. It is in these curves that the truth is told. Clearly, President Clinton’s actions increased the amount of currency in circulation in the U.S. economy during his presidency. This increase in the amount of money, allowed for more federal revenue which temporarily created a budget surplus. But what is also clear, is that it was not a real surplus.
If the underlying value of the U.S. economy remained the same, and the amount of currency increased, then at a minimum each new dollar diluted the value of the other dollars in the national piggy bank. The real problem is that the national real value did not remain the same. Our national net value has been in decline for almost 60 years as we have voluntarily decided to stop doing many of the things that created our cumulative value in the first place. At this same time, because we started printing more money in 1972, we have lulled ourselves into the belief that we can afford to spend a lot more. The effect on our national economy is devastating. And the people that have felt the most effect are the middle-class.
The middle-class is not eligible for the subsidies that the poor get. The way the system works is that as the poor get poorer we print more money and we give more to the poor in services. Since the new money goes into the economy, often through loans, investments and interest, those with excess assets, take some of their money and invest it into areas that benefit from the spending of the new printed money. In other words they can offset the loss in purchasing power because they can hedge part of their assets against the devaluation. The middle-class get neither subsidy nor do they have the excess assets necessary to hedge. This is why the middle-class has seen their lifestyles collapse over the past 30 years despite the rhetoric from either side.
Additionally, it was mostly the middle-class that the government targeted for the new spending for homes, bigger mortgages, and higher credit card balances to fund this engine of growth in new ‘out of thin air” currency. Recently, President Obama stated straight-out that it was the role of the middle-class to purchase more to drive our economy. In reality, not only did their increases in earnings buy less, the government convinced them to purchase a lot of things they could not afford based on their continually rising standard of living. A cynic may say they were screwed, blued and tattooed. Prior to the 1970s, those of us alive were taught to save, save, save! About 1973, we started to see a lot of promotion for credit, credit cards, and home ownership.
Now we know that in the end, it is us, or our children and our children’s children that will pay. Along with the myth of the Clinton Budget Surplus, comes the myth of the evil empire that is out to destroy the other side. There is no grand conspiracy to take money from the poor and give to the rich. There is no conspiracy to take all that the rich have and give it to the poor. There are just a lot of short sighted, temporary actions, sometimes done with the best intentions that have had horrible and cumulative unintended consequences. One of the key drivers is the need for our professional political class to continue in their job by trading our vote for perceived valuable free stuff. We now know unequivocally it was not free nor very valuable.
So the next time you hear about the Clinton Budget Surplus, you will have some additional data points to put it, and all of our monetary policy in perspective. Remember, it was old Ben Franklin who said, “A penny saved is a penny earned.” Perhaps he was more correct than we have recently realized!
Regardless of whether you agree with this article or not, please respond by tweeting or forwarding the link to others. While we may disagree on conclusions we can no longer afford to disagree on the need for this dialog. If we do not begin to deal with the underlying issues soon, our fate will be sealed by circumstances beyond our control.