US National Debt Myth Busters Part III: Re-Thinking Keynes

Michael McTague  |

“Never put off until tomorrow what you can do today,” Part III

In this final piece, we sum up our findings on the myth and offer a few predictions. Parts I and II discussed four compelling issues about the national debt and the federal government’s swollen deficits. Washington continues to grow and the nation leans on this monetary support. In addition, the size of the federal budget and its debt suggest that the dollar will be cheapened to soften the blow of ballooning interest payments. In such an environment, taxes will likely rise and the entrepreneurial spirit will languish.

Despite the frightening scope of the problem, pundits brush off its significance. As the economy went south a few years ago, many called up the tenets of John Maynard Keynes for support. Greater government involvement in a sputtering economy together with liquidity would surely spur investment and job creation. So, the debt spiraled as high as the hopes of the debt creators.

Re-Thinking Keynes

Since the Great Depression, argument ceased about government involvement in the economy. With laudable intentions, the new Keynesians were able to count on an element missing in the 1930’s – massive liquidity provided by Washington. The tarot cards foresaw solid job growth, WPA-style infrastructure work and businesses borrowing and creating jobs with the full support of low interest rates held fast by Quantitative Easing I, II and III. What a letdown they must feel. The reality of the last six years fit the prediction about as well as a 32 inch waist in mothballs fits its 40 inch waist owner.

Keynes’s great insights forged a massive infrastructure boom throughout the 1930s, which sowed the seeds of thousands of jobs. This time was different. No new wave of Golden Gate Bridges. Infrastructure fell down the priority list. Of the $100 billion promised to upgrade transportation and communication facilities, little has been spent; most funding has been shifted to future needs. The infrastructure portion of the stimulus amounts to a “facelift.”

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Not surprisingly, the historically low interest rates did not go unnoticed. Goldman Sachs, American Express and others turned themselves into bank holding companies to borrow from the Federal Reserve. Much of that cheap money remains on balance sheets – rather than out in the economy stimulating an increase in employment. Some of the stimulus evolved from the federal government’s nearly unlimited taxing power. Thanks to generous help from Washington, states re-hired workers whose jobs were lost because the recession pillaged state and local tax revenue.

Deficits are Shrinking

The stimulus effort got some good news in May; the deficit is shrinking thanks to higher federal tax revenue and payback from some bailout funding. Fannie Mae and Freddie Mac have reversed course and are running in the black. Since the deficit has shrunk somewhat recently, the heat is off. The neo-Keynesian must be feeling relief – like a boxer behind on points sitting in his corner between rounds. When the bell rings, they will wish they had landed that big punch in an earlier round.

Two reasons explain this tax windfall. Federal tax rates rose in January and major corporations turned very profitable. In every recession, the Fortune 500 reverses losses by cutting inventory and chopping heads. Citibank alone has laid off 25% of its workforce since the Recession hit. Caterpillar, GM, Bank of America and others have pared their ranks as well.

The Myth Buster Looks Into the Future

What about tomorrow – the time so few are worrying about? Three things will happen. First, interest rates will rise in part because the Federal Reserve will back off its efforts to maintain low interest rates. The federal deficit will explode because the government must pay annual interest on its massive debt. The explosion has a long fuse and will creep along for a couple of years; then, bang!

Second, tax rates will inch upwards – enough to yield additional revenue and to take the heat off Washington, short term. Paul Krugman, a lantern bearer for the stimulus, has written that “…families have to pay back their debt. Governments don’t…” This means the government will continue to put off until tomorrow. The Myth Buster took on Krugman a while back when he predicted the end of the euro. Let’s see if he is right about the national debt.  

Third, a new mantra will arise – a means of softening the pain of rising debt. Current needs will again be seen as more important than the debt. Look for the dollar to be cheapened – a superb way to lessen the bite of debt. Expect to read arguments favoring a rise in money supply and explanations that inflation was too low for too long. All of this will open a new round of put-off-until-tomorrow.

This myth stands up quite well. Next month we will look at another myth.



Michael McTague, Ph.D. is Executive Vice President at Able Global Partners in New York.

DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not necessarily represent the views of Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions. To read our full disclosure, please go to:


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