The word “war” must be worn-out by now.
After two harrowing World Wars, Korea, and Vietnam, presidents have also called on Americans to fight metaphoric wars on poverty, crime, drugs, and terrorism… not to mention actual clashes in Bosnia, Iraq, Afghanistan, and more recently in Lafayette Square across the street from the White House. Politicians now deem the struggle to defeat COVID-19 a war, and, indeed, the effort has required mobilization, requisition, and MASH units more fitting for Korea’s 38th parallel in the 1950s than the east side of Manhattan.
To offset the COVID-induced Great Cessation, the Federal Reserve and Congress have pumped in unprecedented levels of monetary and fiscal stimulus, fearing that the economy would otherwise sink like a dense dumpling in a bucket of broth at a 1930s soup kitchen. In April, Congress green-lit $3 trillion of spending, while the Federal Reserve has bought about $3 trillion worth of securities, including corporate bonds of nearly 800 private companies. President Trump and Congress will likely up the ante this summer. The 2020 budget deficit looks to hit about 18% of GDP, and the ratio of debt to GDP is hurdling over the 100% mark – numbers not seen since Franklin Roosevelt was photographed with a cigarette holder jauntily protruding from his patrician lips.
Assuming we eventually defeat COVID-19 and do not devolve into a dystopic Terminator scene that would bring Arnold Schwarzenegger out of retirement, how will we avoid the fiscal cliff and national bankruptcy? To answer these questions, we should grasp some lessons from the World War II era. That war did not bankrupt us, and even though the debt-to-GDP ratio soared to 119%, by the time of the Vietnam War, that ratio had slid to just above 40%.
Before talking finance, though, it’s helpful to realize how sweeping and all-encompassing World War II was, especially compared to our current challenge. In today’s effort, President Trump has invoked the Defense Production Act, ordering General Motors to prioritize manufacturing of ventilators and requiring medical suppliers to make more swabs for coronavirus testing. Travel and leisure companies have been especially squeezed. Disney, for example, closed its theme parks and cruise ships, and DreamWorks was forced to release its new Trolls movie by home-streaming rather than in-theater viewing. This, no doubt, is a hardship. But consider what Disney management faced in the early 1940s.
They turned the Disney fantasy machine into a war machine, producing everything from military logos to training films.
Although the Disney headquarters in Burbank was thousands of miles from any bombs or rifle shots, shortly after the Japanese attacked Pearl Harbor on December 7, 1941, 500 American troops marched through the gates of the Disney Studios and took over. The troops had two missions. First, they were protecting a nearby Lockheed aircraft plant. Second, they turned the Disney fantasy machine into a war machine, producing everything from military logos to training films. Disney designed a logo for the Navy’s torpedo boats, also known as mosquito boats. It was a menacing mosquito straddling a torpedo. Dumbo showed up on air squadrons riding bombs and saying, “We never miss.”
Over 90% of Disney’s film production in 1942 was devoted to the war, and the Navy pressed the studio to churn out 6 times as much feet of film as they had been during peacetime. Though Walt Disney was a patriot and proud that his company could serve the military, even he was startled when an old Navy commander camped out in his personal suite for months, and perhaps thinking he was on the front lines at Guadalcanal, actually began washing his socks in a bucket while Walt tried to conduct production meetings. The Department of War harnessed Disney’s talent to produce films with such eye-catching titles as Hookworm, How Disease Travels, and Cleanliness Brings Health. Needless to say, Disney’s typical fans did not race to buy tickets. With 1,500 people on the payroll, the studio soon found itself more than $4 million in debt.
While Walt understood the need to sacrifice, occasionally the U.S. government seemed less than grateful. In one notorious example that I document in my book Lasting Lessons from the Corner Office, the U.S. Treasury commandeered Donald Duck to appear in a film warning Americans to pay taxes on time, called The Spirit of ‘43. (A Scrooge McDuck-like character says, “Aye laddie, it’s your dough, but it’s your war, too.”) Treasury Secretary Henry Morgenthau actually complained to Walt about Donald Duck’s performance. Walt Disney blew up: “I’ve given you Donald Duck… That’s like MGM giving you Clark Gable!” Despite Donald’s apparently flawed acting, tens of millions of Americans saw the film, with a Gallup poll showing that 37% were more willing to pay taxes.
The war was financed with a blend of roughly 40% taxes and 60% debt and seigniorage (that is, the profit from minting coins and printing pieces of paper). Buyers of debt received a measly return. The Federal Reserve joined the war effort by intervening in markets to keep one-year paper at 0.375%, compared to the prevailing 2% to 4% peacetime rates. Ten-year notes yielded just 2%. Of course, in 2020, those rates sound downright lofty!
Who bought U.S. bonds, the majority of which were designated in small denominations of $25 or less? American citizens, many from a sense of patriotism as they planted Victory Gardens and saluted posters depicting young soldiers hurling grenades and charging across enemy lines. Employees of the Federal Reserve Board got into the act, too, and competed to see which offices could buy more bonds. In April 1943, New York Fed employees snapped up more than $87,000 worth of bonds and were told that their purchases enabled the Army to buy a 105mm howitzer and a P-51 Mustang fighter plane. The Army sent the New York Fed a letter and photograph, displaying the aircraft with the name “N.Y. Federalist” painted on the side. The plane flew across the English Channel to battle the Luftwaffe over France and Germany.
And the thought of swapping American dollars for higher-yielding foreign assets seemed ludicrous and likely to lure J. Edgar Hoover’s team to stomp down your door.
Patriotism aside, many Americans snapped up the bonds from the sheer lack of other good choices. It is easy to forget that until banking deregulation in the 1980s, the federal law called Reg Q prevented banks from offering high rates on savings accounts. And the thought of swapping American dollars for higher-yielding foreign assets seemed ludicrous and likely to lure J. Edgar Hoover’s team to stomp down your door. While the U.S. equity market was open to investors (the Dow Jones Industrial Average actually rallied after 1942), broker commissions were hefty and only about 2% of American families dared to own stocks. Stock investing seemed best-suited for Park Avenue swells, or for amnesiacs who forgot the 1929 crash. In contrast, a majority of American families participate in equities today.
In sum, during World War II, the savings of American families were secured in their home country and locked into bonds. Treasury paper bore three things: a paltry yield, a distant maturity, and the stern-looking photo of a former president.
The trim, short lines of the Eisenhower jacket may have looked appealing, but it was rations, not fashion, that made Americans like Ike’s style.
Of course, the limits on personal finance were not more dramatic than the limits on consumer purchases. After the Pearl Harbor attack, the U.S. War Production Board banned a wide range of items, including double-breasted suits, trouser cuffs, and pleated skirts, all of which wasted valuable material. To walk around in a big-shouldered, broad-lapelled zoot suit at that time was a near-criminal act. The trim, short lines of the Eisenhower jacket may have looked appealing, but it was rations, not fashion, that made Americans like Ike’s style.
It was not just the Eisenhower jacket that hemmed in America. While Roosevelt undid some of the damage of the Herbert Hoover administration by amending the dreadful 1930 Smoot-Hawley Tariff Act and building deposit insurance into banking, he raised individual taxes even higher than Hoover had and doubled the corporate tax rate from its 1930 level. Just as dire, he padlocked the economy in a cage of wage, price, and output controls, depleting it of any dynamism.
FDR’s Agricultural Adjustment Act, for example, employed thousands of inspectors to drive by farms in trucks and fly over them in repurposed crop-dusting aircraft to make sure that farmers did not plant more crops or raise more livestock than the federal government permitted. Millions of acres of fluffy cotton plants and sweet corn cobs were plowed under, and millions of piglets were slaughtered. By 1935, America faced shortages of corn and cotton and had to import these staples from abroad.
Rather than dwelling on the Great Depression of the 1930s, let’s take a look at “the Depression that never was,” immediately after American troops came home in 1945.
After all, millions of soldiers were coming home and trading in their helmets and flak jackets, but for what? Their old jobs had vanished,
World War II shuttered key parts of the civilian economy, while forcing millions of Americans to step away from their usual jobs. As the war ended, future Nobel laureate economists Paul Samuelson and Gunnar Myrdal predicted a dispiriting business relapse into the intensive-care unit. After all, millions of soldiers were coming home and trading in their helmets and flak jackets, but for what? Their old jobs had vanished, and many of their former employers had either gone bankrupt or had switched under the Second War Powers Act from stitching sofas to, say, fabricating pilot seats for fighter-bombers.
Whereas almost 41% of U.S. GDP came from the government’s till in 1945, that share would shrink to just 14.4% by 1947. Even Rosie the Riveter would be laid off because no one could afford to fly on a passenger plane except movie stars and high-society types. Samuelson warned, “We shall have some ten million service men to throw on the labor market,” heralding “the greatest period of unemployment and industrial dislocation which any economy had ever faced.”
What happened instead? When Japan surrendered in August 1945, the U.S. economy did indeed freeze, but only until November’s Thanksgiving holiday. Then, average weekly work hours began to climb. Textbooks routinely attribute the rebound to “pent-up demand”: returning soldiers were dying to buy cars and homes.
But this is a lazy cliché. Where did returning soldiers and their families get the money to express their pent-up demand? Army privates and Navy sailors were paid $50 per month whether they charged through front lines or peeled potatoes at stateside bases. And Medal of Honor winners took home a bonus worth precisely $2.
Here’s a more persuasive explanation: President Harry Truman and a Republican Congress let the cage of New Deal regulations spring open, corporate taxes were cut (including a repeal of the “excess-profits” levy), and businesses encountered a more flexible, optimistic environment, sending stock prices higher. As a result, in the first six months of 1946, private investment leapt 50% higher than during all of 1945, before consumer demand had a chance to catch up.
Prior to the war, labor unions had marched to demand shorter hours and had prodded the U.S. Senate to pass a bill limiting the workweek to 30 hours. But after 1945, returning soldiers – eager to grab a slice of prosperity – demanded to work longer hours, and so union leaders quietly shredded their faded protest leaflets. Increasingly confident businesses began hiring more, and average weekly work hours began to soar, giving millions of Americans the wherewithal to afford the radios, refrigerators, and cars that would roll off assembly lines.
In its November 25, 1946 issue, Life magazine devoted a centerfold to “Family Utopia” and displayed the 1947 American Dream: a modest house with a children’s slide, a three-burner electric stove, and a modern dad, who, with Midway or Normandy in the past, now lusted for lawn furniture, a rubber boat, and a bow-and-arrow set.
But how did the monumental war debt get resolved? Three factors stand out. First, the U.S. economy sped along quickly. From the late 1940s to the late 1950s, despite recessions in 1949 and 1953, the economy averaged a 3.75% growth pace, which shunted massive revenue flows into the Treasury. During this period, U.S. manufacturers faced few international competitors. The fearsome factories of Germany and Japan had been pounded to rubble, and China’s primitive foundries could turn out little paper umbrellas for poolside, suburban Mai Tai parties, but not automobiles and home appliances. Second, inflation took off after the war, as wages and prices were released from government captivity. From March 1946 to March 1947, prices jumped 20%. This was not a result of reckless monetary hanky-panky. This was merely allowing prices to reflect the true cost of doing business. But because government bonds paid so much less than the 76% rise in prices between 1941 and 1951, the value of government debt obligations decayed.
A third force came from locking-in borrowing rates for a long time. The average duration of debt in 1947 was more than 10 years, about twice today’s average duration. By the end of the Eisenhower era, the combination of these three factors pushed down the debt-to-GDP ratio to about 50%.
Beyond funding and testing antiviral drugs and vaccines, federal and state governments should encourage flexible business pricing, including wages.
So what do we learn from this saga in 2020? Lesson number one: Breaking down a cage of regulations can free up resources and encourage the economy to grow faster. Beyond funding and testing antiviral drugs and vaccines, federal and state governments should encourage flexible business pricing, including wages. Is now the best time to force near-bankrupt restaurants to pay waiters more? Probably not (although wealthier restaurant owners could cough up some hazard pay). Is now a good time for California to give up its battle against Uber, independent truckers, and freelance writers and stop forcing gig workers to be regulated as official employees? Probably yes. And is now the time for Congress to repeal the barnacled and protectionist 1886 Passenger Vessel Services Act, which drives jobs away from U.S. port cities? Without question.
The White House and Congress should also revamp unemployment benefit programs to nudge laid-off workers back on the job as soon as safe and reasonable employment offers come in. In 2011 in the Washington Post, I proposed “signing bonuses” for individuals collecting unemployment insurance. Because laid-off workers tend to take new jobs just when their unemployment benefits expire, I suggested a sliding scale whereby people would receive more money if they accepted work sooner, before their benefits ran out. If star athletes get signing bonuses, why shouldn’t bank tellers and grocery clerks?
Lesson two focuses again on debt duration. The U.S. Treasury should give tomorrow’s children a break by issuing 50- and 100-year bonds, locking in today’s puny rates for a lifetime. You might think that no one would trust that a government would be around in 50 or 100 years. But corporations have successfully auctioned long-term bonds. Disney issued “Sleeping Beauty” bonds and the market scooped them up. Norfolk Southern enjoyed a similar reception when the railroad issued 100-year bonds. CBS News reported, “institutional investors bought them like crazy, leading Norfolk Southern to more than double the issue.” Imagine, buying 100-year bonds from a railroad. Will rails even exist in the 22nd century? Dozens of other companies, including Coca-Cola, IBM, Federal Ex, and Ford have also issued 100-year debt.
It doesn’t take a rocket scientist to understand the benefit of ultra-long bonds, but institutions of higher education – including the University of Pennsylvania, Ohio State, the University of Southern California, and Yale – have also issued 100-year bonds. Governments across the globe are also grasping the concept. In 2010, buyers even grabbed Mexico’s 100-year bonds, despite a pockmarked history of devaluations and defaults that stretch from 1827 to 1994.
More recently, Ireland, Austria, and Belgium have issued 100-year bonds, while France and Spain have sold off 50-year instruments. The average maturity of U.K. debt is 3 times longer than U.S. debt.
Deregulation and longer duration will not be enough to solve the debt problem, of course… We must also reform entitlement spending, though that discussion is for another day.
Finally, I must mention the inflation strategy. Should we ignite inflation and launch prices into the stratosphere to shrink debt? I don’t think so. Investors no longer represent a captive audience as they did in the 1940s, and “bond vigilantes” will sniff out a devaluation scheme in advance, driving interest rates higher and punishing the value of the dollar and the buying power of citizens. Of course, if the Fed were to take the dangerous, inflationary tack, it would be a lovely time for holders and hoarders of gold and cryptocurrencies.
Unlike military campaigns, the war against COVID will not end with a bombing raid, a treaty, or a sailor and nurse smooching in Times Square. Regardless of the final image, COVID-19 will leave us with a debt time bomb. We can defuse it, but only if we can also win the battle against policy inertia and policy stupidity. This war won’t end in a bang – but it better not end in a bankruptcy.
Todd G. Buchholz has served as White House director of economic policy and managing director of the legendary Tiger hedge fund. He was awarded the annual teaching prize in economics at Harvard, was named one of the “21 Top Speakers for the 21st Century” by Successful Meetings magazine, and is the author of numerous books, most recently, The Price of Prosperity: Why Rich Nations Fail and How to Renew Them. @econTodd
