The below graph shows that throughout the 1960s, the US experienced GDP growth consistently, with several prints of GDP in the +10% range.
That would put the recent +4.1% print of GDP growth that President Trump loves to talk about to shame. As a matter of fact, the US has not had a decade like the 60’s ever since the 60’s.
Recall that the 1960s were a turbulent time for the world and the US. The Vietnam War, and the Cold War, raged, and the military industrial complex powered the economy, as it had during World War II. The 1970’s saw the arrival of volatility and several recessions. Most importantly, it saw the arrival of inflation that broke the US economy for the entire decade, and into the 1980s.
The end of the Gold Standard brought upon the globalization that drove the Chinese Industrial Revolution, at the expense of US industry. How? Because Nixon realized that if he was going to devalue the US Dollar, and thereby proliferate the world with US Dollar paper currency, he needed to find a place where that money could go. He needed a place US Dollars could go, and yield a return. China was that place. Although Nixon failed in many ways, his “Opening of China” initiative, and the subsequent investment of now trillions of US Dollars in China, allowed the US to prolong its post-war domination.
Notice in the above graph that inflation (red line) used to trigger recessions. You can see the recessions in the graph by the gray shading. In 1960, the US experienced a recession accompanied by sub 2% inflation ( as indicated by the core PCE number). Once the Gold Standard was removed, and the US Dollar was no longer pegged to the price of Gold, recessions in 1971, 1974-1975, and 1980, were all accompanied by high inflation. In 1975, inflation reached 10%. Inflation again spiked in 1980, triggering another recession. These are all examples of inflation triggering recessions.
The reason why this is odd is because normally, recessions mean that prices go down, not up. The type of inflation that triggers prices to rise, and economic growth to fall, is called Stagflation. Stagflation is extremely hard to fight. The reason why stagflation is so hard to fight is because Central Banks, such as the US Federal Reserve, can’t fight the recession by reducing interest rates. That would only make the inflation problem worse. Inflation can only be tamed with higher rates.
When stagflation occurs, the Central Bank priority is to tackle inflation first. The Central Bank must raise interest rates, which means making the recession worse. This is why in the mid 1970s and the early 1980s, there were several quarters of negative GDP growth i.e. economic contraction.
The US was in peril during these days. Politically, the US was a disaster in the 1970s, after Watergate, and the Nixon impeachment, and the failed presidencies of Gerald Ford and Jimmy Carter. Even when Ronald Reagan arrived in the early 1980s, it took taking the top tax rate (rate paid by wealthiest Americans) from 70% to 33% to stabilize the economy. The below graph of the top tax rate shows that throughout the 1960’s, when inflation was tame and the economy roared, the top tax rate was between 70-90%! By that metric, one has to assume that inflation was a problem in the 60s, but somehow it wasn’t evident. Somehow it was hidden by the war economy.
Does that sound familiar? History repeated itself! As we wrote earlier, the same thing happened during World War II. The war economy, incentivized and directed the government, obscured inflation.
The dramatic decrease in taxes, both personal and corporate, shows how devastating the inflation of the 1970’s and 1980s proved to be to the US economy. It showed that policymakers thought the only thing that could save the economy was government financing, which is exactly what the Ronald Reagan Tax Cuts were. They simply took money that would normally be meant for funding the government (and reducing deficits), and gave it to wealthy individuals and corporations. The name given to this policy was Reaganomics, also known as Trickle Down Economics.
The above chart shows us something interesting. It shows the US budget deficit/surplus going back to 1960, as a % of GDP. Taking the government deficit as a percentage of GDP is a better way of analyzing it. As long as the deficit is not a large proportion of the country’s GDP, deficits are ok. This is because a large economy can easily finance a relatively small deficit by a combination of taxation and debt financing without hurting the economy.
When the deficit becomes a large portion of GDP, funding the deficit by way of taxes would have a negative effect on the economy. Notice that the US Budget had a surplus in 1969. In 1970, the surplus became a deficit, and grew larger until it was -5.3% of GDP in 1983. As this piece by the Brookings Institute tells us, President Reagan realized right away that they had overdone it on the tax cuts. From Brookings,
“The tax cut [Reagan Tax Cuts, 1981] didn’t pay for itself. According to later Treasury estimates, it reduced federal revenues by about 9 percent in the first couple of years. In fact, most of the top Reagan administration officials didn’t think the tax cut would pay for itself. They were counting on spending cuts to avoid blowing up the deficit. But they never materialized.”
After the 1981 Reagan Tax Cuts were passed, the White House Budget Office projected that the deficit would explode higher as a result. From Brookings again,
“As projections for the deficit worsened, it became clear that the 1981 tax cut was too big. So with Reagan’s signature, Congress undid a good chunk of the 1981 tax cut by raising taxes a lot in 1982, 1983, 1984 and 1987. George H.W. Bush signed another tax increase in 1990 and Bill Clinton did the same in 1993. One lesson from that history: When tax cuts are really too big to be sustainable, they’re often followed by tax increases.”
Raising taxes led to George H.W Bush being a one-term president, which led to a Democrat, President Bill Clinton, taking office, who also raised taxes, in a bipartisan manner, with then Republican congressmen John Kasich.
Bi-partisanship led to a budget surplus in the late 1990s. During the 2000s, before and after the 2008 Financial crisis, government spending surged. Today, the deficit is quite frankly, massive, and only expected to grow. The deficit today also has the added effect of adding to the National Debt, which is at ~$22 Trillion.
The below chart is worth pointing out. It’s the Federal Debt as a percentage of GDP. Notice how when the deficit became a surplus in the mid and late 1990s, the Federal debt dropped significantly, from a peak of 65% of GDP in 1995 to a low of 54% in 2001, right before the 9/11 terrorist attacks.
Also notice that the tax increases that Reagan put into effect when he realized he had gone too far with cuts in 1981, were ineffectual. The 1980’s saw the Federal debt as % of GDP go from 30% to 60%, a gigantic increase. This shows how difficult it is to reign in tax cuts, and the prolonged effects of both tax cuts and tax increases. This is why tax policy that is rushed through congress is a bad idea, as were the Trump Tax Cuts of 2017. Already, talks that the Trump Tax Cuts were a mistake are being heard, even among Republicans.
Some people say that Defense spending is a huge component of the deficit. The chart above, of Federal Debt as a % of GDP, shows otherwise. We know that the 2000s in the US were a time of massive defense spending. The US government built up a military complex to fight and survey that rivaled anything ever done before. Two wars in Iraq and Afghanistan and a housing boom sent the US economy skyrocketing. Therefore, GDP grew along with spending. Tax revenue increased and kept the debt in check.
The Great Recession of 2008 sent the ratio of debt to GDP soaring. Why? Because GDP crashed, the economy contracted, tax revenue plummeted, and spending on fiscal stimulus (programs like TARP, bailouts, and Obama’s Economic Recovery Act) skyrocketed.
The federal debt today is 104% of the total output of the US economy. Stunning.