Public Debt and Inflation


By GEORGE V. McLAUGHLIN, President, Brooklyn Trust Co., Brooklyn, N. Y.

Delivered at Annual Dinner Meeting of Furniture Manufacturers Representatives of New York, Inc., January 11, 1944

Vital Speeches of the Day, Vol. X, pp. 278-280.

WHEN my good friend, Mr. Jaffin of your organization, asked me to speak to you on the topic of the public debt and the chances of "inflation" in the post-war period, it seemed like a pretty large order. How large the public debt ultimately will be, depends entirely on when the war will end, and practically every professor, barber, bootblack, and banker has an opinion on that subject except myself. And as to "inflation", that word seems to mean just about whatever anyone wants it to mean.

It is easy to be facetious and say that we have had inflation for more than ten years now, and mat we ought to be used to it by this time. But, seriously, I think I may guess what is in your minds on these subjects, and give you a common sense answer. That is all that I can do, for I make no pretensions to being a technical economist.

Like many others in various other lines of business, I think you are anxious (and rightly so) about the piling up of public debt day by day, month by month, and wondering how it can ever be paid off without impairing the soundness of our currency at some future time. We have seen the thing happen in other countries and have had a few mild experiences right here—in particular, following the Civil War and again following the First World War. But many people are asking today, "Isn't it going to be worse this time?" and no one has a definite and positive answer, although most people have an opinion of sorts.

It seems ridiculous today, but it is a fact that ten years ago even bankers discussed in whispers whether the country could stand a public debt of 40 billion dollars without public bankruptcy and inflation. Today the debt of the Federal Government exceeds 165 billions and when the war ends it will be at least 200 billions and is more likely to stand somewhere between 250 and 300 billions of dollars.

That much is fairly certain, for the deficit of the Federal Treasury is currently running at the rate of 4 billions per month and is more likely to be larger rather than smaller during the remaining months of the war. And even after the last shot is fired, there undoubtedly will be a further rise due to heavy demobilization costs. It would, therefore, not be surprising to see a 300-billion-dollar Federal debt if the war lasts through 1945. This compares with a 25-billion dollar debt following the First World War.

Now let us try to find out what the majority of people mean by "inflation." To frame a technically accurate definition would be rather cumbersome, so let us adopt a short, simple one in popular language, such as "higher prices, caused by too caused by too much money and not enough goods." Looking back to the pre-war period in the middle of 1939, it is obvious that we have some inflation now. Our money supply has risen about 90 per cent, if we consider "money" to mean coin, currency and bank deposits. Coin and currency in the hands of the public has risen from 7 to 20 billion dollars, while bank deposits have gone up from 56 to approximately 100 billion dollars. Prices of some things have more than doubled, while others have remained the same. The average cost of living is said to have increased 25 per cent.

The shortages of some goods are so well known that it is superfluous to mention them. On balance, the total supply of civilian goods is less than in 1939, but not nearly as much less as some experts had predicted. Thus we have all the elements of inflation, and some manifestations of it. But, one may well ask, why aren't there more?

With a 90 per cent rise in money supply and an even greater rise in payrolls, one might have expected to find the cost of living up 100 per cent instead of 25 per cent. Indeed, that is exactly what happened between 1915 and 1920—namely, a doubling of the money supply and a doubling of the cost of living. There is obviously something different about the economic situation today, and if we can find out just what it is, we may have a clue to what the future will hold.

Undoubtedly rationing and price control have had a good deal to do with keeping down the cost of living, even though they were put into effect rather late. Regardless of one's political viewpoint, one must admit that rationing and control of prices have been an important influence in preventing runaway markets in the necessities of life. They have been a source of considerable annoyance to many people at times, but those who complain usually do not stop to imagine what would have happened without them.

However, there is something else. Were rationing and "ceiling prices" the only reasons for the maintenance of a fairly stable price level during the past few months, one might logically expect to find an entirely different situation among the prices of things not subject to "ceilings" and coupons—for example, real estate and common stocks. Yet there has been no spectacular "boom" in these items. It is true that, generally speaking, real estate and common stock values are somewhat higher than four years ago—but there has been no "boom" and nothing like the ballooning of values that occurred in 1925-1929, when the total supply of money was far smaller than is the case today.

The most important influence, in my opinion—and there is some factual evidence to support it—is that more money is being saved than the economists had predicted. More than 20 billion dollars have been invested in War Savings Bonds since Pearl Harbor, mostly by individuals. A substantial part—no one knows how much—of the 20 billions of currency and coin now in circulation undoubtedly represents savings by people who are unaccustomed to use banks. Deposits of savings banks and savings and loan associations and savings deposits of commercial banks have been rising faster than ever before, despite the sale of war savings bonds and the hoarding of currency. In addition, debts are being paid off, particularly installment debts.

One may safely conclude that the habit of saving, one of the oldest of human instincts, is still very much alive, despite the poor example set by our Government in the years before the war, and despite all the propaganda ofthe "spending school" of economists who gravely asserted that "over-saving" caused and prolonged the depression of the Ninteen Thirties. Apparently their theories have not spread beyond the "parlor intellectual" level.

The problem of inflation thus boils down to a simple question of psychology. It is not the quantity of money, but rather the extent to which it is spent, that governs the price level. This is not a new discovery. It has long been known, but since there is no way to measure mass opinion except through so-called "polls" based on small samples, few realized the extent to which the increased personal incomes generated by the war would go into savings.

One might well ask the question, why is the impulse to save stronger today than it was during the last war? The best explanation I have heard is that the memory of the long depression of the Nineteen Thirties is still fresh in the minds of almost everyone. At one time or another during that period practically everyone experienced either unemployment, fear of unemployment, or fear of loss of income, if not actual loss of both income and capital. "A burnt child dreads the fire" would be a simple answer.

Again, one may ask, how can there be so much saving while at the same time there is so much spending? The answer to that question is that we see the spenders, but we don't see the savers. The night crowds in the places of entertainment in this and other cities are easily seen; but they do not include all those whose incomes have increased—probably not more than a small fraction.

Now, let us see what conclusions about the post-war period we can draw from observation of the present. It is obvious that the supply of money in the form of currency and bank deposits will be larger than at present, for the three things which could bring about a reduction are not likely to happen for some time—(1) Substantial reduction of the public debt, (2) Substantial reduction of private debt, and (3) Large scale gold exports. We may safely conclude that there will be plenty of money in the pockets and bank accounts of the public, although the pattern of distribution may not be quite the same as at present.

The big question is largely a psychological one—what will people do with their money after the whistles blow to announce the final armistice? If they rush to try to buy the things they have been doing without, there could easily be created an inflationary rise in prices. If they are patient until our manufacturing plants can be converted to production of civilian goods, the price level will behave—that is, it will rise only to the extent that is required by increases in labor and material costs.

Some of the war-time control measures will undoubtedly have to be continued through the re-conversion period. But the emotional let-down which will naturally follow the last armistice may generate enough political pressure to sweep away all public controls. If that happens, the task of regulating prices will fall upon private enterprises, possibly acting through trade associations. This task may not be so great as we now imagine, for the public will stop buying when prices rise too high, as was demonstrated in 1920.

There are some reasons to believe that there will be no great spending "spree" after the war. Much of the money now being earned—and saved—will be in the hands of the persons who had been employed in war-production plants. Thousands of these plants will have to close for re-conversion, and their workers will have to live for a while on their severance pay, their savings, or their unemployment insurance checks. These temporarily unemployed workers, together with the men demobilized from the armed forces, are quite likely to recognize the uncertainties of their future and, asa result, to go slowly on spending. This attitude may easily spread to persons whose employment is not interrupted.

It also must be remembered that "public spending" includes business spending as well as personal spending. The investment of capital in improvements, enlargements and replacements by business enterprises has long been recognized as a powerful influence on general business activity. While the question of making such outlays of capital in the post-war period is largely an individual question with each enterprise, there is no doubt that the judgment of business management is subject to the same influences as those which govern personal spending. If the future is full of uncertainties as to taxation and markets, managements will generally restrict themselves to replacements of worn-out plant and equipment. If the future looks "rosy", the tendency will be, as it has always been, to go "all out" on improvement and expansion.

There is no doubt whatsoever that from the purely physical standpoint, our productive capacity can supply all the goods the public will need after re-conversion has taken place. In fact, the expansion of the physical volume of production in this country since 1940 has been one of the miracles of this war. It has astounded even the experts. Output of manufacturing industries has more than doubled in less than four years. It has supplied the materials and equipment needed by ourselves and our allies for a global war in two hemispheres while at the same time supplying the requirements of our home front at an average level only slightly below that of 1939. Most of the dire predictions of civilian privation made some two years ago have failed to materialize, and the reason is that no one could foresee the miracle wrought by business enterprise in expanding its output, in spite of the handicaps of strikes, red-tape and shortages of some materials.

There is, therefore, no basic reason for inflation in the post-war period in this country. Although the money supply will be vastly larger, productive capacity has kept pace with it. Historically, inflation has occurred only when money supply out-ran capacity to produce, and in its extreme forms has been observed only in economically poor countries.

This is not saying, however, that a post-war boom with inflationary price-rises cannot occur. It can occur, if there is a proper combination of influences. The question "how much" in regard to production of goods is easily answered with the word "enough." The questions, "What Kind?" and "When ?" are the unknown quantities. How many war plants can be converted into the production of the kind of goods the public will want? Into what kind of production can our airplane factories, shipyards, powder plants, be converted, and how soon?

If you can answer the question whether the public will be patient during the readjustment period and will retain its war bonds and other savings, instead of liquidating them and trying to buy non-existent merchandise or speculating in stocks and real estate, then you will have answered the "inflation" question.

Business management can help, too, in avoiding inflationary conditions. It can refrain from speculative accumulation of inventory, avoid price mark-ups beyond those warranted by current costs, and help foster a public psychology of patience through its advertising.

But what about the public debt? Who is going to pay it off and when? In my opinion, it will not be paid off, certainly not in the lifetime of anyone here. As each issue matures, it will be refunded with another. Perhaps in the course of time some of it will be paid off, as was done between 1920 and 1930 with a portion of the debt of the First World War, but I do not think the repayment will be on a large scale for a long time to come. This country hasn't yet paid off all the debt incurred to fight the First World War, and I am told that England has not yet paid off all the debt incurred during the war against Napoleon. If the Government can balance its budget within a reasonable time after the end of this war and provide a small amount each year for repayment of the principal of debt outstanding, I do not think we need have cause for worry.

The interest burden will be, of course, large in proportion to our pre-war ideas, but at 6 or 7 billions per annum it may not be so serious as one might suppose. This year the Federal Government will collect over 40 billion in taxes. Even if the tax burden is cut in half after the war, so that it will be 20 billions instead of 40, there will be enough to pay the interest on a 300 billion dollar debt with some 13 or 14 billions per annum left over for other purposes.

By my lack of grave alarm over the public debt I do not wish anyone to get the impression that I have gone over to that school of "brain trusters" who say that the public debt isn't important because we "owe it to ourselves." Anyone should know that the people who pay taxes to provide the interest are not the same ones who receive the interest, and there is bound to be some political tension between those who pay and those who receive. The public debt IS important, but winning the war is more important, and I would therefore say that the time to really do something about the public debt will be six months to a year after the final armistice.

We cannot finance a global war without increasing our debt. But we certainly can stop the increase as soon as demobilization has been completed. If we do that, and if we keep ourselves calm until industry is ready to produce what the public wants, the problems of the public debt and inflation will have been solved.