Chapter Fifteen POST-WAR CONSOLIDATION Periods of rapid decline in government spending was generally triggered by the end of wars at prior times in U.S. history. The period immediately after World War II was an exception to this pattern. Although expenditures fell from $95.2 billion in 1945 to $36.9 billion in 1947, the pre-war level of budgets under $10 billion was never again reached as defense spending remained high when we entered the Cold-War Era with the Soviet Union. There was a budget surplus each year from 1946 to 1949, and the total debt never fell below $250 billion. Fiscal prudence no longer centered on balancing the budget, but took into account the effect which government spending had on economic growth and stability. A new fiscal philosophy following the economic ideas of John Maynard Keynes was incorporated into the Employment Act of 1946. The Federal government was given responsibility for avoiding economic recessions, maintaining high employment, and keeping prices steady. The basic idea of the new school of economics was that government spending should be used as a tool for controlling total demand in the economy. The government was to increase its spending during periods of recession, to maintain a high sales level of goods and services. If inflation became a problem, the government would reduce its spending as a way of cutting down the inflationary gap. In this way, as Seymour Harris, a leading proponent of the new economics stated, "Debt management can be an instrument for keeping our economy on an even keel.” 1 Post-War Economics In effect, this school of economics established a different set of standards for managing the government's fiscal affairs. Few people 1 Harris, National Debt, 271. would object to a government maintaining a deficit during a national emergency such as a war, so long as it was paid back during normal times. There was nothing imprudent about borrowing money to save the nation. However, the new program viewed a period of recession in the economy as important an emergency as a war. Therefore, the same criteria that applied to wartime spending should apply in peacetime. A public debt incurred during a recession was to be reduced when normal times returned. These economists were indifferent as to whether the public debt should ever be totally retired. Keynes had stated the position quite clearly, "I think the argument for extinguishing the national debt is partly an aesthetic argument, that it looks nice to have a clean balance sheet, and I think it is partly false analogy from private account keeping; an individual likes to be out of debt. But for the nation as a whole it is merely a bookkeeping transaction." 2 In the period immediately after the war, officials at the Treasury and the Federal Reserve were concerned about whether the economy would enter into a period of recession or a period of inflation. At the same time, there was doubt about whether policies that had worked reasonably well to finance the war effort could be continued in the post-war period without damaging the economy. For example, in the Autumn of 1945, Secretary of the Treasury Fred Vinson told an audience in Peoria, Illinois, that interest rates "should continue low for a long time to come," a view that was repeated a year later by Secretary of the Treasury John Snyder. Low interest rates, it was felt, would be helpful in stimulating the economy, by making it easier for businesses and consumers to borrow. Since the government pays interest on its debt as well, low rates would also serve to keep taxes down. The possibility of inflation was recognized at the Federal Reserve, and it uses its open market operations during normal periods to control the amount of money and credit in the economy, not to help finance public debt. When it wants to expand money and credit, the Federal Reserve purchases government securities, and when it wants to contract them, it sells government securities. As long as the Federal Reserve must buy government securities in support of low interest rates, it cannot exercise any influence over the amount of money and credit in the economy. 2 Harris, National Debt, 70. 3 Charles C. Abbott, The Federal Debt: Structure and Impact, (New York: The Twentieth Century Fund, 1953), 39–41. Post-War Fiscal Management The situation immediately after the war was very tricky in terms of the management of money and credit. As long as the Federal Reserve stood ready to buy government securities, those securities were extremely liquid. Savings bonds, because they could be redeemed at any time, were also liquid. Consequently, a large proportion of government securities were as good as money, for they could readily be turned into cash and spent at any time. Although their existence did not represent an inflationary gap per se, they had the potential for causing one. These worries concerning inflation would become greater after 1947, when consumer prices rose by 18 percent. 4 The Treasury tried to offset some of the inflationary gap through its post-war debt management program. The program had as a goal, in addition to reducing the debt, "to reduce bank ownership of Federal securities and widen the distribution of the debt." 5 The debt reduction plan was helped by government budget surpluses until 1948, when Congress enacted a tax reduction over the veto of President Truman. Total debt was reduced by $28.5 billion from February 28, 1946, to June 30, 1949. Holdings of debt by banks was reduced by $34 billion during the same period. Since this reduction was funded in part by the sale of savings bonds, which increased by $7.5 billion during the same period, the goal of achieving a wider distribution of debt was attained. 6 Nonmarketable securities were 22.3 percent of the total public debt outstanding by June 30, 1949. 7 This increase in the proportion of savings bonds as a funding source was a continuation of the policy of fighting inflation by absorbing purchasing power from individuals. However, the Federal Reserve still had concerns over inflation rates and the interest rate structure. The Federal Reserve would have preferred to regain some influence over money and credit by withdrawing its support of interest rates on Treasury securities. They felt that this was especially important as businesses began borrowing funds to reconvert and rebuild their factories in the transition from war production to consumer goods production. The Federal Reserve stopped its support of the 3/8 percent interest rate on Treasury bills in the 4 Murphy, National Debt, 275. 5 Secretary, Annual Report, 1949, 15. second half of 1947; later that year the price at which the Federal Reserve would support long-term government securities was also lowered. As a result, the interest rate structure changed from its wartime levels to a range of 1 to 1.5 percent on shorter term issues and 2.5 percent on longer issues by the end of 1948. This policy meant that long-term rates would actually rise, because in 1946 longer term issues were selling at prices above par, with their yields falling to as low as 2 percent. The policy of the Federal Reserve was characterized in early 1948, by Alan Sproul, President of the Federal Reserve Bank of New York as one of "modest restraints" designed "to prevent bank credit from adding further to inflationary pressures and, if possible, to reduce somewhat the supply of money." 8 The Federal Reserve recognized that its policies allowed the existence of too much liquidity in the banking system, as banks could turn their holdings of government securities into reserves at any time. In fact, the Board of Governors of the Federal Reserve had warned in its annual report for 1945, "The money supply can be increased on the volition of the banks irrespective of national monetary policy." This combination of tighter credit by the Federal Reserve, and the sole use of longer-term issues of higher-interest savings bonds by the Treasury, resulted in increases in the annual interest rates that the Treasury had to pay (see Table Four). However, by 1947, conditions in the government securities market stabilized and remained so for the next several years, with the total debt remaining fairly constant. Sales of new issues, and exchanges of maturing and called debt for new securities were accomplished quite smoothly. Since some of these exchanges were for new issues with lower interest rates, the computed rate of interest actually declined slightly in 1950. Source: Annual Reports of the Secretary of the Treasury, 1946-1950. 8 Abbott, Federal Debt, 63. 9 Abbott, Federal Debt, 67. Bureau Operations As the debt reduction was small, and refunding relied heavily on nonmarketable savings bonds, the workload of the Bureau of the Public Debt was not significantly reduced after the war. There was a tremendous backlog of work in the Chicago Office by the end of the war. As the Fiscal Assistant Secretary reported several years later, "The condition that impressed us most was what we considered a serious 'bottleneck' of a tremendous mass of work in the Chicago Office of the Bureau of the Public Debt. Problems which are simple in principle sometimes become almost unmanageable because of sheer volume." 10 Much of the volume of work arose through the redemption of Series E Savings Bonds. Throughout the depression of the 1930s, many Americans had not had sufficient income to purchase the consumer goods they desired. The return of prosperity brought about by the war production caused incomes to rise, but in general, consumer goods were not available for purchase due to the production of material and equipment needed for the war. It is important to remember, for example, that no automobiles for sale to the general public were produced during the war. Personal income that was not spent on necessities had to be saved, and savings bonds were an important method for that saving to take place. The savings bond program probably helped to reduce the inflationary pressures that existed during the war by drawing off money from the public. When the war ended, Americans wanted to go on a buying spree. For many, this meant that they had to use at least a part of their savings for this purpose. This meant that they began presenting their savings bonds for redemption. Commissioner of the Public Debt, E.L. Kilby, reported on January 1, 1946, that there were backlogs in the audit operation of 67 million redeemed bonds, and in the posting operation of 76 million redeemed bonds. At the same time there was a backlog of 93 million bond stubs in the alphabetic keypunch operation. The keypunch backlog was solved within a year through the use of extra operators and overtime. 11 10 Department of the Treasury, Report of the Fiscal Assistant Secretary to the Secretary of the Treasury, (Washington, D.C.: December 1, 1952), 7. 11 E.L. Kilby, Report of Commissioner E.L. Kilby to the Secretary of the Treasury, (Washington, D.C.: December 1, 1952), 2. |