The “fiscal cliff,” a combination of tax increases and severe spending cuts scheduled to kick in next year, is a product of multiple deceptions. Both the expiration date on the Bush-era tax cuts and the trillion-dollar “sequesters” that were enacted as part of last year’s debt-ceiling deal were designed to cover up an overarching problem: the country’s out-of-control debt.
The U.S. government today owes $16.05 trillion to bondholders and creditors. This debt is already larger than the country’s annual economic output and threatens to cripple the economy for generations.
In its 235-year history, only twice has the country run up this big a tab: during the Civil War and World War II. Each time, though, the United States managed to dig its way back, regain its credit and emerge as the world’s leading economy. Both episodes offer lessons for today’s predicament.
To finance the Civil War, President Abraham Lincoln’s Treasury Department borrowed heavily. Public debt exploded between 1861 and 1866 to more than $2.75 billion from $90 million. Lincoln’s government also cheapened the currency through inflation.
By the time Robert E. Lee surrendered to Ulysses S. Grant at Appomattox Court House in April 1865, the greenbacks issued by fiat had lost two-thirds of their value (measured against gold), leaving the country with oceans of debt and a debased currency.
To regain solvency, four things had to happen. First, the government paid down the debt. Starting in 1867, the U.S. Treasury every month sold gold and bought bonds, slowly paying off creditors. By 1878, it had lowered the debt by almost 25 percent and the country was able to return to its traditional gold standard. No more fiat paper.
Second, Congress kept up revenue with high taxes, in the form of protective import tariffs, which helped local businesses and allowed the government to afford Reconstruction, farm homesteads, railroad land grants and westward expansion.