America Will NEVER Pay Off Its Debt

As unprecedented as the current debt situation may seem, America has actually been in a pretty similar position before.

Back in 1946, the US had just finished paying for the biggest war in its history.

Debt held by the public had hit 106% of GDP.

That is to say, the country owed more than everything it produced in an entire year.

And yet by 1974, that figure had fallen to about 23%.

How did it climb out from under a debt that size? Well, a few forces were at work here.

Decades of primary budget surpluses, rates capped below inflation and surprise inflation with a booming post-war economy helping along the way.

So let's first look at the economy.

The war ended, factories swapped tanks for cars and fridges and the post-war boom took off.

Defense spending fell from about $1.1 trillion in 1945 to $177 billion by 1950 in today's money, so the government mostly stopped adding to the pile while the economy around it kept getting bigger.

Growth helped, but those budget surpluses and suppressed real interest rates did much of the work.

Demographics gave the economy a tailwind as well, even if they weren't a direct driver of the debt falling.

Soldiers came home and started families, and the baby boom that followed fed a huge generation into the workforce.

Back in 1960, there were five workers paying into Social Security for every person drawing from it.

That's a lot of people paying in and very few taking out.

Then there was inflation.

From 1942 to 1951, the Federal Reserve pegged interest rates at the Treasury's request, capping long-term bond yields at just 2.5%.

Then price controls came off while rates stayed low and prices jumped.

For 24 of the 30 years after the war, real interest rates were negative, so bondholders were repaid in dollars that bought less every single year.

Great if you're the borrower, less so if you're the lender.

But there's an important point here.

The dollar pile never really shrank.

The debt didn't get paid off.

It got outgrown.

So why can America just run the same strategy again? Well, because all three of those forces have turned around.