The Global Debt Crisis, II: The Story Behind the Problem

Paradoxically, before we can understand how the U.S. federal government — and virtually every other government on earth — became burdened with such a gigantic mountain of debt, we have to understand how the United States tried to reform its financial system and get out of debt in the wake of the Panic of 1893, the Great Depression of 1893-1898, and the Panic of 1907.

The Panic of 1893 revealed (among other things) serious weaknesses in the National Bank system that had been in place since 1863. The amount of the currency was fixed — "inelastic" — and backed by government debt. When push came to shove (as it did with the "money famine" of 1894), the system very nearly gave way under the strain. A debt-backed fixed currency was inadequate to the demands put on it by an advanced commercial and industrial economy.

Efforts to make the currency more elastic by increasing the amount of government debt were recognized as being both financially unsound and politically unwise. The country was in the middle of the worst economic crisis it had ever faced, and debauching the currency was seen as a step toward financial suicide. In any event, the country had worked for two generations to restore the faith and credit of the government following the Civil War.

Added to that was the fact that many people realized that if the government could finance itself with debt instead of taxes, politicians would become unaccountable to the citizens. As Henry C. Adams explained,

"As self-government was secured through a struggle for mastery over the public purse, so must it be maintained through the exercise by the people of complete control over public expenditure. Money is the vital principle of the body politic; the public treasury is the heart of the state; control over public supplies means control over public affairs. Any method of procedure, therefore, by which a public servant can veil the true meaning of his acts, or which allows the government to enter upon any great enterprise without bringing the fact fairly to the knowledge of the public, must work against the realization of the constitutional idea. This is exactly the state of affairs introduced by a free use of public credit. Under ordinary circumstances, popular attention can not be drawn to public acts, except they touch the pocket of the voters through an increase in taxes; and it follows that a government whose expenditures are met by resort to loans may, for a time, administer affairs independently of those who must finally settle the account." (Henry C. Adams, Public Debts, An Essay in the Science of Finance. New York: D. Appleton and Company, 1898, 22-23.)

The presidential campaign of 1896, however, diverted calls for reform of the financial system by bogging down in William Jennings Bryan's "free silver" proposal, viewed by many as "silver socialism" and a serious danger to the recently restored credit of the country. The bumper crops of 1897 and 1898 in the United States at the same time there were crop failures in Europe ended agitation for reform by seeming to solve the problem.

The lull was only temporary, however. The Panic of 1907, caused by bank speculation in the stock market and manipulation of the system by J. P. Morgan, renewed demands for reform. The presidential campaign of 1912 centered on the need for a true central bank to replace the National Bank system, and an income tax to ensure adequate revenue for the federal government raised in a way that would not pass the tax burden of the rich on to those in lower income levels.

Taft did not lose the election because Theodore Roosevelt split the Republican Party. By 1906 the G.O.P. had effectively diverged into an ultra-conservative wing under the control of Nelson Aldrich and J. D. Rockefeller, and a leaderless progressive wing. Woodrow Wilson managed to win most of the moderate Democrats back from Roosevelt by gaining the support of William Jennings Bryan and adopting a progressive stance toward financial reform that copied Roosevelt's. Wilson's campaign made a good thing of characterizing Roosevelt's protégé Taft as Aldrich's stooge, firmly in the pocket of the "Money Trust" headed by J. P. Morgan.

In this, Wilson had more than a little inadvertent assistance from Roosevelt. Roosevelt was outraged at what he saw as Taft's betrayal of the progressive cause, and made no bones about letting everyone know it. The only Democrats who failed to go over to Wilson were a sizable number of progressives who distrusted Wilson's flip-flopping and lack of experience and stuck with Roosevelt, and the more radical socialists and populists who rejected Wilson because of Wilson's earlier support for laissez faire capitalism.

Having won the election largely on the strength of his promise to implement immediate and sweeping changes to the monetary and tax systems, however, Wilson began waffling. The combined efforts of Representative Carter Glass of Virginia and Secretary of State William Jennings Bryan were needed to get Wilson moving to fulfill his campaign promises.

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