Debunking The Clinton Budget Surplus Myth

By now, most Americans understand that our national economy is in deep trouble.  With increasing frequency, articles are appearing discussing the steadily accumulating massive debt, the looming insolvency of Social Security, Medicare and Medicaid, the inability of our congressional leaders to rein in spending, an increase in pending bankruptcies of many municipalities and perhaps soon some states, and the overall impact of this crisis on our own personal finance and lifestyle.  Yet for most of us, it seems completely abstract—more like a dream. Many simply ignore the facts, believing it will just go away.  After all, we have all seen our prosperity improve exponentially over the past 60 years. Haven’t we?

These issues cannot be discussed in sound bites and superficial ways.

We all believe that our wages have risen; many of us have purchased houses, some more than one, constantly upgrading our lifestyles.  We have been able to buy all the modern conveniences—flat panel televisions, computers, cars, cell phones.  We have taken vacations, saved for retirement or received pensions, and constantly demanded and received increasing benefits like more vacation days, health, vision and dental coverage. Most of these are things that our parents and grandparents would never have dreamed of. We have had the government encourage us to live on credit, and all of us have been unequivocally assured that we need not worry about saving for any rainy day difficulties because the government could, and would, take care of all of us.  We have been told that if we want the economy to improve we need to spend more—that saving is bad for the economy. Yet most of us have never questioned this assertion.

We need to look critically at the Clinton Budget Surplus and determine if it was both a true surplus and if the method employed to achieve this feat was good for the economy and the middle class.

So while we sit here in the middle of an economic disaster, few of us seem willing to acknowledge the problem, and even less willing to take on the task of addressing the underlying problem.  We wonder how a nation like ours, with so much money, could be unable to pay for these things.  Believing in the promise of American Exceptionalism so fervently, we have never questioned how we could see a rise in the amount of money in the U.S. go from $500 billion in 1972 to over $16 trillion in 2008, an increase of thirty-five times.  We have never asked if the real underlying value of the Nation also increased thirty-five times.  We are America–of course it could!  It had to, because there are Americans, who in 1972 were making a salary of $9,000.00 per year, who in 2008 were making over $350,000.00 per year—38 times as much. Some have made much more.  Since the “War on Poverty” began in the mid-1960s, we have continued to increase spending to subsidize the needs of the poor.  Clearly, we can afford this.  After all, today there are more poor than ever, but we don’t see them dying in the streets, most are able to get healthcare and there are lots of governmental agencies focused solely on providing things they need.  We know that almost one-half of the population is getting some or all of their annual income from federally subsidized programs.  We simply must have had these increases or we could not have paid for it—right?  And if you look at the middle-class—well, let’s not really look at the middle-class. They just have to be doing alright–after all, they are the middle-class.

Repeatedly, over the past few days, the central political topic has shifted from the one fundamental issue that polls show the electorate is clearly basing much of their decision upon—the U.S. economic disaster, its effect on jobs, buying power, the middle class, and ultimately, our nation’s ability to compete in the world today.  The tactic to avoid the debate has been to focus on changing the subject, to the war on women, the war on the middle class, the war in Afghanistan, the war on the poor, and the war on any other populist ideal.  Not only is the continual derision getting tiresome, it is also starting to show in the polls.  More, and more, likely voters are dragging the Obama Administration and Republican contenders back to their main concern—the economy.  Clearly,  “Who will be better for the economy?” is the underlying question of this election and perhaps many more to come.

Recently, the President, slipping in polls and running out of options other than divisiveness, has hauled out the “big gun” of the democratic legacy, President Bill Clinton, to support the fiscal policy of the current administration, despite the fact that President Clinton has been at odds with these policies more often than not.

Now that it appears the justification for four more years of the current administration is switching from the promise of “Hope and Change” to running on the Clinton presidency’s budget surplus record, perhaps it would be wise to analyze the Clinton Budget Surplus and determine if it was both a true surplus and if the method employed to achieve this feat was good for the economy and the middle class.

Total Currency in Circulation (CinC) 1900- 2011

Unfortunately, we will have to have to dig a bit in the weeds of the policies and actions of the past 50 years in order to extract a few important points.  The chart above will help show the cause and effect of much of what has driven our current problems.

From its inception, the United States of America’s currency, with only a few relatively brief exceptions, was based on its relative value to one ounce of gold.  For the most part, the rest of the world followed the same principle to assure that all nation’s currencies exchanged goods for a fair valuation.  The dollar value compared to gold, like other currencies, was a relative measure of work output based on the total value created by U.S. workers, divided by the total amount of money and that was divided by the total amount of gold in U.S. possession.  In fact, throughout history, currency has always been nothing more than a relative measure of work and the value of that work to either the encompassing society or later between nation-states.  The reason for the gold standard was to assure that increases in currency were backed by real, tangible, economic value.  In other words, it was to prevent any nation, or trading partner, from just printing paper to pay for their goods and defraud their trading partners of the underlying value (balanced by the price of gold). Currency was the real measure of the total value of a nation and therefore, the real representation as to the buying power of the citizens in that nation was based on that total national value, backed by its gold, divided by the total currency in circulation.

$100.00 in Gold, divided by 100 $1.00 bills yielded a real value of $1.00 of internationally trade-able gold per $1.00 bill.  If a nation printed 200 $1.00 bills with the same amount of gold in the national treasury, then despite the face value of $1.00, other nations would only value it as worth 50 cents in gold.

If you look at the chart above, you will see that the solid black line represents the Total Currency in Circulation (CinC).  You can see that the total CinC in 1900 was approximately $9 billion, in 1972 was $500 billion, and in 2009 was over $16 trillion.  The chart also shows the various presidential administrations and party affiliations from 1961 to 2009 as well as some key events that had major effects on our economy.  You will also see that both parties bear some responsibility for the current economic disaster but, it is also clear that some of the decisions made, likely with the best of intentions and for very valid reasons at the time, have had some very bad unintended consequences.

Looking just at the CinC line you can see the rapid effects of a number of our major policy decisions.  For instance if you look at 1935 through 1945, you can see the beginning of the spike in amount of U.S. currency, driven by real tangible asset growth due to the war production and programs like “lend-lease” and “cash and carry” created by President Franklin Roosevelt as he endeavored to both help the allies win the war and recover the American economy. This chart tracks just currency growth and not expenses or trade deficit, so you see no impact from programs like social security here.  The gold standard did not allow the printing of currency simply to pay for goods and as such, unlike today, the need for cash did not stimulate the production of new money. Hence, increases in spending did not have a “stimulative” effect on our economy.  For the most part only production of tangible goods and services could stimulate the economy, not mere debt.

In 1965, President Lyndon Johnson expanded the Social Security Act of 1935, to include a new, initially restricted, safety net for seniors and sick and disabled individuals, dubbed Medicare and Medicaid.  Johnson, initially had significant resistance from within his own party including very powerful democrats like Representative Wilbur Mills, considered the foremost expert on Social Security at the time. Mills felt that the nation simply could not afford such an expansion of Social Security.  Mills felt the initial actuarial predictions were off by an order of magnitude and would by the mid-1970s put the country in a very bad economic condition.  After the democratic sweep of congress in Johnson’s first election, Mills quit resisting the tide against him and, for the pragmatic purpose of continuing his career as a member of the House of Representatives, joined the bandwagon and pushed the legislation through the Ways and Means Committee that he chaired. Upon passage of the bill by the committee Mills famously told President Johnson on a conference call, “today I am giving you something we (democrats) can run on next year and every year thereafter.”(You can hear this exchange yourself by listening to the Johnson Tapes available on line)  In less than a year, congress began the continual expansion of what started as a safety net, into the partly socially beneficial and partly economically problematic entitlement that we see today.

After World War II, the U.S. had accumulated a huge percentage of the world’s gold reserves, mostly due to President Roosevelt’s war supply policies.  As a result, the U.S. economy began to drive up gold’s value, and the U.S. dollar became the world standard currency.  As a result of the rising value of gold and the U.S. position of owning much of the world supply, the amount of dollars in circulation began a gradual and significant rise.  The wealth of Americans was truly increasing. By the 1960s, however, much of the world was converting their U.S. dollars, accumulated as payment for trade goods, back into gold. By the early 1970s, the U.S. had only a fraction of the gold reserves still in its possession.  The effect of the gold standard now worked in the opposite way—limiting how many new dollars we could print without a corresponding real gain in tangible work value.  During this same period, a number of the core economic industries, like steel, mining, clothing, cotton production, food production, fisheries, and oil production, among others, began to be reduced, either because: the population no longer wanted such jobs, we were now concerned over the environmental impacts of such activities, or due to rising U.S. worker cost (wages & benefits) making America no longer a competitive producer.  Additionally, Europe had rebuilt its own production capacity, lost during the war, and was no longer reliant on the U.S. as its principal supplier.  America now more often a net purchaser, not a seller, was moving from a trading surplus into a trade deficit.

By the time President Nixon took office, Wilbur Mill’s prediction had come true.  The U.S. had entered a period where the limiting effect on the production of new dollars had placed Nixon’s administration in the position that the government was simply running out of money due to the rising cost of entitlements like Medicare and Medicaid.  Additionally, the cumulative effects of both the Korean and Vietnam War had further drained cash and gold from the U.S. coffers.  By 1972, the now combined cash drain of the trade deficit, Social Security, Medicaid and Medicare, and the wars had left Nixon with insufficient cash reserves to pay federal expenses.

Nixon took what was at the time heralded as the bold step to remove the U.S. from the gold standard.  Looking at the chart above you see that the spike in the increase in currency begins slightly before this step in 1970.  The realities of the need for cash had driven the government to begin increasing currency supply prior to the removal of the gold standard restriction.  Since the U.S. economy was the benchmark, for a short period this increase, and its effect was not very visible.  In fact, it has been argued that if Nixon had not removed the gold standard in 1972, the U.S. economy would have collapsed shortly thereafter.

Having U.S. currency no longer tied to the ownership of gold, transformed the U.S. economy to one now based on the creation of debt.  Before this action, the amount of currency could only be created based either on the increase in tangible value of the U.S. economy (assets and production) to the total gold, or by an increase in the gold owned.  Now currency in the U.S. was tied to the formula of fractional reserve lending employed by banks.  The bank could create and led ten dollars of new money for every dollar of assets (including debt) shown on their books.  This was the birth of the so called Finance, Investment, and Real Estate (FIRE) economy.  This is where the increase in new currency begins its rapid rise.

A significant portion of debt, in the form of mortgages, was in the hands of Savings and Loans.  S&Ls were not banks and therefore not able to create money at the rate of 10 to 1 like banks.  So initially the rise of currency was limited because most of the leverage-able debt was only able to be leveraged based on a dollar for dollar future return on a loan, in other words, the mortgage plus interest paid back to the S&L throughout the life of the loan.

There was a change in accounting rules during this period that limited the S&L industry from using the full repayment amount for what they could lend out to only the amount that they could realize if the asset (home) was sold today.  This is the so called “mark to market” rule that began during S&L deregulation in 1980 and culminated with FAS 115 in 1993.  It is this, in conjunction with some tax reform legislation that reduced housing sales drastically, that spelled the death of S&Ls.  Perhaps this was simply happenstance and not proscription but the bankrupting of S&Ls conveniently drove the asset value for mortgages from the S&Ls that could only get a 1 to 1 leverage, to the banks that could print new money against their newly acquired mortgage debt at the rate of 10 to 1.  As the S&Ls collapsed, you see the beginning of the hockey stick in the rise of the amount of currency in circulation.

Still, as we will see in the later chart, the rise in new currency was not keeping up with the increase in costs due to the combined effect of both federal spending and the accumulating trade deficit.  The U.S. Treasury was continually relatively short of cash. Even with the 10 to 1 leverage ratio afforded by the banks in creating this new money, it could not keep up.  A number of individuals, driven by the Federal Reserve and the banks, argued that the historical prohibition of banks participating in speculation through connection and ownership of investment banks was limiting the ability of the banks to absorb all the “bad” S&L mortgages.  So the Glass-Steagle Act was effectively overturned and banks now had direct control over investment banks and Wall Street brokerages.  With the cooperation of the Federal Reserve, the banks took significant advantage and used this new power to create new classes of securities called derivatives.  Since 10 to 1 leverage was not keeping up with the rising federal spending and trade deficit, then what we needed, according to the Fed and the banks,  was to be able to justify creating more money out of thin air.

In the 1990s the death of the S&Ls and easing of banking regulations allowed fractional reserve lending to rapidly grow from 10 to 1, to 100 to 1, and then to over 1,000 to 1.

With debt growth capped by the restricted amount of people building and buying homes, we needed another accelerator.  So the banks turned to their new Wall Street subsidiaries, and mortgage backed securities were created.  The home, and its underlying mortgage, could up till this point only create 10 times its value in new currency.  As an example a $128,000 home would allow the bank to create only $1,280,000 in new currency.  But, if we then package this mortgage with other mortgages, we can sell these new securities to 100 people.  Now we create 1,000 times the original mortgage amount (10 to 1 times 100 equals 1000 to 1).  This is why you see the huge increase in the rate of currency creation from 1994 to 2002.  But by 2002, this was still not enough so the always creative Wall Street subsidiaries of our banks then packaged these mortgage-backed-securities derivatives into new packages of the same derivatives and sold them to 100 more people.  Now we are at a ratio of 10,000 to 1. This is one of the reasons you see the additional spike in the curve in 2004. It is also the reason that some experts say the total amount of derivatives in the world, plus the insurance hedge, is in excess of $1.25 quadrillion dollars. (A quadrillion is one thousand million million)

Was all of this accidental?  Who knows but the affect is still the same!

All went well till we arrived at 2008, when the housing market collapsed due to the government’s promotion of home ownership no matter what the cost or ability to pay.  When these new home owners found that the increase in the numbers of dollars in salary, and home value was not directly translating into real purchasing power, the bust occurred. In retrospect, it was predictable.  If you look at the dashed line you will see a trend analysis of what we would have had in our true value based economy if we had stayed on the gold standard.  You see that today, we would have only about $6 trillion in currency in circulation in 2008, not the $16 trillion.  What does this mean in English?  It means that you may have made $150,000 dollars in income last year, and own a $330,000 home but, you actually only have  about $94,000 in real worldwide purchasing power from your earnings, and your home is worth about $206,250.00 in real world asset value.

Now with this background, we may be able to finally have a more valid understanding of the Clinton budget surplus, how it came to be, and what impact its method of creation really had on people’s real net worth and the national economy.

Editor’s Note: This is the first installment of a two-part series on the Myth of Clinton’s Budget Surplus.

(Thomas W. Loker served as the Chief Operating Officer of Ramsell Holding Corporation. Prior to joining Ramsell, Mr. Loker was the founder and senior partner of Wild Tiger Holding Company and Thomas Loker Consulting. Visit his website at and his blog at