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Federal, state and local debt hits post-WWII levels

Feb. 16 (Bloomberg) -- Michael Tennenbaum, founder of Tennenbaum Capital Partners LLC, discusses Federal Reserve policy and the outlook for the U.S. economy and the distressed debt market. Tennenbaum speaks with Deirdre Bolton on Bloomberg Television's "InsideTrack." (Source: Bloomberg)

Reischauer stressed that after World War II, consumers, many of whom had purchased savings bonds, and banks, which had been required to hold certain amounts of government debt, were in strong positions. Today's consumers and banks are strapped.

"We had large household savings, and we flourished," he said of the post-World War II era.

Inflation also reduced the value of World War II-era debts because the United States could pay them back with money that had less buying power. Inflation reached 14 percent in 1947. Many investors fear that inflation is looming now, too, and may be the only way to ease the debt burden. But with high unemployment and slow growth, so far there is little sign of it. On Thursday, the Labor Department said inflation was 1.2 percent during 2010.

Rogoff and Carmen M. Reinhart, a University of Maryland economics professor, have done research showing that once government debt surpasses 90 percent of GDP, average growth rates slide 4 percent. In emerging markets, the threshold is lower and the damage to growth greater.

Slower growth will only slow the erosion of the national debt.

State budget experts say that some governors have exaggerated their fiscal woes. Thanks to relatively low interest rates, states spend on average 4 percent of their budgets to make debt payments, said Joshua Zeitz, state and municipal finance analyst at a research firm, MF Global, and former senior policy adviser to former New Jersey governor John Corzine. (By some calculations, he said, the average is a still modest 5.5 percent.)

Zeitz said that many governors speak of "cuts" when they mean cuts from projected spending, assuming continued growth from inflation and other factors. Many states whose governors boast of making budget cuts could end up with higher levels of spending.

Wisconsin, where Gov. Scott Walker (R) has rocked the legislature with proposed limits on state employee unions, is one of those, Zeitz said. The state is on a two-year budget cycle. This year the governor has talked of a $137 million shortfall, though Zeitz said it was largely of Walker's own making through tax cuts and spending initiatives. In any case, that amount would equal 1 percent of the state budget. "A 1 percent shortfall does not constitute a crisis," Zeitz said.

Walker said the state faces a more than $3 billion deficit next year, but Zeitz said that includes assumptions about program growth and revenue.

Scott D. Pattison, executive director of the National Association of State Budget Officers, estimates that state government revenue will increase 5 percent this year. "The pie is expanding," he said.

But not fast enough for the government sector overall. According to Obama's fiscal 2012 budget proposal released Monday, the federal government's net interest payments (not including money owed the Social Security fund) will rise from 1.4 percent to 3.4 percent over the next decade.

Federal debt (not including debt held by the Social Security fund) fell to a post-World War II low of about 24 percent in 1974. After tax cuts and increased defense spending under President Ronald Reagan, it rose to about 49 percent in 1993, before President Bill Clinton's budget deal took effect. It then fell to 32.5 percent in 2000, but starting rising again when President George W. Bush took office. Tax cuts, war spending and recession costs have more than doubled that level since.

Recalling the post-World War II economy that helped ease government indebtedness, Reischauer said: "It wasn't that when you looked out the windshield of the federal car that you saw steep hills ahead as you do now. It's a very different kind of situation."

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