The US today not only looks ill, but dead broke. To offset the pandemic-induced economic downturn, the US Federal Reserve and Congress have marshalled staggering sums of stimulus spending, out of fear that the economy would otherwise plunge to 1930s soup-kitchen levels. The 2020 federal budget deficit is projected to reach 18 per cent of GDP, and the US debt-to-GDP ratio hurdle over the 100 per cent mark. Assuming that America eventually defeats Covid-19, how will it avoid the approaching fiscal cliff and national bankruptcy? To answer such questions, we should reflect on the lessons of World War II, which did not bankrupt the US, even though debt soared to 119 per cent of GDP. WWII was financed with a combination of roughly 40 per cent taxes and 60 per cent debt. Buyers of that debt received measly returns. These US bonds were bought predominantly by American citizens out of a sense of patriotic duty. Patriotism aside, many Americans bought Treasury bonds out of a sheer lack of other good choices. Until the deregulation of the 1980s, federal laws prevented banks from offering high rates to savers. While US equity markets were open to investors, brokers’ commissions were hefty, and only about 2 per cent of American families owned stocks. Investing in the stock market seemed best-suited to Park Avenue swells, or for amnesiacs who had forgotten the 1929 crash. By contrast, a majority of American households own equities today. In any case, US household savings during WWII were up – and largely in bonds. Treasury paper bore a paltry yield, a distant maturity, and the stern-looking image of a former president. How, then, was the monumental war debt resolved? Three factors stand out. Why US economic outlook looks cloudy until November First, the US economy grew fast. From the late 1940s to the late 1950s, annual US growth averaged around 3.75 per cent, funnelling massive revenues to the Treasury. Moreover, US manufacturers faced few international competitors. British, German and Japanese factories had been pounded to rubble in the war, and China’s primitive foundries were far from turning out automobiles and home appliances. Second, inflation took off after the war as the government rolled back price controls. But, because government bonds paid so much less than the 76 per cent rise in prices between 1941 and 1951, government debt obligations fell sharply in real terms. Third, the US benefited from borrowing rates being locked in for a long time. The average duration of debt in 1947 was more than 10 years, which is about twice today’s average duration. Owing to these three factors, US debt had fallen to about 50 per cent of GDP by the end of Dwight Eisenhower’s administration in 1961. So, what’s the lesson for today? For starters, the US Treasury should give tomorrow’s children a break by issuing 50- and 100-year bonds, locking in today’s puny rates for a lifetime. It is worth noting that many corporations have already successfully auctioned long-term bonds of this kind. And Ireland, Austria and Belgium all issued 100-year bonds. To be sure, a longer duration will not be enough to solve the debt problem; the US also desperately needs to reform its retirement programmes. But that is a discussion for another day. Finally, what about the post-war experience with inflation? Should we try to launch prices into the stratosphere to shrink the debt? I advise against that. Investors are no longer the captive audience they were in the 1940s. “Bond vigilantes” would sniff out a devaluation scheme in advance, driving interest rates higher and undercutting the value of the dollar (and Americans’ buying power with it). Any effort to inflate away the debt would result in a boom for holders and hoarders of gold and cryptocurrencies. Unlike military campaigns, the war against Covid-19 will not end with a bombing raid, a treaty or celebrations in Times Square. Rather, the image we should bear in mind is of a ticking time bomb of debt. We can defuse it, but only if we can win the battle against policy inertia and stupidity. This war won’t end with a bang, but it very well could end in a bankruptcy. Todd G. Buchholz, a former White House director of economic policy under George H.W. Bush and managing director of the Tiger Management hedge fund, is the author of New Ideas from Dead Economists and The Price of Prosperity. Copyright: Project Syndicate