“Hmm, there’s got to be a catch here somewhere, but I just can’t figure out what it is!”

That’s the punch line of an old joke about a wheeler-dealer offering something attractive — on the condition the offeree sell their soul to the devil. Somehow, the dupe can see no possible downside!

But also illustrates the mindset of the American people, and the officials they elect, in the face of looming crises. These deals we’re being dealt intertwine our nation’s budget deficits and debt with the money supply, interest rates and the financial bailout policies of the Federal Reserve system.

Our reality is that the American public, and thus the American electorate, refuse to take action in the face of an ever-growing national debt. Ditto for our ever-more-frequently-intervening Federal Reserve.

Any objective person could see eternal downsides in selling one’s soul to Satan; but what about letting the U.S. economy slide toward an abyss? Few officials are sounding alarms and describing the problems accurately, free from partisan skewing. The vast bulk of elected officials, the media and the general public remain blasé, as if no choice actually exists, or the outcomes won’t be that bad. In the United States at least, we have not had a catastrophic economic collapse for 95 years. A very few Americans remember what that was like. We collectively don’t fear one now. However, that does not mean it won’t happen again.

To understand all this, back up 80 years and review how our economy has evolved.

In 1946, the first full year after World War II, the U.S. economy boomed. The national debt “held by the public” — meaning money not owed from one Treasury pocket to the other — was $242 billion. Gross Domestic Product was only $228 billion. So the debt-to-GDP ratio was a record 106%.

But, after a slight postwar dip, output was set to grow strongly. The population was growing. Employment was up. Modern, affordable housing was abuilding. The proportion of the population getting post-secondary education spiked. Exports to a shattered world boomed. Food was plentiful and cheap. Rural electrification neared completion and two decades of transformative highway building was about to kick off. Average incomes certainly were lower than now, but many people felt well off and getting better.

Moreover, our central bank had learned hard lessons from the 1929 crash and the Great Depression that followed. It could supply adequate money for sustainable economic growth but with low inflation. It could step in to prevent the failure of individual banks and it could buffer harsh economy-wide effects from general economic downturns.

One should not overemphasize the positives. Our nation still had much poverty and many injustices. Rising output was not lifting all boats. Yet people were optimistic and had good reason to be so. Real value of output grew by 4.2% a year from 1948 to 1968. That is after adjusting for 1.9% average annual inflation. By 1968, the national debt was down to only 30.1% of GDP and still falling. Budget deficits had averaged 0.3% of GDP over those two decades, including three years of war in Korea and the first half of Vietnam.

It was in the 1970s that things seemed to fall apart and the 1980s were even worse in several ways. Consumer prices rose 6.8% a year, with gasoline even more. Unemployment, which had averaged 4.8% in the 1960s, grew to 6.2% in the 1970s and 7.3% in the 1980s. Over a hard nine-month run from September 1982 to June 1983, unemployment stayed above 10%, the worst since the Depression.

Perhaps more importantly in the collective memory of baby boomers, Reagan administration deficits coupled with Fed tight money drove interest rates to historic highs. This punished potential home buyers. High rates also attracted foreign money, driving the value of the dollar skyward. A “strong dollar” sounds good to many, but it is costly to foreign customers, making our products expensive abroad, and thus hammers any U.S. sector that exports. This includes farming, forestry, computers, airplanes and earthmoving and railroad machinery.

An expensive dollar also scourges industries that compete with imports. Steel and automobiles stand out. The 1980s devastated the “rust belt,” east of the Mississippi and north of the Ohio rivers. We lost about 300,000 jobs out of steel, another 300,000 out of autos and put over 250,000 farms through bankruptcy.

However, what surprises many today, given the dismal reputation of those years, is that real GDP did continue to grow, 3.3% average over the 1970s, 3.2% in the 1980s and then returning to 3.3% in the last decade of the century. Keep that in mind when we look at our new millennium, with average growth barely breaking 2% a year.

The record of the Fed and the monetary policies it implemented is mixed. While chaired by William McChesney Martin, it showed prudent competence from the Korean War to the end of the 1960s. Martin spanned administrations from Harry Truman through Richard Nixon.

In 1971, Nixon replaced Martin with a distinguished economist, Arthur Burns, whose policies touched off the great inflation. Burns served until 1978 when Jimmy Carter replaced him with someone even worse, corporate CEO G. William Miller. Just 17 months later, with inflation spiraling out of control, Carter kicked Miller upstairs to be Secretary of the Treasury. His replacement at the Fed was Paul A. Volcker, the most courageous and competent Fed Chair ever. Led by Volcker, the Fed squeezed inflation out of the economy by constricting money supply increases. This raised interest rates to punishing levels just as fiscal prudence was being tossed aside.

On the this fiscal side, Congress had become increasingly tolerant of budget deficits. In the 1950s these averaged less than 0.4% of total outlays. Those in the 1960s were twice as large. And those in the 1970s two and a half as high as the 1960s. In the 1980s, under slogans popular to some Republican leaders that “deficits don’t matter” and “tax cuts pay for themselves,” this proportion of the budget that we borrowed doubled yet again. That decade’s average annual deficit of 3.8% of GDP was 10 times the 0.38% average in the 1950s.

In the 1990s, with two deficit hawks, George H.W. Bush and Bill Clinton in the White House, budgets returned, at least temporarily, to sanity. Deficits averaged 2.1% of GDP over the decade as a whole. But that average obscures a steady fall from high deficits, as the decade began, to slight surpluses in fiscal years 1998 through 2001.

That last surplus year started four months before the inauguration of Dick Cheney as vice-president and George W. Bush as president. That ordering is important because it was the VP who drove the fiscal agenda for the next eight years. Cheney is the one to blame for throwing away the budgetary sustainability that had been gained in the 1990s.

So much for fiscal issues and inflation. Suffice it to say that deficits do matter, and tax cuts do not pay for themselves. And it gets worse over time.

What about the Fed’s role in the money supply, interest rates and stability of financial institutions?

In the tightly regulated initial decades of the post-war period, bank failures were rare. That changed. In the “farm financial crisis” of 1980-1994, over 1,600 ag-related banks were closed by the Fed and FDIC. Bank owners lost their capital, but all depositors were protected even if above the FDIC-insured maximum. The same happened when Continental Illinois, the seventh largest U.S. bank, went bust in 1984.

Many savings and loans, retail banks created by quirks in banking law decades earlier, made reckless investments when the Fed’s high interest rates in the early 1980s crushed their traditional business. Some 1,600 were closed, with over $125 billion needed from the U.S. Treasury to top up depleted federal deposit insurance funds.

Strikingly, in view of what happened in the early 2000s, over 1,000 S&L managers were criminally prosecuted. Many served prison time. Again, owners lost their equity, but no depositors lost their money, regardless of size of deposits. It was clear that past policies had created “moral hazard,” perverse incentives to take risk, but the way small banks and S&Ls were closed did not create large incentives for future reckless practices.

The Fed, however, started to skate on thin ice. In October 1987, there was a sudden stock market crash with the Dow index dropping 22% in one day. The Fed stepped in, creating lots of new money. Price indexes recovered smartly. From one point of view, this was precisely why we had created the Fed, to step in with liquidity that staunches generalized panic across financial markets. That is true, but it also established a precedent that the Fed would fight any large stock market drop. That precedent deviates from the Fed’s major mandates and today is actually dangerous.

In 1993, the Fed acted prudently with minor interventions to prevent a severe European exchange rate crisis from affecting our system. And it mostly carried out helpful coordination when financial crises spread across Asia in 1997. However, the Fed did intervene in a way that remains controversial today when Long-Term Capital Management, a U.S. based hedge fund, faced going bust because of an Asia-related investment it had made. The Fed did not bail out the fund directly, but lent cash to a consortium of banks that took over LTCM. While no one was saying “too big to fail” — yet — that was becoming the operative principle.

As the tumultuous 20th century closed, the U.S. was in a highly favorable economic situation, for households, for producers and for our financial system. We would throw nearly all of that away in the next decade, eventually bringing us to the edge of the chasm where we stand now. But we do have choices, albeit maybe hard ones, as we deal with these economic devils. More on that in a future column.

St. Paul economist and writer Edward Lotterman can be reached at stpaul@edlotterman.com.