It’s Not the Deficit! It’s Not the Debt! Here is why.

Cancun 2004 034

Lets talk economics.  I keep making what may seem to some very reasonable statements such as calling the deficit irrelevant and also saying the same about the debt. Sometimes I say that both the debt and the deficit are irrelevant. Many, however don’t agree. Others agree but only in terms of priority.  Let be clear. The federal deficit and the federal debt, both are irrelevant. Not just today, but tomorrow, and even fifty years from now.

The common argument I hear insisting that America is better off  with a balanced budget (no deficit) is that with a balanced budget, our debt decreases and more money is available to private enterprise for investing. The other advantage to fiscal austerity say the debt and deficit scolds is that by adding to our debt every year, eventually our debt will grow so large that our descendants will be stuck with a huge bill that will never be paid off.

Lets examine that last paragraph I wrote and see if positions of the the austerity advocates actually make sense. First, is it true that deficits take away money that private enterprise would use to invest and thereby create jobs? The answer is simple, of course not. Very few companies will or can invest in expanding their business on the hope that other companies will do likewise. Investment follows opportunity. A business recognizes an untapped market or a new product they believe has potential, they will invest. But that investment money does not come from the government. It comes from banks. And banks also need to believe that their funding will be paid back. And paid back at an interest rate above inflation. (! That was a very important point ! )

This is the reason that the Fed is handing money over to banks. So that they would lend it to entrepreneurs to expand or start a business. But there are two reasons that very little of that expansion of the private sector is taking place. Neither of them have anything to do with government deficits. The first reason is that in order to prevent inflation the Fed makes the funds available to the banks at a very low interest rate, an effective rate of zero. The second reason is that low employment and lower wages of the employed make it difficult for banks to confidently fund many investment ideas.  There is actually a third reason or possibly its just a consequence of the lowered interest rate. Since banks pay virtually nothing for money from the Fed, they only charge a small interest rate and it is very hard to justify funding anything when their profit is so low.

An economic Catch-22, is our problem, not deficits. With a balanced budget and everything else the same, nothing changes. Money being provided to banks for just about nothing. The banks in turn will not finance business growth and expansion because too many people don’t have enough money to buy new products, and even if they did, the banks are not likely to risk inflation by heating the economy. Since if inflation is greater than the interest rate it means the banks lose money.

I believe I have demonstrated that a balanced budget will not resolve any economic problems in the short term, but what about the accumulation the annual deficit into debt. Will it eventually grow so large that our entire budget only services the debt?

The answer is that in order for that to occur, inflation would have to turn into deflation. A condition where the price of goods and services drops. While the economy of a nation is very much unlike the budget of a household or even a business, we can illustrate some things in the terms of a household.

When the government borrows money to fund it’s deficit, it is NOT similar to the loan we take out to finance our homes. However, that is probably the closest comparison. Under a normal inflation rates of about 3.5% your home’s value and your salary will increase each year at that rate. Unfortunately, so won’t your expenses. Except for your mortgage. And the same is true of the bonds the US sells in order to fund it’s deficit. The bonds taken out now have a very, very low interest rate. The interest can be paid with dollars for year after year at an ever lowering relative cost. When bonds again are issued at higher rates, then it would mean that inflation has increased from its anemic 1.5%; meaning that the bonds currently issued are paid each year at virtually no relative cost. In fact, right now is a good time for the government to cash out existing bonds and deficit fund new ones at the current rate. In any case, the government has control over the bond payments, except for the 25% owned by foreign countries, which may be subject to demand payments. There are other mechanisms to manage the debt, but I will leave that a future blog where I examine alternate ways to manage the economy.



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