Deficits, Debt and Demand

Federal government deficits and debt are here to stay.

Courtesy: The Canadian Atlas

(EUGENE, Ore.) - The Federal Government had a deficit of $1.4 trillion dollars last year and is projected to have a deficit of $1.35 trillion this year. These numbers are so large that to an average person looking at them they immediately engender a sense of impending doom.

Politicians and commentators often use these numbers as talking points, pointing to them as indications of failed policies, and using them as justifications for new policy proposals. This commentary may draw on some facts, but often relies only on uninformed gut-level reactions.

What does it actually mean for the Federal government to be in debt? What does it mean if the Federal Government is running a deficit? These questions are less frequently asked, and even less frequently answered.

In practice, Federal government debt is not the same as individual, State, or corporate debt. The Federal government cannot, at least on paper, go bankrupt.

The Federal government is the only entity with constitutional authority to create money. Federal debts are always balanced out by the fact that they can be wiped away with the creation of new money.

The Federal government does not simply create money in order to pay its debts because this also has consequences. In practice, it is a form of limited default.

According to economic theory, If the government creates large amounts of new money, then the purchasing power of existing money holders is decreased, which is called inflation. Inflation is a tax on all money holders, both average people, and those who the government owes money to.

If the Federal government creates new money to pay off its debts, then it is in practice paying back less than originally borrowed, and at the same time, taxing the entire population of money holders, who see the money they have decrease in value.

The Federal government deficit and the Federal debt require some suspension of disbelief if one is to assume that they are not going to be reduced through money creation.

It is generally assumed that money creation will have to play some role in paying off the government’s debts because there is simply no other way for the books to be cleared. Federal government expenditures are very difficult to reduce, new taxes are hard to impose, and future liabilities for Social Security and Medicare are projected to increase dramatically.

Facing a set of books that would give an auditor nightmares for weeks the Federal government is stuck in the position of trying to maintain “confidence,” while it attempts to cover its debts through money creation.

The Federal government is creating money, which devalues all other money assets. However, the Federal government is also taking on new debts, which provide existing government debt holders with insurance against inflation. Even though those who hold government debt are not getting back as much as owed, they are getting new promises to pay, which offset losses on earlier debts.

Increasing government debt allows the costs of inflation to be shifted entirely onto money holders, while those who hold government debts are insulated from inflation by new debt issues.

This debt cycle can only go up, because the less valuable money becomes, the larger (in dollar terms) the debts must be.

Increasing Federal debt is simply a fact of life until the Federal government engages in structural debt reform.

Structural debt reform means taking apart the private banking sector, and by extension, re-ordering the international financial system that has built up around the U.S. economy and U.S. dollar denominated assets.

Structural reform would be risky, disruptive to business, and disruptive to international trade. It would also entail the end of U.S. hegemony in the international financial system, which would be a severe detriment to the image, power and prestige of U.S. government and corporate leaders.

The structural reform route is one that government officials will never pursue unless forced to. The risks are too high and it would be directly contrary to the personal interests of everyone in a position of power in both the Federal government and the corporate world.

The Federal government and the American people thus hang in a state of limbo. The Federal government borrows progressively larger amounts of money, standards of living slowly decline, and everyone waits for the inevitable crisis that these conditions must create.

In the short term, economic theory is that government spending is necessary in order to stimulate demand. Large government deficits are necessary because if people do not have money, they cannot spend. If people cannot spend, businesses cannot operate. If businesses cannot operate, people cannot be employed.

This argument seems sound, but should be taken with a few caveats.

First off, simply creating economic activity on paper does nothing. The only purpose of economic activity is to improve the quality of life for the people engaged in it. If you are living the same life, it does not matter if your salary is $5,000, $50,000, or $5 million.

One of the fundamental causes of a failing economic system in this country is the over-emphasis on the abstraction of money at the expense of the true purpose of economic activity, which is to improve peoples’ lives.

Simply putting people to work may be a good way of keeping them occupied, but it does not actually do anything for the person or for the society unless that work is both personally and socially productive.

If the Federal government stimulates demand by simply dumping money into the system, this is not likely to create much in the way of productive employment. It is a temporary palliative that keeps people in their houses, fed, and occupied. This may be necessary in the short term, but it is no long term solution.

There is a difference between demand for a new car, a bigger tv, or an ipod, and demand for food, education, health care, or housing.

The most obvious difference is that many consumer products are manufactured outside of the U.S., and so stimulating demand for them does nothing to increase productive activity and employment in the U.S. and only exacerbates the problem of international debts.

There is however an even deeper difference between demand for different types of products, which is never perceived if you only judge things by their dollar value.

Food, education, health care, and housing are investments. They yield a return in value for the money spent. Spending money on something that is only consumed has a dramatically different outcome than spending money on something that is a productive investment.

Eat a good meal, and you will be healthier, happier, and more productive. The consumption of food itself gives rise to the potential for new productive endeavors. The quality of food consumed plays an enormous role in personal health, and in subsequent health care costs.

Education is also investment. The costs of education pay off many times over in the course of a person’s life.

Health care can keep people productive and engaged in their community when otherwise illness or injury might prevent that. Money that is spent on health care is not simply consumed, but yields both a short and long term return in terms of a more active, more capable, and less troubled population.

The home is a critical element in a person’s health, safety, and well being. The home environment is a crucial part of psychological well being for adults and especially for children. Money spent in this area is a critical investment with long term returns that are reaped for generations.

If the Federal government is going to stimulate demand through running deficits, then there has to be a focus on putting that money toward the productive long term investments that will actually result in an improved quality of life for our society.

Investment in health care is something that is badly needed, especially in the rural areas of the country. Investment in agriculture that is not simply an input for an industrial process, such as manufacturing ethanol, is badly needed. Investment in education at all levels, but especially in medical professions, is badly needed.

The fake conservatives and free marketers call this socialism and government planning. The fact of the matter is that that the government is planning either way.

If the government does nothing but dump money into the economy, then they are planning for failure. If the government spends its money on productive investments, then they are planning for social stability and increasing standards of living.

Federal government deficits and debt are here to stay. The only thing that will change that is a crisis that makes the recent one look insignificant by comparison. The Federal government will run large deficits and spend money regardless of who is in office. This course is dictated by their debt arrangements, which leave them with no other options. The only real question is whether or not that money is spent on productive investments for our society’s future, or wasted on more “free-market” schemes.