The upcoming vote on raising the debt ceiling has given politicians one more thing to misrepresent, misunderstand and misuse as a bargaining chip. In February 2010 Congress agreed to raise the debt ceiling to $14.3T. But because we are running a persistently large deficit that level is fast approaching and so politicians are grasping at the opportunity to use this issue as a bargaining chip. Unfortunately, there is an absurd hypocrisy when discussing the debt ceiling. As James Hamilton described in 2006 you can’t vote to sustain the deficit AND then later use the debt ceiling as a bargaining chip against higher debts. After all, the two are directly related:
“One of the peculiar embarrassments of the American political process is the fact that Congress votes separately on the deficit and debt, as if they were two different decisions. This bizarre arrangement allows Congress the luxury of instructing the Treasury to spend more than it takes in as revenue while at the same time voting to deny the authority to borrow the funds that would be necessary to implement the plan.
If the government is (a) required by the deficit legislation to spend, and (b) precluded by the debt legislation from borrowing, the Treasury would be forced into default. The greater the likelihood markets attach to such an event, the higher will be the interest rate the government has to pay on Treasury debt. A politician who votes for the spending and tax measures that produced the deficit but against a debt ceiling consistent with these is deliberately wasting taxpayer dollars for no purpose other than to grandstand before voters as a “fiscal conservative”. Anyone playing such a game has complete contempt for the intelligence of their constituents.”
I don’t expect most politicians to understand our monetary system. Lawyers, after all, are not monetary experts. But this much should be obvious. If you’re going to agree to a tax cut for the rich and a payroll tax cut of 2% in one month you can’t come back the VERY next month and complain about high debt levels.
The saddest part of this whole conversation is that we’re even having it at all. The government balance sheet is nothing like a household or business balance sheet. Since 1940 the US Congress has agreed to alter the debt ceiling 78 times. Of course, over this period the debt ceiling has always increased as the US economy has grown and the needs of its citizens have grown. Why Congress even votes on the debt ceiling is beyond me. I guess it’s to give the appearance of fiscal constraint. The kind of constraint where you can agree to a $1.3T annual deficit in December 2010 and then come back in January 2011 and complain that there is too much debt.
Does this mean the aggregate debt level of the USA is unimportant? After all, the piper has to be paid, right? Yes and no. As I said above the government is nothing like a household or business and its balance sheet should never be managed as such. In 2010 Professor Randall Wray described the reality of the debt situation in the USA:
“With one brief exception, the federal government has been in debt every year since 1776. In January 1835, for the first and only time in U.S. history, the public debt was retired, and a budget surplus was maintained for the next two years in order to accumulate what Treasury Secretary Levi Woodbury called “a fund to meet future deficits.” In 1837 the economy collapsed into a deep depression that drove the budget into deficit, and the federal government has been in debt ever since. Since 1776 there have been exactly seven periods of substantial budget surpluses and significant reduction of the debt. From 1817 to 1821 the national debt fell by 29 percent; from 1823 to 1836 it was eliminated (Jackson’s efforts); from 1852 to 1857 it fell by 59 percent, from 1867 to 1873 by 27 percent, from 1880 to 1893 by more than 50 percent, and from 1920 to 1930 by about a third. Of course, the last time we ran a budget surplus was during the Clinton years. I do not know any household that has been able to run budget deficits for approximately 190 out of the past 230-odd years, and to accumulate debt virtually nonstop since 1837.
The United States has also experienced six periods of depression. The depressions began in 1819, 1837, 1857, 1873, 1893, and 1929. (Do you see any pattern? Take a look at the dates listed above.) With the exception of the Clinton surpluses, every significant reduction of the outstanding debt has been followed by a depression, and every depression has been preceded by significant debt reduction. The Clinton surplus was followed by the Bush recession, a speculative euphoria, and then the collapse in which we now find ourselves. The jury is still out on whether we might manage to work this up to yet another great depression. While we cannot rule out coincidences, seven surpluses followed by six and a half depressions (with some possibility for making it the perfect seven) should raise some eyebrows. And, by the way, our less serious downturns have almost always been preceded by reductions of federal budget deficits. I don’t know of any case of a national depression caused by a household budget surplus.”
So you can see that there is clearly something odd about the way this entity known as the US government is able to run ever increasing debt. How can the United States continually issue debt without ever paying the bills? The important point is that the Federal government is never solvency constrained in the same way a household or business is. Through its symbiotic relationship with the Fed and the banks it can always find funding. There is no such thing as the US government “running out of money”. If the needs of the private sector are particularly high (let’s say the private sector wants sweeping tax cuts to alleviate pressure during a balance sheet recession) then the government will run a large deficit and the debt ceiling will increase accordingly. Since the USA is never solvency constrained there is no solvency issue as there is for a household or business. After all, if you could just credit your bank account with dollars you’d probably stop worrying about solvency also.
This doesn’t mean we’re experiencing some sort of free lunch, however. Maintaining the correct level of deficit spending is, in many ways, a balancing act performed by the government. It is best to think of the government’s maintenance of the deficit like a thermostat for the economy. When the economy is running cold the deficit can afford to be higher. When it is hot the deficit should be lower. Because there is no solvency concern in the USA (as there is in the revenue constrained European nations) the only concern is inflation and with record low inflation rates there is no fear of the deficit resulting in hyperinflation which would be a pseudo form of default. As a trade deficit nation it’s important to note that, by accounting identity, a budget surplus would effectively drain the private sector of the currency in which the government requires it to transact. As mentioned above by Professor Wray it’s no coincidence that government surplus has tended to be followed by economic downturn. Hence, the perpetually increasing government debt in accordance with the size and needs of the US economy over the last 200+ years.
But politicians are trying to have it both ways now. After agreeing to high deficits just last month they’re now ignoring the operational reality of our monetary system, worrying about solvency, comparing us to Greece and using this latest issue as a bargaining chip to fear monger and force concessions. With leaders like this who needs comedians?