DEFICIT HYSTERIA & THE DEBT CEILING
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?
Cullen Roche
Mr. Roche is the Founder of Orcam Financial Group, LLC. Orcam is a financial services firm offering research, private advisory, institutional consulting and educational services.
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238 Comments
TPC,I must say you are unusual in your willingness to respond to comments. This site is unusual because of that and I admire you for it.
However all of this economic theorizing misses the point. I think the frenchman had it right. America is a great experiment in democracy but eventually a democracy collapses because the population discovers they can vote themselves whatever they want. That is the point we are rapidly reaching in this country.
All of this discussion ignores the fact that if exports don’t balance with imports we are sending our jobs overseas. We have passed the point of no return as we have destroyed the manufacturing base in this country and there are no jobs for the uneducated. Without jobs, there is no sustainable economic base and the tax base diminishes. Without a tax base the government’s debt/deficit whatever you call it becomes unsustainable and that is what is happening in this country. This is the real issue we are facing as a nation and unless we fix it soon economic theories won’t save us.
“However all of this economic theorizing misses the point. I think the frenchman had it right. America is a great experiment in democracy but eventually a democracy collapses because the population discovers they can vote themselves whatever they want. That is the point we are rapidly reaching in this country.”
I disagree with this because Americans just overwhelmingly voted to reduce spending!
“ 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“…
Well how so typically socialist of you Roche…
Pray tell, what is your rationale why a person who earns $350K per year should pay one more penny in taxes than someone earning $35K per year…
“The government balance sheet is nothing like a household or business balance sheet?…
Thanks FDR…
“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”…
Gosh! What are these alledged needs of the citizens?
Funny thing is we have a Constitution Roche and I guess I shouldn’t expect YOU to consider the FACT that there were limits put into said Constitution for what the federal government can “give” (ha! ha!) to the citizens to fill those “needs”…
I got to give you Roche props for your rationale but that doesn’t help if ‘full faith and credit of the United States’ evaporates on the world stage…
Good stuff though roche…
wow this got really long… i’m still a little befuddled by MMT, but i am getting the basics of it, i think.
i think the crux of the issue is whether or not deficits matter;
regardless of which school of thought you are, the answer is that deficits do matter- not how it is created, but how it is spent. if it is spent on non-productive things, which is a tendency of lousy politicians, then ultimately the country will not benefit in the long term, which will cause interest rates to rise.
now, if i’m not wrong- in MMT, interest payments too does not matter because the govt can just print to make the payments or with a central bank, it can create an interest rate for the govt bonds.
however, and this is what MMT folks advocate as well (i think), even if the govt does not run into bankruptcy- the erosion in moral values, societal ethics, proper legal enforcement- will ultimately cause the people to abandon the usage of the currency by overthrowing the govt… regardless of and perhaps because of, the govt subsequently chooses to enforce “legal tender” by force of arms.
inflation forces interest rates to rise and after reading the 2 main camps- Austrian and MMT, i realize that they really have the same definition;
Austrian; Too much money chasing too little/same number of goods.
MMT; production of goods does not keep up with demand.
while they differ on the cause, i think both are pretty much the same; “inefficient/excessive govt spending” and the end result is the same- hyperinflation, govt failure.
the main difference i think, is that the Austrians want to limit govt’s ability to spend through a commodity based currency (for good reasons, i might add), while the MMTers see absolutely no need to- but that DOES NOT MEAN THAT MMTers AGREE ON INCESSANT GOVT SPENDING.
the main issue surrounding MMT, as i see it, is that whether we like it or not, it has two main political effects;
a) it gives govt unlimited powers to spend
b) it causes to people/groups of people to demand “spend on me”
these are true, but we have to remember that these are choices, not definites.
given today’s context, the most important thing is that the govt had the choice NOT to bailout the banks, they had the choice not to have super-sized militaries, they had the choice not to invade foreign countries… etc; but they did.
i guess what i’m trying to say is that; if you are angry at all of these nonsense going on with the govt, you must direct your anger at the bureaucrats, not the system. the MMT system merely gives the people more choices and leeway;
for example, it was generally acknowledged during the 2008 crisis that if it was allowed to spread, main street would’ve faced issues far greater than what we have today. yet, rather than choosing to protect main street from that, the govt chose to bailout the banks, which causes moral hazard by encouraging them to do what they had done before and further more, by doing so the govt lost the opportunity to reduce their influence in Washington (regulatory capture).
worst of all, they incurred the wrath of their own people.
for us who can see what is going on, what happens next? the govt now cannot touch the banks because they don’t have a “handle” on them, the govt wants to help its people through spending, but the people has no confidence in them to do it properly in their interests.
and this is where i differ from most people in looking at the deficit hysteria; it is not so much that people do not understand MMT, in fact i think it is irrelevant. it is a political issue, it is a crisis of public confidence; i view the deficit hysteria as a “no” vote to the govt’s ability to spend wisely.
in fact, because NO ONE HAS BEEN PUNISHED (except Madoff) and Main Street is pretty much in the same situation/worse off, the public now views a “yes” vote to raising the debt ceiling as condoning everyone who caused the crisis and that is not what they want. put it simply, they want to see “heads rolling”- it has been entirely unacceptable for them to see none.
yes, the public might not understand that because of the accounting identity, they themselves will be worse off than before, but i personally think that if that is the way people will “wake up”, then it might not be such a bad thing… though it will be really messy by then…
in addition, right now is a good time for anyone who wants to change things and believe that it is possible to do so; if the USA continues down this path, the pain will be much worse. heck, even if you think that it is inevitable that the USA will continue down this path, if you think that it is worth saving, then i think smarter folks should step up and prevent the pain from being worse.
at the end of the day, its the people that matters; they must be honest, upright and frank. if they are not, then i will just end this with Mark Twain’s quote;
“History never repeats itself, but they rhyme.”