President Obama: “Good evening. Tonight, I want to talk about the debate we’ve been having in Washington over the national debt — a debate that directly affects the lives of all Americans.”
Comments: OK, there certainly has been a debate going on, and it has affected the lives of Americans at least in the sense that it fills the airwaves and newsprint. Polls show, however, that what working Americans are concerned with is jobs, jobs, jobs. In spite of the hysteria in Washington over the debt and debt limits, for most Americans, it is all still a big ho-hum.
What about those Americans who truly count—the bond vigilantes on Wall Street? An even bigger ho-hum. If markets really feared a government default in less than two weeks, there’d be a massive run out of Treasuries and dollars. Interest rates would be spiking toward infinity and beyond. I was in Manhattan last week and I did not see any bond traders jumping from windows. The reigning attitude is that even the bozos in the House are not going to allow the government to default.
President Obama: “For the last decade, we have spent more money than we take in. In the year 2000, the government had a budget surplus. But instead of using it to pay off our debt, the money was spent on trillions of dollars in new tax cuts, while two wars and an expensive prescription drug program were simply added to our nation’s credit card. As a result, the deficit was on track to top $1 trillion the year I took office. To make matters worse, the recession meant that there was less money coming in, and it required us to spend even more — on tax cuts for middle-class families; on unemployment insurance; on aid to states so we could prevent more teachers and firefighters and police officers from being laid off. These emergency steps also added to the deficit.”
Comments: To be more accurate, the President should have noted that since the founding of our nation, the federal government has spent “more money than we take in” virtually every year. And the few times that we have spent less money “than we take in”, the economy tanked. Here is what I wrote back in 1999, just as President Clinton was celebrating his success at achieving budget surpluses (sorry this is a bit long and wonky; those who are squeamish can quickly look at the dates of our budget surpluses and our depressions and then skim over the accounting of government spending and taxing):
The federal government has been in debt every year but one since 1776. Far from viewing government debt as a horror to be avoided, at least some of the founding fathers recognized the benefits.
Thomas Paine proclaimed that “No nation ought to be without a debt” for “a national debt is a national bond.” Alexander Hamilton asserted that “A national debt, if it is not excessive, will be to us a national blessing.”
Andrew Jackson, however, labeled the public debt a “national curse” and, like President Clinton, set out to retire it. By 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 six 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.
The United States has also experienced six periods of depression. The depressions began in 1819, 1837, 1857, 1873, 1893, and 1929. Every significant reduction of the outstanding debt has been followed by a depression, and every depression has been preceded by significant debt reduction. Further, every budget surplus has been followed, sooner or later, by renewed deficits.
However, correlation—even where perfect—never proves causation. Is there any reason to suspect that government surpluses are harmful?
At the macroeconomic level, government expenditures generate private sector income; taxes reduce disposable income. When government spending exceeds tax revenue (a budget deficit), there is a net addition to private sector disposable income….
When the Treasury sells bonds, some of that extra disposable income is devoted to saving, accumulated as private sector wealth held in the form of government debt. Even if the Treasury did not sell the bonds, however, the private sector would be wealthier by an amount equal to the government’s deficit, but this would be held in the form of non-interest-earning cash (and bank reserves) for the simple reason that the total value of checks issued by the Treasury to finance expenditures would exceed the total value of checks written by the private sector to pay taxes.
When someone in the private sector receives a Treasury check, the check is deposited in a private bank, whose reserve account at the Fed is credited; at the same time the Treasury’s deposit at the Fed is debited.
When someone in the private sector writes a check to pay taxes, the taxpayer’s bank deposit is debited; at the same time the Fed credits the Treasury’s deposit and debits the private bank’s reserves. When depositors withdraw cash from banks, the banks’ reserves are reduced as the Fed issues currency.
The sale of Treasury bonds also reduces bank reserves because bond buyers pay with checks drawn on private banks, which leads the Fed to debit bank reserves and credit the Treasury’s deposit.
In this way government deficits result in a net increase to bank reserves and cash held by the public. Most of this increase is then drained as the Treasury sells bonds.
In other words, government deficits always add disposable income and wealth to the private sector; the income is received first as a Treasury check and then may be transformed into an interest-earning government debt. On the other hand, when tax revenues exceed government spending (a budget surplus), private sector disposable income is reduced….
Because checks received by the Treasury exceed the value of checks issued by the Treasury whenever there is a surplus, outstanding cash and bank reserves will be reduced. To restore cash and reserves, the private sector sells Treasury bonds. The bonds are purchased by the Fed and the Treasury; the purchase restores reserves and cash…
Note that if the Treasury refused to buy the bonds (that is, refused to retire outstanding debt), then only the Fed would be left to buy them. This is why any sustained surpluses must be met by Treasury retirement of the debt, for otherwise the Fed would accumulate vast holdings of Treasury debt (on which the Treasury pays interest) while the Treasury would hold huge deposits in its checking account at the Fed. (In practice, the Treasury tries to end each day with a deposit of $5 billion.)
Movements of the budget position are largely automatic. Rapid economic growth, such as that experienced in the United States since 1992 or in Japan previous to 1990, tends to cause tax revenues to rise faster than government spending, resulting in surpluses. Recessions and depressions tend to cause tax revenues to fall as spending rises, resulting in deficits.
….[H]istory suggests that over the longer run, deficits stimulate the economy and surpluses are harmful.
Source: http://www.levyinstitute.org/publications/?docid=581
Well, what happened to those Clinton budget surpluses? First, they were not “set aside” to take care of baby-boomers; and they were not—as President Obama claims—used to fund the Bush taxcuts for the rich. Nay, budget surpluses automatically led to a reduction of outstanding Treasuries—which by identity meant a reduction of the net wealth held by the private sector. And the budget surpluses reduced private sector income. Dollar for dollar.
And so, second, the Clinton surpluses crashed the economy, leading to the Bush recession and the renewal of budget deficits. Seven for seven, every budget surplus crashed the economy. History may not repeat itself, but it rhymes perfectly.
Finally, here is the scenario President Obama paints for our future, if we do not cut deficits and debt.
President Obama: “Now, every family knows that a little credit card debt is manageable. But if we stay on the current path, our growing debt could cost us jobs and do serious damage to the economy. More of our tax dollars will go toward paying off the interest on our loans. Businesses will be less likely to open up shop and hire workers in a country that can’t balance its books. Interest rates could climb for everyone who borrows money — the homeowner with a mortgage, the student with a college loan, the corner store that wants to expand. And we won’t have enough money to make job-creating investments in things like education and infrastructure, or pay for vital programs like Medicare and Medicaid.”
Comments: Here he makes the cardinal mistake of confusing a sovereign government’s budget with the household’s credit card debt. The sovereign government is different in two ways: first, it is the issuer of the currency and can never run out. In my long quote above, I lay out the realities of government spending. As Chairman Bernanke as well as former Chairman Greenspan have argued, government spends by “keystrokes”, crediting bank accounts. It cannot run out of keystrokes. (See http://neweconomicperspectives.blogspot.com/2010/03/tell-your-representative-to-leave.html and http://neweconomicperspectives.blogspot.com/2011/06/mmp-blog-2-responses_23.html.)
Budget deficits and debt will not cost us jobs and will not reduce our ability to afford our commitments to tomorrow’s seniors (called “entitlements” within the beltway—an adoption of neoliberal terminology–as if our seniors are spoiled little brats who think they are entitled to feed at the public trough, rather than valued members of our community who worked their whole lives and now deserve a decent life after retirement).
Yes, deficits could be too big—they could push the economy beyond full employment, causing inflation. But if that should ever happen in some distant future, the time to deal with the problem will be then—not now when we have some 15 or 20 million Americans seeking jobs that do not exist.
Second, the interest rate is a policy variable, with the central bank (our Fed) setting overnight interest rates and the rate paid on bank reserves at the Fed. No amount of deficit spending or outstanding government debt will cause that rate to go up; it will go up only if the Fed decides to raise it. And that is why the deficit hysteria in Washington has not caused interest rates to go up. To be sure, the Fed does not normally set longer-maturity rates, although with Quantitative Easing it has been targeting Treasuries, which made a marginal contribution to lowering longer term interest rates.
In any case, if we ever get to a point where issues of longer maturity bonds by the Treasury is pushing up the rates paid by “everyone who borrows money”, as President Obama puts it, the solution is to stop issuing those treasuries. The maturities issued by the Treasury is also a policy variable. The Treasury can choose instead to issue 30 day bills—whose rate closely tracks the Fed’s overnight interest rate target (fed funds rate). And that, as we already discussed, is a policy variable under complete control of the Fed. No matter how hard markets might try, they cannot influence that rate, and no matter how many treasury bills are issued, the Fed will be able to keep the overnight interest rate under its control.
To conclude, while we might be willing to accept the President’s appeal for compromise on the debt limit debate, there is no reason to accept his economic analysis. He has not made any reasonable case for tying deficit or debt reduction to lifting the debt ceiling. Nor has anyone else.
As such, if you are going to contact your representative, please insist that he or she reject the budget-cutting that the President, the Republicans, and most of the Democrats are trying to ram through following the shock doctrine approach I discussed last week. Their real goal remains to slash and burn the remnants of FDR’s New Deal protections.