EVERYTHING YOU NEVER WANTED TO KNOW ABOUT DEBTS AND DEFICITS

I’m not accustomed to promoting spending beyond your means. Like most Americans, I borrowed when I needed to and always considered my ability to repay my obligations. So, it’s naturally compelling when I hear the patriotic calls from conservatives for the United States Government to conduct their financial affairs similar to the way our citizens conduct their personal financial affairs. It all seems reasonable…right? Not really.

Make no mistake…there are times when the government should seek to go heavier on borrowing and other times when the government should go stronger on savings. One such opportunity was missed in the first decade of the 21st century. When the year two thousand rolled around the United States government was spending about $300 billion less than they were taking in. Republicans gained control of the White House, Senate, and House of Representatives. They promptly cut taxes to the richest two percent of the country reversing what could have been a $3 trillion dollar surplus over the next ten years reducing what was a $5 trillion debt, and turned it into an additional $1.2 trillion of debt. Then, they lurched into an unnecessary war against the weakest of adversaries creating an additional $1 trillion of debt and the loss of 4000 additional precious souls of our military and hundreds of thousands of Iraqi’s. Those are the years we should have been saving…but, we were spending frivolously.

Now…things are different. Twentieth-century British economist, John Maynard Keynes argued in 1930 that private sector decisions sometimes lead to inefficient macroeconomic outcomes and therefore, advocated active policy responses by the public sector, including monetary policy actions by the central bank and fiscal policy actions by the government to stabilize output over the business cycle. The theories forming the basis of Keynesian economics were presented in The General Theory of Employment, Interest and Money, published in 1936. He advocated interventionist economic policy, by which governments would use fiscal and monetary measures to mitigate the adverse effects of business cycles, economic recessions, and depressions. His ideas are the basis for the school of thought known as Keynesian economics. Simply put, Keynes believed, and was proven right by means of the recovery from the Great Depression, when he advocated the government should spend money to stimulate the economy when the private sector doesn’t, or can’t.

Recently the New York Times in their editorial of February 7, 2010, the Nation magazine in their March 22, 2010 issue, and Time magazine in its March 15, 2010 edition has expounded on the debt and deficit. The Nation and Time articles were particularly interesting in that they were composed by James K Galbraith, economist and professor at the University of Texas, and Zachary Karabell, president of River Twice Research. Mr. Galbraith is the son of John Kenneth "Ken" Galbraith, who was a Canadian-American economist. He was a Keynesian and an institutionalist, a leading proponent of 20th-century American liberalism and progressivism. Yeah…and his son teaches at the University of Texas…fact is stranger than fiction.

The aggregation of these writings advocates the following conclusions. Mr Karabell writes that “the numbers are undoubtedly daunting, with projections of total gross debt reaching 100% of U.S. gross domestic product (GDP) this year or next and surging every year thereafter. But, the debt is probably not as much of a problem as the anxiety we have worked up about the debt.” The amount the country pays to service the national debt isn’t particularly onerous. Interest payments in 2010, (expected to be $500 billion), are not much different in inflation-adjusted terms from what servicing cost 20 years ago, especially to GDP. The same is true for household debt, which has shot up astronomically in dollars but consumes about the same percentage of household income to service as it did in the 1990’s. Said differently, we’re paying about the same percentage of our income to service debt as we did 20 years ago.

The reason we can afford such large debts is that interest rates are so low. At the beginning of 2000, it cost the U.S. government more than 6.5% to borrow money. It now cost less the 2.5%. Relative to the size of the economy, the debt isn’t particularly high by global standards. Of course, we have to be concerned that one day those rates could go up.

Many are concerned with the amount of borrowing from China. I, personally, think there is another argument to this worry. As, I’ve written before in this blog…when you owe the bank $100,000 they own you…when you owe the bank $100 million you own them. The same thing can be said for China. They are in the same boat with us, like it or not. Even with the U.S. economy weak, the dollar remains one of the few truly safe havens, and that means interest rates could stay low for a long time, which in turn means that our debts, however big, can be managed. And, for those of you who have heard the recent threats that the rating agencies might down-grade U.S. Treasuries from their current rate of Aaa…well, China can’t exactly stand for that either. Though eliminating deficits might seem wise, it could actually be fatal to future prosperity. We have to invest and spend to build a future, to help re-create a workforce, and for now debt is a means to that end, provided the Administration and Congress shows it can effectively channel that money.

Half of the debt of trillions of dollars is owed by the federal government to itself, and a quarter more is owed to the American public…a bit of a surprising fact. As incredible as this is…the debt the government owes itself can simply be rolled over endlessly. As long as the dollar remains central to the global system, and there is little chance of that changing in the next decade, the government will have the latitude to borrow more than most other countries.

America’s indebtedness would be sustainable and even healthy if the underlying economy were vibrant, innovative and strong and if federal and state governments could channel those moneys productively and quickly. The problem isn’t how much debt we’re carrying today; it’s whether the economy of tomorrow will be able to justify it. And, as I have previously written, it’s widely recognized that if we could reduce the unemployment rate to 4% the deficit would completely disappear. America isn’t investing enough in its future. We are failing to mobilize resources to improve our health care and infrastructure and stay competitive in global economy that is more clamorous than ever. Hopefully, with the signing of health care legislation on March 23, 2010 (now a very famous day in history and one we should all mark down) perhaps we’ve begun to address the healthcare solution.

James Galbraith goes further…he is concerned with what might happen if a deficit reduction attitude infects the recession’s recovery position we now find ourselves in. He believes a big deficit-reduction program would destroy the economy that remains after the Great Recession. To cut current deficits without rebuilding the private credit system is a sure path to stagnation and probably a second recession. This, Galbriath is surely correct about. Until financial regulatory reform takes place all the same factors remain in place for another crushing financial meltdown…the next one being worst than the last. As sure as the sun will come up tomorrow the financial titans who bought us down in 2007 and 2008 will bring us down again. I work with these people every day. They are as clueless today as they were in 2006. They do not get it!!!

We need to re-establish strong growth and high employment. There are two ways to get the increase in total spending that we call “economic growth.” One way is for government to spend. The other is for banks to lend. That’s basically all there is. Governments and banks are the two entities with the ability to create something from nothing. If total spending power is to grow, one or the other of these two great financial institutions has to be involved.

Here are the undisputable facts of Galbraith’s argument. DEFICITS PUT MONEY IN PRIVATE POCKETS. They own that cash free and clear and they can spend it however they see fit. But, bankers don’t like budget deficits because they compete with bank loans as a source of growth. When banks loan you money it’s not free and clear because you have an obligation to pay THEM first…principal and INTEREST. Wall Street labors hard to confuse the issues. They never thought to warn you about the financial crisis they were creating. These same financial geniuses are warning of the impending bankruptcy of Social Security, Medicare, even the United States itself. Remember, the rating agencies who were publically anointing sub-prime mortgage securities as Aaa securities are now warning that the United States might lose the same rating.

This is where Galbraith takes on a notion that is in contradiction to how we manage our personal debt. The notion that the burdens of public debts will impose burdens on our grandchildren. All of this forms part of one of the great misinformation campaigns of all time. It may seem like homely wisdom, especially, to say that “just like the family, the government can’t live beyond its means.” But, Galbraith insists, “it’s not.” In these matters the public and private sector differ on a very basic point. Your family needs income in order to pay its debts. Your government does not. With government, the risk of nonpayment does not exist. Government does not need to have cash on hand. It is possible that government may spend imprudently. Too much spending may lead to inflation, usually by depreciation of currency…but, with the world in recession there is not an immediate risk. No government can be forced to default on debts in a currency it controls. Public defaults happen only when governments don’t control the currency in which they owe debts.

Galbraith insists public debt is not a burden on future generations. Public debt does not ever have to be repaid. Governments do not die…except in war or revolution, and when that happens, their debts are moot. In the entire history of the United States public debt has increased on all but about six short occasions, with each surplus followed by a recession. These debts are the foundation of economic growth. Bonds owed by the government yield net income to the private sector, unlike all purely private debts which merely transfer income from one part of the private sector to another. Social Security and Medicare are government programs that cannot go bankrupt and cannot fail to meet their obligations unless Congress decides.

Public deficits and private lending are reciprocal. Increased private lending generates new tax revenue and smaller deficits, which is what happened in the 1990’s. A credit collapse kills the tax base and generates more spending, which is what’s happening now, and big deficits are the accounting counterpart of the massive decline, last year, in private bank loans. If we could revive lending we should do it up to a point. Decentralized and competitive banks have much more flexibility. A good banking system, run by capable people with good business judgment who know their clients is good for the economy. However, right now we don’t have functioning big banks. We have “too big to fail,” incompetently run banks. Galbraith believes that all the deficit hysteria is intended to divert attention from dysfunctions of private banking, and is helpful in distracting us from doing meaningful financial reform.

Finally, The New York Times brings a meaningful conclusion. The Times states, “the cold hard economic truth is this; at a time of high unemployment and fragile growth, the last thing which government should do is to slash spending. That will only drive the economy into deeper trouble.” “Spending without taxing is a recipe for huge deficits and running big deficits when the economy is expanding only sets the country up for bigger deficits when the economy contracts.” And, “once a deep recession takes hold, slashing government spending is not going to solve the problem. It only makes is worse.”

The Times offers the following as evidence of stimulus spending by the government having a position effect on a contracting economy. “The stimulus package slowed job losses and helped spur activity – in the third quarter of 2009, the economy grew at an annual rate of 2.2%, and the initial fourth-quarter reading was 5.7%, a rebound few thought possible.”

I’ve said this before but it is worth repeating. Being a deficit hawk in a time of severe economic contraction is like be a water conservationist while your house is on fire. There are times to manage your debt as an individual, and as a country. But, the characteristics are different for us as individuals as opposed to us as a government.

These collective writings from the editors of the New York Times, Zackary Karabell, and James Galbraith are a compelling argument against those conservatives who have seen the light since Barrack Obama was elected. The conservatives might have a point…but, they have it all backwards.