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The Deficit Crisis Is a Fantasy

letsgetitdone's picture

After going to one of the AmericaSpeaks community conversations yesterday, I'm even more confident that the deficit crisis being promoted by the Peter G. Peterson Foundation, AmericaSpeaks, the National Commission on Fiscal Responsibility and Reform, and the Obama Administration, as well of much the world's global elite is a fantasy. There is no truth to it, and it is a dangerous fantasy, because if one believes it, then that can be a self-fulfilling prophecy. The austerity they recommend for the long-term can make the slow growth and difficult times they project come true. It can catch us all in a nightmare of their making. The “reasoning” behind their fantasy is simple enough. It is:

1. Long-term projections, like the CBO's and others that project further than 2020 based on the CBO's projections show that the national debt is going to grow rapidly in the coming years, and that we cannot “grow our way” out of the debt as we did during earlier periods.

2. Due to the increasing debt, Federal interest costs will be increasing dramatically.

3. This will create other effects, such as driving interest rates up more generally including consumer interest rates. Increasingly heavy Federal borrowing will also “suck up private sector capital” and hurt investment in new innovation increasing productivity.

4. Over the long term, rising debt, interest rates, and sharply rising interest costs, both for the Government and for consumers, and “crowding out” of private capital, represent a problem of the highest importance that threatens to harm our economy and lower our living standards.

5. So, America must immediately take the measures needed to solve this deficit problem after recovery from the present recession.

And there are at least four reasons why this line of reasoning is a fantasy.

First, the Government can deficit spend without issuing debt instruments (“look Ma, no more rising national debt”) or committing to paying interest costs. It has the constitutional authority to spend money without offsetting its expenditure by issuing an equivalent amount of debt. The more it chooses to do that, the more it creates an oversupply of reserves in the reserve funds market, and the more it does that, the more competitive forces in that market will drive short-term interest rates on reserve funds toward zero. If the Government further decides to cease offering longer-term debt instruments, and to offer overnight debt only, it would decrease its annual interest costs to very near zero. So, there need be no rising national debt, nor rising Federal interest costs, nor rising business or consumer interest costs, nor sucking up private capital for investment. The whole deficit terrorist nightmare can go away. The Government can start refusing to issue debt now, and persist in that policy for as long as it wishes. Why doesn't it do that?

If it did, then, for example, the roughly $31.15 Trillion National Debt projected by AmericaSpeaks in 2025, which is 114% of their projected GDP for that year, would be reduced by roughly $11.6 Trillion to 19.6 Trillion, or about 71.6% of GDP, hardly alarming even by the standards of deficit terrorism. In 2025 alone, this would reduce projected Government expenditures by $1.49 Trillion, or about 60.5% of the projected deficit for 2025.

Second, the deficit terrorist projections of GDP growth are way out of line with historical averages, and that is why they think we cannot grow our way out of hard times. In effect, they are projections from the Bush and recent Obama Presidencies. If one computes 10 year growth ratios of GDP unadjusted for inflation, the historical growth ratio norm (average) is roughly 2.0. In contrast, the very conservative CBO projection from 2010 – 2020, is 1.54, just a bit higher than the 1.50 of the decade now ending. If the Government were to forget neo-liberalism, and follow continuously aggressive stimulative policies of the kind opposed by the deficit hawks, and proposed by Modern Monetary Theory, the growth ratio is very likely to return to the historical norm, since other than in the 1930 – 40 decade, the only time it dipped below 1.69 was during the current decade. Since deficits depend on tax revenue, and tax revenue, in turn, is closely related to GDP, the conservative GDP projections of the CBO and the deficit terrorists, more generally drive up the deficit numbers, and by depressing the GDP numbers also drive up the public-debt-to-GDP ratio – a double whammy supporting their fantasy that there's s deficit/debt/debt-to-GDP ratio “problem.”

Here's the huge difference it makes if we assume a return to something like the historical norm, while also assuming that the Government ends debt issuance this year. a) The US incurs much smaller deficits than CBO projects from now through 2014. b) In 2015 the US gets its first surplus since 2001. c) The projection then shows rapidly increasing surpluses from 2015 until 2025. d) The total accumulated surpluses are $10.1 Trillion, and this exceeds the $7.5 Trillion public debt recorded by the end of 2009.

In short, if we quit using debt instruments and used deficit spending to drive growth up to historically normal levels, then according to this alternative projection, we'd have one big surplus crisis and not a deficit crisis at all. In fact, another way to look at this is that if we did these two things, and spent the whole $10.1 Trillion surplus, plus what the deficit hawks projected, the US Government would be able to spend $80 Trillion between now and 2025, and would still have a public debt of only $7.5 trillion, which would then be about 17.8% of GDP, and if we were willing to tolerate a debt-to-GDP ratio of 40%, the Government could spend $89.4 Trillion over the 15 year period, an average of about $5.96 Trillion, per year, a level of expenditure (not including interest costs) greater than that projected in 2025 by AmericaSpeaks, and more than $2.5 Trillion or 75% greater than the Government is on track to spend this fiscal year.

Third, of course, we cannot project either the surplus problem I projected, or the problem the deficit terrorists project. Both are fantasies; just dreamland. Economists and financial experts can't project accurately even five years out, much less 10 or 15 years out. They cannot project even a few years out. In 2000, they were talking about surpluses as far as the eye could see. In 2006, very few recognized the problem of the housing bubble or projected the crash of 2008 and the Great Recession. Now, they are projecting slow growth over the next 15 years. Why should anyone be foolish enough to base significant public decisions on their medium and long-term projections? Why should anyone make decisions implementing long-term plans to cut any public programs that are of benefit to Americans over a period of 10-15 years, when the projections showing the need for cuts are so much like a fairy tale.

As for my own projection, of a surplus problem, that is very unlikely to happen because we know that surpluses are historically unsustainable, which is why they are a problem. Whenever, the US has experienced a few years of surplus they have been followed by either a recession or a depression. This isn't just an empirical fact, Modern Monetary Theory indicates that surpluses in the Government sector are equivalent to deficits in private sector savings. That is, when the Government runs a surplus, it removes financial assets from the private sector, unless foreign sector exports, balance off that surplus, not a possibility anytime soon for the US. So, the longer the US runs a surplus, MMT says that the greater is the chance it will have a recession, and that the "automatic stabilizers" in the safety net will kick in and turn the surplus into a deficit. So, my projection above can't come true. Nevertheless, it still presents a useful narrative, because it shows that even if the Government were to spend nearly $20 Trillion more than CBO/AmericaSpeaks, projects it will spend through 2025, then the result, in terms of their beloved debt-to-GDP ratio would be quite acceptable.

Fourth, the plans of the deficit terrorists to get everyone committed to a course of deficit reduction over the next 15 years are reminiscent of the kinds of five year plans that we became familiar with in the first half of the 20th century in planned economies. There too, people tried to set targets for the economy and plans to implement those targets that proved incapable of coping with political, social, and also economic realities. These plans were too rigid to adjust to circumstances. The deficit terrorists ask people to formulate plans committing to cuts to be implemented over the long term in most areas of Government expenditure without reference to the consequences of making those cuts, or to the conditions we have no way of projecting which will obtain when the planned cuts are to implemented. What if the planned cuts aren't small enough, because a program has become obsolete? What if expansion is needed in certain areas and not cuts?

Of course, the deficit terrorists will respond by saying that everything can be adjusted if conditions require and that their plans are not intended to be a strait-jacket, but only a guide to let us arrive at fiscal sustainability over a long period of time. But the questions we must ask are: 1) why “fiscal sustainability” and fiscal responsibility should be measured by national debts, deficits, and debt-to-GDP ratios? Those are just abstractions; they do not measure real wealth or Government solvency. Governments with currency control in their own fiat monetary systems, cannot become insolvent. They have no solvency risk. So these numbers don't signify fiscal sustainability or responsibility. Rather, they are a lot of sound and fury signifying nothing and distracting us from the real things we ought to be doing.

For 2) what are the real consequences if the Federal Government evaluates what it is doing according to its impact on these numbers and acts accordingly? Unfortunately, we are already seeing these consequences and they are not pretty. They are failure to meet our unemployment problems, failure to meet our pressing need to repair our infrastructure, or to solve our environmental and climate problems, failure to extend the social safety net to those in need, failure to educate our young, failure to rebuild the energy foundations of our economy, taking Medicare for All off the table on grounds that it could cost more than $1 Trillion over a 10 year period and would contribute to an increase in the deficit and the national debt: failure, failure, failure, and more failure; and the destruction of real wealth as our country declines into insignificance. What's fiscally sustainable and responsible about that?

(Cross-posted at All Life Is Problem Solving and Fiscal Sustainability).

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