The lost decade

The media frequently claim federal deficits spend “taxpayers' money.” This, as Star Trek's Mr. Spock would say, is “illogical.” If deficits spent tax money, they wouldn't be deficits.

The definition of deficits is spending beyond tax receipts. “Ah,” you say. “But our children and grandchildren will pay the taxes.” Wrong again. There is no historical relationship between tax rates and deficits. In more than 50 years, tax rates have gone down or remained level, depending on your income. This, despite huge deficits and even a couple surpluses.

Since it is unlikely tax rates will rise – at least that's what all the politicians promise -- your children and grandchildren will not pay for today's deficits.

As for being indebted to China et al, this is another myth. The federal government borrows by creating Treasury securities (T-bills, T-notes and T-bonds) from thin air, backed only by “full faith and credit.” It then sells these securities to acquire dollars it previously had created. When the securities mature, the government buys them back, plus interest.

“Full faith and credit” is an intangible collateral. The government has an unlimited supply. This gives the government the power to create unlimited amounts of T-securities. Finding buyers for these T-securities is addressed by offering interest rates high enough to attract investors.

While the government currently creates T-securities from thin air, it just as easily could create money from thin air – similarly backed only by full faith and credit – and eliminate the borrowing step. No longer would we be troubled by federal debt, federal deficits, concerns about China et al or interest payments. The same controls over T-security creation would apply to money creation. We merely would eliminate the one step that causes so much controversy.

Why does the U.S. government create T-securities to obtain U.S. dollars, rather than creating U.S. dollars directly? Borrowing is a relic from the gold-standard days, which ended in 1971. Prior to that, U.S. dollars were backed in part by gold, a tangible product in limited supply. This limit prevented the government from creating as many U.S. dollars as it needed, so it had to borrow these dollars.

When you think about it, the notion of the U.S. government being forced to borrow U.S. dollars – dollars it alone has the power to create – is ironic and inefficient. By creating dollars directly, the government would eliminate deficits, debt and those huge interest payments, along with all the controversy these subjects cause.

Rodger Malcolm Mitchell
http://www.rodgermitchell.com

Sorry for the length of this post, but when I read that raising taxes and/or reducing spending is a path to recovery, I must respond.

A large economy has more money than does a small economy. Therefore a growing economy requires a growing supply of money, aka deficit spending.

Concern about the federal debt revolves around two beliefs: Someone (often characterized as “our grandchildren”) will have to pay those debts, and large debts cause inflation. For us citizens, personal debt is concerning, because debt must be repaid. People go bankrupt when they can't repay their debts. But, if you owned a magic printing press, and you had the legal right to print as much money as you wished, debt never would concern you.

Received a bill for a million dollars? No problem. Turn on the magic press and poof!, it's paid. Unfortunately, you and I don't own a magic press, so we worry about our debt.

The federal government, uniquely among all U.S. debtors does own that printing press. It can pay bills of any size, which is how today, it easily services a gross debt of $12 trillion. Not even during the current recession has any federal check bounced. Not even close.

Still we worry about federal debt as though it were our own. Why? Partly because so many people tell us we owe the federal debt. How silly. Debt is owed by borrowers. We are not the borrowers. In many cases, we are the lenders, the owners of T-securities. The government is the borrower, and we are not the government. There will be no bill collectors on our doorsteps, demanding that we pay our mythical share of the federal debt.

But won't “our grandchildren” have to pay for the debt through higher taxes? For the past 50 years, tax rates actually have gone down, despite massive deficits. There is no relationship between deficits and tax rates, which are political, not financial, decisions.

What if tax rates don't rise, or rise moderately? Let's do the math. Say in Year One, taxes total $10 trillion and spending totals $11 trillion. Spending exceeds taxes, which causes a $1 trillion debt.

In Year Two, tax rates rise, so taxes now total $11 trillion, but spending rises to $12 trillion, and now the debt has risen to $2 trillion.

How much of Year One's debt did taxpayers pay? None. Taxes weren't even sufficient to pay for Year two's spending, let alone pay for last year's debt. The only time taxpayers pay for debt is when taxes exceed spending, i.e a surplus.

This is why surpluses have caused all six depressions in U.S. history. Surpluses, not debt, cost taxpayers money.

The inflation logic is that federal debt increases the money supply (true), which dilutes the value of money (not true). Money value is based not only on supply, but also on demand.

Money supply can increase massively, and still not cause inflation, if demand goes up as much. Demand is determined by risk and reward. Risk is inflation (which is a result, not a cause), so the key to money value is reward.

What is the reward for owning money? One reward is the ability to buy things with it, but in a massive economy like ours, there always are plenty of things to buy. The real reward for owning money is interest. The higher the rates, the more valuable the money. That's why the Fed raises rates at even the hint of inflation, and that also is why in the past 50 years, there has been no relationship between federal deficits and inflation. None.

In conclusion, rather than being concerned about federal debt, we should be concerned about economic growth, which relies on money growth, i.e deficits. Surpluses should scare you, because they kill the economy. Always have; always will

Rodger Malcolm Mitchell
http://rodgermmitchell.wordpress.com/

Clinton's surpluses immediately were followed by a recession.

Every depression in U.S. history (There have been 6) was introduced by a series of federal surpluses.

In the past 50 years we have had 9 recessions. All were introduced by a series of reductions in debt growth.

All 15 of the above were cured with increased deficit spending.

Whether from tax cuts or from spending increases, deficit growth is necessary for economic growth. A growing economy requires a growing supply of money. Deficit spending is the government's method for adding money to the economy.

For an economy to grow, the money supply growth must exceed population growth, inflation and the current account deficit.

Rodger Malcolm Mitchell
http://rodgermmitchell.wordpress.com/

Rodger,

Neither premise is correct. If your premise were correct, then why did the US just have the deepest reduction in economic activity since the Great Depression, after Bush went on the greatest deficit spending and tax-cutting spree in several decades.

The fact is that every depression in U.S. history has not been preceded by a series of federal surpluses. The current economic downturn (the worst since the Great Depression) stands in apposite to your contention.

While your theory is fundamentally sound re: "For an economy to grow, the money supply growth must exceed population growth, inflation and the current account deficit" the operational causation assigned is not.

There is no correlation between what you espouse and our current situation. In fact, I would argue that we are facing a balance-sheet depression where real incomes, assets, etc. are struggling to overcome the grip of a deflationary spiral. The collapse in balance sheet wealth to the tune of at least $13.5 trillion cannot be eclipsed by U.S. government deficit spending of a $1.6 Trillion a year. The government won't emphasize this, because it would result in markets taking actions that would ensure the lost decade of Japan....the only distinction is that Japan had actual wealth to cannibalize while the U.S. growth has always been built on mountains of leverage. At some point, our capital market system will reach an inflection point. By then I hope I am getting paid in Rembi or Euros.