Learning to Love Federal Budget Deficits

I’m often asked to speak in favor of lower Federal deficits. I’m not sure how clear I’ve been about this here, but I’ve long been very skeptical of the standard argument, found on both sides of the aisle, that fiscal discipline is a Good Thing.™

I realize that it takes some nerve to fly in the face of all the fine people on our side who say “It’s OUR money, not the government’s!” and “We’re saddling our grandchildren with debts they won’t be able to repay!”

But the first statement is only true insofar as the dollars that the government creates are technically liabilities incurred to the taxpayers. (That’s why it says “Federal Reserve Note” on the top of our paper money.) They can literally create as many dollars as they please.

The second statement is hogwash because government debt can be rolled over indefinitely, so long as people are willing to hold it.

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As far as the Left is concerned, I’ve never really understood what they mean when they say that the government should be fully funded from current revenue. Maybe it’s a combination of two things: they like it when people pay higher taxes; and they think that big deficit numbers (simply by virtue of being ugly) make it harder to propose yet more government spending.

But we might be forgiven for confusing the total supply of “money” with the total supply of “dollars,” because in today’s world they’re basically the same thing. In real life (as opposed to Wall Street life), the absolute number of dollars in circulation matters far less than the specific breakdown of how the nation’s economic productivity is put to use.

Government generally seeks to redirect an ever-increasing proportion of the country’s aggregate productivity. You can do that in one of two ways (in practice, we use a combination of both).

You can tax people at higher rates. This reduces the ability of individuals to access goods and services, thus increasing the share available to actors that are favored by the government.

Or you can deficit-spend. This adds to the global stock of financial assets, which has an effect practically indistinguishable from monetary inflation. Inflation works in the economy by attenuating the purchasing power of already-existing money. So as with higher tax-rates, it also increases the share of total productivity that may be disposed by government-favored actors.

There is a lot of subtle differences between the two approaches, but that’s mostly financial and economic mumbo-jumbo. The interesting difference between the two is that deficit spending is regressive. The people who pay the price in terms of reduced access to goods and services are the ones at the low end.

And since we won’t be enacting any kind of a flat tax anytime soon, deficit spending is available to fill in the gap between what the top 1% of all income-earners are able to provide, and what the government would actually like to spend. (Keep in mind that the general spending level can’t decrease, because it’s responsive to what the people want: spending is high because we all like our government programs.)

John McCain has at times actually said that his goal is to get total government spending at or below the post-war average, which is around 18 or 19 percent of total GDP. (Before the New Deal, federal spending in peacetime was often no more than 2 or 3 percent of GDP.)

This actually represents a policy choice which directly contrasts with what the Democrats want. Although Barack Obama won’t stoop to actually discussing the issue himself, there are people like Paul Krugman, who has said in so many words that he wants to see the government’s share of the economy rise to 28%.

But regardless of how big the government’s share of the pie should be, that’s a different argument from how we fund it. Adding more deficit spending to the mix could be attractive to either side.

How can you tell when you’re doing too much deficit-spending? Easy. When the long-end of the Treasury yield curve goes too high, and when foreign central banks stop buying two-year agency and Federal paper like it was candy. In other words, fiscal discipline will be enforced at the margin by our creditors.

-Francis Cianfrocca