Deficits 101

Uncle Milton in the comments:

To Rob:Maybe I should be like Dick:
Cheney to Treasury: “Deficits don’t matter”
Former Treasury Secretary Paul O’Neill was told “deficits don’t matter” when he warned of a looming fiscal crisis.
O’Neill, fired in a shakeup of Bush’s economic team in December 2002, raised objections to a new round of tax cuts and said the president balked at his more aggressive plan to combat corporate crime after a string of accounting scandals because of opposition from “the corporate crowd,” a key constituency.
O’Neill said he tried to warn Vice President Dick Cheney that growing budget deficits-expected to top $500 billion this fiscal year alone-posed a threat to the economy. Cheney cut him off. “You know, Paul, Reagan proved deficits don’t matter,” he said, according to excerpts. Cheney continued: “We won the midterms (congressional elections). This is our due.” A month later, Cheney told the Treasury secretary he was fired.
Looks like Paul O’Neil was prescient. (and early…)

What Uncle Milton fails to understand is that it’s not the deficit itself that is so important, but more what is causing it.
If you figure out what is causing the deficit, then you can figure out how to deal with it. Bush was running up huge deficits by tax cuts and massive spending on wars. The way to deal with that is to get rid of the tax cuts and stop fighting the wars.
The present deficit is being 90% caused by the present financial crisis. Only 10% of it is being caused by stimulus spending. So there goes the whole rightwing argument that the deficit is due to excess spending.
As long as the financial crisis persists, the deficit will persist. No amount of austerity measures will actually reduce the deficit in the midst of this crisis. All deficit reduction will do is harm citizens and workers and also harm the economy via decreased government spending. So we have to decide what kind of deficit we want to run. Do we want to run a positive deficit by putting people back to work, etc. or do we want to run a negative deficit via decreased tax revenues and a slowed down economy, possibly progressing to Depression and deflation?
With high unemployment, governments will run deficits. It’s inevitable. These unemployment-driven deficits will continue for as long as the high unemployment goes on. Austerity will not drive down these deficits. It will just cause declines in the economy, possibly leading to depressions or even deflation.
Deficit hawks say the main danger from deficits and the reason we need to engage in austerity measures right now is that deficits will lead to increases in interest rates. The present interest rate from the Fed is 0%. However, they are probably referring to interest rates on long-term federal bonds. Low deficits will be rewarded in low interest rates for US government bonds (a good thing), whereas the bond market will punish fiscal irresponsibility by raising interest rates on US government bonds.
Let’s see if there is anything to that. Interest rates on 10 year US bonds are currently 4%, low by historical standards. In 1990, they were at 8%, and that was when we had not only a balanced budget but a budget surplus, which George Bush promptly blew. So, looking 10 years out, the bond market is not worried at all about US deficits and is not punishing the government for its deficits by higher interest rates. So the theory is not working. There is no risk of high interest rates at the moment. The deficit hawks’ argument is revealed to be a gigantic lie.
Another argument is that bond markets can change at any minute. We have to reduce deficits now because the bond market could change at any time. But this makes no sense. If the bond markets are irrational, all arguments towards rationality along the lines that the bond markets punish irresponsibility and reward austerity vanish. We are not dealing with a rational market here. And if the market is irrational, it makes sense to borrow now as long as it is offering good deals (low interest rates so the state can borrow cheaply).
Another argument is that deficits lead to the risk of inflation.
There is little to no inflation in the US at the moment, so this argument appears to be hogwash as far as right now anyway. Core CPI inflation is running at 1%. The opposite of inflation, deflation, is actually the worry here.

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8 thoughts on “Deficits 101”

  1. Libertarians like Ron Paul say say its the Federal Reserve’s fault and that we all need to use gold instead of paper(fiat money) , and thatll fix the economy.

  2. To Rob:
    What Uncle Milton fails to understand is that it’s not the deficit itself that is so important, but more what is causing it…. The way to deal with that is to get rid of the tax cuts and stop fighting the wars.
    Did you miss my comments about my thoughts on dramatically reducing defense spending and raising taxes on the wealthy..? I also suggested raising taxes on household items with the exception of essentials like food, drugs, and clothing and also raising gasoline taxes. (similar to Europe…) I suggested doing that instead of austerity… of course borrowing money (for the moment..) is easier.
    Obama & company (but definitely started by Bush & company..) have spent a large amount of money baling out banks, AIG, and in the future very likely Fannie and Freddie. I don’t specifically blame Obama but I do believe it’s a continuation of the Bush policies. Have you actually looked at how the stimulus money is being spent…? What happens when it’s gone..? (Which it will be soon..) Back to square one. If they had spent money on some of the green energy ideas (wind, solar, etc..) I would have been impressed. Move electrical generation away from fossil fuels… use the natural gas now used for electrical generation to power trucks and fleet vehicles (much cleaner than diesel..) the payback would not be immediate but it would help solve some of the deep structural problems that the US has. But it was all talk.

  3. Yes the 10 bond yields were around 8% in 1990 but we were running big deficits then under Bush I. If you meant 2000 then they started out in the high 5s and trended down throughout the year:
    http://www.federalreserve.gov/releases/h15/data/Monthly/H15_TCMNOM_Y10.txt
    30 year yields have trended down also:
    http://www.economist.com/blogs/buttonwood/2010/04/bond_yields
    One of the reasons the yields are low is that central banks like China and Japan are buying bonds as well as the Federal Reserve. It can work for a while…but unfortunately there is inflation.. in things we need (Heath care, school tuition, fuel, food…) but deflation in this we have (houses..) and minor deflation in things we don’t really need (big screen TVs…)
    There is most definitely inflation in the developing countries such as China, Brazil, and Vietnam. Guess who they blame for this… the US.

  4. In other words the government can just spend as much and inefficiently as it wants without any accountability forever…? They can just make up money…? It just doesn’t seem sustainable, whatever the current debt theory is. And most mainstream articles I read are all for debt, not the other way around. It’s only the populous which is against it and they have some good reasons for that.
    Going off the gold standard and getting into huge debt was part of the reason the crisis occurred. Most of our economic expansion in the 90s was debt-based and illusory. We don’t make anything anymore, we fiddle around with our debt. Sure, that’s going to work out in the long run. The US, UK and Japan governments are like rich people who get the best credit cards and nobody cares that they rack them up because they think they’re good for it, like they’ve always been, but some day this won’t be the case. I don’t care if it’s in 50 years… we need to think far ahead. We’ve been on the quarter system economically for too long. I don’t want to leave this nation a shithole to my future children.
    I would be for debt if we built decent railroads or something, but we don’t. Out government sucks. We’re still at war, making freeways, shitty healthcare, etc. We give vast sums of money to crappy corporations. And the stimulus money went to quick projects, so nothing really important even gets built. Understanding this stupidity, I’d rather spend my own money and not have any higher taxes/government debt burden.
    If the government represents us we should have a say in how much debt we want that government to have, even if we are laymen. To the layman the idea of huge debt sounds bad and yet we’re repeatedly told by the elite we need it. Most of us don’t care about erecting some 10 million dollar recreation center or some other bs nobody will go to, so we oppose this shit (useless speedbumps, inefficient streetlamps, development, low-income housing).
    Basically it comes down to the fact that government money benefits both the Goliaths who are waging war with their government contracts, who continue to make shitty cars and products, who continue to keep us addicted to oil…. and also to the Leeches who offer nothing back to society, but suck, suck, suck. The Goliaths gulp, the leeches suck and every now and then the middle class gets a “chupito”.
    Is it really hard to understand that people want to cut money to them both? Middle class people get hardly anything from the government, some roads, schools and stuff, sure, but no cash sums like these goliaths and leeches. The Corporate State is all for the Government. Fuck them. We’re not voting against social democracy, we’re voting against them taking it away by linking arms more and more with the Government. And at the same time they use their Moral Superiority by enlisting leeches and making us Evil anytime we oppose government incursion. So the middle class gets even more paralyzed, the underclass grows and the corporate state consolidates its power…. oh, but it wont take full control until 2074!! What consolation!! Of course, then we’ll have some society like Ancient Egypt, rulers and slaves, pawns and kings. Personally, I’d like to do my part stop it.
    Well, I guess I’ll waddle off for another slice of pizza and beer, pathetic little American that I am. Leftists spit us, tell us we’re stupid and evil for wanting to moderate spending, then tell us how to rule our country (the one they hate). Fuck that.

      1. I’m against austerity, btw. But I don’t see why you worship the government and think it’s going to solve all of our problems. Have you even been to Europe, Japan, Russia, talked to people there, and see what they think of the increasing bureaucratization of life?

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