by Art Patten, Symmetry Capital Management
A Bloomberg National Poll, conducted June 17-20, found voters choosing jobs over the deficit or federal spending as their top concern by 42 percent to 30 percent.
Yet 74 percent of Americans support an amendment to balance the federal budget, according to a CNN poll conducted July 18-20 by ORC International.
I’m not angry America, just concerned.
It sounds very, very logical that the federal government should run a balanced budget over time, like everyone does (in one way or another!).
However, if a balanced budget amendment is ratified, at some point in the future, 100% of voters will choose jobs as their primary concern. That’s because eventually, it would effectively shut down our formal, monetary economy. People could try to get by through barter, but without some major institutional and operating adjustments—both here and abroad—the opportunity costs imposed by a balanced budget amendment would be greater than almost anyone can imagine (balanced budgets have been bad enough!).
It sounds strange, but it makes sense once you get your head around it. Here’s a simple, three-stage thought exercise designed to help:
Stage One: Where Money Comes From
Economies that use money and operate financially need a reliable supply of new money. But where does money come from?
Most people would say their paycheck or their bank account! But that doesn’t tell you what the original source of those dollars is, i.e., who or what caused them to first appear.
Most economists would say the central bank, failing to acknowledge that when a central bank creates money out of thin air, it usually does so in order to buy an existing government liability, which it then takes off the market. There is no creation of net new financial assets occurring in that scenario.
So where did the dollars that we use to save, invest, pay taxes, and buy services and stuff from each other come from? And where will they come from in the future?
Most of them were created by federal budget deficits! The U.S. government, because it is the only supplier of new dollars (along with the Federal Reserve, when it chooses to be), has the ability to spend new dollars into existence.
Big deal, right? Well, it is a big deal if you have a constitutional amendment that forces the government to stop creating new dollars!
Stage Two: How I Learned to Stop Worrying and Love Fiscal Deficits
A long time ago, our economy operated on a gold standard, where new money was produced by mints that turned gold ore and bullion into coins. For the most part, the gold used to make coins came from new gold mine production. In other words, gold mines sought to run perpetual “deficits” of gold. As long as those deficits were around the right size to meet the overall demand for new money, the system operated fairly well.
There were long periods where gold mine output fell chronically short of what the economy required, and the typical result was recession or depression. This problem could have been managed by allowing the nominal price of gold to adjust upward or downward as needed, but Sir Isaac Newton had put the kibbosh on such a practice many decades earlier. The problem became even worse as population growth exploded from the nineteenth century through today, and it’s one of the main reasons that gold was finally abandoned as the foundation of our monetary system. But the mechanics of a gold standard, because they were pretty straightforward, are useful in trying to understand other types of monetary systems, including our current one.
So guess what? No one ever worried about the fact that the mines were running those ongoing and occasionally sizeable deficits! No one believed that the mines should, over time, re-bury the same amount of gold that they produced in a year. But that’s the historical equivalent of what a balanced budget amendment to the Constitution would do. If it were thought to be a good idea then, we would have had a ‘net zero gold mine output’ constitutional amendment. But most people alive then would have recognized it as being a really lousy idea.
An even worse idea would have been to re-bury all of the gold that had ever been minted, which would have sucked the entire monetary foundation out of the economy. That would have been economic suicide (or murder if one country did it to another). Anyone who advocates the federal government paying down or paying off its debt today is advocating economic suicide.
History aside, the bottom line is that federal deficit spending today plays the same critical role that gold mine output did in much of the nineteenth century. That should be axiomatic to anyone with a functioning brain, once they wrap their head around it.
Stage Three: What’s the Downside?
Once you do get your head around it, it’s easy to see that in almost all circumstances, a sovereign government should run deficits (so that the rest of us don’t have to!). But what are the risks involved in deficit spending, if any?
First, let’s look at the upside. The axiom that federal deficits are to our economy as gold mine output was to a gold standard economy, is (almost) 100% apolitical and non-partisan. I say “almost” because some people would prefer a different arrangement for money production. But within the context of our current system, people on all points of the political spectrum should be able to agree on this fact, once they’ve gotten their heads around it. Deficit too small? Cut taxes and/or raise spending. Too large? Raise taxes and/or cut spending. It allows politicians to keep having the same old fights they’ve always had, it just points them in the right direction. The problem today is that politicians on all sides of the aisle believe that deficits are too large, based only on (1) scary-looking numbers with dollar and percent signs in front of them and (2) macroeconomic theories (mainstream ones) that ignore the existence of the gold mine-government deficit axiom. They’re fighting the wrong fight. Instead, they should be duking it out over how to lower unemployment. Should we lower taxes? Which ones, and by how much? Should we better align tax rates? Should we spend more on job creation? Where and by how much? Should it involve physical capital, training programs, educational or employer subsidies, an employer-of-last resort program? As we observed last fall:
[Obama] could have promised to take a closer look at direct support measures for household incomes and employment. A long payroll tax holiday, not just for employers as some of our well-heeled masters in the Senate recently proposed, but for employers and employees, would provide an immediate boost to household incomes and additional support to the economy. Other forms of tax cuts would help too. So would a promise to simplify our federal tax code. If he were even remotely as audacious as FDR, he could mention the possibility of a jobs program like those enacted under the New Deal. As we continue to point out, these are eminently bipartisan ideas. David Frum has cited a payroll tax holiday as something for the GOP to rally around. Conservative Nobel economist Ned Phelps has written about a federal employer of last resort program in [his book] Rewarding Work. And yet [Obama] can’t say either of these things, because: (1) on economic and fiscal policy he has cast his lot with the New Democrat gang that, as a result of mostly luck, believes that the 1990s prove that federal budget austerity and marginal tax rates pushing 40% provide the keys to economic nirvana; and (2) he’s listening to austerity sirens like Alan Simpson and Erskine Bowles who proclaim that future entitlement obligations have already “bankrupted” the U.S., despite the fact that it’s impossible for the U.S. to go bankrupt.
What other risks and wrinkles are there?
Inflation is the biggest one. If deficits create more money than the economy requires, inflation is the result. Too many dollars will chase too few goods to keep the overall price level stable. That, along with unemployment trends, is what we, our elected representatives, and the policymakers they appoint should be focused on, not some pulled-out-of-thin-air theoretical maximum on deficits or debt levels. I have some concern that if a critical mass of voters and politicians were ever to get their heads around this concept, there would be a significant risk of inflation, as everyone would start to assume (like Dick Cheney, as alleged by Paul O’Neill) that “deficits don’t matter.” Deficits, like gold mine output once upon a time, do matter. They should be neither too large nor too small.
Another risk, which other proponents of this view rarely seem to mention, is agency risk. Deficit spending should be carried out in as democratic a manner as possible. The People should have a meaningful degree of control over how new dollars are allocated, whether it’s the government’s spending needs for goods and services, funds to state, local, and foreign governments, transfers to the elderly, poor, and disabled, and so on. Corruption is endemic to human activities. We have to ensure that the framework this country was founded on continues to effectively manage political agency risk. Of course, this risk is also present in the current austerity fetish, as policymakers tussle over whose government cash flows will get cut and by how much. It would just assume a different direction when the importance of deficit spending is understood and accepted.
Finally, a major wrinkle is that the U.S. dollar is the world’s reserve currency, and almost everyone wants to sell us stuff in one form or another. What’s good policy for us domestically may cause problems abroad. In theory, floating exchange rates offer a way to manage asymmetric policy needs, but as with most things in economics, there isn’t a free lunch. And many countries pursue policies that are designed to support their objective of selling stuff to the U.S., which can prevent exchange rates and economies from adjusting as freely as they otherwise would.
- A monetary and financial economy requires a reliable source of new money. That used to be gold mines. Today, it’s sovereign national governments simply spending new money into existence. It’s axiomatic that sovereign national governments are to today’s economy what gold mines were to the gold standard economy.
- There was never any concern over the fact that gold mines ran perpetual “deficits” of gold, and no one in their right mind ever suggested that mines should re-bury all the gold they had ever produced. That would have caused immense economic harm. Likewise, there should be no concern today over a sovereign government running perpetual fiscal deficits, and it would be utterly insane to pay down, or worse, pay off existing sovereign debt just for its own sake.
- So please, understand that a balanced budget amendment to the U.S. Constitution would be ECONOMIC SUICIDE, and tell your congressman and president or favorite candidates for booting them out! But do it while their economic advisors aren’t looking—simple ideas cause PhDs’ brains to short-circuit.
IMPORTANT DISCLOSURES: Symmetry Capital Management, LLC (“SCM”) is a Pennsylvania registered investment advisor that offers discretionary investment management to individuals and institutions. This publication is for informational, educational, and entertainment purposes only. It is not an offer to sell or a solicitation to buy securities, or to engage in any investment strategy.
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The Great Debate©: Wray vs. Tanner on the Deficit by John Lounsbury
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Coin Seigniorage and the Irrelevance of the Debt Limit by Beowulf (at Fire Dog Lake)
Understanding the Modern Monetary System by Cullen Roche (at Pragmatic Capitalism)
Coin Seignorage, the MMT crowd are back by ducati998 (at his blog)