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Is A Budget Deficit Necessary for an Economy?

For those looking for true empirical evidence in economics face frustration.  It is fairly easy to accumulate evidence to support any theory.  Economists have yet to develop a formula that both identifies and quantifies the billion points which are the sum of the economy.

In the real world, any theory requires testing for proof.  This test requires this one point of the economy to be adjusted according to the theory, and the other billion minus one points held constant.  And that is the rub, all of our economic theory is based on billions of points moving simultaneously – and trying to “prove” that only one point made the economy better or worse.

In economics, empirical “truth” is not much more than competing theories put forth by dogmatic camps.  Proof is shown by taking a few points of historical data – not the billion points which would create a chaotic and unprovable view of any theory.  Further, the elements which comprise the economy are continuously morphing – the economic dynamics of the 1930′s are significantly different than the 2010′s.

The USA federal budget balancing debate is a case in point.

Dogmatically, I want to believe there are tipping points (drinking too little water – you die, drinking too much water – you die).    Overall, balance is necessary.   Therefore I naturally migrate to the view that over time, the budget must have balance.

The above graph includes the only recent economic period where the budget was balanced (the right scale value is for the red line with 1 being a balanced budget, a value >1 being a surplus, <1 a budget deficit).  A reasonable person would expect that the economy (blue line is GDP) would react positively.

Yet, economic performance started to degrade as the Federal Budget came into balance.  Did the balanced budget cause this?  What were the other major factors?

My mantra is the saying “be careful what you wish for, you might get it.”  I personally would love to prove a balanced budget is necessary for the economic health of a country.  I have a hard time getting my head around there may be fundamental differences between your personal budget and a sovereign budget.

Is it possible a certain amount of deficit drives a modern economy?

Economic News this Week:

Econintersect’s economic forecast for June 2011 indicates growth in June will be less good.

This week the Weekly Leading Index (WLI) from ECRI declined from 4.1%  to 3.7%.  This level implies the business conditions six months from now will be approximately the same  compared to today.  This index is eroding and clearly in a downtrend.  If the current trend line holds, this index will be in negative territory in 2 months.

The declining WLI and Econintersect’s own index is in sharp contrast to the growing Leading Economic Index (analysis here).

Initial unemployment claims improved this week 16,000 to 414,000 but remains elevated, and the real gauge – the 4 week moving average – remained unchanged at 424,750 because of backward revision.  Because of the noise (week-to-week movements), the 4 week average remains the reliable gauge.  Historically, claims exceeding 400,000 per week yields employment gains less than the workforce growth.

We are continuing to see terrible April and May 2011 data.  Econintersect’s previous economic forecasts predicted a growing economy but at cycle peaks.  The data being released continues to indicate we are on the downside of cycle peaks – with the cycle peak likely being in March, or possibly April 2011.  The data is less good, but not contracting.

Econintersect does not count surveys as data, nor believes they accurately forecast economic conditions.

Weekly Economic Release Scorecard:

Item Headline Analysis
Invalid Mortgage Transfers

Yves Smith looks at why the market will soon notice the mortgage securitization issues are not going away
May Conference Board Leading Indicator
Up
The LEI is bucking the trend of every other leading indicator saying the future conditions are improving
Consumer Metrics

Rick Davis walks through the ongoing consumer contraction.
May New Residential Permits
Up
This market sector is bottoming after falling since 2006
June Philly Fed Business Survey
Big Down
Second survey this week implying the economy may be contracting
May Industrial Production
Literally Flat
YoY Growth trend has fallen from 8% to 4% in one year
May Consumer Price Index
Up to 3.6%
Big price increase driver energy moderated, but offset by cars and clothing
June Empire State Manufacturing Survey
Big Down
This noisy survey dipped into recession territory
May Container Counts
Up
Counts are up 5% YoY showing the economy is still expanding
March Business Sales
Up
Final manufacturing, wholesale and retail numbers are on the low side of current trends
June Small Business Survey
A little lower
Small business is the producer of jobs in the USA
May Retail Sales
Down
Flat or Up compared to April
May Producer Price Index
Up to 7.3%
Manufacturing price increases still driven up by energy
Global Financial Crisis

Steve Keen wrote this post one year ago, and all that has changed is the can was kicked down the road
May Treasury Statement

A look at historical data shows less and less of government spending is getting into GDP
Health Care Costs

Elliott Morss points at five inefficiencies in the USA medical system
Budget Balancing

Rick Davis suggests budget balancing is recessionary, but can be offset by cost benefits of relaxing regulations
The Volatility Machine

Dirk Ehnts reviews Michael Pettis’ book
European Debt Repudiation

L. Randall Wray says it is time to admit the Euro Monetary Union was designed to fail
USA – Tyranny & Oppression

Washington’s Blog warns truth is the first casualty of war
Trade in Eurozone

Dirk Ehnts examines if you can consider trade between EMU countries as trade in a historical sense
Ireland a Model for Fiscal Reform

William Black believes Ireland proved as desirable a model for Europe as Texas proved as a model for federal deregulation of S&Ls
VIX

Albertarocks charts out why the $VIX is not surging
World Markets

Doug Shorts compares global markets
Call-Put Ratio MacroTides explains the meaning of the current extreme lows
USA Markets

Jeff Miller says Market sell off may have gone too far
Iraq War

Frank Li says the real cost of the Iraq War is not $ cost

Bankruptcies this Week: Xanadoo Holdings (fka Pegasus Satellite Communications Holdings), Perkins & Marie Callender’s (fka The Restaurant Company)

Bank Failures This Week:

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One Response to Is A Budget Deficit Necessary for an Economy?

  1. Roger Erickson says:

    > “I personally would love to prove a balanced budget is necessary for the
    > economic health of a country.”

    Why, exactly? Why not just observe reality & accept whatever it is?

    > “I have a hard time getting my head around there may be fundamental
    > differences between your personal budget and a sovereign budget.”

    How could there NOT be a difference between the budgets used by a fiat currency issuer and a currency user? They involve two different contexts.

    1) A currency issuer manages a budget in terms of real goods & services, inputs & capabilities, and issues as much scorekeeping numbers in any format needed in order to keep score. That’s how nations launch, update & revalue sovereign, non-convertible, floating-Fx fiat currency systems. It’s currency supply has to float, in order to match changing transaction patterns.

    2) A currency user utilizes a currency budget as an accurate proxy for local real goods/services/capabilities budgets. A user’s currency budget has to balance locally.

    There’s actually no relation between the two. Thinking there is is a classic fallacy of composition. If you double the population of people with locally balanced currency budgets the net currency supply for the nation still must increase, and hence appear as a fiat deficit. Just don’t forget that magic word, “F.I.A.T.”, and it’s definition.

    > “Is it possible a certain amount of [fiat] deficit drives a modern economy?”

    Sure seems inevitable. Does a certain amount of input over output allow a baby to grow? How else will a nation grow if it doesn’t take in (consume) more than it did last year? Any nation that grows in both population & economic activity certainly must have a constantly growing currency supply, just to keep up with usage demand. That same demand requires more shoes, more pencils & more checks etc every year too. We just don’t bother to call those altered records a Shoe Deficit, a Pencil Deficit or a Check Deficit. However, post the gold-std, they’re all tracked as fiat numerals monitoring the numbers of a particular tool used in an increasingly dynamic economy.

    We don’t financialize growth of either babies or nations, or at least shouldn’t try. The sum i/o of a growing economy can never be hindered by the fiat currency that it alone produces. Fiat currency has to follow, & can never fully define, national growth. The whole reason for going to fiat currency was to further remove meaning of currency as a static value, and increase proportional domination of it’s definition as purely a denominator of context-dependent transactions. Fiat currency necessarily has floating value in real terms. Without that step, currency supply can’t adequately follow rapid policy changes, which then can’t follow rapidly changing contexts.

    The currency budget of a fiat currency issuer is nothing more than the pencil marks or computer entries that it creates to track the rapidly growing volume of transaction in an economy. It’s just bookkeeping, keeping score.

    From 1939-1945 financial records alone you’d never guess that the USA went from being a moderate military to the dominant superpower on the planet.