Monday, March 23, 2015

The benefits of a balanced federal budget

On March 11, 2015 the US Senate Committee on the Budget held hearings on “The Better Way: The Benefits of a Balanced Budget.” A distinguished political economics professor, Mark Blyth, told the Committee there are no such benefits. Moreover, a balanced budget would be harmful. 

He acknowledged that our intuition tells us that to spend more than we earn leads to bad outcomes over time. To take on debt now to spend more brings on future debt and interest payments that result in having less in the future. This leads to the idea that saving is always better than spending. When applied to the federal government this idea is wrong and counterproductive.

It is a fallacy to think that the federal debt is like that of a household or firm, which we must pay off in a certain time. Otherwise, the mortgage holder may repossess our property. Federal debt has no time limit, and we never need to pay it off. Government issues the money it borrows. So, it can always make its interest payments, most of which return as income to the economy.

Prof. Blyth reminds us that government debt is an asset of the private sector and consists of Treasury securities. By law the Treasury sells securities to cover federal deficits. These securities are rock solid investments for pension funds and are risk-free collateral. To say we want less government debt is to say we want less private assets. Further, paying down the debt takes financial assets out of the private sector.

About sustainability of government debt, Prof. Blyth points out that only three things matter. They are the rate of growth of the debt, the rate of growth of GDP (Gross Domestic Product), and the rate of growth of population. If these are growing, as they can in the US, promises made now will be redeemed in the future by a larger population and a larger economy. Then our federal debt as a share of GDP can decline, and our ability to service the debt increases. 

Because of the financial crisis, recent increases in debt relative to GDP resulted from a combination of increased deficits and reduced GDP. We can trace the financial crisis back not to government debt but to an explosion of private debt. Private debt is the real villain in this story.

A country with a sovereign, fiat currency can always pay its bills. It can not become insolvent. That means the concept of saving has no meaning for a sovereign state. Thus, it makes no sense to save financial assets today so that the country can meet its commitments tomorrow. So, it is important to invest financial assets today to assure that real assets are available in the future. No amount of future financial assets can enable our grandchildren to access a health facility or cross a bridge that does not yet exist. 

Prof. Blyth noted that we can invest government debt in long-term developments. Private investment prefers short-term developments leading to profit.  He pointed out that the National Institute of Health has provided about 40% of the R&D in the biotechnology and pharmaceutical industries. Other government developments benefited, for example, Apple, Inc. It integrated into its iPhone the TCP/IP Internet protocol, the GPS network, and the touch screen. These Department of Defense developments helped make Apple, Inc. the most valuable company in the world.

Prof. Blyth contends that following current myths leads to unfortunate consequences. "We can not saddle our grandchildren with a crushing burden of debt." and "We need a painful budget today to protect future generations." are two such myths. They translate to "Let’s shrink the economy today so that the parents of today earn less money and pay more for services. That will make sure that their grandchildren grow up poorer, with a smaller economy, and a worse education."

We need not condemn our grandchildren to such a future! Unfortunately, on our present course of austerity we will.