Wednesday, April 15, 2015

A balanced federal budget is dangerous

This is a rewrite of the previous post. It starts and ends the same, but the argument is different. Hopefully, it is easier to follow, because it is important.

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

Prof. Blyth’s testimony was in stark contrast to those of the Committee for a Responsible Budget and the Business Roundtable, who also testified. They echoed the deficit hysteria that has obscured rational discussion of the federal debt and how it affects our economy.

It is a fallacy to think the federal debt is like a household mortgage that we must repay with interest in a certain time. If we fail to pay, the mortgage holder may repossess our property. Federal debt has no time limit, so we never need to pay it off.

Federal debt is an asset of the private sector and consists initially 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. Their only financial burden now and in the future is interest service. For the most part, that interest is income to the domestic economy.

We should remember that our fiat monetary system replaced the old, gold-standard system years ago. Since then, federal spending is not limited by a fixed amount of money. It is limited only by the availability of productive workers and facilities. Deficit spending puts unemployed workers back to work, and the risk-of-inflation bugaboo exists only if we are already at full employment. 

Our economy consists of a federal sector and a domestic private sector. Within the private sector every financial asset has a corresponding debt. Financial assets and debt net to zero. The private assets associated with federal debt involve no corresponding private debt. Those assets can remain as savings in the private sector for as long as the republic exists. To the penny, “national debt” equals net private savings.

Let's not be stupid.

To be crystal clear, when federal spending exceeds revenue from taxes, we have a federal deficit. Likewise, a private sector deficit occurs when the sum of everyone’s spending including taxes exceeds their income. When one sector has a deficit the other will have a surplus. But, there is another sector to consider. 

Year after year, we have imported more from the rest of the world than we have exported to it. This causes a persistent outflow of financial assets from our economy to the foreign sector. As a consequence, one or both of the domestic sectors, federal and private, will sustain a deficit. Simply put, the sum of domestic deficits will equal the foreign deficit. It’s a matter of bookkeeping.

If the federal sector somehow manages to have a balanced budget, financial assets will go out of the domestic private sector. We can bet that within that sector Main Street will take the hit.

We should understand that, without full employment, federal deficits help grow the domestic economy. And, it will shrink if federal deficits do not make up for the foreign trade deficit. “Balanced budget” is just a euphemism for austerity. 

A more harsh form of austerity is when the federal sector must run a surplus in the face of a foreign deficit. That would be like Greece!

Still, we have Presidential candidates, who offer up balanced-budget myths. A favorite is, “We must not saddle our grandchildren with a burden of debt.” According to Prof. Blyth they might as well say, "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 must not condemn our grandchildren to such a future! Unfortunately, on our present course of austerity we will.

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