Wednesday, May 18, 2022

Lowering the Deficit is Ludicrous Public Policy

The Bureau of Economic Analysis (BEA) released preliminary GDP figures for 1Q22 that indicated a contraction of -1.4%. This came as a surprise for just about everyone, but we had been warning that Biden’s emphasis on running fiscal surpluses to reduce the deficit would cause a recession (although we didn’t think it would happen this quick!).

The Congressional Budget Office (CBO) just released preliminary figures for the first 7mos of the fiscal year 2022, which shows a deficit that is only one-fifth of what the government paid out over the same period in 2021. Said differently, the US federal government’s net spending into the economy y/y is down 80% from a year ago. That is a dramatic drop. Given that economies generally require an increase in the total money supply in order to grow, an 80% drop in money injections from the world’s monopoly supplier of the reserve currency is bound to cause significant financial stress and pain. No wonder we have experienced an absolute bloodbath in financial markets year-to-date. As I write this, the major US stock market returns for the year so far have been as follows:

DJIA -10.14%
S&P 500 -14.21%
NASDAQ -23.40%

And bonds haven’t offered any cushion. The US 10-year Treasury Note began the year with a yield in the mid-1.6% range; in just four months, it now sits at 3%.

President Biden has been doing a “victory lap” (if you could call it that) on his administration’s supposed fiscal responsibility. His remarks per CBS News:

"The bottom line is that the deficit went up every year under my predecessor before the pandemic and during the pandemic. And it's gone down both years since I've been here. Period," he said.

There are two problems with this. First, voters don’t seem to actually care, as Biden’s approval rating continues to make new lows. Let me repeat: people do not actually care about the national debt and/or deficits. This is despite all the rhetoric, usually from Republicans and conservatives, about the evils of government deficit spending and the national debt. Here is a quote from the previously referenced CBS News article from Norman Orstein, an emeritus scholar at the conservative-leaning American Enterprise Institute:

Norman Ornstein, an emeritus scholar at the conservative American Enterprise Institute, noted that deficits are often "abstract" for voters. The recent low interest rates have also muted any potential economic drags from higher deficits, which have risen following the COVID-19 pandemic and, separately, the 2008 financial crisis, to help the economy recover.

"They're more likely to respond to things that are in their wheelhouse or that they believe will have a more direct effect on their lives," Ornstein said. Deficits are "a step removed for most voters, and we've been through periods where we've had the big deficits and debt and it's not like it devastated directly people's lives."

Republicans use the debt limit as a political weapon to make life difficult for Democrats not because they care about deficits and debt, but for raw political power i.e. “because they can.” That’s right: children go hungry because Republicans want political power.

What's fascinating about this take too is that it runs directly counter mainstream conservative, Republican narratives. We wrote previously about John Cochrane, economist and senior fellow at the conservative Hoover Institution, and his incoherent view that government deficits make the public anxious about its ability to repay, which causes inflation. So which is it? Do deficits cause people to fear the government won't be able to pay back its debt, or are they too far removed from the public for people to care? These two positions are mutually exclusive.

But singling out Republicans isn’t fair. The reality is that it’s Biden’s Democrats who are actively working to reduce the deficit and make children starve by denying families the Child Tax Credit. And Democrat Bill Clinton was the last president to run a budget surplus, while Democrat Barack Obama spoke of the United States' moral obligation to "tighten its belt." So, both political parities are clueless and unnecessarily cruel.

But ignoring the accounting realities of “debt reduction” - it removes from, rather than adds to, national savings - let’s think about the actual mechanics of debt/deficit reduction. Earlier in this article, we referenced the US 10-year Treasury Note. It’s generally understood that Notes issued by the US Treasury are backed by the full faith and credit of the United States federal government, and is included in the calculation for the “national debt.” However, “paying down” the debt would require tendering such Notes for dollars. As we’ve pointed out before, the dollar bill in your pocket is also a Note, only it’s issued by the US Federal Reserve rather than the Treasury. It literally says “Federal Reserve Note” at the top. These notes are likewise backed by the full faith and credit of the United States federal government. So “paying down the debt” really just means swapping one type of debt, US Treasury debt, with another type of debt, US Federal Reserve debt. Both are essentially the same “credit” - they are guaranteed by the same parent entity, the US federal government. It just so happens that one type of debt, that issued by the Federal Reserve, has special “legal tender” properties: it is legal tender for cancelling all debts, public and private. That’s why we think of it as “cash.” But at the end of the day, it is still a (credit risk-free) debt instrument that is an obligation of the US federal government. Which is why lowering the deficit is such ludicrous public policy - it doesn’t actually accomplish anything, except for removing financial savings from the real economy. How any “conservative” would support confiscation of private savings as sensible policy is simply baffling.

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