January 31, 2004


What's below started out as an e-mail reply to an essay by a colleague. The essay took the position that deficits don't matter, not very much anyway. For some reason, this touched a nerve with me. And I composed and fired off the response below. I've edited it a bit. But it's still a little cruder and heavy handed that I'd normally publish. However, I think the crux of it is right. If you've got comments, fire away. regards, Dan Deficits don’t matter? Or do they? The first issue you need to clear up when answering this question is if “deficit” refers to total U.S. debt (public/household/corporate) as % of GDP or just Federal debt. Households and corporations borrow in the open market. And although rates are manipulated by the Fed, the risk they take is their own, i.e. bankruptcy. Bankruptcy laws have changes and made it easier for people or corporations to go bankrupt without really paying the price. It might be a good idea to bring back debtor's prisons. But still, at least in non-public borrowing there's a price to be paid for being a bad credit risk, either in bankruptcy itself, or having to pay higher interest rates. You get kicked out of business and it becomes harder for you to waste someone else's capital again. The market spots a failure. The point being that the household/corporate debt as a percentage of GDP is less important, in my mind, because it reflects choices people willingly make with their own money (or with shareholder money). In each case, the borrower is held accountable by the market place. Shareholders punish stocks that waste capital (eventually). They sell them and move on to more efficient enterprises that don’t waste their money but multiply it. And I suspect at the household level, homeowners who borrowed cheap to buy too much house will soon owe more than they own. All of which is fine. No one holds a gun to your head and tells you to buy a house or Amazon.com and 900 times earnings. It’s simple risk and reward, resolved by market forces. Government borrowing is different. The government doesn't borrow money to create income-producing assets or make capital investment (home ownership). We’ll exclude for now the subject of government investment in basic infrastructure. For purposes of this discussion, let’s say that, for the most part, the government borrows to simply redistribute income, to make transfer payments. It does not create wealth. Because the government pays off its bonds with tax revenues (which it collects at the barrel of a gun) it's able to borrow at much lower interest rates than the private sector. And it's also able to run regular deficits as a percentage of its income because the income itself is...virtually guaranteed. No one "chooses" government services. The government imply collects its revenues through confiscation, a nice business if you can get it (or if you command the army and the police.) This has an obvious effect: it encourages even more government borrowing to distribute more money to get more votes to spend more money on the people who voted you in. It's nothing new. Neither is it sustainable. At what point does it become unsustainable? I suppose a government could borrow over 100% of GDP if there were people willing to own the bonds. But my main argument here is that an economy in which government borrowing becomes an increasingly large portion of GDP is one that's creating less wealth than it could. The economy grows less fast than it might. That means fewer tax revenues, fewer jobs, and fewer growing incomes. This takes its toll over time, but you see its net effect in socialist Europe. The pie gets smaller. ( It doesn't, "Make the pie higher," as Bush once said.) Worst of all, government deficits are addictive to shameess pandering politicians. Take your pick from either side of the aisle. Which brings me to point number two... Discretionary vs. Non-discretionary Spending: No Way Out Over 70% of 2004's $2 trillion in federal spending is non-discretionary. It's spending mandated by law, including Social Security, Medicare and Medicaid, and interest on the debt. There are fixed, legislated growth rates in non-discretionary spending, that can only be reduced by an act of political will (not likely). Barring a political magnetic pole reversal, federal spending is only going to keep growing. And if spending grows faster than income...deficits will only get larger. And by the way, the Medicare prescription drug benefit grew in cost by another $143 billion since November. It's now going to cost over $500 billion over ten years...or nearly 6% of GDP. Optimists suggest we can (a) grow our way out of it or (b) cut discretionary spending. Maybe. But defense and homeland security make up the bulk of discretionary federal spending. And the President has budgeted for 7% INcreases on both those next year, not decresases. Plus, that doesn't even include an extra $40 to $50 billion to pay for continuing operations in Iraq and Afghanistan. Those aren't included in the budget submitted, although at $407 billion and 4% of GDP, its still an impressive increase in an area where we're told we could save money. Bottom line: the war on terror, like the cold war and like world war two, is a blank check to increase discretionary spending. And since the war has no definable ending...the increases are seemingly infinite. If discretionary spending ain't going down, and non-discretionary spending CAN"t go down, there's only one choice left: MEGA GROWTH in TAX REVENUES (hint, hard to achieve by cutting taxes) But what about growing out of our deficits? A federal deficit of 5% of GDP doesn't seem so bad, historically speaking. Why not 10%? 15% 20%? Again, the point is that this is not simply a mathematical question of sustainability, but one of how wealth is created. I'd say that when the available savings of the world (since the U.S. economy is not creating a lot of savings for its own pool of investment capital) go increasingly to simple income redistribution programs and not to new investment or job creation...the long-term ability of the economy to create capital and wealth is hollowed out. The world is paying for American retirement and healthcare and getting less than 5% for the privilege. How long will that last? Government borrowing diverts savings away from productive investment and towards simple wealth redistribution. Over time, capital formation slows down...and so does business investment...as has happened here in Europe. My third and final, and most serious bone of contention is moral. The more content we are with regular government deficits, the less responsible we become for ourselves. Borrowing increases actual indebtedness...but it increases dependence, too. People get used to expecting things to be paid for and provided by the government. Once created and funded, how many government programs have gone away? Very few, if any. They develop a constituency of bureaucrats who need them for jobs or of tax payers who reap the booty of the wealth distribution. The whole exercise in representative government then becomes a shameless debasing game of looking out for your piece of the loot at the expense of your neighbors and friends...and your children and grandchildren. At root this is an argument that public debt (debt taken out in the name of the people and not by an individual or corporate risk taker) quickly becomes a shallow political ploy to win elections. This becomes corrosive to private morality. As an example, take the heat waves in France this past summer. Fifteen thousand people who survived the depression and World War two died in their homes or unattended in hospital beds from the heat. Their doctors, neighbors, and children were at the beach, on vacation, confident that the tax dollars they spent were taking care of their loved ones. When Chirac gave his speech to the nation addressing the human catastrophe, he said that no one person was to blame, but that all of France was to blame. That's pretty convenient. All of France means not me and not you but all of us. So let's just do better next time. Maybe in their private moments the children and neighbors of these people DO blame themselves for subcontracting their responsibility to take care of their elders to the government. And then again, maybe they DON'T. Maybe the cumulative affect of letting the government become the moral middleman is that you don't care about anyone but yourself anymore. You care about your job, your leisure time, your life. You work less, have fewer children, and stop believing in God or anything more than yourself. It may be a stretch...but I think it all starts the moment we accept that spending more than we earn--as a nation, through our government-- is morally tolerable. If it's not good for a private household to do it, not good economically and not good morally, why would it be better for the government to do it? Non-discretionary spending is busting the budget. Seventy percent of government spending is non-discretionary promises to pay for things the government does now, but which used to be done by families, churches, or the private sector. We have locked in these promises and have closed the discussion of whether we ought tom or can afford to keep making them. This view also suggests that we shouldn't treat our economics as mere mathematics. Economics used to be called moral philosophy. The study of the choices people made with their money couldn't be separated from whether the choices themselves were "good." The market judges "good" by whether the good or service you provide makes things better for people. If it does, you get rewarded for your risk. If it doesn't, generally, you fail. Debt isn't immoral per se. But taking on debt you have no intention of repaying is. And doing in the name of the "State" or the "people" may give you the political cover you need to explain away your recklessness. You disguise it as concern for the "public good" or for "society." But morally speaking, when you sanction it, you're contributing to the impoverishment of your economy and the debasement of your own morality.


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