Mike the Mad Biologist

One of the things that never ceases to amaze me is that our entire political class (both politicians and the mandarin hangers-on) still does not comprehend that the balance of accounts must sum to zero. That is, aggregate savings (all the stuff private entities, from corporations to individuals to non-profits, own) require government deficits (one way around this is trade surpluses, but we try to deal with the real world around here). It is impossible for the government and the entire private sector to both run surpluses. This isn’t political theory or ideology, it’s arithmetic.

So when you hear some talking head or politician talking about how he or she intends to cut government spending–reduce the deficit–and put more money in your wallet, well, check if your wallet is still there. Likewise, concerns that deficits mean we’ll be paying 20-25% of GDP in interest payments are a delusion worthy of creationism, as explained by a for reals economist, James Galbraith (italics mine):

Go down a few lines and they [the Congressional Budget Office] also have the short-term interest rate going up to 5 percent. It’s that short-term interest rate combined with that low inflation rate that allows them to generate, quite mechanically, these enormous future deficit forecasts. And those forecasts are driven partially by the assumption that health-care costs will rise forever at a faster rate than everything else and by interest payments on the debt will hit 20 or 25 percent of GDP.

At this point, the whole thing is completely incoherent. You cannot write checks to 20 percent to anybody without that money entering the economy and increasing employment and inflation. And if it does that, then debt-to-GDP has to be lower, because inflation figures into how much debt we have. These numbers need to come together in a coherent story, and the CBO’s forecast does not give us a coherent story. So everything that is said that is based on the CBO’s baseline is, strictly speaking, nonsense.

And by way of Edward Harrison, we have real world examples of the balance of accounts:

financialsectorbalanceseu

Look at the upper right panel, Spain in 2006. The government had a surplus of about two percent of GDP. The capital account balance is about nine percent of GDP (crudely, the capital account is foreign investment–money flooding into the country), and the private holdings are negative eleven percent of GDP (many Spaniards were in hock up to their eyeballs due to housing debt). But you’ll notice the numbers sum to zero (9 + 2 + (-11)). The numbers also sum to zero for Spain in 2009, even though its budget is now negative at a deficit of nine percent GDP, while both the private sector and the capital account have surpluses totaling nine percent.

You’ll see the exact same pattern across the board. Now, there can be inflation due to deficit spending when the economy is at maximum employment. And certain types of deficit spending increase the savings of some versus others: tax breaks for Paris Hilton enrich the wealthy, while unemployment benefits help the poor. These policies themselves have additional social and economic consequences such as income redistribution*, which is why we have political parties and so on.

But the absurdity of demanding that we reduce deficits with massive unemployment, underemployment, and large swathes of the middle class in debt is foolish. We will only exacerbate these problems.

*If reducing economic inequality is viewed as a positive goal, then one might end up reducing deficits (or at least, not expanding them), but that is simply an outcome of policy. Likewise, if you tax one group to pay for government functions that help another group, this wealth transfer has little effect on deficits. It may, however, be desirable social policy.

Comments

  1. #1 Janne
    May 17, 2010

    The economy – the world economy, even – isn’t a closed system, though. You got energy and time flowing in from the outside, constantly creating more economic value. Food and timber are good examples where you do get a net inflow of value; even if you would factor in the costs of growing and harvesting, the energy used came in for free, making a net increase in economic value.

    Same thing with time: an author writing a book, or an artisan making a chair from that timber, have created value from thin air, as it were, using the renewable resource of time. Again, even if you factor in the costs that go into making the stuff (and remember, the food they eat, and the timber used for the chair was already partially “free”) you end up with a net increase in overall value.

    Which by the way explains why we do need an appropriate amount of monetary inflation. If money is to work as a stable medium of exchange, the value of it has to stay approximately constant compared to all other stuff, which means the relative amount of money has to be constant. And since overall economic value increases over time, so must the amount of money.

    So yes, it is indeed possible for everybody (in the aggregate) to run surpluses. It all depends on how the constant extra inflow of value is divided up.

  2. #2 Paul Murray
    May 18, 2010

    “So yes, it is indeed possible for everybody (in the aggregate) to run surpluses. It all depends on how the constant extra inflow of value is divided up.”

    Ghaah! Yes, the real economy runs a surplus (more or less. Every wooden chair eventually rots away to valuelessness). But currency – money – is always issued as debt. If someone is producing a surplus *and selling it*, then someone must be buying it. (when they are not selling it, then you are in a depression.) If the reserve simply printed cash and gave it away, then privately held cash would not be balanced by public debt. But that’s not what they do.

  3. #3 BenK
    May 18, 2010

    The real issue turns out to be inflation/deflation (punishing those who save vs punishing those who consume) and the question of whether people are more efficient, happier, more fulfilled working for a giant government bureaucracy, a large faceless corporation, or a small business. If the government essentially raises taxes and inflation by issuing/spending money, it shifts the balance of society in fundamental ways – towards massive centralization and overconsumption. This may look good in the hampster-wheel model of the economy, in which money moving around is by itself evidence of good things, but it doesn’t contribute to any general benefit.

    Further, there are some goods that evaporate faster than others. Shipping is a great example.

    In places like Europe, it is possible for Germany to tax itself, or to tax Greece, to pay for goods shipped from Germany or from Greece. It is possible to impoverish Europe as a whole by raising the relative investment in shipping vs goods.

    Some people may not want to care about deficits and debts and interest payments – because they find high taxes inconvenient to explain to prudent people. That motivates too much of the discussion from ‘economists’ like Krugman.

  4. #4 Eric Lund
    May 18, 2010

    As Paul correctly points out, we are not talking about goods and services here, only money.

    Consider what happens when you save money anywhere other than the Bank of Sealy. You are really lending that money to someone or something else, whether directly (bonds, or a loan to one of your friends or relatives) or indirectly (by depositing it in a bank which then lends out this money to make a profit and–if you’re lucky–pay you some interest). You lend out this money because you (or the bank lending it out on your behalf) believe the interest on the loan is enough to compensate for the risk that the borrower won’t pay. If there are no borrowers, the system breaks down, and you might as well put your money under your mattress.

    However, money is not a conserved quantity. Central banks can and do print more in order to cover deficits. All other things being equal, this is inflationary because it increases the supply of money without necessarily increasing the supply of goods. It can nonetheless be good fiscal policy by helping to stimulate demand for goods, which is the entire point of Keynesian economics. The trick is to avoid putting so much currency in circulation that it triggers a hyperinflationary spiral. So far this hasn’t happened to us, or to Japan (who have been doing this sort of thing for a couple of decades now), because the newly printed money has mainly gone to shoring up balance sheets rather than large amounts of new lending.

  5. #5 Janne
    May 18, 2010

    Eric, my point was that for the value of money to be stable it needs to be a stable proportion to the overall economy. And as the economy increases over time so must the money supply. Scarcity is relative. If you didn’t print any new money you’d have deflation as the money in circulation becomes scarcer relative to all the goods and services it’s supposed to be used together with.

    So yes, some appropriate level of money printing has to go on all the time. If you exceed that level you get inflation of course – and if you go below that level you get deflation.