I’ve written before about the tyranny of double-entry bookkeeping when it comes to budget deficits: decreasing public debt requires either an increase in total private debt or a decrease in the ‘trade deficit’ (current account balance). Rotten Apple has a very clear explanation of how this works. First, the (very simple) math:
Private Sector Balance + Government Sector Balance – Current Account Balance = 0
The private sector balance is the excess of savings over expenditure for businesses and households.
The government sector balance is government tax revenues less spending.
And the current account balance is (in simplified terms) a country’s exports less its imports.
Rotten Apple then asks:
What would happen if President Obama decided to immediately return the budget to surplus and start paying off the public debt?
And the answer:
One or both of the following would automatically have to happen to compensate:
A: The private sector balance returns to a deficit. In other words, businesses and households start leveraging up again and taking on more debt, possibly sowing the seeds for an even bigger private debt crisis down the road.
B: The trade balance returns to a surplus. How would this happen? Most likely, a combination of a big depreciation in the US dollar and massive deflation and unemployment, which would reduce the relative cost of US goods in global markets.
Almost none of the politicians that you hear hyperventilating about the deficit every day are aware of this, which is why you constantly hear nonsensical statements to the effect that cutting government spending will restore confidence and boost the economy. The UK is currently finding out the hard way that life is not so simple.
When this is combined with the largely unrecognized reality of not being on the gold standard, we actually can afford to do the things we need to do:
One of the key innovations of the last century–and unappreciated, not to mention unknown, by most–is fiat currency: we are not on the gold standard anymore. The total amount of money we can have isn’t fixed by how many shiny pebbles we can pull out of the ground. If we need to print more money so we eliminate idle capacity (human and industrial), we can simply do that. Inflation can arise once we eliminate that idle capacity. Likewise, if we flood a sector (or economic class) with money, that can lead to inflation in that sector as well as misallocation of resources. As much as I would like it, pumping $250 billion per year into microbial genomics probably wouldn’t be a good idea. But arbitrary concerns about deficits shouldn’t limit our economic activity….
…what this means is that deficit increases or reductions don’t matter per se, it’s how we reduce or increase the deficit that matters. Throwing people out of work and having idle capacity by cutting back on spending? Could be stupid, depending on the spending. Increasing or decreasing taxes? Depending on the outcomes (e.g., how does this affect income equality or reduce the incentive for certain behaviors), it can be good or bad.
Yet we are still stuck with flat-earth economics as the dominant paradigm. Sigh.