Mike the Mad Biologist

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

Where:

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.

Comments

  1. #1 ShortWoman
    March 17, 2011

    “What would happen if President Obama decided to immediately return the budget to surplus and start paying off the public debt?”

    Why not ask what would happen if monkeys flew out of my ears?

    For that to happen would involve one of three things that would effect the rest of the equation: spending would have to be *drastically* cut, taxes would have to *drastically* rise, or a combination of steep budget cuts and steep tax hikes. You can’t do any of those things without making changes to the economy that will change the public sector balance and the trade balance.

  2. #2 Juice
    March 17, 2011

    So the answer is to keep spending? Right now, the national debt is pretty close to 100% GDP. And either that equation is total BS (the private sector has some sort of aggregate surplus? because the government is close to bankrupt and we have a trade deficit) or someone is counting the private sector balance in some way that can’t be honest. Flat earth economics, indeed.

  3. #3 Ema Nymton
    March 17, 2011

    Damn, Juice. You don’t hold back, do you? You want to make sure everyone knows that you are a complete dumbass.

  4. #4 Wow
    March 18, 2011

    The US can save a lot by cutting subsidies to fossil fuels to nil.

    More money can be made by increasing inheritance tax to 100% (maybe, if you’re feeling nice, with a tax free lump of $100,000).

    Even more can be cut by removing the welfare state that is copyright extension. Seriously. When it’s being persued as a civil matter, it costs a lot, but there are attempts to make it automatically criminal which means the state picks up the ENTIRE tab. So go back to the founding fathers on copyright and patents: 14 years, 14 year extension, a copy to be given to the LoC for copyrights, and a working model of any patent to be submitted or blueprints of same. Roll back DMCA (costs of persuit is extreme).

    Then you have a military that is bigger than everyone else combined. Halve it. Nuclear weapons are never to be used except in extremis, so no funding for replacements. When you’ve got enough to kill the planet 150x over, you can afford a few duds.

  5. #5 antifia
    March 18, 2011

    Keep the current account at zero, for the sake of simplicity. When the government generates a fiscal surplus and uses it to pay off debt held by the private sector, both the goverment and the private sectors balace at zero – or am I missing something here? A more important issue, in my opinion, is the effect of fiscal austerity measures on the GDP levels. A society that can spend (or produce) less than what it could do before is a poorer society, no matter how the sectors manage to balance their budgets. However, even if I believe Keynes beats Cameron any day of the week, this is all good before you are considered to be in financial distress – before your debtors start doubting your capacity to pay back what you owe. The economic consequences of a loss of confidence in the U.S. goverment capacity to honour its debt wouldn’t be pretty.

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