03 July 2010


The budget-deficit hysteria always returns--like the summer monster movies and with the same amount of hype--whenever there is an economic downturn. As always the hysteria is based on misunderstandings of the macroeconomics of a country such as the US with a sovereign economy. "Sovereign" means that the currency is "sovereign," in that it is a national currency with, since 1973, a floating exchange rate (unlike most countries), and with no promise to convert at a fixed exchange rate to another currency.

This means that the federal government does not need to run like a household--and should not. There is no resemblance of a sovereign government to a household or a firm. Incidentally, long-lived firms allow their outstanding debt to grow year-by-year, with no final retirement of debt (unless the firm goes out of business). Firms, however, keep separate capital accounts for this debt and must service their debt. But, a modern sovereign government does not have to have a balanced current account, partly because it will never "go out of business." Thus, the sovereign government is not constrained as are household and firms because it issues its own currency and commands that payment be made in that currency.

In an economic downturn fiscal expansion is needed. Importantly, prolonged deficits do NOT threaten our future--they never have. However, tax increases and reduction in government spending WILL wreak havoc. We are not about to become the next failed state--Zimbabwe or Weimar Republic. Those countries were/are not sovereign, meaning they could not control their economies.

In the 221 years in the existence of the federal government, it has been in debt EVERY YEAR except a brief time beginning in 1835 when the public debt was retired and a budget surplus was run for two years. Not unrelated, in 1837 the economy collapsed into a deep recession. The federal government has been in debt ever since. The record should be long enough to demonstrate that the deficit system has staying power and works.

The important point is that the U.S. federal government is the sole issuer of the dollar, which is always accepted as payment, thus the federal government is not constrained in its ability to "finance" spending because--this is key--it does not need tax and bond revenues in order to spend. Modern sovereign governments do not really spend tax revenues, nor do they borrow by selling bonds.
They spend by crediting bank accounts. So, budget deficits lead to net credits to bank accounts. Government spending increases private disposable income, while taxes reduce spending.

Today's deficits do not burden future generations with debt that must be repaid, not do they crowd private spending now or in the future. The deficit scare restrains the political climate from allowing a democratic government from doing what is democratically beneficial for its citizens.

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