"Not-strong-enough-to-say-NO" is *not* the problem

From a comment by David, on "Inflation: True or False" by David R. Henderson at the Hoover Institution:

Borrowing creates money out of thin air, which is an expansion of the money supply. The largest borrower/debtor on the planet is the U.S. Treasury. In 2017, the U.S. National Debt was $20 trillion. As if that wasn't bad enough, by 2020, it had grown to $28 trillion... The driver of all that borrowing is some combination of Congress and the White House--primarily Congress, as the Treasury has no option but to borrow to pay for the excess and largess of a Congress that is not strong enough to say, "No."

That seems to be what everyone thinks: Congress or somebody is not strong enough to say "No" to government spending. When you get right down to it, that's probably why people are insurrecting.

Here's the thing: 

• Cutting government spending will not fix the problem. 
• Raising government spending will not fix the problem. 

The size of government is not the problem. I know what Reagan said:

"Only by reducing the growth of government," said Ronald Reagan, "can we increase the growth of the economy."

I know. But Reagan was wrong about why growth was slow.

 

People sometimes measure the size of government by the size of government debt. That debt is huge: inexplicably, incomprehensibly, incredibly huge.

The biggest problem with government debt, I think, is that we have lost control of it. We cannot stop the increase.

But the reason we cannot stop the increase is simple: We have the wrong solution.

Everyone thinks we have to reduce government spending. As Rush Limbaugh said:

what actually causes budget deficits [is] spending more money than you have.

But Limbaugh didn't mention income. He only mentions spending and the money we "have".

The problem is with income.

Adam Smith wrote:

Every workman has a great quantity of his own work to dispose of beyond what he himself has occasion for; and every other workman being exactly in the same situation, he is enabled to exchange a great quantity of his own goods for a great quantity or, what comes to the same thing, for the price of a great quantity of theirs.

In the Project Gutenberg version of The Wealth of Nations, the phrase "what comes to the same thing" occurs 19 times. Smith must have thought the phrase important. A quantity of output comes to the same thing as the price of that output. It has the same value. In other words, income equals output.

GDP can be measured as the value of output we produce in a year, or as the value of income we earn in a year. The only difference between the two totals is due to measurement error.

The important thing, and what surprised me most in Econ 101, is that income equals output. So if GDP growth is slow it means the growth of output is slow, but it also means the growth of income is slow. And slow income growth is the kicker.

Reagan wanted to increase the growth of the economy so that income would increase. That is something we all want. How to make it happen is the question.

In my previous post I show this graph:

The graph shows the relation between the federal debt and everyone else's debt, for the US. Our debt is bigger than the federal debt, except for a few years at the end of World War Two. Our debt was more than five times the government debt in 1974 when GDP growth slowed. Our debt was more than five times the government debt in 1929 when the Great Depression started. Our debt was more than seven times the government debt in 2007, and then we had the financial crisis and the Great Recession. When our debt is too much more than the government debt, bad things happen.

Our debt was a bit over three times the government debt in 1919, and 3½ times the government debt in 1993. Our debt was not low then, but it was low enough that the economy could grow with vigor. After 1919 we had the Roaring Twenties, and after 1993 we had what Alan Greenspan called "the New Economy". Both bouts of vigor ended in disaster: high debt and disaster.

Our debt was less than the government debt in 1945, and after the war we had a "Golden Age" that lasted all the while our debt was less than three times the federal debt. We had troubles when the ratio went above three. The "Great Inflation" began around 1965, but our debt kept growing faster than government debt and the economy kept growing. Then in the mid-1970s, productivity growth slowed and GDP growth slowed and income growth slowed.

It was at this point that government debt started to grow faster. It grew slightly faster than our debt for 20 years. The red line wanders slowly downhill during those years. Finally, in the 1990s, our debt was low enough (relative to federal) that the economy could grow with vigor. 

But we always let debt-other-than-federal increase until it makes the economy go bad.

Really, the problem is policy. It's the government's job to make the economic environment a good one for growth. If you want to be angry with government for something, let it be this: not that the federal debt is too high, but that debt-other-than-federal is too high. Their policies encourage that. They should discourage it.

It is the times when debt-other-than-federal is low that economic growth is at its best. But of course the economy grows because we use credit, and our debt increases because we use credit. When our debt gets high enough, it brings trouble to the economy.

The saddest part of all this is that our solution is to reduce the federal debt. What we need is to reduce debt-other-than-federal -- just the opposite of what we are doing.