"Deficits have become the norm"

"Deficits have become the norm", they say. The Peter G. Peterson Foundation makes this excellent observation:

Historically, periods with spikes in deficits and corresponding increases in the national debt have been periods associated with war or a severe economic downturn. Today, deficits have become the norm and are no longer caused by periodic spikes in wartime or recession-related spending, but rather by a long-term, structural mismatch between spending and revenues.

Deficits were not always the norm, but they are now. That's an excellent insight. But I think the overview should also point out that the deficits are getting bigger.

The problem is getting worse: from occasional deficits, to deficits as the norm, to bigger deficits as the norm. This is the kind of problem that keeps Republicans up at night, while Democrats sleep like babies.

Hey. I don't complain about the federal deficits. But if the problem is growing worse, we should probably admit that the situation has become "unsustainable" -- and that is a word that might even wake up the Democrats.

If the situation has become unsustainable, the facts have changed. So I must say: when the facts change, I change my mind. What do you do?

 

I said "the problem is getting worse" and maybe you thought I meant the deficits problem is getting worse. That's not it; as I also said, I don't complain about federal deficits. I don't think the deficits are the problem, nor the debt. I think the problem that causes the deficits is the problem. And the trouble is, that problem is getting worse. The problem that causes the deficits is getting worse -- and as a result, the deficits are now getting bigger.

So now you might think I mean government spending in excess of revenue is the problem. But again, no. The big picture is not as simple as "spending in excess of revenue". Spending and revenue are the arithmetic of deficits but not the economics of them, not the cause.

I do know that spending in excess of revenue creates deficits. But I do not accept the assumption that deficit spending is the cause of deficits. The economy is not that simple. Government revenue and government spending requirements change with changes in the economy. The true cause of deficits is their economic cause.

Imagine a cost problem.

In the days before the cost problem, as Peterson might say, there would be deficits in times of war and during economic downturns. In normal times, then, there were no deficits. But why am I going by what Peterson said? I need to see this for myself.

This graph shows the federal deficits relative to GNP for the years 1919-1955:

Graph #1: Federal Deficit (or Surplus) as a percent of GNP
Surpluses are above zero. Deficits are below zero.

I don't find GDP data for these early years, so I'm using GNP.

The graph starts with deficit for 1919, the year following the first World War. Then there is a decade of budget surpluses, small ones. After 1930 we have deficits during the "severe economic downturn" called the Great Depression, then big deficits during the second World War. After the war, budget surpluses in 1947 and '48, and a very small surplus in 1949. Then

• a deficit in 1950, recession-related,
• a surplus in 1951, despite the Korean war,
• deficits in 1952 and '53, Korean war-related, and
• deficits in 1954 and '55, probably recession-related.

In these early years, the deficits do appear to be related to war and to economic downturns, as Peterson says.

With more recent data, we can use GDP:

Graph #2: Federal Deficit (or Surplus) as a percent of GDP
Slide the scrollbar right to see more, or just click the graph

The graph begins before the Depression, with the last two of the small budget surpluses shown on the first graph, for 1929 and 1930. Then deficits during the Great Depression and the second World War, as noted above. Then we have a series of recessions, with budget surpluses in the booms, and deficits in the slumps. But this pattern barely lasts through the 1950s.

The 1960s is almost all deficits. Late in the 1960s is a bigger deficit (the bigger low of 1968) that does not have a corresponding recession: There is no recession bar on the graph at 1967. However, there was a "near recession" in 1967. Milton Friedman predicted it in 1966, in Newsweek. Rowland Evans Jr. and Robert D. Novak provide brief historical context about this "forgotten crash" in an excerpt at my old blog.

After the deficit of 1968, the federal budget was ever-so-slightly in surplus in 1969. That was the last surplus until the 1990s, if those even count.

The continuous deficits of the 1960s may have been the result of the "full employment" budgeting by the Keynesians in the JFK and LBJ administrations; it may have been a worsening of the "cost problem" that I asked you to imagine; or it may be a combination of the two.

In the 1970s the deficits were bigger than in the 1960s. I once thought these bigger deficits resulted from the inflation of the 1970s, with higher prices causing the bigger deficits. Now I'm not so sure. The graph shows the deficits as a percent of GDP. And GDP in the 1970s was also embiggened by inflation. So it isn't inflation that makes the deficits look bigger.

The deficits could be bigger in the 1970s because the government was spending more, as everyone thinks. Or the deficits could be bigger because of the growing cost problem. And you must not reject the cost problem at this stage, as it has not yet been identified.

In the 1980s the deficits were bigger than in the 1970s. All my friends blame Reagan for that. But if a Democrat had been elected instead, would he have spent any less?

You'll have to slide the scrollbar to the right to see it, but in the 1990s the deficits got smaller. The internet attributes this victory to the agreement between Bill Clinton and Newt Gingrich that ended the government shutdown. I attribute it to a change in monetary balances that reduced the financial cost of using money, improving economic performance enough to turn deficits into surpluses in the '90s.

But the 1990s introduced us to even bigger changes in federal deficits. As the Graph #2 shows, the changes in deficits, both increases and decreases, have been far bigger than even those of the 1980s. You know, yes, we had the covid, and the government response cost a lot of money. I think it was worth it, but that's not the point. The point is that the covid-related changes are the only ones that can be attributed to something other than bad policy.

Most people attribute the deficits to bad politicians. I don't. I think the politicians don't know how to fix our economy. They don't have a clue. I see people on one side saying we have to cut federal spending and people on the other side saying we need more federal spending. Both sides are wrong. What we need is less private sector debt.

The cost problem is what it costs us to use money. How much interest do we pay out of our annual income? How much debt service? We pay a lot, because we have a lot of debt. "We" being the private sector, and "a lot of debt" being the debt of the private sector.

We buy less because we pay so much debt service every year. And the things we buy are more expensive because businesses use a lot of credit and pass along the cost of it in the prices we pay. These are the facts that underlie the cost problem.

The Peterson article says we have "a long-term, structural mismatch between spending and revenues." And their next sentence:

By addressing that mismatch, policymakers can put our nation on a better path for economic growth, opportunity, and prosperity.

Yeh. But I am afraid that Peterson wants to "address the mismatch" the same way everyone else wants to address it: by cutting federal spending.

Federal spending is not the problem. We have a cost problem, a financial cost problem. We have so much debt, and we pay so much interest on it, that we can no longer afford to live. 

Everyone who points a finger, points it at us and says we did it. We borrowed too much. We spent too much. It's our fault. So they say. But we live in a world where economic policy constantly encourages the use of credit, and constantly promotes the expansion of credit availability so that we should never run out of money to borrow.

But we are running lower and lower on the money we use to pay our bills. Why? Because they use "tight money" to fight inflation. Tight money means less money. They want us to use credit instead.

What, buying stuff on borrowed money doesn't cause inflation? Of course it does. And borrowed money has the extra cost of interest, as well as repayment of principle. Every dollar of debt is a cost problem, and we have a lot of debt.

We need to use less credit, and to replace it we need money that doesn't require debt service. And since we will have more money, we should fight inflation by reducing our use of credit: by having fewer policies that encourage credit use. Plus we need a few policies that encourage us to pay down our debt faster. Policies that help us do that will fight inflation and reduce our debt for us.

The federal government runs deficits because stimulus spending no longer works. Stimulus spending no longer works because the private sector has so much debt that people can no longer afford to live. Yet every way we turn, our only option is to use more credit.

To reduce the deficits we must solve the cost problem by reducing private sector debt and debt service. It's a simple plan, easy to keep in mind.

Private sector debt is oppressively high because policy accelerates borrowing but does not accelerate the repayment of debt. We borrow money faster than we pay it back because policy demands it. Apparently, policymakers never noticed this problem.

To reduce private sector debt we need policy to induce us to pay down our debt faster than we borrow. Of course, this is not "normal" -- It is the opposite of normal policy. But it is necessary, unless we have debt forgiveness on a massive scale. And that is not likely to happen.

Deficits have become the norm because we use credit for money.