On the cause of deficits

Definitions: debt and deficits  

I re-read the Simkhovitch paper "Rome's Fall Reconsidered" yesterday. He writes:

Social labor varies in its productivity. At all times this productivity had and has its limits. These limits of the productivity of our labor become, for society, physical conditions of existence. Within these limits our entire social life must move. These limits life must accept as mandatory and implacable; to them it must adjust itself.

... The accurate knowledge of the productivity of our labor can explain to us why things were as they were, why they became what they are and what one may expect from the future.

That passage brought to mind this statement from mine of June 6: "Spending and revenue are the arithmetic of deficits but not the economics of them, not the cause."

Paraphrasing Simkhovitch, the limits on the productivity of our labor explain why deficits were as they were, why they became what they are and what we may see in the future. More generally, it is economic conditions that determine what happens with federal deficits. So, again: Spending and revenue are the arithmetic but not the cause and not the economics of deficits.

 

Jane Jacobs, in The Nature of Economies, has Hiram saying

I'm convinced that economic life is ruled by processes and principles we didn't invent and can't transcend, whether we like that or not, and that the more we learn of these processes and the better we respect them, the better our economies will get along.

The more we respect these principles and processes, the better our economies will be.

I know you like to say that government, by spending more than it takes in, is the cause of deficits. I know. At least you have the arithmetic right. But you are leaving out everything, except what Milton Friedman might have called the proximate cause. As I see it, you cannot have an economy full of bad economic policy, turn your back on it, and rightly say excessive spending caused the deficits. That argument is bullshit. 

Anyway, in half a century of trying, the plan to cut federal spending has not come close to working. For half a century, deficits have only grown bigger. How long does a plan have to fail before we say Gee, maybe we need a better plan.

That's why the House Freedom Caucus made such a stink about the Debt Ceiling this year. The Freedom Caucus is not yet ready to say we need a better plan.

Here, a graph showing two measures of federal deficits. Surpluses appear above the zero level; deficits show up below zero:

Graph #1: The blue line is FRED's FYFSGDA188S showing Surplus or Deficit as Percent of GDP.
The red line shows the yearly changes in the Gross Federal Debt as Percent of GDP.
The blue line shows a surplus in the latter 1990s; the red line does not.

We need a better plan. Forget the math. We have to do the economics, understand the problem, and fix it. And we have to fix it before too many more Debt Ceiling crises come up, because one of these times the standoff will last just long enough that the US defaults on its debt. Then we'll be in a world of shit. You think things are bad now!

How big a problem will it be if the US defaults? We should probably all go out right now and buy enough rope to hang ourselves, because when the time comes, we'll be wishing we did. 

The Arthurian alternative is to convince all the Republicans and all the Democrats that we don't need to balance the budget, and we don't need to "set public spending always to the level required to achieve full employment, and then accept whatever deficit may result." We just need to bring private-sector debt down so that we can afford to live again.

Why? The plan is to reduce cost by reducing the size and cost of finance -- that is, by reducing the size and cost of private-sector debt. A gradual but persistent fall in household debt service payments will free up money for spending and saving. A gradual but persistent fall in business debt-service cost will allow businesses to reduce the prices they charge for their products.

If prices fall by 1.5%, and household debt service falls by 1.5% of DPI, we can buy 3% more output. This 3% gain, on top of whatever normal growth we can eke out, will boost economic growth until your jaw drops.

How? We can make this change happen if we want it. But we have to change economic policy to make it happen. We need to rely increasingly on cash -- on income -- to fund our day-to-day purchases. And we need to restrict credit growth to fight inflation. Yes, we need pretty much exactly the opposite of the policy we have had since the 1960s. After so many decades of unchanging policy, the pendulum has swung too far in favor of finance.

With a growing economy, and growing income, we will find the cost of the social safety net falling, and the federal budget moving toward balance. So you see, the deficit-cutting comes last and comes automatically and develops momentum when we respect the natural processes of our economy and make use of them, as Jane Jacobs describes, and as Vladimir Simkhovitch seems to understand as well.