There currently is no such thing as a deficit or debt problem the U.S. or in most of the developed world. Neither the U.S. deficits nor the federal debt will ever need to be repaid, and won’t be, even by future generations. Here’s a hint: We’re not on the gold standard anymore when these things used to actually matter. The United States is monetarily sovereign. All of our so-called debt is denominated in our own currency, which means, we owe debts in a currency over which we have absolute unilateral power to create and control.
Here’s a little background to help you understand a little better:
During the Great Depression, a small recovery had begun in 1936. Unemployment had dropped from 25% to 14% and GDP had grown at 12% for 4 straight years. Because some members of Roosevelt’s cabinet — notably Secretary of the Treasury Henry Morgenthau — were uncomfortable with the idea of running a long-term deficit, the administration moved to eliminate it. In 1937 the federal deficit fell to $2.5 billion (or 2.8% of GDP) from the previous year’s $5.5 billion (or 5.5% of GDP) as Roosevelt and Congress slashed spending by 18%. In 1938 spending dropped another 10% from 1937. The government effectively ran a balanced budget that year with a deficit of only $100 million or 0.5% of GDP. Then 1937-38 hit and the unemployment rate spiked back to 19% while GDP contracted over 6%. We had a double dip Depression.
It was only a scant 3 years later when the government began massive deficit spending to produce economically worthless military products that were soon to be shipped overseas to be blown up in the air, sunk in the sea, or quickly abandoned on the ground. The ‘never before seen’ massive deficits immediately brought the economy to full employment while even expanding the workforce, still with full employment. The debt was never paid off, nor was there any meaningful inflation and the resultant money spent into circulation fueled for several decades one of the greatest industrial expansions and the strongest middle class that the world had ever seen.
People intuitively used to understand that in hard times, money was scarce and in good times money was plentiful. In our current monetary system, money is only created by debt. This debt in turn, is created in only two ways, by the private sector banking system or the public sector federal deficit. The private sector (the banking system) creates money simply by making loans and no, they do not lend out deposits. They never tell a borrower to wait a moment while they check to see if they have enough money. No bank is ever reserve constrained. When they get low, they obtain reserves on the market or from the Fed. The borrower then takes the proceeds of the loan and spends it by paying his suppliers and workers who in turn spend it further into circulation.
The public sector (the government) creates money with deficit spending. It is the deficit itself that creates the money that gets spent into circulation regardless of where it is spent. Even Social Security and Medicare payments all get re-spent into the economy. Money spent on large capital projects or military equipment all gets re-spent paying workers and suppliers who in turn re-spend it on their own necessities of life.
During the 2008 financial meltdown, the money supply collapsed because the largest of the private sector components of money creation, mortgage lending, imploded. People and businesses, burned by the massive credit crises began paying off additional debts thereby further exacerbating the money supply collapse.
This is called in some circles, a balance sheet recession. Even though the Fed flooded the banking system with reserves, the money supply did not grow because there was no demand for new loans. All that new Fed money, printed for the private sector, was sitting idle in individual bank’s reserve accounts at the Fed.
Why? People and business severely burned by default and economic uncertainty had no desire to borrow, and banks having been severely burned by default and the economic uncertainty had no desire to lend, nevermind the severely tightened lending standards. Private sector money creation was dead. That left the Federal deficit (the public sector) as the only remaining means of credit (and money) creation and demand stimulation. Thankfully, the Trillion dollar deficits created in part by what economists call the automatic stabilizers (unemployment insurance, welfare, social security, etc.) spent by the government into circulation did their jobs admirably and helped save the Republic from another depression. However, given the long years of stagnant economic growth with no inflation with deflation lurking, it is becoming more and more apparent that the deficits were still not large enough.
The deficit has since been slowly shrinking thanks to a slowly reviving private sector and the consequent increase in tax revenue from a reviving economy. However, without more federal deficit spending or a significant increase in bank lending, or until someone finds and proposes a way to inject money into circulation to fuel a vibrant economic expansion, we will continue to have low employment growth, low wage growth, low tax revenues and will continue to run the risk of further economic stagnation. Further reductions in federal spending, and without increases in private sector credit creation, will most certainly result in another recession.
Fiscal austerity at this point in an economic cycle, without the private sector stepping in to fill the gap, is precisely the wrong economic policy prescription and can only make things worse just as it has done in Greece, Spain, Italy, now France and possibly even Germany, and every other nation upon which austerity (zero monetary growth) has been forced.
Despite the many assertions in the media and elsewhere, the U.S. is not anything like Greece. Nor are we anything like the proverbial mom and pop sitting around the kitchen table trying to pay bills. Greece, Ireland, Italy, Spain, and any country in the Euro Zone (and maw and paw) all borrow debt in a currency that they do not unilaterally control. In the EU they borrow Euros. The U.S. however, is the sovereign monopoly supplier of the Dollar which it absolutely controls and therefore has no risk of insolvency or default. The U.S., the U.K., Japan, and others that issue and “borrow” in their own currency, are *monetarily sovereign*. They unilaterally control their currency as well as all government debts they incur which are denominated in their currency.
That there may be inflationary risks, it is true, but even they are non-existent so far (as we have recently seen) and when the economy is operating at levels below the full productive capacity of our existing plant and labor supply in which abundant supplies of idle plant and labor are available. The contra-argument is more likely, that the risk of deflation is much higher when there is idle plant, high unemployment, and small federal deficits insufficient to stimulate aggregate demand.
The vanished breed of bond vigilantes understood this. The bond vigilantes are essentially extinct in monetarily sovereign countries as interest rates remain at or below zero, economic growth remains slow, and, despite zero interest rates, inflation has been zero. In the U.S., in spite of the Trillion dollar deficits, deflation still lurks as commodity and energy prices collapse.
It is mostly our politicians and their allies who still promote and live under old discredited gold standard dogma sound bites wherein, like Henry Morgenthau, there exists this firm conviction that the deficits must be paid or future generations will have to either pay up or part with their gold hoard. In today’s modern monetary world, the proverbial gold supply (or hoard) is, effectively, unlimited.
The only things that really matter as far as inflation is concerned, are, whether our existing plant is operating at capacity, how quickly new investment can add to that capacity, is our labor force operating at capacity, and how quickly can we expand it. It need not require a war. There are many many valuable capital projects that can add to our national wealth in the form of ports, airports, mass transit, roads, bridges etc. that can be built or re-built instead of making arms and weapons that will ultimately be destroyed or quickly become obsolete and abandoned.
Absent plant and labor constraints, and except for the usual dislocations caused by re-allocation of resources, there *usually* is no threat of inflation to a monetarily sovereign economy. Only by injecting newly created money into the economy by means of deficit spending to stimulate aggregate demand will an under-performing economy ever hope to become a fully employed economy that would ever run the risk of overheating and showing any signs of inflation.