Re: Balanced Budget and Depression

[mosler@xxxxxxxx]

On Thu, 1 Feb 1996, "Charles J. Reid" <cjreid@xxxxxxxxxx> wrote:
>Greetings!
>
>I hope the professionals on this forum will not mind me posing this
>question:
>
>A couple of days ago on C-Span a professor, Nicholas Archer, I think,
>presented some graphs indicating that, throughout American history, the 6
>major depressions were ALL preceded by periods marked by efforts to
>balance the federal budget and reduce the debt. Can professional
>economists sustain this conclusion drawn from the historical evidence?

The statements is correct.  Additionally, since 1948, every reduction
in the deficit as a % of GDP has been closely followed by a deceleration
in the growth of GDP.  All recessions have been preceeded by deficit
reduction and all recoveries preceeded by an increasing deficit, again,
as a % of GDP.
>
>I am just someone with a political science education monitoring this
>forum (and I also produce a community access TV talk show). Prima facie,
>in simplistic macroeconomic terms, a reduction of govenment spending -
>whether direct spending or interest payments on the debt -  as a
>proportion as a proportion of GDP, would reduce consumption, leading to
>over-production, stockpiling of inventories, laying off of workers, etc,
>leading to lower wages, greater unemployment, and ultimately an increase
>in business bankruptcy and investment losses.
>
>Is this thinking correct? (Sorry if it's too simple for you folks.)

I have contended that it is even simpler.  The fact is, with a fiat
currency like the dollar, the driving force is that we all need the
government's money to be able to pay Federal taxes.  The only source of
dollars to pay taxes is the government.  So a balanced budget is actually
the theoretical minimum the government can spend.

Enclosed is a recent essay.  If you wish, I'll send you a hard copy
of my longer analysis, "Soft Currency Economics" or you can download it.
>
>If so, what does this imply vis-a-vis current conservative economic
policy?
>
>Hope you don't mind my intruding on your forum.
>
>-- Charlie Reid
>cjreid@xxxxxxxxxx
>"Salus populi suprema est lex" (Cicero)
>The welfare of the people is the highest law.
>
>
>
          " We all agree on the problem...."

The assumptions underlying the current budget debate are
erroneous.  Historical analogies include "the earth is flat"
and "the earth is the center of the solar system."  Chicken
Little has returned, and the consequences are counter agenda
for all parties.

The noble attempt by Congress to balance the budget will
result in a weaker economy.  Pressed hard enough, a true
depression will follow.  Every time the budget deficit, as a
percent of GDP, drops, the GDP growth rate drops a few
quarters later.  It is only after the deficit begins to
expand again that the economy recovers.  The historical
correlation is 100%.  Lowering interest rates, in an attempt
to boost the economy, is seldom effective.  When the
government is a net payer of interest, lower rates reduce
spending, increasing fiscal drag.

Governments are monopoly issuers of fiat currency.  The
incorrect but prevalent understanding is that issuers of fiat
currency must tax, borrow, or otherwise raise revenue so they
can spend it.  Taxing and borrowing are considered "funding"
operations.  Consequently, the discussions revolve around how
governments can raise "needed revenue" to fund spending.
Revenue shortfalls are of great concern, and, indeed, led to
a government shutdown.

Contrary to the general perception, fiat money is driven by
the fact that the tax payers need the government's money to
pay their taxes.  By levying a tax, the government creates a
need for its fiat currency.  It creates this need,
presumably, so it can obtain the real goods and services it
desires via the spending of its currency.

>From inception, the only source of money needed to pay taxes
is the issuing government.  The government cannot actually
collect the tax it levied, or borrow any of its fiat
currency, until it first spends or otherwise provides the
funds.


A balanced budget, from inception, is therefore the
theoretical minimum that a government can spend.  This is an
accounting identity.  If individuals and business desire to
hold actual cash, that money must be "left over" after taxes
are paid.  All cash held by the public must be money provided
by the government in excess of the need to pay taxes (deficit
spending).  That is also true for all dollars held by foreign
central banks at the Fed.  For these, and other structural
reasons, the possibility of a balanced budget does not exist,
and the current attempt to balance the budget will likely
result in a severe deflation.  When the government does not
spend enough to cover the total need for dollars created by
taxes, the usual result is that tax receipts fall short in
the resulting recession.  A deficit remains.  Accounting
identities have a way of being satisfied, one way or another.

Likewise, the government can borrow its currency only after
it provides it.  Government borrowing therefore functions as
interest rate support, not funding.  Nominal savings is not
removed or displaced, it is given a place to earn interest.
If the government were to spend more than it then collected
in taxes, and did not offer securities for sale, the fed
funds rate would immediately fall to 0% bid.  Treasury
spending is a reserve add.  Selling securities, by the Fed or
Treasury, is a reserve drain.  This underlies the empirical
evidence that nations can run any debt ratios they want, in
their own fiat currencies, and still "fund the debt."  It is
just a reserve drain.

For all practical purposes, there is no such thing as a
balanced budget.  Singapore, for example, shows a budget
surplus, but that does not include all government spending in
excess of collected taxes.  The central bank spends Singapore
dollars to buy foreign currencies.  This "off balance sheet"
spending brings the consolidated spending to about 2% higher
than collected taxes.  The same happens in Czechoslovakia.
Fiscal policy is tight enough so the only way to get enough
local currency to pay taxes is selling foreign currencies to
the central bank.  If the central bank makes the taxpayers
"beg" by letting the local currency appreciate too much, the
economy gets softer.  Japan is a good example.

Consider inflation.  Since the taxpayers need the
government's money, the government defines its currency by
what it will pay for goods and services.  By changing what it
will pay for something, the government redefines its
currency.   Currently, the government fights inflation by
maintaining an economy weak enough for the private sector to
be under pressure to sell things, which keeps prices from
rising.




How large a deficit is prudent?  Let the market decide!  This
option has not even been considered.  For example, the
government could offer a job to anyone who wanted one, at
some minimum rate of pay deemed appropriate, and let the
deficit float.  This would end unemployment and unemployment
compensation, eliminate the need for minimum wage laws, and
promote price stability.  Employment (rather than
unemployment) would define the currency and become the
stabilizer.  The price of labor would be stable.  Private
sector wages would be some spread versus the benchmark of
government employment.  If the government labor force was
larger than needed by the government, taxes could be lowered.
That would result in fewer government workers and reduced
government spending as the private sector hired them.

The Fed sets short term rates.  Congress has ultimate control
over the Fed.  Short term rates go up because the Fed, and
ultimately Congress, wants them to.  They are not determined
by market forces.  Treasury securities are not necessary,
unless the government wishes to support higher long term
rates.  Short term rates could be maintained simply by paying
interest on excess reserves held at the Fed.

The Federal debt is all the money spent but not taxed.  It
was borrowed after it was spent, so the holders of the money
could earn interest.  The government pays interest
voluntarily, depending on how much it wants savers to be able
to earn.  Have you ever heard anyone say, "I wish the
government would stop selling securities so I can get my
money back!?"

The current budget debate is based on erroneous assumptions.
Washington does not understand fiat money.  Until it does,
the economy will continue to underperform.

See "Soft Currency Economics:"
http://inca.gate.net/~mosler/softecon.html
December 15, 1995

Warren Mosler