But Do Deficits Really Matter?

Can we sell our seed corn indefinitely?

This is Part 4 of Rule 9: Debt is Dumb

The Law of Supply and Demand says that deficit spending subsidizes Capital over Labor, so with our sky high chronic federal deficits we should be seeing low wages and high real interest rates. Well, we have seen flatlined real wages for the working class from the early 70s until Trump, but interest rates are currently very low adjusted for inflation. Reality is not conforming to theory.

I can think of several possible explanations. Maybe some think tankers in the audience can figure which of these are the reason.

Just-In-Time Inventory Control freed up a lot of capital. In the days before Reagan, parts were stockpiled in warehouses to provide a buffer against strikes and other disruptions. Many retail stores had a significant Back Room. But then industry discovered that they could improve both quality and return on investment by minimizing inventory. Reduced inventory improves quality because defective parts get detected as they are made vs being discovered weeks later when taken out of a warehouse. Return on investment is improved because manufacturers don't have to finance as much parts inventory.

When Just-In-Time Inventory Control works, it really works. But when the economy is jolted by a shock, such as COVID-19, the fragility of the arrangement becomes apparent.

Running factories at full capacity also frees up capital. If you run one factory for three shifts instead three factories for one shift, you have one third as many factories to finance. The arrangement also saves real estate. On the other hand, working night shifts is not healthy and not family friendly. And it's hard to quickly increase production in the event of shocks to the economy, as we recently experienced with toilet paper and lumber.

The U.S. has become the new Switzerland, but with nukes. Many of the world's currencies are extremely unstable. There is a strong worldwide demand for stable money. While the dollar is subject to more arbitrary printing than Bitcoin, the dollar is still backed by real wealth. The U.S. still exports food, timber, bulk chemicals, military weapons, and Baywatch. Also, U.S. real estate is rather nice, and we have more surplus than most countries.

Closing factories frees up even more capital. Why build or maintain a factory when you can simply hire some engineers to design a product and then outsource to China? We buy manufactured goods from China in exchange for trade secrets and government bonds. (Without the Fed and Treasury creating money out of thin ether, perpetual trade deficits would produce noticeable cash shortages at home. Deficit spending is another example of subsidized outsourcing.)

There are Baby Boomers still saving for retirement. Yes, there are Boomers already collecting Social Security checks, but since many Boomers were slack on the savings front while young, many are still saving money while collecting Social Security. And the late Boomers are still in their early 60s and late 50s. When the Boomers truly retire, things might get "interesting."

Not all interest rates are low. For those launching a business that doesn't fit the Paint-by-Numbers model that banks are allowed to finance, capital costs are still high. Maybe this is due to high risk. Or maybe this is due to the fact that the tax code and government regulations funnel a large fraction of our national savings into favored investments -- such as real estate, blue chip stocks, etc. Retirement accounts are generally forced into "safe" investments.

T Bills are today's cash. There is a price to holding onto large amounts of dollar bills: inflation. Those who want ready cash with less penalty hold their cash in the form of short term Treasury Bills. This is the part of the Keynesian paradigm which is correct: with inflation people cannot simply keep money in vaults without penalty. As of February 2022, the public holds roughly $4 trillion in Treasury Bills. One can reasonably argue that this component of the national debt is really just cash "printed" into the economy vs. true debt.

This leads to another interesting question: just how big is the true federal budget deficit? The higher the rate of inflation, the greater the depreciation on existing debt. When the public holds $30 trillion in debt, a five percent inflation rate computes to $1.5 trillion in depreciation of the debt, which is roughly the size of the nominal budget deficit during the Trump economic boom. Not only that, the true rate of inflation might be higher than the official rate. Just look at the price of housing, education, legal services, etc.

But I still believe in balancing the budget. Given how easy counterfeiting is with modern printers, we may need to go back to gold coins or forward to some kind of crypto thingy. My trust in the latter is limited, and any government run crypto could give the government Beastly power. Moreover, given how the government uses the banking system as an end run around the Constitution for enforcing Deep State dictates, I want to reduce penalty for holding onto plain old cash.

Also, our game of offsetting deficits with inflation could be fragile. We might not always have the luxury of being banker to the world. China could muscle in at any time. Enforcing the Petrodollar is a dangerous and bloody game. Somebody might notice that the strong dollar unbacked by sufficient exports is a form of tribute collection. And what happens when interest rates go up to match inflation? There is a potential positive feedback loop of catastrophic proportions.

Finally, I dislike the gutting of American industry. We are selling our national seed corn to China in return for cheap merchandise at Wal Mart. And as we outsource and inflate the currency, we force our working class to knee walk for a raise every year just to break even.

Balance the damn budget.

The Politics of Balancing the Budget

Running on a platform of protectionism and balanced budgets, H. Ross Perot nearly became the first third party President since Abraham Lincoln. The votes are out there. Meanwhile, Donald Trump performed the equivalent of a partial takeover of the Republican Party by the Reform Party -- but only partial.

The Santa Claus economists still dominate the Republicans in Congress. Most of them have sworn fealty to Grover Norquist; they would have to break their oaths in order to come up with sufficient revenue enhancements to balance the budget. And as for budget cuts, the only Congresscritter who was calling for sufficient cuts was Ron Paul, and he's retired.

Can the Republican Party be reformed? Or do we need a Can Do Basic Arithmetic Party? I leave this question as a homework assignment for the audience.

For those troubled by the thought of increasing taxes, see the next Rule. I have some ideas which might be palatable even for Establishment Republicans.