Saturday, September 11, 2010

Do deficits matter?

Well, that depends on who you ask.

So, why all the hubbub about deficits?

A government who has its own currency can never go bankrupt. Why?, because they can print money and print money and print money and never run out of their own currency to pay back their lenders (bond holders) even if these bond holders are foreigners (such as the Chinese). So no matter how much the government spends it will always be solvent. So why are deficits bad? Printing money that isn't based on any real value is inflationary. If the government prints a lot of money and puts it into circulation by spending it or even by dumping it out of helicopters then the inflation rate will most certainly rise and potentially go crazy.

A government who doesn't control its own currency and can't print their own money, can go bankrupt and therefore can't run up large deficits as is the case with the individual nations belonging to the European Union.

So the United States is in no danger of going bankrupt. It is in danger of run-away inflation by continuing to run up large deficits and increasing the public debt. At the moment there is no threat of inflation, deflation is much more of a concern. So fiscal austerity isn't a pressing need, in fact it may contribute to deflation, but in the long term, deficits aren't a good idea because of their inflationary consequences.

In my opinion, the government should run deficits during a recession but should run a surplus in a growing economy. Unfortunately, experience has been large deficits during both. The only surpluses the U.S. has run in the past 50 years have been in the late 90s during the Clinton administration.

Here is a graph of the last 50 years:

I imposed my own green line of what I think would be more ideal:

Eventually, we will have to cut down our deficits by increasing taxes or decreasing spending, or both. Is now the time? That's tough to say in the face of high unemployment and threats of deflation, but the current deficits certainly aren't feasible in the long haul.

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