–Deficit fears do more damage than deficits Monday, Nov 16 2009 

An alternative to popular faith

Those concerned about large federal deficits cite fears of inflation, high interest rates and obligations of our children and grandchildren as major factors. See:

http://rodgermmitchell.wordpress.com/2009/11/15/deficits-and-interest-rates-another-myth/, http://rodgermmitchell.wordpress.com/2009/10/30/deficits-the-possible-vs-the-certain/ and several other posts on this site. Ever since we went off the gold standard in 1971, deficits have not been related to inflation or high interest rates. And no one pays for deficits, which is what makes them deficits. We, the children and grandchildren of Reagan-era parents, never paid for the huge Reagan deficits. (By definition, deficits are paid for only when we run surpluses.)

While deficit fears are misplaced, the damage these fears do is significant. Read these recent headlines.

08/14/09: Deficit Plays Into Health Reform: Democrats say it will be hard to push an ambitious health reform bill through Congress unless it reduces projected federal spending on medical care and begins to bring the national debt under control.

11/14/09: High Costs Weigh on Troop Debate for Afghan War: The budget implications of President Obama’s decision about sending more troops to Afghanistan are adding pressure to limit the commitment, senior administration officials say.

11/14/09: China’s Role as U.S. Lender Alters Dynamics for Obama:
China’s position as the country’s largest foreign lender means that President Obama is likely to spend more time reassuring Beijing than pushing reforms.

11/14/09: Obama vows ‘serious’ bid to cut US deficit: Obama’s Republican critics, and some conservative Democrats, have called on the president to rein in spending on huge programs such as health care and climate change to avoid inflating the sky-high deficit.

Thus, deficit fears will impact medical care, the fight against terrorism, financial reforms and efforts to prevent climate change, improve the infrastructure, improve education, etc. More specifically, read what the Wall Street Journal editors said on 11/16/09 about a new Medicare Commission:

“So far, the commission has banned knee arthroscopy for osteoarthritis, discography for chronic back pain and implantable infusion pumps for pain not related to cancer. This year, it is targeting such frivolous luxuries as knee replacements, spinal cord stimulation, a specialized autism therapy and MRIs of the abdomen, pelvis or breasts for cancer. Currently, the commission is pushing through the most restrictive payment policy in the nation for drug-eluting cardiac stents – simply because bare metal stents are cheaper, even as they result in worse outcomes.”

The belief deficits are harmful is debatable, at best. What is not debatable is that deficit cutting absolutely, positively will injure our grandchildren and us. Peculiarly, those wanting to cut federal spending consider themselves “prudent,” while the nation suffers under the blows of their meat axe.

Rodger Malcolm Mitchell

–Deficits and interest rates: Another myth Sunday, Nov 15 2009 

An alternative to popular faith

11/15/09 (AFP): “The US government announced last month that it had closed its 2009 fiscal year with a record budget deficit of 1.417 trillion dollars, up 962 billion dollars from the prior year. The huge gap stemmed from declining revenues and a massive boost to spending in a 787-billion-dollar stimulus plan designed to jolt the world’s largest economy from its prolonged recession. Concerns over the deficit underscore a fundamental tension undercutting Obama’s presidency in its first year — the extent to which he is attempting sweeping political change at a moment of historic financial peril.

“Many economists say high deficits during economic crises are acceptable to fuel government spending to stimulate growth. But long-term deficits can result in high interest rates, making it much harder for consumers to finance outlays such as new homes and cars.”

Yet another myth in the pantheon of economic myths circulating the globe. Look at the following chart and tell me whether you can see a relationship between deficits — even large deficits — and interest rates.

Debt vs Interest Rates

Contrary to popular faith, deficits are not the cause of inflation or high interest rates. Browse through the posts on this site, and you will see why.

–Federal Debt/GDP– A Useless Ratio Sunday, Nov 8 2009 

An alternative to popular faith

Lately, we’ve heard a great deal about the federal debt/GDP ratio.

The Investopedia says, “The debt-to-GDP ratio indicates the country’s ability to pay back its debt.” This ratio often is quoted in stories predicting the demise of America if federal debt continues to rise and especially if the debt ever were to exceed 100% of GDP. (Since we are about to hit that level, and we still exist, the debt hawks now have moved the time of Armageddon too 200%. But Japan is there already, so maybe move it to 300%?)

This nonsense ratio is so important, the European Union once required, as a condition of membership, the ratio of gross government debt to GDP not to exceed 60% at the end of the preceding fiscal year.

What would you say if I told you the total number of hits the Chicago Cubs made in 2008 is 47% of the total number of runs the Cubs have scored in all of their 100+ year history? You might well say, “Huh? What does one thing have to do with the other? One is hits; the other is runs. One is 100+ years; the other is one year. It’s classic apples vs oranges.” And you would be right.

Yet, that is exactly what the debt/GDP ratio represents. Federal “debt” is the net amount of outstanding T-securities created in the history of America. The GDP is the total dollar value of goods and services creating this year. The two are unrelated. The federal government does not use GDP to service its debt. In fact, federal debt service stimulates the economy, so more debt is stimulative.

Actually, federal “debt” is not even related to federal “deficits” by function, though the two are related by law. During the gold standard days, the Treasury was required by law to issue T-securities in the amount of the federal deficit. It was necessary then, because the Treasury could only produce money in the amount of gold reserves. In 1971, we went off the gold standard, which gave the Treasury the unlimited ability to create money. The creation of T-securities no longer is necessary; it is a relic of the gold standard days. A government with the unlimited ability to create dollars does not need to borrow those dollars.

The government “borrows” by creating T-securities out of thin air, backed only by full faith and credit, then exchanging these T- securities for dollars it previously had created from thin air, which it destroys. The government just as easily and as prudently could create dollars from thin air, also backed only by full faith and credit, and dispense with the creation and sale of T-securities. That would reduce and ultimately eliminate federal debt, and over time the debt/GDP ratio would = 0. Perhaps that would make the debt hawks feel better, but fundamentally nothing will have happened. The three-step method for creating money merely had been reduced to a one-step method.

To pay its debt, the process is reversed: The government creates dollars out of thin air, which it exchanges for T-securities, then destroys the T-securities. The whole process is two equal asset exchanges. T-securities exchanged for dollars, then dollars exchanged for T-securities. No net money is created, except for interest.

Today, Japan’s ratio is close to 200%, the U.S. is close to 100% and has been much higher. By contrast, Russia’s, Chili’s, Libya’s, Qatar’s and others are below 10% – which tells you nothing about their economies.

As for GDP indicating “the country’s ability to pay back its debt,” again we have apples/oranges. The value of goods and services created by the private sector, has no relationship to the federal government‘s ability to service its debt. Because the federal government has the unlimited ability to create dollars, it has the unlimited ability to service its debt (the debt it doesn’t need in the first place.)

Finally, Debt/GDP (shown as “FYGFDPUN/GDP”) has no relationship to inflation:

Debt/GDP vs inflation

And that is why the debt/GDP ratio is meaningless.

Rodger Malcolm Mitchell

-Richard Koo–If you don’t believe me, believe him Saturday, Nov 7 2009 

An alternative to popular faith
Listen to Richard Koo’s tape at http://www.ritholtz.com/blog/2009/11/richard-koo-great-recessions-lessons-learned-from-japan/comment-page-1/#comment-233008. He says some of what I have been saying for the past 15 years. Federal deficit spending is absolutely, positively necessary for economic growth.

I hope our government leaders listen to him, though I doubt they will. They sure haven’t listened to me. The reason: The debt hawks have the nation worried, because they equate federal debt with personal debt. So you hear that your grandchildren will have to pay the debt, and large deficits cause inflation, and surpluses are more prudent than deficits — none of which are true.

So, we struggle with trying to provide universal health care, which the government can and should provide, while debt fear negatively impacts the physical and financial health of millions.

Deficit spending grows the economy and can provide health care, too — and it never needs to be paid back. Never. But Congress, the President and most of the economists simply don’t get it. They don’t even look at our economic history, which repeatedly shows long-term deficit spending is necessary for long-term economic growth.

Rodger Malcolm Mitchell

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