Among the Tea (formerly Republican) Party’s many hates, is the hatred for federal deficits, and they share this antagonism with nearly every American. Yet, based on my own personal reading, I believe the media and the politicians, and many economists do not even know what a federal deficit is, let alone how it relates to the federal debt.

Let’s begin with semantics. A quick trip to dictionary.com says:

DEFICIT: 1. the amount by which a sum of money falls short of the required amount.
2. the amount by which expenditures or liabilities exceed income or assets.
3. a lack or shortage; deficiency.
4. a disadvantage, impairment, or handicap: The team’s major deficit is its poor pitching.
5. a loss, as in the operation of a business.

Look at all the negative words: Fall short, lack, shortage, deficiency, disadvantage, impairment, handicap, poor, loss. From the standpoint of intuition, clearly a “deficit” is something to be avoided. Yet, a federal deficit merely is the arithmetic difference between two, mostly unrelated numbers: Federal taxes collected vs. federal dollars spent.

These numbers are mostly unrelated, because federal taxes do not pay for federal spending. Either can exist without the other, and subtracting one figure from the other is meaningless — or at least has been since 1971, when we went off the gold standard. Prior to then, federal taxes did pay for federal spending, so there was some justifiable logic in comparing taxes with spending. Today, such a comparison is like subtracting the number of runs the Cubs score in a particular game, from the number of people who attend that game.

Having said that, one reason to subtract taxes from spending does remain, and it is an important one. Because the federal government creates federal dollars by spending, and federal taxes destroy federal dollars, federal deficits are the net amount of federal dollars the federal government creates each year.

Does creating federal dollars sound like an activity which should be viewed as “falling short, lacking, a shortage, a deficiency, a disadvantage, an impairment, a handicap, something poor or a loss”? When you think about it, doesn’t creating federal dollars come closer to positive words like: “Income, surplus, profit, accumulate, increase, build and benefit”? And when you think about it further, isn’t that exactly what the so-called “deficit” does for our economy? A growing economy requires a growing supply of money, and the federal deficit supplies that money.

Because the word “deficit” historically has had negative connotations, many people find positive connotations to be impossible to imagine, thus the ongoing efforts to reduce the deficit, when in fact, the efforts should be to increase the deficit. But it gets worse. There is widespread belief that federal deficits increase the dreaded federal debt, and that federal debt is nothing more than an accumulation of federal deficits.

Wrong.

Like “deficit,” debt is a word with strong pejoratives. According to thesaurus.com, words related to “debt” are: “bankrupt, beggared, behindhand, insolvent, liable, minus, not paying, owing, unable to make both ends meet, unpaid, unremunerated, unrequited, unrewarded, worse than nothing.” With a family history like that, is it any wonder that “debt” has such bad press?

Federal “debt” actually is an accumulation of federal debt instruments, of which the four majors are: T-bills (one year), T-notes (10 years), T-bonds (30 years) and TIPS (Treasury Inflation Protected Securities — 5, 10, and 30 years). The debt process is this:

1. Federal government creates dollars out of thin air, by crediting a creditor’s bank account. At this instant, dollars and deficit are created but no “federal debt.”
2. Federal government elects to create T-securities also out of thin air, when it exchanges them for previously-created dollars. At this instant, federal debt is created. The money supply does not change, as the dollars are destroyed the instant the T-securities are sold.
3. To redeem the T-securities, the federal government re-creates dollars, exchanging them for T-securities and destroying the T-securities. Again, the money supply doesn’t change.

So all federal “debt” is nothing more than the total of outstanding T-securities, which are created and redeemed with no effect on the money supply, other than liquidity (dollars are more liquid than T-securities). Neither creating, nor redeeming T-securities has any inflation repercussions, and because a Monetarily Sovereign government does not use income for spending, T-securities are a useless relic of the gold standard days, neither affecting, nor affected by, federal tax collections, federal spending, economic growth or the federal deficit.

For such a benign investment — one neither causing nor reducing inflation, neither increasing nor reducing taxes, neither increasing nor reducing the deficit, and one whose sole effect is to reduce economic liquidity — federal “deficit” surely has acquired a bad name, based on the almost universal desire to reduce it. And strangely, this effort at debt reduction does not take the logical step of merely eliminating the creation of T-securities, but rather it focuses on reducing federal deficits, which do not have an operational relationship with federal debt.

Isn’t it amazing that your favorite politician, your favorite newspaper editor, your favorite talk-show moderator, your favorite columnist and the vast majority of the world’s economists do not understand this basic, operational truth: Even were federal taxes to equal federal spending (a deficit of zero), this would not change the Treasury’s need or ability to create/sell T-securities, and even were T-security creation/sales to be eliminated, this would not change the federal government’s ability to create dollars. Instead, they spend their lives decrying the federal deficit, which is necessary for economic growth, and decrying the federal debt, which has become meaningless for virtually all economic purposes, rather than focusing on properly directed methods for improving our lives.

So, the next time you read or hear some self-anointed “expert” saying the federal debt must be reduced, or the federal deficit increases the federal debt, or worries about whether other countries will buy our debt, or worries that “paying off the debt” will cause inflation or the current favorite bogey man, hyperinflation, know this: No matter what the credentials, that person simply does not know what he/she is talking about. Period.

After so many years, the flat-earth, leech-applying, flag-flying, evolution-denying, deficit-decrying, logic-defying, repeatedly-lying still rule, stomping through our lives, damaging everything in their path. With barely a whimper from us.

Rodger Malcolm Mitchell
http://www.rodgermitchell.com

No nation can tax itself into prosperity, nor grow without money growth.