–How the federal budget really works

An alternative to popular faith

A parable about the Fed budget:

We shall call him “Mr. Fed.” He has an unruly daughter named “Taxpay,” whom he wishes to encourage toward goodness, while teaching her basic budgeting. So Mr. Fed tapes two sheets of paper to the refrigerator.

One sheet is titled “Taxpay Savings.” The other sheet is titled “Deficit Scoresheet.” Each day when Taxpay is good, Mr. Fed will draw a checkmark on her Savings sheet, and because he is teaching her double-entry accounting, he also will draw a checkmark on his Deficit Scoresheet.

Taxpay wants these checkmarks, because Mr. Fed will allow her to use them to buy things like staying up late or having friends for a sleepover. She trusts Mr. Fed to exchange these goods and services for checkmarks (In some quarters this trust is known as “full faith and credit.”) Also, if she is bad, Mr. Fed will tax her, so she needs checkmarks to pay any “bad girl” taxes she might incur.

All of the first week, little Taxpay is good, so by the end of the week she has accumulated 7 checkmarks on her Savings sheet. Similarly, Mr. Fed has drawn 7 checkmarks on his Deficit Scoresheet.

The system works so well, Mr. Fed tells Taxpay that from now on, he will give her 2 checkmarks for every day she is good, which of course requires that he also draw 2 checkmarks on his Deficit Scoresheet.

This is no problem for Mr. Fed who has plenty of pencils to draw checkmarks. But it outrages a visiting busybody named “Debthawk,” who asks Taxpay the nonsensical question, “Who is going to give Mr. Fed checkmarks to reduce the number of checkmarks on his Scoresheet?”

Puzzled, little Taxpay asks, “Huh? Why does Mr. Fed’s Deficit Scoresheet need to be reduced? It’s just a scoresheet for accounting purposes. The checkmarks don’t cost Mr. Fed anything. They are free, backed by nothing. They merely are arbitrary symbols that Mr. Fed can draw in unlimited quantities. They are exactly like the dollars the federal government produces, now that we are off the gold standard – arbitrary symbols, free and backed by nothing other than full faith and credit.”

Taxpay is pretty smart for a little girl, obviously smarter than Debthawk, who keeps insisting that one day Taxpay’s children and grandchildren will have to give Mr. Fed checkmarks to offset those on the Deficit sheet. Debthawk calls this “inter-generational transfer.”

In short, Debthawk wants a “balanced budget,” aka “deficit neutral” which means every time Mr. Fed gives Taxpay a checkmark, she should give it back. Think about the sense of that.

The first day of the next week, Taxpay is bad, so Mr. Fed taxes her. He erases a checkmark on her Savings sheet, and also erases a checkmark on his Deficit Scoresheet, reducing the Deficit Score to 6 checkmarks. Debthawk is thrilled, failing to notice the reduction on Taxpay’s Savings sheet.

Taxpay then decides to spend all her remaining checkmarks for permission to have a dozen friends at a sleepover. Mr. Fed erases all her Savings checkmarks and simultaneously erases all the checks on his Deficit Scoresheet. At first elated to see the Deficit Scoresheet having no checkmarks, Debthawk belatedly realizes that Taxpay now has no checkmarks left to pay for future goods and services. This puts everyone into a Great Depression, at which time Debthawk says, “I always knew that in emergencies like this one, Mr. Fed would have to add to his Deficit Scoresheet so Taxpay would have checkmarks.” (Of course he did.)

But, the minute Mr. Fed started to give Taxpay more checkmarks, Debthawk again complained about there being too many checkmarks in the Deficit Scoresheet. Poor little Taxpay. Debthawk wants to take away her precious checkmarks, and because his mind is closed, she can’t seem to convince him that is unnecessary.

And that is the way the federal budget really works.

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

Faith is belief without evidence. Science is belief from evidence.

–The federal deficit debate

An alternative to popular faith

THE WELL-KNOWN, ANTI-DEFICIT POSITION
A federal surplus is more prudent than a federal deficit

THE LITTLE-KNOWN, PRO-DEFICIT POSITION
That is the popular faith.* But, a large economy has more money than does a small economy. Therefore, a growing economy requires a growing supply of money. Federal deficit spending is the prime source of that money. All six recessions, since the end of the gold standard (1971), have been introduced with a surplus or a reduction in deficit growth. All six were cured with an increase in deficit growth. When we have insufficient money growth we have recessions or depressions. The Great Depression immediately followed years of surpluses, and ultimately was cured with deficits.
–//–
THE WELL-KNOWN, ANTI-DEFICIT POSITION
Large deficits are unsustainable. The interest payments alone will grow to a point where they occupy the entire federal budget.

THE LITTLE-KNOWN, PRO-DEFICIT POSITION
Unlike you, me, cities, states and corporations, the federal government uniquely has the power to create unlimited amounts of money, a power it gave itself in 1971. To service a deficit of any size, including interest payments, the government merely creates money ad hoc, by crediting the bank accounts of creditors.
–//–
THE WELL-KNOWN, ANTI-DEFICIT POSITION
We cannot keep borrowing forever. Foreign nations will refuse to keep lending us money to support our profligate ways.

THE LITTLE-KNOWN, PRO-DEFICIT POSITION
The government does not need foreign nations to lend us money. The federal government borrows by creating unlimited amounts of T-securities from thin air, backed only by full faith and credit, then selling them for the money it previously created. The government just as easily and safely could create money from thin air, also backed by full faith and credit. This would eliminate the borrowing step as well as all concerns about debt. Federal borrowing is a relic of the gold standard days.
–//–
THE WELL-KNOWN, ANTI-DEFICIT POSITION
The fact that the government borrows is prima facie evidence that the government needs to borrow.

THE LITTLE-KNOWN, PRO-DEFICIT POSITION
Federal borrowing is a relic of the gold standard years, when the government did not have the unlimited ability to create money. Today, borrowing has zero advantages over direct money creation, and many disadvantages, not the least of which is the mistaken belief
federal debts are a problem.
–//–
THE WELL-KNOWN, ANTI-DEFICIT POSITION
Federal deficits increase the money supply, which reduces the value of money and causes inflation.

THE LITTLE-KNOWN, PRO-DEFICIT POSITION
The value of money is based on both supply and demand. Increasing the demand for money prevents/cures inflation. Demand is determined by risk and reward. The reward for owning money is its utility as an exchange vehicle and interest rates. To fight inflation, the government increases the reward by raising interest rates. Since 1971, there has been no relationship between inflation and federal deficits.
–//–
THE WELL-KNOWN, ANTI-DEFICIT POSITION
Raising interest rates to fight inflation will hurt business and the economy.

THE LITTLE-KNOWN, PRO-DEFICIT POSITION
Since 1971, there has been no relationship between interest rates and economic growth. Low rates have not stimulated (as Greenspan and Bernanke have learned); high rates have not inhibited. The reason: For every borrower there is a lender. What helps one, hurts the other. It’s zero sum. For example, high rates help holders of CDs, bonds, T-securities. Also, changes in interest rates represent minuscule changes in business costs. Additionally, high rates have had a slightly stimulative effect, because they’ve forced the federal government to pump more interest money into the economy.
–//–
THE WELL-KNOWN, ANTI-DEFICIT POSITION
Our children and grandchildren will pay for today’s deficits through higher taxes in the future.

THE LITTLE-KNOWN, PRO-DEFICIT POSITION
The government pays its debts by marking a credit in the bank accounts of its creditors, and marking a debit in its own balance sheets. No physical money changes hands. The government can do this endlessly. It does not use tax money to pay its bills. When taxes are received, the government debits the payers’ bank accounts and credits its own balance sheets. Effectively, the tax money is destroyed. The government has no vault or fund of money. It merely makes electronic notations. That is why today’s taxpayers do not pay for the massive Reagan deficits. There is no historical relationship between tax rates and federal deficits.
–//–
THE WELL-KNOWN, ANTI-DEFICIT POSITION
There is no such thing as a free lunch. One day, someone will have to pay for today’s federal spending.

THE LITTLE-KNOWN, PRO-DEFICIT POSITION
Federal money is, in fact, a free lunch to the federal government. It pays its bills by crediting vendors’ bank accounts. This costs the government nothing other than a few electrons sent to the banks’ records. Nothing collateralizes our money other than full faith and credit.
–//–
THE WELL-KNOWN, ANTI-DEFICIT POSITION
When the debt exceeds the value of all government assets, the government will be bankrupt.

THE LITTLE-KNOWN, PRO-DEFICIT POSITION
Federal assets, such as the Grand Canyon and Washington Monument do not collateralize our money. As a holder of U.S. bonds, China is a creditor to the government, but China cannot lay claim to such federal assets as Lake Michigan or the Supreme Court building. China’s collateral is the U.S. government’s full faith and credit, nothing more.
–//–
THE WELL-KNOWN, ANTI-DEFICIT POSITION
I have to pay my bills and be careful with my borrowing. Otherwise I will go bankrupt. The government is you and me. It must do the same as we do.

THE LITTLE-KNOWN, PRO-DEFICIT POSITION
The government is not you and me. It collects taxes; we pay taxes. It can create money at will; we cannot. As a sovereign nation, with the unlimited ability to create money, America cannot go bankrupt. The belief that the government is the same as its citizens gives rise to the myths about deficits.
–//–
THE WELL-KNOWN, ANTI-DEFICIT POSITION
As our population ages, and more people collect Social Security, the program will go bankrupt unless taxes are increased or benefits decreased.

THE LITTLE-KNOWN, PRO-DEFICIT POSITION
Social security is a federal agency, much like the Department of Defense, Congress, the Supreme Court and 100+ other federal agencies. No federal agency ever has or ever will go bankrupt, simply because the federal government itself, having the unlimited power to create money, cannot go bankrupt.
–//–
THE WELL-KNOWN, ANTI-DEFICIT POSITION
Technically, the government already is bankrupt, since it doesn’t have the money to pay all its debts, and must rely on future tax collections.

THE LITTLE-KNOWN, PRO-DEFICIT POSITION
The government has no money, yet doesn’t rely on tax collections. It pays its debts merely by changing the numbers in its creditors bank accounts. The government acts like a football scoreboard. When a team scores a touchdown, the scoreboard “owes” it six points. No one asks, “Where is the scoreboard going to get six points?” This is explained in detail at http://www.moslereconomics.com/2009/12/10/7-deadly-innocent-frauds/
–//–
THE WELL-KNOWN, ANTI-DEFICIT POSITION
Many countries – Germany, Italy, Brazil et al – have suffered from hyper-inflation caused by excessive money printing.

THE LITTLE-KNOWN, PRO-DEFICIT POSITION
Each instance of hyper-inflation has been caused by unique circumstances, but generally, hyper-inflations have been caused by governments not addressing the root causes of their inflations. They mistakenly printed more money in response to inflation. This exacerbated modest inflations into hyper-inflations.
–//–
THE WELL-KNOWN, ANTI-DEFICIT POSITION
Most prominent economists believe the deficit and debt are too large.

THE LITTLE-KNOWN, PRO-DEFICIT POSITION
That is exactly the way scientific progress is made. The vast majority of prominent scientists have a belief. Then a minority (sometimes just one person) proposes a new hypothesis, which at first is denounced. Eventually the vast majority begins to change its mind, and the new hypothesis becomes the majority. Then the process repeats.

*Faith is belief without evidence. Science is belief from evidence.

–Federal Debt: A “ticking time bomb”

An alternative to popular faith

Popular faith holds that the federal debt is a ticking “time bomb,” ready to explode into inflation and high interest rates, and destroy our economy. Here are a few references, beginning 70 years ago. Note that the language remains the same, down through the years — repeated predictions of a disaster that never seems to come.

Even with the end of the gold standard in 1971, arguably the most significant economic event since the Great Depression, the debt-hawk language never changes — as though 1971 were a non-event.

Sept 26, 1940, New York Times: Deficit Financing is Hit by Hanes: ” . . . unless an end is put to deficit financing, to profligate spending and to indifference as to the nature and extent of governmental borrowing, the nation will surely take the road to dictatorship, Robert M. Hanes, president of the American Bankers Association asserted today. He said, “insolvency is the time-bomb which can eventually destroy the American system . . . the Federal debt . . . threatens the solvency of the entire economy.”

Feb 11, 1960, New York Times: Mueller Assails Rise in Spending: The enormous cost of various Federal programs is a time bomb, threatening the country’s fiscal future, Secretary of Commerce, Frederick H. Mueller warned here today “. . . the accrued liability is a ticking time bomb. Some day someone will have to pay.”

Oct 4, 1983 Evening Independent – The United States and the developed world face a “ticking time bomb” because of the huge foreign debt involving loans to Third World nations

Oct 26, 1983, David Ibata: “ . . . home-building officials called for a commission to propose ways to trim the $200 billion federal deficit. The deficit is a ‘ticking time bomb‘ that probably will explode in the third quarter of 1984,’ said Fred Napolitano, former president of the National Association of Home Builders.

Feb 21, 1984, James Warren: “‘We now hear from them (the Reagan administration) that deficits don’t cause high interest rates and inflation,’ AFL-CIO President Lane Kirkland said. ‘If that’s the case, we’ve suddenly discovered the horn of plenty and should stop worrying and keep borrowing and spending. But I don’t believe it. It’s a time bomb ticking away.”

January 12, 1985, Lexington Herald-Leader (KY):The federal deficit is “a ticking time bomb, and it’s about to blow up,” U.S. Sen. Mitch McConnell, a Louisville Republican, said yesterday.

Feb 17, 1985, Los Angeles Times: We labeled the deficit a `ticking time bomb‘ that threatens to permanently undermine the strength and vitality of the American economy.”

Jan 5, 1987, Richmond Times – Dispatch – Richmond, VA: 100TH CONGRESS FACING U.S. DEFICIT ‘TIME BOMB‘

November 28, 1987, The Dallas Morning News: THE TICKING TIME BOMB OF LONG-TERM HEALTH CARE COSTS A fiscal time bomb is slowly ticking that, if not defused, could explode into a financial crisis within the next few years for the federal government and our nation’s elderly. The ticking bomb is the growing cost of long-term care.

October 23, 1989, FORTUNE Magazine: A TIME BOMB FOR U.S. TAXPAYERS The government guarantees millions of mortgages, bonds, deposits, and student loans. These liabilities, now twice the national debt, are growing fast.

May 1, 1992, The Pantagraph – Bloomington, Illinois: I have seen where politicians in Washington have expressed little or no concern about this ticking time bomb they have helped to create, that being the enormous federal budget deficit, approaching $4 trillion and growing now at an annual rate of $400 billion per year.

October 28, 1992: Ross Perot: “Our great nation is sitting right on top of a ticking time bomb. We have a national debt of $4 trillion. Seventy-five percent of this debt is due and payable in the next five years. This is a bomb that’s set to go off and devastate our economy and destroy thousands of jobs.

Dec 3, 1995, Kansas City Star: Deficit is sapping America’s strength. Concerned citizens. . . regard the national debt as a ticking time bomb poised to explode with devastating consequences at some future date.

April 14, 2003: Porter Stansberry, for the Daily Reckoning: The baby boomers are heading into retirement with no savings and no productive companies to support them in old age. Generation debt is a ticking time bomb…with about ten years left on the clock.

October 1, 2004, Bradenton Herald: A NATION AT RISK: TWIN DEFICIT A TICKING TIME BOMB: Lawmakers approved Bush’s request without cutting federal spending by a penny, thereby fattening the country’s projected record deficit of $422 billion by another $145 billion next year.

May 31, 2005, Providence Journal, Defusing the Medicare time bomb, Some lawmakers see the Medicare drug benefit for what it is: a ticking time bomb, set to wreak havoc on the budget and shoot future tax rates sky-high.

April 5, 2006, NewsMax.com, “We have to worry about the deficit . . . when we combine it with the trade deficit we have a real ticking time bomb in our economy,” said Mrs. Clinton.

Dec 3, 2007, USA Today: US debt: $30,000 per American. WASHINGTON (AP): Like a ticking time bomb, the national debt is an explosion waiting to happen.

*September 24, 2010, Email from the Reason Alert: ” . . . the time bomb that’s ticking under the federal budget like a Guy Fawkes’ powder keg.”

*July 7, 2011, Washington Post, Lori Montgomery: ” . . . defuse the biggest budgetary time bombs that are set to explode as the cost of health care rises and the nation’s population ages.

[*Added subsequently]

And on and on and on. You get the idea. That time bomb has been on the verge of explosion at least since 1940. Even today, the media, the politicians and sensationalist economists refer to the debt as a ticking time bomb. Please look at the following graph and see if you can find any relationship between deficit spending vs inflation and/or interest rates.

This graph shows there is no predictable relationship between federal deficits vs. inflation and or interest rates.

If the debt is a time bomb, it surely has the slowest fuse in history. The pundits have been wrong, wrong, wrong, all these years. We should understand federal deficits, even large federal deficits, have not caused inflation or any other negative economic effect, and the debt is not a ticking time bomb? It’s an economic necessity. Let us turn away from faith and start to rely on facts.

The faith healers* are killing our economy by restricting money growth. See: The damage done by deficit cuts.

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

*Faith is belief without evidence. Science is belief from evidence.

–Deficit fears do more damage than deficits

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:

https://rodgermmitchell.wordpress.com/2009/11/15/deficits-and-interest-rates-another-myth/, https://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
http://www.rodgermitchell.com