The relationship between federal deficit spending and GDP growth

Those who do not understand (or who pretend not to understand) economics, repeatedly confuse federal finances with personal finances.

Those people decry the size of the federal deficits and debt as being “unsustainable,” which these measures would be if they were personal deficits and debt.

The federal government, being uniquely Monetarily Sovereign, never can run short of its sovereign currency, the U.S. dollar, so the government can “sustain” any size deficit and debt.

Gross Domestic Product is a common measure of the economy
Federal deficit spending adds dollars to the economy.
Economic growth, by formula, requires growing dollar supplies:

GDP = Federal Spending + Non-federal Spending + Net Exports

If the deficit critics were correct, you would expect to see:

GDP reduction caused by deficit growth
GDP increases caused by deficit reduction
Recessions caused by deficit growth
Recessions cured by deficit reduction

Yet that is exactly the opposite of what you see.

Image result for great depression — Every depression in U.S. history has been caused by federal debt reduction*

*Historically, reduced deficits have caused recessions and even depressions. Increased deficit spending is necessary to cure recessions and depressions.

1804-1812: U. S. Federal Debt reduced 48%. Depression began 1807.
1817-1821: U. S. Federal Debt reduced 29%. Depression began 1819.
1823-1836: U. S. Federal Debt reduced 99%. Depression began 1837.
1852-1857: U. S. Federal Debt reduced 59%. Depression began 1857.
1867-1873: U. S. Federal Debt reduced 27%. Depression began 1873.
1880-1893: U. S. Federal Debt reduced 57%. Depression began 1893.
1920-1930: U. S. Federal Debt reduced 36%. Depression began 1929.
1997-2001: U. S. Federal Debt reduced 15%. Recession began 2001.

The following graph compares the annual federal debt percentage changes (red line) which reflect deficits, vs. GDP percentage changes (blue line). The vertical bars are recessions.

What you do see is:

- Reduced debt growth leads to recessions
- Increased debt growth cures recessions
- Increased debt growth leads to increased GDP growth

For clarity, let’s examine individual segments of the above graph:

Prior to 1974, federal deficits rose then fell, pulling GDP along with them. This reduced deficit spending precipitated the recession of 1974, which was cured by increased deficit growth through 1976.

The increased deficit growth precipitated increased GDP growth, with momentum carrying GDP through 1979, when it too began to fall.

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As a result of the long period of falling deficit growth, even the short upturn in the last quarter of 1979 could not save the economy, and the falling momentum of GDP resulted in the recession of 1980.

The increased deficit growth cured the recession, which ended in the 3rd quarter of 1980, when GDP turned up, and continued to be pulled up by more deficit growth.

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Continued, increasing deficit growth pulled GDP up, and even when deficit growth declined, in 1981, momentum pulled GDP upward.

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Yet again, you see that familiar pattern. Declining deficits lead to the recession of 1981, which growing deficits cure by the end of 1982.

Increasing deficits pull GDP upward, and even when deficit increases end in the 2nd Qtr of 1983, momentum continues to carry GDP upward.

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The enormous deficits of 1983 force powerful GDP growth momentum, which reverses as deficit growth continues to decline.

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And there again, the familiar pattern: Reduced deficit growth forcing down GDP growth, and even a short period of deficit growth increase cannot forestall the recession of 1990-1991.

And again, increased deficit growth cures the recession and turns GDP growth upward.

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As always, the predictable pattern:

First, deficit growth pulls us out of a recession and forces GDP growth upward.
Then, deficit growth tops out, but momentum carries GPD growth along for several years.
Finally, GDP momentum yields to decreased deficit growth. (This time, we actually ran a federal surplus, which normally would cause a full-fledged depression. However, we were “fortunate,” and “only” suffered the recession of 2001.
Then, as always, it took increased federal deficit spending to pull us out of the recession in 2002.

……………………………………………………………………………………………………………………………………………………..

And here we go again: Massive deficit spending pulls us out of a recession; after escaping that disaster we begin again to cut deficit growth, then (in mid-2007) we increase deficit growth; but it’s too late, and we enter yet another recession; this one is the “Great Recession” of 2008.

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Now here we are, today. Huge deficit growth, having cured the recession, we continue not only those big deficits, but even grow them, first at 30% annually, finally leveling off at about 5% annual deficit growth — a big number, considering the size of the deficit.

This has caused GDP to average a robust average of about 4% annual growth.

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Despite all the incontrovertible data, the next time you open your newspaper, or watch you local federal finance TV “expert,” you will be told that the federal debt and/or deficit are (oh, horrors) at record highs, and are “unsustainable,” or a “ticking time bomb.”

It’s no coincidence that GDP is at record highs, too. Federal deficit spending lifted it there.

Rodger Malcolm Mitchell
Monetary Sovereignty
Twitter: @rodgermitchell
Search #monetarysovereignty Facebook: Rodger Malcolm Mitchell

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The most important problems in economics involve:

Monetary Sovereignty describes money creation and destruction.
Gap Psychology describes the common desire to distance oneself from those “below” in any socio-economic ranking, and to come nearer those “above.” The socio-economic distance is referred to as “The Gap.”

Wide Gaps negatively affect poverty, health and longevity, education, housing, law and crime, war, leadership, ownership, bigotry, supply and demand, taxation, GDP, international relations, scientific advancement, the environment, human motivation and well-being, and virtually every other issue in economics.

Implementation of Monetary Sovereignty and The Ten Steps To Prosperity can grow the economy and narrow the Gaps:

Ten Steps To Prosperity:

1. Eliminate FICA

2. Federally funded Medicare — parts A, B & D, plus long-term care — for everyone

3. Provide a monthly economic bonus to every man, woman and child in America (similar to social security for all)

4. Free education (including post-grad) for everyone

5. Salary for attending school

6. Eliminate federal taxes on business

7. Increase the standard income tax deduction, annually.

8. Tax the very rich (the “.1%”) more, with higher progressive tax rates on all forms of income.

9. Federal ownership of all banks

10. Increase federal spending on the myriad initiatives that benefit America’s 99.9%

The Ten Steps will grow the economy and narrow the income/wealth/power Gap between the rich and the rest.

MONETARY SOVEREIGNTY

–News: China must control inflation, exports and GDP growth. But how?

The debt hawks are to economics as the creationists are to biology. Those, who do not understand monetary sovereignty, do not understand economics. Cutting the federal deficit is the most ignorant and damaging step the federal government could take. It ranks ahead of the Hawley-Smoot Tariff.
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On December 17, 2010 Columnist Michael Schuman published an online article saying:

Chinese inflation hit 5.1% in November, the fastest clip since the pre-crisis boom months of 2008. Though much of the increase is in food (up 11.7% from a year earlier), the inflationary pressures are spreading to more aspects of the economy.

By hiking interest rates, the central bank would be increasing the interest burden on borrowers. That, in turn, could intensify a bad loan problem at China’s banks that many economists believe is an inevitable result of the lending boom.

So the Chinese have instead turned to an old favorite, price controls on certain staple foods.

Inflation is the loss in value of money compared to the value of goods and services. The cure for inflation is to increase the value of money and/or to decrease the value of goods and services.

The later is difficult for any government to accomplish, other than with price controls. Sadly, price controls have serious defects. They lead to reduced supply, while allowing demand to increase, which invariably causes pent up demand and black markets.

A second approach is for the government to buy, store then mete out supplies of oil, when prices rise. Because oil is the prime mover of inflation, this can be an effective anti-inflation plan, if the government has the discipline to do it. The plan falls apart when the government becomes reluctant to part with any of its suddenly-more-precious oil.

In all, increasing the value of money seem to be the best prevention/cure for inflation. That can be accomplished by decreasing the supply of money or by increasing the demand for money. Reduced government spending or increased taxation can reduce the supply. However, reducing the money supply not only leads to recessions and depressions, but involves very slow, uncertain and cumbersome processes.

In addition to the difficulty of knowing how much to increase taxes or to reduce spending, the even more difficult question is which taxes to increase and/or which spending to decrease. By the time politicians finish debating and voting on these highly political questions, the situation either may have passed or more likely, worsened appreciably.

Preventing/curing inflation requires agility and incremental response, for which interest rate modification is ideal. Raising interest rates can be done instantly and in tiny increments. It increases the demand for money, which increases the value of money – perfectly anti-inflationary.

China’s reluctance to strengthen its currency probably is tied to its false belief it must continue to build its export business, which relies in part on the weakness of the yuan. The function of exports is to bring money into an economy, but China, being Monetarily Sovereign does not need additional money coming in from outside its borders. It has the unlimited ability to create money.

China also may subscribe to the popular belief that low interest rates stimulate its economy. American history shows this belief to be false. See: Low interest rates do not help the economy. China also may believe high rates increase business costs, and so actually could foster inflation. However, in America at least, high rates have not corresponded with inflation. (See Item 12,) probably because interest is a minuscule part of most companies’ costs..

The Chinese government has the ability to be its nation’s own best customer. It does not need to rely on exports. This is a fact for all Monetarily Sovereign nations. China has the means to prevent/cure its inflation by raising interest rates. It needs only to understand its own powers.

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

No nation can tax itself into prosperity. Those who say the stimulus “didn’t work” remind me of the guy whose house is on fire. A neighbor runs with a garden hose and starts spraying, but the fire continues. The neighbor wants to call the fire department, which would bring the big hoses, but the guy says, “Don’t call. As you can see, water doesn’t put out fires.”

–Which Taxes Are Fairest? Which Taxes are Least Fair?

The debt hawks are to economics as the creationists are to biology.

Lately, there has been more talk about revising our taxes to be more “fair.” There even is an organization that calls itself FairTax.org, which promotes a national sales tax, a first cousin to the European style value-added tax.

All federal taxes remove money from our economy, and for that reason, all federal taxes hurt our economy. Unfortunately, the belief that federal taxes are necessary (They are not) is so powerfully ingrained, it is impossible to have a rational discussion on the subject.

So we are left with repeated attempts to fix the unfixable.

Tax fairness often is confused with tax simplification.

The U.S. Tax Code contains 50 Chapters. Each chapter is divided into Sub Chapters, each of which is divided into Parts, and then into Paragraphs, all of which are subject to interpretation by Congress, the Internal Revenue Service and the courts.

Because all elements of our economy are intertwined, the interpretation of one paragraph impacts the interpretations of other paragraphs, which then require further interpretations, which impact other paragraphs and ad infinitum. Thus, our Tax Code has acquired infinite complexity, which one could argue is unfair.

Supposedly there was a king who nailed laws too high to be read, then punished those who broke the laws. Would that have been fair?

Tax complexity is inevitable. Imagine the simplest possible tax idea: Tax every man, woman and child $1,000 per year. Period. Simple enough? Fair?

How long would it be before “modifications” would be made? Reduce this tax on the poor. Increase it on the rich. Multiple definitions of “poor” and “rich.” Various payment requirements (monthly? quarterly? annually?).

Charitable deductions allowed? Do businesses pay? Definitions of “business” vs. “person.” Even the simplest possible tax idea soon will turn ever more complex and so, unfair.

The American ethic is based on “getting ahead” and on “fairness.” However, being ahead seems unfair to those who are behind.

Taxes can be levied in a variety of ways, all justifiable as “fair” and all condemned as “unfair.” For instance:

A unit tax on individuals: Each person pays the same tax (similar to an airport departure tax). This tax is fair, because it treats every individual equally. This tax is unfair, because it takes as much from the poor as from the rich.

“Sin” or luxury taxes on cigarettes, liquor, entertainment, gambling, restaurants, travel, etc. are fair, because they tax things we do not need. These taxes are unfair, because they arbitrarily designate certain items as not being needed. (Is an apple “needed?”)

FICA is fair, because the people who pay are the people who receive Social Security and Medicare. This tax is unfair, because it is a regressive tax.

Sales taxes are fair, because each person pays according to his consumption. Sales taxes are unfair, because they place a burden on low income people, who spend a greater percentage of their income and save/invest less.

Flat-rate income tax is fair, because each person pays the same rate. These taxes are unfair, because the poor cannot afford to pay as high a rate as the wealthy. They also are unfair, because some people will pay more than others.

Progressive rate income tax is fair, because high earners can afford to pay a higher rate. This tax is unfair, because even at a flat rate, higher earners would pay more. A progressive rate compounds the unfairness.

Tax on Social Security benefits is fair, because social security is just another form of income. These taxes are unfair, because income tax already was paid on Social Security deposits. It is a double tax.

Tax on Medicare benefits. See above.

Inheritance tax is fair, because wealthy families can afford to pay more. This tax is unfair, because taxes already have been paid on the assets being inherited. It is a double tax.

Personal property tax is fair, because the wealthy can afford to pay more. This tax is unfair, because taxes already have been paid on the earnings needed to acquire the assets. It is another double tax.

Tax on stock dividends is fair, because dividends are no different from any other income. This tax is unfair, because companies cannot deduct the cost and already have paid taxes on the earnings. It is one more double tax.

Taxes on corporations are fair because business should pay its share. These taxes are unfair, because they penalize workers by reducing corporations’ ability to hire and to pay salaries and benefits.

All taxes are fair and unfair, depending on whose toes are pinched. Discussions of tax fairness are sophistry, demagoguery or both. If you hear someone arguing that one federal tax is fairer while another is unfair, mark that person as a liar or a fool.

The question of federal tax fairness is not an appropriate subject for economics’ discussions. No tax is fair, and the federal government doesn’t need tax money. Perhaps the discussion is more appropriate for a psychology seminar.

If taxes are wrongly to be collected for anti-inflation purposes, the real question should be: How harmful is it to the overall economy?

In nearly all cases, the tax will be harmful. (Exceptions may be taxes collected to curtail harmful items that politically cannot be eliminated by law. These include taxes on guns, drugs, cigarettes, etc.)

I submit that the most harmful taxes tend to be those most likely to widen the Gap between the rich and the rest, i.e. the most regressive taxes.

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

–A personal musing. What is the future of jobs? Do jobs matter?

The debt hawks are to economics as the creationists are to biology. Those, who do not understand monetary sovereignty, do not understand economics. Cutting the federal deficit is the most ignorant and damaging step the federal government could take. It ranks ahead of the Hawley-Smoot Tariff.
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A personal musing. What is the future of jobs? Are we wrong to focus on job creation? Here is an excerpt from an article that ran last year:

CBS Reports; WALLINGFORD, CT., Jan. 5, 2009
The Future of Jobs in America; Innovation, R&D, and Education are Keys to Job Creation, By Anthony Mason

For 23 straight months now, the U.S. economy has been hemorrhaging jobs. . . One in six Americans, 17 percent, is underemployed. That’s nearly 25 million people who are out of work, have given up looking, or been forced to take a part time job. The recession has wiped out 15 percent of our manufacturing workforce. That’s more than 2 million jobs that will likely never come back.

Here is an excerpt from a recent article:

Jobs in China, By ANDREW JACOBS, The New York Times, 12/12/2010
In 1998 . . . Chinese colleges produced 830,000 graduates. . . . Last May, that number was more than six million and rising. . . The economy, despite its robust growth, does not generate enough good professional jobs to absorb the influx of highly educated young adults. And many of them bear the inflated expectations of their parents, who emptied their bank accounts to buy them the good life that a higher education is presumed to guarantee.

It widely is believed America suffers from a shortage of jobs. I suggest that may not be true. Rather, America suffers from a shortage of money.

It began with the Industrial Revolution. Since then, machines have done more work that people once did. Machines chased people off labor-intensive farms to manufacturing and white collar work. Then, machines run by people, chased people off those jobs. Soon, machines run by computers began to take over. But someone had to build and program the computers, so jobs in electronics industries expanded. Now computers have begun to build and program computers.

So from where will the next jobs come? And does it matter?

Most people really don’t want a job; they want money. Yes, some jobs may offer personal satisfaction, and may occupy otherwise dull hours, but for most people seeking jobs, money is the primary goal.

Wait, Rodger. People do not want money. They want what money will buy. They want more security, better shelter, food, clothing, health care, education. They want admiration. They want envy. They want accomplishment. They want to win.

O.K.., money can’t buy everything, but it can buy much of what people want. A jobs is a means to obtain money, which in turn is a means to obtain the things we want. And that Rube Goldbergian “means-to-a-means-to-a-means” connection is being superseded by machines.

Those who have seen the “Star Trek, The Next Generation” TV series are familiar with the “replicator.” It can synthesize any non-living product, seemingly out of thin air. If such a device existed today, our money and job needs would decline radically. Yes, we might continue to work for satisfaction, for creativity, or to fill otherwise-empty hours – but not so much for money, since there would be little need for money other than perhaps to pay for some services. The replicator could supply our product needs.

Replicators may seem far off, but we are evolving in that direction, where machines supply more and more of our product needs. And as that happens we butt up against what will be increasingly difficult questions: Why must we work to obtain money – and why must people struggle to find jobs to obtain money – especially since money is free?

That’s right. Money is free. The U.S. federal government has the infinite ability to create money out of thin air. In essence, the U.S. government is a “money replicator.” At the touch of a button, the government could supply each of us with unlimited money. Want $1 trillion? No problem. Here, take $2 trillion. There is no physical money; it’s all just data, and data is infinite.

Extreme amounts of money creation would reduce the value of money (aka “inflation”), but the point is this: There is no fundamental reason why anyone in America should lack food, clothing, shelter, education, health care simply for lack of a job. There is no job-related reason for poverty in America. Our “money-replicator” government has the power to lift everyone from poverty and supply all their basic needs.

This brings us to an important difference between why people want to work and why the economy wants people to work. While people work to obtain goods and services, the economy wants people to work to create goods and services. If we all owned replicators, and if no one worked, eventually we would have no progress and no services, and the economy would collapse.

There may be a compromise, between where we are today and an economy with no jobs at all. I’m not sure exactly where that compromise is, and surely it would change over time, but here are a couple of “what-ifs.” What if:

–The government’s “money replicator” gave every man, woman and child enough to pay for food, clothing, home, health care, entertainment and education through college — i.e. ended poverty?
–Those who wanted more than basics could work, but the standard, legal work days were lowered from 8 hours to 6 hours to 4 hours or less, providing more jobs for all who wanted them?
–Federal taxes, being unnecessary, were phased out?

Of course, the devil is in the details. What about Inflation? Motivation? Progress? International relations? I have some thoughts on these, which I plan to provide in later posts. I believe we eventually will loosen the connection between jobs to money to goods and services. It won’t be “if” but “when,” and it will be an improvement over our current situation of too much joblessness, poverty, illiteracy, homelessness, sickness and struggle.

Time and energy devoted to the creation of jobs may take us down the wrong path. Perhaps we should focus on the creation and distribution of money.

What are your thoughts?

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

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