Faith is belief without evidence. Science is belief from evidence.
Economics is a science, so evidence should provide the foundation of any economic belief. But there is one belief in economics, so widespread and seemingly logical, it seldom is questioned. Yet it is responsible for every depression and most recessions in American history.
The belief is that U.S. federal deficits cause inflations, are owed and paid for by taxpayers, limit the availability of lending funds, reduce savings, increase dependence on foreign lenders and have other negative consequences, in short, the belief that federal deficits should be limited or even eliminated.
Not one of these beliefs is supported by historical evidence.
Do federal deficits cause inflations? The Federal Reserve Bank of St. Louis (http://research.stlouisfed.org/fred2/fredgraph?s[id]=AWHI) allows you to create a graph comparing annual changes in inflation vs. annual changes in federal debt for the past 50 years. The graph demonstrates that increases in federal debt have been coincident with reduced inflation. Example: The Carter inflation came with reduced deficits. The Reagan record-setting deficits came with reduced inflation.
Inflation is caused by many, non-cyclical events – wars, oil crises, droughts, etc. – and easily is controlled by making money more valuable, i.e., by raising interest rates. There is no modern historical relationship between federal deficits and inflation. In just the past 30 years, federal debt has grown 1,000%, yet even with today’s massive deficits, we are teetering on the edge of deflation, not inflation.
Are federal deficits owed and paid for by taxpayers? Debt is owed by debtors. We are not the debtor; the government is. We are not the government. We pay taxes; the government collects taxes. We are limited in the debt we can service; the government is not. The only cost to taxpayers is taxes. When taxes are not increased, taxpayers pay nothing for government deficit spending. Tax rates have been reduced from the Clinton days. So, the Iraq war and all the recent economic stimuli have not cost taxpayers one dime.
In the past 30 years, the federal government spent $9 trillion completely unsupported by any taxes. Neither we nor our grandchildren have paid for these expenditures. Who paid for them? The federal government. How? By creating money. In 1971, President Nixon divorced the dollar from gold. He did this to give the U.S. government the unlimited ability to create money to pay its debts. After 1971, the government no longer has needed your money.
Do federal deficits limit the availability of lending funds? Federal deficit spending adds money to the economy. There is no mechanism by which adding money to the economy can limit the availability of lending funds. Deficit spending increases the availability of lending funds.
Do federal deficits reduce savings? Because federal deficit spending adds money to the economy, some of the added money goes to savings. On the contrary, federal surpluses, which remove money from the economy, reduce savings.
Do deficits increase dependence on foreign lenders? Many foreign countries lend to us by buying T-securities. They do this, not out of kindness, but because they consider these securities to be a good investment. If every country stopped buying T-securities, the U.S. government would have two choices. It either could raise interest rates sufficiently to make T-securities attractive again, or simply could print money without borrowing.
That’s not as imprudent as some believe. Currently, the U.S. government borrows by creating T-securities out of thin air and then selling them. The government just as easily, and more safely, could create money out of thin air, and skip the borrowing stage. Borrowing, as a way to create money, is a relic from the days when money was backed by gold. Today, federal borrowing no longer is a necessary, or even an efficient, way to create money.
Do deficits have any negative economic impact? History shows deficit increases generally to correspond with GDP growth increases. By any economic measure, deficit increases have been beneficial. However, there is one possible negative result. Truly monumental deficits conceivably could lead to inflation. How big would they need to be?
We already know that a 1,000% increase over the past 30 years did not cause inflation, and today we fight deflation. To repeat such an increase would require deficits exceeding $3.5 trillion. So, we safely can say deficits far exceeding $3.5 trillion would be needed to cause inflation, and even then we could fight the inflation by raising interest rates.
The Concord Coalition, an organization devoted to eliminating federal deficits, has an impressive web site (www.concordcoalition.org), and many prominent members. The site speaks of “unsustainable deficits” and “debt burden,” but nowhere on this huge web site will one find any historical evidence showing that deficits are unsustainable or a burden. The faith is merely that debt is bad, and evidence or even debate is unnecessary.
In summary, U.S. federal deficits have not had negative economic effects. Evidence shows that large economies have more money than do small economies, so a growing economy requires a growing supply of money. Therefore, federal deficits are necessary for long term economic growth.
The harmful, irrational fear of deficits has prevented the government from taking prompt action to prevent or end recessions, and even as this is written, many in Congress oppose actions that would increase deficits and the money supply.
Just as in the days of Copernicus and Semmelweis, those relying solely on faith disparage the facts, much to the detriment of the populace.