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US deficits and government spending — more fallacies
Gerard Jackson
Born-again deficit hawks argue that eliminating US deficits will lower interest rates and raise national savings. On the other hand, opponents claim that the deficits do not matter. This is not the same as saying that deficits stimulate growth and employment, which is what Democrats used to claim.
What Democrats and their media supporters’ make a point of downplaying is that deficits occur because spending exceeds revenue. They like to minimise this fact because to do otherwise would likely as not draw attention to their reckless spendthrift ways — not that they are the only ones who feel free to chuck taxpayers’ money at anything that they think will vote for them.
Basically there are only two ways by which governments can finance deficits: borrow money or print it. Now government borrowing usually drives up interest rates: it also directs savings from private investment to government consumption. The effect is to destroy marginal investments and lower economic growth. However, what deficit supporters usually have in mind is not borrowing but monetary expansion, i.e., inflation. Now inflation funded deficits not only distort the pattern of production they also create balance of payments problems as the current account blows out.
Those who justify the deficit on economic grounds are also advocating the printing press. Larry Kudlow, for instance, was arguing a couple of years ago that the Fed needed to pump up liquidity. In plain language, inflate the money supply. This is one of the oldest fallacies in economics and it is the one that brought on the Great Depression.
Moreover, it is the Fed’s loose monetary policy that is basically driving the current account deficit which is now running at about 6 per cent of GDP. It is no good deficit doves arguing that the “current account deficit reflects a healthy, growing economy”. This is precisely what the St. Louis Fed said in April 2001. (Talk about trying to defy economic gravity).
The real problem, as many commentators realise, is not deficits but spending. Governments cannot spend without taxing. As government consumption rises as a proportion of GDP so must taxation. There must come a point where the tax rate has a significant and detrimental effect on growth as it impacts on savings and investment, without which there can be no economic growth.
Democrats and their Keynesian allies would probably argue that to cut spending would increase unemployment by taking spending out of the economy. However, deficit cutting per se has no effect on aggregate spending. If the government cuts the deficit by raising taxes (which it does not hoard) or cutting spending (much more preferable) the immediate result is to change the composition of aggregate spending, not its magnitude. However, if the new pattern of spending favours more investment then the long term effect will be to raise living standards.
Anyway, let history do the talking on this one. Between 1945 and 1947 the US government slashed Federal spending from an annual $95 billion to $36 billion per year — a $59 billion cut in two years. This was a staggering 62 per cent reduction. Instead of the economy spiralling into a depression with 8 million unemployed, as predicted by Keynesians, though not Keynes, prices, wage rates and employment increased.
Reckless government spending is the enemy and it is time for this fact to be continuously and emphatically repeated, regardless of what economic illiterates like Hillary Clinton claim. (Listening to her lecture a crowd on deficits and growth would be like listening to her hubby defend the sanctity of marriage vows).
Eliminating the US deficit will do nothing to bring home to the electorate the damaging consequences of excessive government spending. The cruel irony is that big-spending policies are self-defeating. The real tragedy is that it takes so long for this to become evident. Some people, however, never learn. Do they, Messrs Clinton, Schumer, Levin and Kennedy?
Gerard Jackson is Brookes’ economics editor
BrookesNews.Com
Monday 1 August 2005