In recent years the annual federal budget deficit has been growing at a steady rate. Last year alone the “on budget” deficit was nearly $200 billion. Many people show little concern over these increasing budget deficits and some others who are concerned feel the problem is too great for anyone to tackle. The deficit is not generally talked about with concern among friends and it draws proportionally little serious attention when positioned next to popular daily news items.
The inexorable consequences of continued government deficits will be far more devastating than a few pins and needles from the local Girl Scout Troop, and the general lack of concern by the population indicates little understanding about this “strange” monster called the deficit. Statistically, annual budget deficits are growing faster than the economy and also faster than general revenues. Currently the annual increase approaches 18 per cent; an added $20 billion a year is needed to pay the interest on the previous years deficit. The total Federal debt to date, since the founding of our country is over $1 trillion; yet at the present rate, in the next 10 short years more than a doubling of this debt will take place.
The dangers associated with this debt are very real, and the final principal evil resulting from this debt will be a debasement of the national currency, or in other words, monetization of the debt. Monetization of the U.S. Federal deficit is the most politically acceptable way to “pay” the deficit; however, the consequences of this inflation will be devastating. Economically speaking, a reduction in Federal spending is the only way to reduce our deficits and eliminate the temptation to inflate the money supply if the U.S. is to prosper in the future.
What Is a Debt?
“Individuals and nations can pay for their purchases in three ways: 1) out of current earnings, 2) by drawing from past savings, 3) by going in debt.” Government debt is no different from private debt in that deficit spending is simply spending money one does not yet have. Therefore, if Congress votes to spend more money than they take in by taxation or donation, assuming they don’t have a savings account to draw from, they must run a deficit. Annual increasing budget deficits of course indicate the government truly has no large bank account to draw from. Deficit spending is a result of excessive government spending. This leads to the question: Why is the government caught up in excessive spending, why doesn’t the government stop spending money it does not have?
Why Does the Government Run a Deficit?
The beginning of the U.S. budget deficits are partially attributed to a man named John Maynard Keynes (Keynesian economics). Keynes argued that during a time of depression and unemployment, such as that experienced during the 1929 Great Depression, the government could intervene into private affairs and manipulate savings to offset the generally depressed and unemployed economy. The way he proposed to accomplish this was by increasing “national aggregate demand,” by running a government budget deficit during depressed years. Keynes saw that the borrowed money would have a stimulating effect on the economy when initially introduced; however, when the deficit was paid back he realized an opposite, non-stimulating, effect would result.
Eventually, many people began to understand that a bit of stimulation was pleasant when initially introduced into the economy. Continued deficit spending resulted in continued increases in aggregate demand. Finally, many economists and politicians began to believe that an out standing deficit was the solution to any slowdown in the economy and that deficit spending was a very necessary insurance policy for a successful U.S. economy. This was all very acceptable to those who favored the Keynesian deficits. However, Keynes never resolved how these outstanding deficits would be financed. Keynesian deficits had to be financed and that was the unpleasant catch. More will be said about financing deficits later.
The birth of many government programs we have today started in conjunction with the “Keynesian Revolution.” Among these programs are Social Security, Medicaid, and Food Stamps to name just a common few. (Actually, a list of all government financed programs would be longer than this essay.) The point to be made is that government, over time, began to take on the function of being responsible for more than its original and narrowly defined purpose of protecting and maintaining a free society.
People became accustomed to the government subsidizing part of their income and started to rely on the government for financial security. As time passed the term “entitlement programs” was used to describe these government subsidized payments, and a growing number of students, elderly, and other special interest groups began feeling the government had a duty to provide these subsidized payments to them. Lawrence Reed clearly describes the entitlement program problem he encountered while running for Congress:
Similar experience came my way throughout the campaign. A farmer wanted dairy subsidies; a teacher demanded more money for education; some business man asked for more small business loans; a mayor appealed for more revenue sharing funds, and so on it went. And of course they all wanted me to be sure to send the bill to someone else. Isit any wonder we are becoming addicted to deficit spending, a practice that threatens to sink the U.S. economy with an incomprehensible burden of debt?
As special interest groups began to associate with the “right” to government transfer payments, derived from tax revenues and ultimately deficit spending, politicians began to find themselves in an increasingly sticky funding situation. Politicians are faced with the desire to be elected at the beginning of each new political term, and generally the politician who promises the most benefits from the hard-taxed public to the special interest groups in his district receives the most votes. This was not the sole determinant of who would or would not be elected during the early years of government spending. However, the number of people participating in government-financed spending programs increased rapidly as more and more people became “entitled” to one spending program or another. According to economist Warren T. Brookes, “Nearly 55% of the federal budget goes into what are commonly called ‘transfer payments,’ payments to individuals, families, or state and local governments for which no current service is rendered.”
One can easily imagine what happens if 55% of the people in a particular politician’s district enjoy the benefits of these “free and easy” transfer payments. Most wish to continue receiving them long into the future. If the politicians serving these special interest groups would say, “Sorry, we don’t have enough money to pay your college loans” (or welfare checks, or whatever else the payment they are receiving might be), those receiving the payments will become very unhappy. So unhappy, that if another man runs for office and promises them the same or greater benefits than the incumbent, the population is likely to vote for the greater monetary promise. Considering all the men who wish to run for political office and all the people who wish to receive payment for doing essentially nothing productive, one can see the temptation for politicians to drift toward public spending—and more public spending simply because an increasing majority of the population so demands. A free ride, something for nothing, is not the wisest economic policy.
Obviously, the components of chronic Federal overspending can be attributed to more than just transfer payments; however, transfer payments are the largest part of the Federal budget and clearly demonstrate the kind of political pressure that exists pushing spending beyond balanced limits. For practical purposes, as the demand for public spending increases, political pressure to spend increases, and the size of the budget deficit increases. This is the principal reason for large budget deficits.
Why Is the Deficit Bad?
Apart from the fact that budget deficits are bad for the economy, a point we will consider later, the social “transfer” and “entitlement” programs are detrimental to the economy and population as a whole. These programs transfer wealth from those who produce to those who are not necessarily being productive. Welfare is just one example. The ultimate result is an overall lowering of the standard of living for the population as a whole. Those who receive the payments lose incentive to work, or to be productive. Those who are taxed to support these unproductive persons have less money to save and invest in further productive capital. Since profits resulting from productive activity are partially taken away through taxation, the number of dollars left to save and invest in new capital decreases, and incentive to produce and maintain future capital is squelched. This increased government spending moves in a vicious circle of taxing, redistributing, and taxing again to bring the population to a lower standard of living and finally to a state of socialism.
Having looked at a short explanation of how the government has adopted an overspending policy of financial mismanagement and why the politicians are in a spend-spree bind, we can look further at why these deficits are so bad for our economy and country. Let us consider the political and financial alternatives to reducing or financing the debt. Four possible ways to confront a deficit exist: (1) increase taxes, (2) decrease spending, (3) borrow, or (4) monetize the debt. One or a combination of these options must be enacted when considering debt finance.
The first possible path that can be considered when approaching a budget deficit is an increase in taxes. We may cringe as we read this, for who wants to pay more taxes? Well, in fact, very few people do. That is a basic problem when considering this option of reconciling a Federal debt. The tax rates in the U.S. are already high enough to suit most people. Gary North states, “We have hit the resistance point in taxes as a percentage of personal income.” In other words, today, taxes imposed are not the same thing as taxes collected. This is not to say that there will be no further tax increases. However, taxes will not increase at the same high percentage rate that deficits and Federal budget outlays are increasing. People just will not accept large tax hikes. Imagine President Reagan proposing a $200 billion tax increase to offset next year’s deficit! The government would be confronted with a tax revolt and would be unable to squeeze half of the desired revenue from the population. People are at the resistance point as far as taxes go. (Earlier, we also saw that the combination of increased taxation and spending is undesirable since it lowers productivity, capital accumulation, and the overall standard of living, bringing the U.S. population closer and closer to becoming a purely socialized state.)
Decreasing Federal Spending
If increasing taxes is not a good approach when considering the deficit, let us look at another option; decreasing federal spending. First of all, politicians and elected officials have a lot on the line when they consider decreasing spending as opposed to finding other ways to finance the deficit. As discussed earlier, politics is their job and nobody really wants to lose a job. Economically speaking, almost all the special interest groups are willing to take but none are willing to give.
A reduction in Federal spending is actually a beneficial way to resolve the deficit problem because it reduces the size of the unproductive and inhibitory State burden upon the free market. This option, as economically hopeful as it may be, rests on the prerequisite that the population recognizes the debt hazard and is willing to give up its “Robin Hood Style” of economic gain in order to achieve long-run economic benefit. In addition, government officials must be so aware of the debt hazard that they do not tempt taxpayers to vote them into office on the promise of a free lunch. The chance of reducing government spending at the present time looks grim; however, it is an economically sound option to debt reduction. We will return to this idea of reducing spending later.
A third option one can consider when talking about the deficit is that of borrowing the money to continue enjoying deficit spending. Some real problems exist in borrowing to finance the debt. As Gary North explains, “The debt must be funded by selling debt certificates, and these certificates are never ever redeemed. They become part of the permanent debt base of the messianic State.” This means the government debt base is never paid off. When the government borrows money from citizens or private banks it begins paying interest on that loan immediately and indefinitely. The result of this can be imagined if one looks 10 years into the future when we will likely have a $2 trillion debt. The interest payment at 10 per cent per year on just this $2 trillion would be $200 billion which would have to be paid for by still more borrowing or taxation. Year after year this compounding will continue until not even the interest payments can be made on this debt, let alone the money needed for daily government operation to continue.
Complicating the problem still further is the fact that massive borrowing, even if it could continue indefinitely, will wreak havoc on the economy. Congressional Budget Office Directer Rudolph G. Penner states, “Interest costs are beginning to drive outlays in a very uncomfortable way.” In other words, as the government borrows large amounts of money it begins competing with the private, capital-investing sector of the economy. This causes interest rates to increase and private investment in capita] to decrease due to a higher cost involved in borrowing money and investing it in productive capital. Savings will be transferred and consumed by the unproductive government spending spree at the cost of private investment. Reduced private investment in capital, in turn, means a more restricted economy and lower productivity. Decreased productivity will lower government revenues reliant on tax dollars and start the whole vicious borrowing cycle all over again. During this time the standard of living of each person in the U.S. will continue falling until this ever-hungry debt has siphoned all life out of the economy.
Monetization of the Debt
Now that borrowing, taxing, and reduced spending have been discussed as three possible plans of debt reconciliation, we will turn to a last option, monetization of the debt.
Monetization of the debt is simply the government printing unbacked dollars to pay the debt. You could do precisely the same thing if you were up to your neck in debt and had access to a counterfeit printing machine. All you would need do is print a stack of counterfeit 10s and 20s and proceed to pay your lenders. This, of course, is illegal for a private citizen to do; however, the government uses this method of debt reduction with great regularity.
To understand the monetization process, imagine a small economy in which 100 dollars is the total amount of money in circulation. In this particular year the government collects $50 in taxes and has an added $20 deficit. To pay the deficit, the government decides that monetization is the easiest path to follow. So they tell the Federal Reserve Board (the printing press) that they need $20. The FED sends the 20 crisp new singles, and the government uses these new dollars to pay for their unfunded spending projects. However, now $120 are circulated in the economy instead of $100. Does this mean the economy is $20 richer? Of course not. The government has not created any wealth or capital, nor has it done anything productive. The government, just as any counterfeiter, has actually robbed wealth from some parts of the population and transferred some of that wealth to other parts, exactly as a counterfeiter would do.
Soon people will find that $2 isn’t worth $2 anymore and that they may need $3 to buy what had been a $2 item. As a counterfeiter prints new dollars, the value of each dollar in the economy must decrease; for now there will be more dollars competing for the same amount of goods, simple supply and demand. This monetization process is termed inflation and should not be confused with increasing prices. Price increase is a result of inflation; inflation is government printing of unbacked paper dollars or counterfeiting.
Inflation logically causes an increase in prices, but along with increasing prices there are other undesirable characteristics: (1) First of all, inflation is politically easy. By inflating, the debt is paid in one shot with no need to borrow any money. (2) The population as a whole does not understand the inflation process and, thus, does not react in the same way they would to large tax increases. (3) People enjoy getting raises and higher incomes year after year even though the inflated dollars they make don’t buy as many goods as before. (4) Many politicians and economists feel inflation has a stimulatory effect on the economy, reducing unemployment and increasing productivity. No government, however, can “buy” prosperity by printing paper money. Paper money is not wealth. Only increased capital investment and more efficient production can create wealth and revive and build an economy. Because of these characteristics of inflation the temptation by those in government office to overspend, inflate, and overspend some more is enormous. This is simply because the people and government officials view inflation as the easiest and most beneficial option to follow when financing deficit spending.
No Magic Potion
Inflation is not a magic potion, and the dangers of deficit spending are not easily printed away. Essentially, inflation is a “silent tax” eroding wealth from the American wage earner. This inflationary tax is no different from any other kind of tax in that it has the same tendency toward lowering productive activity as would an officially legislated tax. (Refer back to the section on taxation as a method of debt reduction.) Inflationary policies always end in destruction of the national currency, lower the standard of living, and decrease capital accumulation. Continued economic expansion grinds to a halt and a haphazard redistribution of profits and losses takes place. Ludwig von Mises explains:
. . . this wonderful system, [inflation] has one fundamental weakness: it cannot last. If inflation could go on forever there would be no point in telling governments they should not inflate. But the certain fact about inflation is that sooner or later, it must come to an end. It is a policy that cannot last.
In the end, inflation cannot last because the currency and the economy will be destroyed. In recorded history, no inflation ever resulted in continued economic stability and growth; and no practice of continued deficit spending ever resulted in anything but rampant inflation, monetization of the debt. (Incidentally, government can only inflate if it has access to the national currency. This is usually an unbacked currency. In earlier years American dollars were backed by gold. You cannot inflate gold. Since abandoning the gold standard, the U.S. has fallen into the inflationary trap that is now beginning to show its destructive effects.)
The serious effects of government spending and inflating have not yet been fully felt in the U.S., and many people neither see nor feel the threat of these devastating policies. Inflation must, however, be halted. According to that wise economist, Ludwig von Mises:
One of the privileges of a rich man is that he can afford to be foolish much longer than a poor man. And this is the situation of the United States. The financial policy of the U.S. is very bad and is getting worse. Perhaps the United States can afford to be foolish a bit longer than some other countries . . . . Inflation is a policy. And a policy can be changed. Therefore, there is no reason to give in to inflation. If one regards inflation as an evil, then one has to stop inflating. One has to balance the budget of the government.
Borrowing the money for long periods of time, as we saw, is not feasible because of the compounding effect of interest on these never-redeemed debt notes, competition with private borrowing, and a quickly depressed economy. This is politically unacceptable and a path no previous government has followed for long.
Increasing taxes and inflating are essentially the same thing since inflation is a tax. The public, however, will not stand for much increase in direct taxation without a blatant tax revolt. Large tax increases will not materialize into large revenue increases. Inflation, on the other hand, is a “silent tax”; few people understand it and fewer still would propose a plan to abolish it. Politicians like it because they are not easily associated with the inflating process, and for a while there seems to be no limit to the amount of money they can tax from the American citizen by inflating. They can promise their electors the many benefits of entitlement programs and all other programs in exchange for votes in the name of easy money. However, I repeat, in recorded his tory, no inflation ever resulted in continued economic growth, and no practice of continued deficit spending ever resulted in anything but rampant inflation.
Right now the U.S. government is both inflating and deficit spending. Time is running out. A serious reduction in government spending is the only way to pull the U.S. economy out of otherwise certain economic destruction. Reduced government spending will not only eliminate the deficit and all the danger associated with it, but, also, revitalize American industry and productivity. Reduced spending will again free American enterprisers to invest in productive capita] and let them profitably produce to the best of their ability. More and better capital investment is the only way to increase the per capita standard of living in a society despite age- old attempts to produce wealth by means of the printing press.
The lessons of inflation are slowly learned if learned at all. Therefore, if a serious sustained reduction in government spending is not maintained, the U.S. will follow the history of other nations to a similar inflationary fate. Politicians, citizens, teachers, and economists must intelligently resolve this problem by realizing the hazards of this seemingly inevitable inflation and by voting to greatly reduce government spending, thereby defusing the deft-cit time-bomb aimed at our country.
“The country,” declares G. C. Wie-gand, “is faced with grave problems—thirty years of inflationary boom may be followed by thirty years of relative decline, which may seriously affect the character of American society, free enterprise, and personal freedom,—but the country has the potential economic, social, and moral resources to overcome the threatening crisis. It all depends upon whether the leaders have the necessary wisdom and courage to lead, and the people have the stamina and will to make necessary sacrifices. The future of America is ultimately not an economic but a moral issue.”
1. Gary North, Remnant Review, Vol. 11, No. 2 (P.O. Box 8204, Fort Worth, Texas: 20 Jan. 1984), p. 7.