Tom Power - December 17, 2012
Not a “Grand Bargain” but a “Grand Bluff”
Not a “Grand Bargain” but a “Grand Bluff”
All the talk in Washington DC is about how large the sacrifice is that we collectively have to make to get the federal government budget back in the black. Given that it has been concern about the federal deficit and the cumulative federal debt that was the economic club that got us backed into this corner, it is time to ask just what it is about the federal deficit that is so scary. The standard answer is that we are loading up the nation and future generations with the burden of this debt. At some point in the future, we are told, the debt will come due and our children and grandchildren will have to reduce their standard of living to pay it off. Either that or the federal government will go into default and have to declare bankruptcy.
That sounds plausible because that is what any household or business that took on too much debt would have to do. But the federal government has one power households and businesses do not have. It creates and manages the money supply.
Think about what in involved in paying off a U.S. Treasury Bond. You or your neighbor or the Chinese government takes the U.S. Treasury Bond to a bank or the U.S. Treasury itself and says, “This bond has matured; pay me what you owe me.” The federal government says “Sure, would you like us to credit you checking account by the amount we owe you or would you like cash.” If you take cash, you trade one piece of paper issued by the U.S. Treasury that paid interest and get in return some other pieces of paper called dollars issued by the U.S. Treasury or the Federal Reserve System. The government does not have to tax anyone to carry out this transaction; it can just makes electronic entries in your bank account which you can spend as you use your debit card or checks. Exactly who is likely to be stressed or hurt by this type of transaction?
The point is that U.S. Treasury bonds only obligate the U.S. government to pay interest in dollars and then, at maturity, present other dollars to the owner of the bond. But the U.S. government is the source, the creator, of those dollars. That was all you were promised. A relatively safe way to temporarily store your surplus dollars while, in the meantime, earning some interest in dollars.
This basic fact does not mean that the federal government can blithely ignore the dollars it is creating and the impact its involvement in the economy may have. But the concerns we should have are not that the federal government will run out of money, will not be able to honor its obligations, or will have to impose ruinous taxes on its citizens to pay its debts.
The legitimate concerns involve avoiding high rates of inflation, protecting the purchasing power of the dollar in international markets, and leaving leeway for the government to be able to stabilize the economy somewhat, stimulating it at times and slowing it down at other times.
Clearly if the government adds its demand for goods and services to that of private businesses and households during a time of full employment and rapid growth, something will have to give and what will give is that prices will begin to rise. While a relatively low rate of inflation appears to be better than deflation or falling prices, rapid inflation is disruptive and encourages unproductive defensive activities. But during periods like the present, with relatively high rates of unemployment, stable prices, and slow and halting growth, worries about inflation are not the proper public policy focus. We should stay focused on putting people back to work and rebuilding our businesses and households.
We also have to be concerned about the confidence the rest of the world has in our currency and the U.S. Treasury bonds in which people and governments store their dollars. If the U.S. were flooding international markets with dollars or Treasury bonds, the value of both would decline and interest rates in the U.S. would rise. That would increase the cost of imports to Americans and make American exports more attractive to buyers overseas. Given that we have been buying more from foreigners like China than we have been selling to them, that result might be seen as a good thing as all those people around the world holding dollars came shopping for American goods, putting our unemployed workers and underemployed factories back to work. But there is no sign that foreigners holding dollars or U.S. Treasury bonds want to get rid of them. Our dollar remains one of the safest ways in the world of storing wealth. There is no crisis brewing here either.
Finally, one of the primary ways the federal government tries to stabilize the U.S. economy is by manipulating interest rates. It lowers interest rates, such as it has been doing for many years since the beginning of the Great Recession, to encourage investments in new machinery, commercial buildings, and homes. When the economy appears to be overheating, it raises interest rates to slow the economy down. But if dollars are being created or debt was being issued by the federal government for other purposes, this economic regulating device might not be available. That is, one branch of government could be working at cross-purposes with another, creating confusion or paralysis in economic policy. But that also does not appear to be a problem at the present time.
What this suggests is that the panic over the federal debt is at best premature and at worst politically contrived to try to force us to abandon a social safety net that has served us well for seventy years. Cannibalizing it now out of fear that our government is teetering on the brink of collapse is simply nuts. Beware of those who tell us they are just trying to save that social safety net by “fixing it,” for they are the very people who have always opposed it.
We should not fall for this politically contrived game of bluff.