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.
1 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 11 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." 2 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 outstanding 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.
Entitlements Claimed
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.
Is it 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. 3 Transfer Payments 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 hew 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." 4
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 expla-nation 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.
Tax Increases
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."
5In 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.
Borrowing
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."
6This 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 Director Rudolph G.
Penner states, "Interest costs are beginning to drive outlays in a very
uncomfortable way." 7 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 capital 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 in creases. (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. 8 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. 9
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. 10
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.
11
Conclusion
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 history, 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 capital 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 deficit time-bomb aimed
at our country.
"The country," declares G. C. Wiegand, "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."12
At the time of the original publication, Mr. Van
Drunen was a senior at Purdue University and was seriously concerned
about the debt he bears.
1 Gary North, Remnant Review, Vol. 11, No. 2 (P.O. Box
8204, Fort Worth, Texas: 20 Jan. 1984), p. 7.
2 G.C. Wiegand, Debts, Inflation and the Future,
(Greenwich, Conn., Committee for Monetary Research and Education,
Monetary Tract 17, Jan. 1977), p. 8.
3 Lawrence Reed, "Where Deficits Come From," Western
Monetary Report, Vol. 3, No. 5 (March 1, 1984), p. 7.
4 Reed, p. 6.
5 Gary North, The Last Train Out (Fort Worth, Texas:
American Bureau of Economic Education, 1983), p. 46.
6 North, Remnant Review, p. 4.
7 "Reagan's Good Times Budget," Business Week, No. 2826
(January 30, 1984), p. 70.
8 Wiegand,p.5.
9 Henry Hazlitt, "Keynesism in a Nutshell," The
Freeman; Vol. 32, No. 11 (November 1982), p. 650.
10 Ludwig von Mises, Economic Policy (South Bend, Ind:
Regnery/Gateway, 1979), p. 63.
11 Mises, p. 72.
12 Wiegand, p. 33.
Henry Hazlitt
I may point out (if that is still deemed necessary in
this inflationary era) that no inflation of which we have historical
knowledge resulted in sound and continued business expansion but only in
currency depreciation, a wanton redistribution of profits and losses,
disorganized output, and economic demoralization. This has been true
whether we begin with the coinage debasement of ancient Rome or the
paper money scheme of John Law in 1716.
The lessons of inflation are soon forgotten. They
apparently must be relearned in every generation.
Reprinted with permission from The
Freeman, a publication of The Foundation for Economic Education, Inc.,
October 1984, Vol. 34, No. 10.
Yourname@libertyhaven.com
