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July 01, 2007

US Economy: The Politics of Deficits and Power
by Gerard Jackson

The Democrats and their media mouthpieces are besides themselves over the rapidly shrinking deficit. You remember? The one that was going to a massive burden on future generations. I still call that in February 2003 al-Reuters gleefully reporting that the US was heading for a "whopping deficit' and that "record high deficits" will be a permanent and onerous burden on American taxpayers. As I pointed out at the time, the deficit is not a "whopping one" in the only sense that matters, and that is as a proportion of GDP.

Nevertheless, despite the historical record, foreign journalists cheerfully reported this nonsense as an economic fact. Geoff Elliott, Washington correspondent for Rupert Murdoch's Australian, could scarcely contain himself, using the Katrina tragedy to damn President Bush and the deficit (record deficit Hit on US economy to top $130bn, 8 September 2005). On another occasion our intrepid Mr Ellis sneered at the "plutocrats who underwrote the Bush campaign" (Not waving, drowning, 9 June 2005). Perhaps it's me, but every time I read Ellis I get the feeling I'm really reading a press release from the Democrats National Committee. Today journalists are being forced to sing another tune, one the reflects economic reality. Elizabeth Stanton of Bloomberg reported that

among the markets that President George W. Bush is doing "a heck of a job," the one he can take the most satisfaction from is U.S. Treasury bills. That's because the unexpected surge in tax receipts may pare the budget deficit by 39 percent to $150 billion this fiscal year, causing a relative scarcity of four-week, three-month and six-month bills".' he result is the biggest bull market for Treasury bills since the terrorist attacks on Sept. 11 drove investors to the safety of the securities.(U.S. Bill Rally Says Bush Is Doing "A Heck of a Job", 25 June)

Old Joe Blow must be scratching his head in puzzlement. President Bush has been continually slammed by the Democrats and their allies -- including their pals on Wall Street -- regarding the deficit. Now that it is shrinking some of these very critics are complaining that it is falling too fast. The man in the street needn't worry, these complaints are code for: "Bush is sabotaging our chances for 2008".

The only political negatives here are for the Democrats. But the situation should raise the question the government should issue bonds. Those in favour argue that because bonds are a 'riskless' investment they can be used as a benchmark against which to price other securities. Therefore, eliminating bonds or any other government debt instruments increases the risk of holding other securities which in turn raises costs for everyone.

I'm truly baffled as to how those geniuses on Wall Street could fall for this garbage. Let us for a moment assume that these sages are right and that government paper is truly riskless. What does that prove? How could this state of affairs possibly provide a benchmark for pricing non-government paper securities?

It never seems to occur to this mob that by issuing more and more credit instruments governments can actually reduce the number of risky investments that might otherwise have been undertaken. That this distinct possibility has virtually dropped out of sight suggests to me that these financial wizards cannot take an economic argument more than stage. (Rubin). Even worse, I have come to believe that they are inherently incapable of even recognising sound economics when it is presented to them.

Now let us do what our money gnomes never seem to do and that is take the argument to another stage. We know that bonds are the means by which governments tap savings. By guaranteeing a given return -- courtesy of the bond holders' fellow taxpayers -- governments divert savings from private investment to projects favoured by themselves. It goes without saying that the larger the bond market the more of the public's savings governments will consume. This means fewer savings for private investment, with marginal projects being the first to be sacrificed. What does it say to us that these financial warlocks appear incapable of grasping this fundamental fact?

It is argued that if there exists a large pool of "idle resources", including labour, then 'borrowing' by the government would not crowd out private investment. But a basic fact is being overlooked: this policy will only work if government spending lifts returns to the private sector. If government policies have kept returns extremely low, or even negative, then a monetary stimulus will have little or no effect on output. This is precisely what happened to the US economy in the 1930s -- thanks to the economic illiteracy of Hoover and Roosevelt. I am not saying anything knew here. Fritz Machlup made exactly the same point:

Credit expansion for the purpose of financing private investment will have slim chances so long as the prospective rates of return continue to be negative. (Fritz Machlup, The Stock Market, Credit and Capital Formation, William Hodge and Company, Limited, 1940, p. 194).

In other words, so long as politicians do not burden the private sector further with costly regulations and heavy taxes a credit expansion generated by artificially low interest rates will trigger a boom, money incomes and expenditure will rise and so increase the flow of government revenues. So long as the growth in revenues is allowed to grow faster than governments spending the deficit will continue to shrink.

But let us not forget that business always looks forward, meaning that if it expects a government to raise taxes and reduce the flow of savings (this is what capital gains taxes do) then these expectations will shape their investment decisions. A this point the likes of Pelosi, Webb, Kennedy, Kerry, etc., will demand more government action.

Machlup also went on to say that

...whether it is private or public investment that is concerned, the credit expansion which is undertaken in order to finance it [government spending], will necessarily produce changes in relative prices and changes in the structure of production. (Ibid, 194).

Unfortunately, the Democrats and their billionaire friends are not interested in sound economics -- only that which will satisfy their lust for power is acceptable. In order to properly deal with the Democrats and their ilk one must constantly bear in mind that bad faith is their principal characteristic.

Robert Rubin and Warren Buffett are billionaires who appear to think that their wealth gives them the carte blanche to deceive the American public about taxes and investment. I dealt with Rubin's economic idiocy in Why the Democrats' tax program could send the US economy south. I shall deal with the sanctimonious Buffet at a later date.

Gerard Jackson
BrookesNews.Com

Gerard Jackson is Brookes economics editor.

Copyright © 2005-2008 Gerard Jackson

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