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In Praise of Deficits


From the Guardian:

‘[Senator Jeff] Sessions appeared to dash hopes of an easy nomination process. “Jack Lew must never be secretary of treasury,” he said. Sessions said comments made by Lew two years ago, when he claimed that Obama’s budget plans would steer the US to a position where “we’re not adding to the debt anymore”, were “outrageous and false”.

The president claimed Lew was well qualified for the job of balancing the budget. “Under President Clinton, he presided over three budget surpluses in a row.” In word aimed at Republicans in Congress, he added: “So for all the talk out there about deficit reduction, making sure our books are balanced, this is the guy who did it. Three times.”‘

Well, if Senator Sessions were to adopt President Obama’s arguments AGAINST the nomination, we’d probably support his objections. As usual, our hopelessly out of paradigm deficit-hating President gets it wrong again in regard to fiscal policy. The roots of our current economic malaise started during the Clinton years when the federal government was running the biggest budget surpluses the government has ever run. Everyone thought this was great because it meant that the government’s outstanding debt was being reduced. Clinton even went on TV and predicted that the budget surpluses would last for at least 15 years and that every dollar of government debt would be retired.

Everyone celebrated this accomplishment, and claimed the budget surplus was great for the economy.

In fact, what was actually happening was that the budget surplus meant by identity that the private sector was running a deficit. Households and firms were going ever farther into debt, and they were losing their net wealth of government bonds. This eventually caused a recession because the private sector became too indebted and thus had to cut back spending.

In fact, the economy went into recession within half a year, although the recession was short-lived due to rise of budget deficits under Bush (which began to put a floor on aggregate demand) along with the increasing resort to toxic debt instruments to help fund a housing bubble – yet more PRIVATE debt, rather than public debt – which created the seeds for the Great Recession of 2008.

Of course we still have large budget deficits. No one talks any more about achieving budget surpluses this decade; almost everyone agrees that we will not see budget surpluses again in our lifetimes—if ever. And these deficits are consistently decried by everybody, including the President (as his misguided praise of Treasury Secretary nominee Jacob Lew illustrates), despite the fact that they ensured that the Great Depression did not morph into Great Depression 2.0. What happened in the United States was that we had a very flexible and effective system of public transfer payments which rose rapidly in the crisis. Unemployment insurance, early retirement under social security, disability, lower tax collections, and then on top of that, the expansion package, the stimulus package, the Keynesian policy that came into effect very quickly. And these things broke the fall in incomes and preserved living standards to a very substantial degree.

The question is whether the US government can run deficits forever. The answer is emphatically “yes”, although this is very separate from the question of whether it should do so. But one thing that the President (and the deficit-phobic Congress) should bear in mind is this: If you look back to 1776, the federal budget has run a continuous deficit except for 7 short periods. The first 6 of those were followed by depressions—the last time was in 1929 which was followed by the Great Depression. The one exception was the Clinton budget surplus, which was followed (so far) only by a recession.

Why is that? By identity, budget surpluses suck income and wealth out of the private sector. This causes private spending to fall, leading to downsizing and unemployment. The only way around that is to run a trade or current account surplus.

The problem is that it is hard to see how the US can do that—in fact, our current account deficit is now around 4% of GDP. All things equal, that means our budget deficit has to be even larger to allow our private sector to save.

Again, to reiterate: government deficits are NOT always good, or that the bigger the deficit, the better. The point I am making is that we have to recognize the macro relations among the sectors. If we say that a government deficit is burdening our future children with debt, we are ignoring the fact that this is offset by their saving and accumulation of financial wealth in the form of government debt. It is hard to see why households would be better off if they did not have that wealth.

If we say that the government can run budget surpluses for 15 years, what we are ignoring is that this means the private sector will have to run deficits for 15 years—going into debt that totals trillions of dollars in order to allow the government to retire its debt. Again it is hard to see why households would be better off if they owed more debt, just so that the government would owe them less.

That’s the kind of thing that our presumptive new Treasury Secretary should be saying at his impending confirmation hearings. Given his record, and the President’s misguided praise in favour of Clinton’s budget surpluses, fat chance of that occurring.

MARSHALL AUERBACK is a market analyst and commentator. He is a brainstruster for the Franklin and Eleanor Roosevelt Intitute. He can be reached at


MARSHALL AUERBACK is a market analyst and commentator. He is a brainstruster for the Franklin and Eleanor Roosevelt Intitute. He can be reached at

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