BUDGET DEFICIT vs. BALANCED BUDGET
Jacob Gelt Dekker | December 25, 1995 Key West, Florida

With emotions running rampant, Americans discuss the budget deficit. Emphatically, impulsive positions are posed as economic facts and wisdom, sound-bites manipulated as expert opinions, and statistical data regardless applied. Patriotic passions condemn opposing views as high-treason and budget deficit discussions only end when blood is drawn.

When I, as a foreign alien, state that from a macro-economic point of view, the budget deficit of the USA has little or no impact on the wealth of the people, I usually have to run for cover before I can explain my point. Therefore, herewith my reasoning - a bit scholastic - but at least this way I will not get shot instantly by hot-headed lanaced-budget patriots.

First of all, it is my understanding that the "budget deficit" is that parat of the national (US) government spending budget not covered by fiscal income, but financed mostly by money-market loan instruments and T-bills.

It is argued that a money-market financed deficit is detrimental to the economy as a whole. Supposedly, in the long run, all fiscal income will have to be dedicated to loan and interest repayments. Therefore, a balanced budget is required to save the nation from inevitable bankruptcy.

I believe this to be a fallacy. Contrarily, a balanced budget could easily lead to deflation and a shrinking economy, seriously hurting all Americans. Mr. Daume, Secretary of the Treasury in 1948, imposed a balanced budget on Japan as part of its post-war Constitution. Despite thirty years of dramatic savings-effort by individual Japanese households, Japan has experienced the most terrible economic recession since 1988 with little hope of recovery. Over the last five years, half of Japan's national savings were wiped out due to deflation and consequent revaluations of its currency. Japan's balanced budget made no difference whatsoever - if anything, it hurt unnecessarily. Japan's government spending deficit between 1948 and 1970 was simply written off on the account of separately financed war repair efforts.

If, for political-emotional reasons, a balanced budget is demanded, the easiest way to achieve it is by increasing taxes and/or reducing government spending. From a macro-economic point of view, it makes no difference.

A budget deficit equips governments with powerful monetary instruments to control the money supply, recycle the savings surplus, influence the interest rates, and reduce or increase taxes.


Money Supply
The money supply has to be in lock-step with economic growth of an economy. The more accurate economic growth is monitored, the better the balancing of the money supply. The best monitoring is in countries that have a VAT (Value-Added-Tax).

Discrepancies between the money supply and economic growth will lead to inflation (too much money) or deflation (too little).

Suppose economic growth of a national economy is 3% of GNP, and government spending is 30% of the GNP. An increase in the money supply of 3% is required (all other factors being equal). If the government had a budget deficit of one-tenth of its budget (3% of GNP), equal to the economic growth, it could simply increase the money supply by that amount through printing new currency, or increase the money supply by tapping into the Federal reserves in exchange for T-bills. (Note, the US budget deficit is only 2% of GNP, whereas the deficit in most European countries is 5% of GNP).

In other words, a financed budget deficit equal to economic growth enables a money supply growth through government issued bonds of no more than that supply growth without affecting any other factors.

That is exactly what most countries do. Conflicts between governments and Central Banks arise over the accuracy of monitored economic growth, since too much or too little will lead to undesired inflation or deflation. With the improvements of electronic monitoring, and with the data of VAT, economic growth monitoring is better than any other time in history.

If - like in Japan - the government has no instrument to control the money supply, the Central Bank has but one option . . . making the money supply growth available to the private economy. Japan has done that for decades with the consequences that average corporate equity is only 5-10%. Japanese companies over-invested, borrowing money market funds against one or two percent interest. the manufacturing overcapacity caused over-supply, low or no product margins, deflation and loss of capital.

The glut of domestic capital led to rampant real estate and stock market speculations, followed by a soap bubble-burt economic bust in 1988. In addition, large portions of Japan's savings were exported with disastrous results - a near 50% loss on money exchange and highly over-priced acquisitions.


The Savings Surplus
Over the last three decades, Western economies changed from individual to collective saving through insurance companies, pension funds and Social Security payroll withholdings. The total savings are recycled through the money market. Unfortunately, there are insufficient investment opportunities, causing speculative bull markets, and money exports through foreign investments. Despite speculation-price increases and money exports, there remains a savings surplus (money that has no investment opportunity). If this money is not taken out of circulation, all other factors remaining equal, overheated consumption an overheated stock market results (see Japan from 1980-1988).

Government-issues of T-bills and legal obligations by participation banks (the Central Bank) to buy bonds turned out to be a perfect instrument to reduce the money supply.

The government should therefore have available an, in size, fluctuating pool of T-bills in order to control the money supply. The new issue of T-Bills should always at least cover the saving surplus, assuming all other factors being equal.

A slow re-release of the "captured" saving-surplus can finance the government deficit.


The Interest
The assets of the US, as well as the liabilities, are owned by the people.

A dramatic , theatrical journalistic outcry is often made, stating that every American man, woman and child owes US$ 30 thousand dollars from the moment he or she is born.

That may be correct, but added to that , at least collectively from a macro-economic point of view, should be the contextual fact that each American owes that money to himself/herself, an a very small part to foreigners. In addition, American individuals also own about US$ 300 thousand in assets, since only 8-10% (depending on whose valuation one takes) of the national balance sheet assets at market value are mortgaged.

Politicians cry foul over national debt held by foreigners. It is true that Japanese, Germans and other foreigners bought and are buying parts of the US national debt. The total amount is well balanced, though, by US holdings of foreign debt, and, on a macro-economic level, has little or no influence on the overall economy.

The same applies to the interest over the debt. The American government owes interest over its borrowing to its own citizens. It can pay that interest in cash or in new T-bills as an instrument to regulate the money supply (see previous). If that is insufficient, most governments convert debt into equity by selling-off state monopolies (there is no reason in the world why the US government must be the largest real-estate owner or the largest car-fleet owner).


Taxes
When governments impose taxes, its citizens are obliged to pay. it is an involuntary contribution of the individual to the State. Monies are never paid back, and the taxpayer never receives any interest on his/her payments.

Contrarily, when a government issues T-bills, money is paid only by those who want to buy them. It is a voluntary contribution to the State. The money borrowed is paid back by the government to the individual, but from a macro-economic viewpoint, it is never paid back since it is rolled-over by the issue of new T-bills. The same applies for the interest. So, in a way, for the government, whether it be taxes or T-bills, it makes very little difference. However, for the individual, T-bills are a lot nicer.

With an economic growth of about 3% od GNP, the value increase of the government's assets outperform the debt (T-bills and interest) increase.


Conclusion
As long as government spending does not cause inflation or deflation and is in lock-step with economic development, there is no reason why tax-income shortages should not be financed on the money market. To the contrary, it supplies the government with excellent monetary instruments to regulate the economy. Having tight checks and balances in place and a separation of power between the Central bank and the Treasury is essential.

The key to prolonged wealth is improved productivity. This can only be achieved by long-term investments from savings. The budget deficit is, for the most part, irrelevant.

Jacob Gelt Dekker