America Needs Deficits

The government must continuously create dollars for the economy to grow, to let people save, and to pay to import more things like oil and manufactured goods than we export. The government creates dollars by writing checks.
This post was published on the now-closed HuffPost Contributor platform. Contributors control their own work and posted freely to our site. If you need to flag this entry as abusive, send us an email.

The U.S. government is not in financial trouble. It can't run out of dollars and it can't go bankrupt. It isn't building a mountain of debt that will burden future generations. It won't have trouble paying for Social Security, Medicare, or other current programs. And it shouldn't avoid deficits and balance its budget as families, companies, states, or governments that use the euro have to do

These statements conflict with what nearly everyone believes. But deficits are as old as the country, having occurred during 128 years, or sixty-one percent of the time since 1799. America's sovereign monetary system is a mirror image of how family and state finances work. The details are complex but the basics are simple. They are confirmed by history and they are vitally important. In brief:

The government must continuously create dollars for the economy to grow, to let people save, and to pay to import more things like oil and manufactured goods than we export. The government creates dollars by writing checks. The dollars enter the economy when payees deposit the checks in their banks. America's dollars are called sovereign because they are created by the US Government. Their value is free floating, which means they are not tied to any other currency or value standard like gold. And bankruptcy is not possible because holders of government bonds anywhere in the world are only entitled to receive dollars as repayment.

Just creating and spending dollars would cause inflation, which the government can prevent with taxes that must be paid with dollars. There are many reasons for imposing taxes, but their primary economic function is to take back some of the dollars the government has created to prevent inflation. The trick is to balance taxes with dollar creation to keep the economy expanding safely.

Dollar creation is the economy's gas pedal and taxes are its brakes. The gas pedal must be pressed more than the brakes to go anywhere. Federal spending is the gas the economy uses to go, and if the government did not spend more than it taxes, the economy would just stand still unless the private sector compensates by taking on massive debts as it did to finance the recent consumption and real estate booms.

Like a car, the economy uses more gas to go uphill than on a level. Right now, millions of people are unemployed or underemployed; they are spending less, losing their homes, or have lost their investments in them; state and local governments are cutting services; and most important, consumer, real estate, and business debts that drove the last decade's boom are being reduced or written off. Inflation from excess government spending is not a problem today. The economy passed a dip when the recession ended, but there is still a lot of hill to climb, and that will take more gas (spending) or less breaking (lower taxes) -- either of which will cause more deficits. The thing to fear is not the deficits but the failure to create them when they are needed.

Comparing the federal budget to a car is more accurate than comparing it with a family or state budget because the government creates its own gas in the form of dollars, while all others must get dollars the government has created before spending them. The key point is that America's monetary system must run a deficit most of the time by spending more than it taxes so that people who want to save for their retirement or other reasons can spend less than they earn. The dollars they save or use to pay down their debts are created by running a federal deficit. No deficit -- no dollars for savings.

Each year's deficit adds to what is called the federal debt. But that is a poor name because it is not like a debt that you or I might have. It is actually the sum of dollars the government has created and people have saved since the nation was founded. It is a national asset that economists call our net financial wealth or total savings. The debt cannot be repaid without eliminating people's savings and that will not happen for long. As Professor Randall Wray of the University of Missouri-Kansas City has explained:

With one brief exception, the federal government has been in debt every year since 1776. In January 1835, for the first and only time in U.S. history, the public debt was retired, and a budget surplus was maintained for the next two years in order to accumulate what Treasury Secretary Levi Woodbury called "a fund to meet future deficits." In 1837 the economy collapsed into a deep depression that drove the budget into deficit, and the federal government has been in debt ever since. Since 1776 there have been exactly seven periods of substantial budget surpluses and significant reduction of the debt. From 1817 to 1821 the national debt fell by 29 percent; from 1823 to 1836 it was eliminated (Jackson's efforts); from 1852 to 1857 it fell by 59 percent, from 1867 to 1873 by 27 percent, from 1880 to 1893 by more than 50 percent, and from 1920 to 1930 by about a third. Of course, the last time we ran a budget surplus was during the Clinton years.

The United States has also experienced six periods of depression. The depressions began in 1819, 1837, 1857, 1873, 1893, and 1929. (Do you see any pattern? Take a look at the dates listed above.) With the exception of the Clinton surpluses, every significant reduction of the outstanding debt has been followed by a depression, and every depression has been preceded by significant debt reduction. The Clinton surplus was followed by the Bush recession, a speculative euphoria, and then the collapse in which we now find ourselves. The jury is still out on whether we might manage to work this up to yet another great depression. While we cannot rule out coincidences, seven surpluses followed by six and a half depressions (with some possibility for making it the perfect seven) should raise some eyebrows. And, by the way, our less serious downturns have almost always been preceded by reductions of federal budget deficits.

That history is vitally important right now. Most Americans believe the deficit must be reduced, but a lesson can also be learned from what happened after 1937. The deficit was reduced too soon and what had begun as a recession turned into the Great Depression. And the lesson doesn't end there. Record deficits were incurred to win World War II, help the world rebuild, and restore the US economy. The Greatest Generation wasn't spooked by deficits.

But then as now, some people worried that the mountain of debt would be a burden on future generations -- the boomers and their children. Attempts were made to reduce the debt but they failed and the economy went back into a recession. The worries, however, did not come true, and nary a boomer nor GenXer worries about paying back the debts incurred during the 1930s and '40s. They will never have to do it because the economy continued to grow, making the debt relatively less important. The lesson says that today, the surest way to ensure a double dip would be to cut the deficit too soon.

There is no financial reason to scrimp on things that need to be done now. Differences about what the federal government should do should be resolved on their merits. But if we want them, we can afford paying for universal health care, supporting education, rebuilding infrastructure, helping new industries create middle class jobs, and assisting troubled state and local governments. It would be a tragic mistake to let our supposed inability to pay keep us from doing what should be done. The liberating power of our monetary system is that it can create dollars to work for us when we need them. We are not captives of the federal budget, the budget is our tool to use wisely.

The monetary system is so different from what most people, including some economists and those in government, think it is, its full power may not be harnessed for years. Just knowing that the government creates money could lead us to act like kids in a candy store unless there are limitations. The budget process and several laws must be reviewed and modified. Basic principles of governance may even need to be changed. And because inflation is the most obvious danger, we need to understand it better -- what it is, how to measure it, and how to control it.

In short, we must learn how to drive again. But if we really care about future generations, we must not let mistaken fears of deficits and the debt keep us from doing what should be done right now to help rebuild the country's strength, care for its people, and prevent another depression.

This discussion is a generalized summary of the views of economists and others who are working with Modern Monetary Theory and Monetary Sovereignty to explain how America's monetary system works. Some of them reviewed it and their suggestions are included. For more information, contact New Economic Perspectives at umkc.economists _at_

Go To Homepage

Popular in the Community