The Federal Deficit is a Symptom, Not a Disease

Member of Congress are infamous for attacking symptoms of a problem instead of going straight to the heart of the disease, and the current "discussion" on the massive federal deficits are yet another case in point. While I do find myself in some agreement with Paul Krugman on the issue of deficits in his most recent column, nonetheless I also find that once again Krugman sets up the straw man argument and falsely portrays himself as a lonely voice of sanity.

I will say it again; the federal budget deficits are symptoms of the larger problem of federal spending and lawmakers and economists should not be fixated upon them while ignoring more important issues. While I agree with Krugman that as the economy improves, deficits will grow smaller, I contend that the Keynesian prescription -- spend like crazy during the recession -- actually has made the economy worse and has prevented a more robust recovery.

Then there are following statements like this that make me scratch my head in disbelief:

What’s really remarkable at this point, however, is the persistence of the deficit fixation in the face of rapidly changing facts. People still talk as if the deficit were exploding, as if the United States budget were on an unsustainable path; in fact, the deficit is falling more rapidly than it has for generations, it is already down to sustainable levels, and it is too small given the state of the economy.

Yes, readers are told simultaneously that (a) the deficit is dwindling because the economy is improving and, (b) the deficit needs to be bigger to help the economy. This is the classic non sequitur in which (a) does not imply (b). His logical chain, I believe, runs as such:

• Deficits should be large if the economy is depressed because extra spending (as long as the revenues come from borrowing or outright money printing or taxes on the "idle hoards" of the rich) boosts the economy, as more deficit spending ultimately will lead to less deficit spending;
• The current federal deficit is dwindling even as government spending increases because the U.S. economy is rapidly improving;
• Therefore, the current U.S. federal deficit is too small.

The idea behind Krugman's thinking here is that the U.S. economy has been mired in a "liquidity trap," a set of circumstances in which individuals as a whole are mired in a perverse Nash Equilibrium in which no one will seek better gains from trade because no one else is willing to do the same. If government does not try to break the logjam with massive new spending (no worry of where to spend, just spend), then the economy will permanently be stuck at a miserable steady-state of high unemployment and low output. Only new government spending can change the circumstances.

Keep in mind that U.S. Government policies before 1929 pretty much adhered to what Krugman says not to do, yet the economy always recovered from downturns. Only from 1929 to 1940 did the government actively intervene, and we call that era the Great Depression, yet today we are told that the New Deal programs actually ended the Depression, which clearly is not true.

Murray Rothbard wrote about the penchant of governments to try to internally bring prosperity by more spending, and he predicted (accurately) that the programs would fail. This section from America's Great Depression is a very poignant commentary on what has been done in the past five years:

If government wishes to see a depression ended as quickly as possible, and the economy returned to normal prosperity, what course should it adopt? The first and clearest injunction is: don't interfere with the market's adjustment process. The more the government intervenes to delay the market's adjustment, the longer and more grueling the depression will be, and the more difficult will be the road to complete recovery. Government hampering aggravates and perpetuates the depression. Yet, government depression policy has always (and would have even more today) aggravated the very evils it has loudly tried to cure. If, in fact, we list logically the various ways that government could hamper market adjustment, we will find that we have precisely listed the favorite "anti-depression" arsenal of government policy. Thus, here are the ways the adjustment process can be hobbled:

1. Prevent or delay liquidation. Lend money to shaky businesses, call on banks to lend further, etc.


2. Inflate further. Further inflation blocks the necessary fall in prices, thus delaying adjustment and prolonging depression. Further credit expansion creates more malinvestments, which, in their turn, will have to be liquidated in some later depression. A government "easy money" policy prevents the market's return to the necessary higher interest rates.


3. Keep wage rates up. Artificial maintenance of wage rates in a depression insures permanent mass unemployment. Furthermore, in a deflation, when prices are falling, keeping the same rate of money wages means that real wage rates have been pushed higher. In the face of falling business demand, this greatly aggravates the unemployment problem.


4. Keep prices up. Keeping prices above their free-market levels will create unsalable surpluses, and prevent a return to prosperity.


5. Stimulate consumption and discourage saving. We have seen that more saving and less consumption would speed recovery; more consumption and less saving aggravate the shortage of saved-capital even further. Government can encourage consumption by "food stamp plans" and relief payments. It can discourage savings and investment by higher taxes, particularly on the wealthy and on corporations and estates. As a matter of fact, any increase of taxes and government spending will discourage saving and investment and stimulate consumption, since government spending is all consumption. Some of the private funds would have been saved and invested; all of the government funds are consumed. Any increase in the relative size of government in the economy, therefore, shifts the societal consumption-investment ratio in favor of consumption, and prolongs the depression.


6. Subsidize unemployment. Any subsidization of unemployment (via unemployment "insurance," relief, etc.) will prolong unemployment indefinitely, and delay the shift of workers to the fields where jobs are available.

Both the Bush and Obama administrations have done all of these things in spades, yet even now Krugman complains that we need larger budget deficits (although the current shrinking deficit reflects economic improvement). The above suggestions definitely set Keynesians to fits of apoplexy, but they pretty much have summed up what the government did before, and the economy always recovered.

The Keynesian response always is the same: we haven't spent enough money. How much is enough? The Keynesians will let us know when we have reached that point - but we haven't reached it yet.

Krugman is correct; the issue is not finding ways to cut the deficit per se, as much of the deficit is due to the condition of the economy. However, as Rothbard so clearly stated above, the massive government interventions have not helped the economy, but instead have slowed the recovery and have made it much harder for entrepreneurs to find those lines of production that are going to be profitable.

The fixation should not be on balancing the budget, both of us believe. However, we part company when we look at how to deal with the issue at hand.

I would ask this final question: If what Krugman has claimed earlier is true - that the U.S. Government's response to the crisis has essentially been one of "austerity" - then how is the economy growing fast enough to shrink the deficit? Furthermore, let me ask if this quote from Krugman even makes "Keynesian" sense:

“People are exhausting their savings,” he (Krugman) said. “People are running out of hope.”

Isn't the destruction of savings during a recession a key to bringing back prosperity? How can this be a sign of "losing hope" if the actions actually stimulate consumption, and every good Keynesian knows that consumption actually is the form of production that creates real prosperity? Furthermore, are we not supposed to be cheering on the Inflation Fairy as it destroys savings and raises real costs to individuals? Inquiring non-Keynesians really would like to know.