The Myth of the Need to Balance the Budget

We are constantly bombarded with the myth that the federal government needs to balance its budget in order the get the federal deficit in check and end out-of-control government spending.  This refrain has been a hallmark of the Republican Party for decades, and more recently espoused with lunatic fervor by the Tea Party. Many Democrats have likewise promoted the idea that balancing the federal budget and reducing the federal deficit through spending cuts is a political goal that would stimulate the U.S. economy.

The logical fallacy in the argument for a balanced budget is that it assumes federal government spending itself has no relationship to the available tax base. Spending cuts to balance the budget is a policy that results in a shrinking tax base, which in turn requires more spending cuts to balance the budget.  This creates a vicious cycle of austerity in the form of spending cuts that erode the tax base leading to more spending cuts.

In the modern age, federal government spending itself is the primary driver of real production. Therefore, increased government spending correlates to an increased tax base.  The tax base increases more and at a faster rate when government spending programs are specifically designed to stimulate economic activity.  A recent example is the Obama stimulus of 2009 and accompanying bailout of the auto industry, which served to maintain existing jobs and create new jobs in manufacturing and infrastructure.  Although money for programs like the Obama stimulus is borrowed, the net rise in the tax base should, if the monetary stimulus is managed correctly, more than pay for itself over time.  In this way, federal stimulus through debt is an appropriate way to increase real production and the over-all federal tax base allowing the debt to be repaid with surplus left over.

But there is an even better way to use debt to stimulate economic production.  The Obama stimulus was a “monetary” stimulus because the money for the stimulus was borrowed from the public primarily by floating US Government bonds, drawing “hot money” into the economy.  However, the most efficient use of debt as a tool for economic growth is a “credit” stimulus.  A credit stimulus to procuring capital goods primarily differs from a monetary stimulus by the cost to borrow. The money for a credit stimulus would be borrowed from a national bank (in our case the Federal Reserve) at interest rates considerably lower than those obtainable in the bond market.  Thus, stimulating production of tangible goods like machine parts, energy generators, infrastructure, etc. is “off-budget,” and a tool to raise economic productivity and the tax base with much lower borrowing costs than obtainable in a monetary stimulus model.  The Federal Reserve has failed to function in this way for many decades.

Presently, the Obama monetary stimulus dollars have long since been spent. Our elected leaders have done nothing since to use government debt properly, with any type of stimulus, to use government spending programs to grow our way out of the continuing depression.

The Democrats are bad enough, but if the Republicans have their way, not only will a credit stimulus be out the window, but monetary stimulus will too. Perhaps the last true attempt at obtaining interest free debt was Lincoln’s issuance of greenback notes. The solution today is to commander the federal reserve with an act of Congress and force it to issue low interest, long maturity debt instruments to the federal government, state governments and authorities, under well-managed credit stimulus with window for investment in productive growth. A focus on infrastructure and large capital expenditures on productive equipment like factories and machine tools is essential.  A program largely on the model of Henry Hopkin’s Works Progress Administration is a recent historical example and model.

No longer can the Federal Reserve serve only the private banks.  And we must never forget that the most evil policy of all would be a “balanced budget” at a time of depression.  Implementing that policy is prosecutable at Nuremberg.

Jeffrey C. Jackson, Esq.