Is the deficit and debt necessarily a bad thing?

I keep on hearing people complain about how we’re living off the backs of our children by creating an insurmountable level of debt that they’ll never be able to pay off destroying America as we know it.

Scary thoughts.

As, a matter of fact, the flames of our beloved Tea Partiers are largely fanned by the words “deficit” and “debt.”

So I decided to take a look at some of the underlying numbers.

First, some facts:

· The current budget deficit stands at about 11% of GDP, about 1 percentage point more than in the last year of Bush’s administration. The percentage of deficit to GDP has risen as high as 28% during WWII, obviously a less-than-normal time in terms of fiscal policy. Right now we’re carrying on two wars (one that’s winding down, thank God) and are hopefully recovering from the greatest economic meltdown since the Great Depression – I think that qualifies as a “less-than-normal” time and justifies higher than usual spending. Historically, the percentage of deficit to GDP has fluctuated in both directions; it will go down again.

· Over the last several decades, much of America’s economic growth has been fueled by deficit spending. During the Reagan years, for instance, GDP grew by 83% while total federal debt grew by 187%; during Clinton’s administration we experienced 45% GDP growth and a 24% increase in debt and during George W Bush’s eight years GDP grew 45% while total debt grew 75%.

· When my parents bought our house for a grand total of $21,000 in 1962, they were scared to death of the $16,000 mortgage they signed up for. 20 years later they sold the house for almost $100K and paying off the mortgage was a non-issue. LESSONS LEARNED: the economy grows, prices go up (hopefully through productivity growth, not rampant inflation), debt is fixed.

· The current federal debt is approximately $15Trillion; it’s hard to get a definitive number for unfunded entitlements through 2050, but I hear that it’s somewhere between $50-80Trillion. If we take total 2010 tax receipts at $2.17Trillion and increase them by 2% per year (about the projected productivity growth for the intermediate term) through 2050, we generate cumulative tax receipts of about $130Trillion over that time (at 3% annual growth in tax receipts, it would be a cumulative total of $163Trillion). Entitlements come out of the budget, so by my simple reasoning we should be able to cover those “unfunded” entitlements as well as pay back the $14Trillion in current debt. Obviously, we would eventuallyhave to get back to a balanced budget or nearly balanced budget for this scenario to play out.

Now let’s ask the converse of the question: what would have happened to our economy 2008-2010 WITHOUT the bailouts, the govt “takeover” of the US auto industry, and the modest stimulus package?

Here’s my prediction:

· Well, if the current unemployment rate is 9.6% WITH all of the above, one would have to predict that it would be significantly higher WITHOUT all of the above. Same for the “real” unemployment rate which most people estimate is somewhere between 15-20%. So let’s say the official unemployment rate goes up to 15% and the “real” unemployment rate to 25-30%. The consequences would be disastrous.

· First of all, tax receipts would plummet and welfare payments, especially unemployment payments, medicaid and medicare payments would rise dramatically. In effect, by not spending we would in effect be creating the very deficit that we were trying to avoid.

· The housing market would take a major nosedive – worse than it is now. People would literally be put out on the street, leading to many social/law enforcement issues. Jobs of anyone employed in construction, the banking industry, the mortgage industry and other related industries would be in severe jeopardy.

· Due to low consumer demand, companies would lay off more people exacerbating the unemployment rate and all of the effects thereof.

· There would be a major sell-off of the dollar.

· The Chinese would probably demand a significantly higher interest rate to buy our debt (if they were willing to buy it at all). This, of course, would increase the amount of the federal budget devoted to interest payments and further exacerbate the “involuntary” deficit we created.

· The balance of trade might actually tip in the US’s favor because of generally less demand, depressing imports. Over time, though, if enough US production capacity was closed down in response to less domestic consumer demand, this situation could reverse, maybe dramatically – hard to tell.

· Multinationals with production capacity in the US (companies like Toyota, Sony, Siemens) would probably shut down over time due to lack of domestic US demand. Instead they would most likely choose to import their products to the US, further weakening the US balance of trade and the value of the dollar

· Public school budgets would be slashed, leading to classroom sizes of 50+ kids in most areas. Same for budgets for law enforcement, sanitation, and public works maintenance.

· Despite, the self-inflicted deficit, the wealthy would scream for a tax cut, which would be counterproductive because 1) they would probably NOT spend the money, but hoard it (most likely they would convert it to non-dollar currencies, further weakening the balance of trade in our Short Term Account) and 2) a tax cut would benefit hardly anyone else because X% of nothing is still nothing.

Perhaps in Milton Freidman’s world all of this is necessary to allow the free market to “adjust” the economy. Yes, eventually the dollar will weaken to such a level where there is incentive to buy US goods, increasing employment and consumption blah…blah…blah….However, I personally would not want to live through such a prolonged “adjustment” period. (According to Keynes, "in the long run we're all dead).

In effect, by not increasing the deficit in the short term with the intent of lessening the burden of debt passed onto our children, we might in fact not only unintentionally increase the level of total debt passed onto future generations but more so be lessening the quality of the America that we pass onto them – if, in effect, America as we know it would exist at all.