“Paying down the debt” is supposed to be a wonderful thing to do, according to conventional wisdom. That theory has a few corollaries, too, including: deficits are bad; debt is bad; surpluses are good; Reagan bankrupted us; Clinton was our economic savior; Bush is bankrupting us worse than Reagan; we’re raising our grandchildren’s taxes; and we should all go home and eat worms.
But wait just one minute. Does anyone besides me and a few others think it might be wise to check those theories and corrollaries against our own history—before we leap to any policy conclusions about raising tax rates or cutting defense and infrastructure spending?
Well, I went ahead and looked up our track record on debt reduction. Result: Once again, I was glad I checked the facts instead of letting politicians do my thinking for me.
Below is a graphic showing what happened in the past when we paid the debt down.
[...here's the source, and here's confirmation.]
[FYI, the term “economic contraction” means the opposite of the term “economic growth.” Also, click on the thumbnail below for a still image of the graphic above.]
Was each contraction caused by its preceding period of debt reduction? Some might accuse me of committing the "post hoc fallacy" (i.e., assuming A caused B simply because A preceded B), but I disagree. Let me be very clear:
In my judgment, debt reduction was at least a strong contributing factor, if not the dominant one, in each of the above economic contractions.
My reason: When the dice come up snake-eyes six times in a row, it’s probably not just a strange coincidence—and when it happens to me, I politely but firmly ask the dealers for a new pair of dice, or just walk away from the game altogether.
I happen to think there is a cause-effect relationship in play. Why? As we’ve seen earlier in this series, “Paying down the debt” means “reducing the public’s supply of T-bonds.” In other words, it means “reducing the public’s net financial wealth” (where net financial wealth = money + T-bonds; see article 2 of this series).
When the public’s T-bond supply gets too low, it puts a damper on the money creation process. And, as we saw in article 1 of this series, when new money is not created at a sufficient pace (or worse, when the money supply contracts), it results in economic stagnation or contraction. To me, that goes a long way to explaining our dubious history of paying down the debt.
Six rolls of the debt-paydown dice, six consecutive snake-eyes. Thank you very much, but I think I’ll walk away from that particular table.
Let’s take a look at the opposite situation, in which the Treasury increases the public’s T-bond supply instead of decreasing it. That gives the Federal Reserve greater flexibility to speed up or slow down the rate at which it creates money, in its attempt to support noninflationary economic growth to the economy’s full potential.
The graphic below is a snapshot of today’s situation: the public’s money supply (M2) is $6.8 trillion, and the publicly-held portion of the national debt is $4.8 trillion.
The Fed drains T-bonds from the public when it needs to create new money. The US Treasury increases the public’s T-bond supply when it is in (...horror of horrors...) deficit spending mode.
The startling conclusion I promised
As we reviewed in article 1, inflation is caused by too much money (the green box above); deflation is caused by too little money. But T-bonds are not money, they are merely “proto-money.” Because of that, and because it takes money to create inflation, it follows that increasing the public’s T-bond supply does not cause inflation. Let me say that another way: Deficits do not cause inflation, because deficit spending is the process of increasing the T-bond supply, not the money supply. Monetary policy causes inflation or deflation; fiscal policy does not.
• fiscal deficits are not the cause of inflation, and
• fiscal deficits are necessary to increase the public’s T-bond supply, and
• T-bonds are necessary for the Fed to create new money without creating socialism, and
• surpluses (i.e., reductions in the public’s T-bond supply) have a nasty track record of preceding economic contractions, and
• our children and grandchildren will never have to pay back the debt if the economy keeps growing...
...then the obvious question becomes:
What the heck is wrong with “deficits”? What is wrong with increasing the public’s supply of T-bonds?
My answer: Not only is there nothing wrong with increasing the public’s T-bond supply, it is highly desirable to continue doing so, and highly undesirable to run fiscal surpluses that would deplete the public’s supply of T-bonds.
In fact, I would welcome a new law that required a Surgeon General’s warning whenever anyone used the term “national debt”:
Warning: “National Debt held by the public” is synonymous with “public’s T-bond supply.” Reductions have an unbroken track record of causing unemployment, reductions in income, and major national and international economic contractions. Fiscal surpluses reduce the T-bond supply; fiscal deficits increase it. Proceed with extreme caution when formulating fiscal policy.
That’s it. A prudent, measured level of permanent deficits would be good for us and our grandchildren. Let’s walk away from the debt-reduction game; it keeps coming up snake-eyes.
If that startles you... well, I told you so way back at the beginning of the first article (see link below).
Comments are open; please don’t be a jerk, and if you haven’t read all six of the articles in this series, please do not comment here until you have. Below are links to all six articles:
1 - Money: The economy’s lubrication
2 - Two Printing Presses: One at the Fed, One at the Treasury
3 - How the Fed creates money without creating socialism
4 - How the US Treasury pays back the debt
5 - The public’s T-bond supply
6 - Paying down the debt: Our dubious history, and a startling conclusion
End note, for partisan ideologues left or right, whose top priority is not economics, but your party-line list of economic talking points:
I fully understand the reasons why you cannot accept the iconoclastic conclusion. Let the hate mail commence. I will attempt to answer all of it.