A brain-teaser on deficit spending for the GAO and CBO

As I was exchanging emails with a friend and monetary expert, we came across some puzzling assertions by the GAO (Government Accountability Office) and the CBO (Congressional Budget Office).  Both organizations were saying the same thing in two separate documents intended to “help” the public understand federal debt. 

Unfortunately, we had to conclude that the opposite of “help” was achieved by those documents. 

Below are two puzzling passages, one from each; both are marked up with the same simple question.

First the GAO document (see p.6):

Next is the CBO document (see p.1):

Now for the brain teaser.  The diagram below should be self-explanatory.  I hypothesized the tax and spend amounts so that each arrow could represent a half-trillion dollars worth of financial flow. 

The challenge is to find the financial resources that have been “absorbed” by the federal government.  I bet you can’t—and I bet nobody at the CBO or GAO can, either.

Not only does deficit spending not absorb financial resources from the private sector, it creates additional financial assets.  Those additional assets are in the form of Treasury securities (“future money”).  And when the private sector grows the real economy at the same rate the Fed turns those new bonds into real money, inflation remains under control while the nation gets wealthier—in both real and financial terms. 

When do you think the GAO and CBO will correct their “help” documents?

Comments

[Bob]

Answer:

When pigs fly.

[john]

Steve:

You one time were saying something like that the great thing about government debt is that it is rolling over and over again, it will be never ever payed back again. So here the federal government absorbs the 0.5 T. The US private sector in general will never cash out that bond again. It will only get intrest that is paid by the US private sector itself. So balance is zero on intrest negative if there are some foreign buyers of government bonds. And if the foreign buyers do not want rolling it over and over again the US private sector has to absorb those outstanding bonds.
Maybe i see it wrong but hey i'm no expert. For the person with the bond it is a financial asset. For the US private sector in total minus 1 person it the bond is a liability!

[Patrick]

id be interested to see what they call the activity of tax collecting. is it "absorbing" resources as well?

its clear to me that the best way to finance gov expenditures is through a mixture of taxes and borrowing- to the extent that over-borrowing doesnt create problems

[embutler]

My take on "absorbed" is both think of the tax income as being wasted on interest rather than buying new services or assets..

[anicolici]

Steve, I think you're right in that the CBO and GAO have chosen the wrong words. However, the government IS indeed taking something away from the private sector here. By borrowing future money and bringing it today, it 1) borrows money that would have otherwise been borrowed by the private sector (there is NOT an unlimited supply as you well know) and 2) ABSORBS economic resources (construction, analysis, etc.) for its own ends rather than private ends.

There is only so much capacity available at any one time and the government requires its share of it (to build a bridge for instance) - it has to commandeer resources to actualize that growth. It is believed by some (including me) that the private sector can better put that money to work since it has a profit motive and can be punished/corrected by the marketplace. In other words, I contend that the economy would grow faster if government was smaller.

[Olivier]

They will never correct their interpretation of "absorption". This is because all this comes from a philosophy -or dogma- well rooted in everybody's minds.
What lies behind "absorption" is simply the neoclassical idea of a limited pool of savings. That idea is perfectly shown in the CBO document when it states that "That activity absorbs resources that otherwise might be invested in the private sector". In short, the CBO thinks that there is limited savings and that in turn it limits investment (debt).
There is a big problem with that "saving pool" theory (wealth available in the economy for purchases of bonds, and wealth is limited). The problem is the origin of that pool of saving. It is there because in the past, economic activity has been so strong as to generate a leftover, or saving, over consumption needs. That strong activity probably came from "pump priming" or deficit spending.
So the scheme in the US is the following: deficit stimuli => growth => income => savings => ability to pay for additional bonds. And so on.
Deficits absorb savings, that is true, but they also create the savings at the same time!

[Steve]

John:
As you say, the private sector will never cash out that bond -- if you consider the Fed a part of the private sector. If you separate the Fed from it, however, it's easier to picture how those bonds ("future money") are eventually turned into real money: that happens when the Fed buys them. And that is how the Fed's $0.8 trillion bond "boneyard" keeps growing and growing. That boneyard will always get bigger, and the interest earned by the Fed on it will always be remitted right back to the Treasury. It's akin to the post office's dead letter pile.

The government is absorbing none of the financial assets pictured. It prints bonds, collects the proceeds, and spends the proceeds right back into the economy.

embutler:
Tax receipts are not wasted on interest; paying interest is like saying "thank you for lending us the principal so we didn't have to raise taxes." Poiticians who say interest is a waste of tax money are in essence saying, "I can eliminate the interest payments and lower your taxes if you'll just let me raise your taxes to pay off the principal." I'm a taxpayer, and I dislike that idea intensely.

anicolici:
You're right that government purchases (not transfers) consume real goods and services, but we are talking about the flow of financial resources. The private sector drives economic growth, and will put those financial resources to good use in the aggregate. There is not a fixed supply of bonds, such that government borrowing drives up interest rates on what's left; that's the crowding out theory, a beautiful one that has been killed by ugly facts and embarrassing absence of evidence.

And watch out for the hasty generalization that "big government" is automatically bad. Government does have fundamental duties that do NOT belong with the private sector. Think back to the '90s: Bill Clinton and an accommodating congress made "big government" smaller -- by making our military and national security apparatus smaller. Penny wise, pound foolish. When national security (i,e,. war-prevention capability) is weakened, wars tend to start, and wars are expensive.

[anicolici]

Steve, no arguments against fundamental duties of government. Also, no argument against interest rates NOT going up as a result of more borrowing, at least not within historically observed ranges.

However, I am skeptical about the government being able to bring money from the future, even given double-entry accounting, without any ill effects.

[Patrick]

anicolici:

the government has been borrowing from the future for a long time now (100+ yrs?), with minimal ill effects

Steve:

you say "There is not a fixed supply of bonds..." arent new gov bond issues limited to paying off expiring bonds and deficit spending?

[anicolici]

Patrick, ok, I see your point. If there are any ill effects, they obviously aren't significant. In this case, I wish Steve the best of luck trying to get the government to change its wording!

[Steve]

Patrick:
I wasn't clear, sorry. The point is there's no conclusive evidence that more deficit spending causes interest rates to rise. A better way of putting it would have been "there's not an inelastic demand for T-bonds that drives interest rates up as deficits go up" in the relevant range of gov't borrowing we are used to. (Although I'm confident that if we eliminated *all* taxes, and funded all spending via borrowing, the market would react adversely; but we won't, and we haven't even tested the tipping point yet.) Here's a good article on this:
http://www.cato.org/pub_display.php?pub_id=2827

anicolici:
I have zero expectation that the gov't will change its wording. I do think it's quite ironic, though, that the doom-peddler-in-chief (our Comptroller General) apparently doesn't even proofread his own bureau's publications. (If he did proofread it, that would imply he agrees with it, and that's even scarier.)

[JIMB]

Financial assets aren't the problem: The gov cannot create real assets (goods / services) at a price which people will willingly pay (hence taxation must be at threat of jail, loss of property, etc) and that action is a net wealth destroyer irrespective of the creation of "financial assets". And yes deficits DO raise interest rates higher than they otherwise would be (but not necessarily up in absolute terms) ... to claim otherwise is to deny supply has anything to do with price. The change in supply driving down prices (interest rates up) lower than they otherwise would be is an apriori fact as undeniable as 2+2=4, not subject to 'empirical verification' as there can be no 'empirical verification' of a logical truth (people use their assets in a way which they value the most for their own psychological satisfaction: which is where the law of supply and demand comes from - not from some after-the-fact analysis which cannot know what prices would have been anyway). Economics is not an empirical science, it is a logically argued structure of human action which is rooted in human psychology.

[Steve]

Crowding out is not universally accepted, and it's about as far from an unchallengeable axiomatic "given" as one can get. Here's Alan Reynolds on this subject:
http://www.cato.org/pub_display.php?pub_id=2827

[Jess Curtis]

@ anicolici

I am not an economist.
However, I understand gvt spending is, in large part, transfer payments: medicare, soc sec, etc. This type of "spending" seems neither more nor less efficient than private sector spending --> its just moving the money around.

The piece of govt spending going to national defence and homeland security is probably not as efficiently spent as it would be were these services privatized, however privatization of these areas leads to other grave problems.

The remaining part of government spending is probably the only part that might create some real drag on GDP growth (this would be the infamous discretionary non-defense spending). And generally I think alot of this type of stuff should be cut. Though I assume some part of that spending is quite a productive investment: investment in universities, research, infrastructure, health, etc.

[Skeptical Realist]

Try this thought experiment mr. optimist:

Give someone all your money, and then let them spend it on you. Find out how much 'they' absorbed.

The point of the manner is if you treat a nation as a monolithic whole and then go on to point out that 'don't worry, we owe it to our selves' you will not see the problem.

The problem is that those closest associated with the bond trade and the financial circles in general get the new bonds and cash first and use it to command resources at the expense of those who get it last: those on fixed incomes and the poor & middle class in general.

The real scenario is that of a game of musical chairs. When the illusory wealth generated by artificially low interest rates by monetary pumping reveals the massive MALINVESTMENTS (projects that will not yield profit - because the public has no resources with which to trade for these goods&services) in the economy, the financial circle will rush to occupy the remaining chairs - to the detriment of outsiders that have no real wealth, but plenty of 'faith in government' notes.

Government has no resources other than what it robs, and therefore it does not add to, but simply reallocates production to the consumptive demands of our elected demogogues and their special interest string pullers and academic rationalizers.

To be more accurate you should adjust the GDP for hedonic manipulation and imputation. You should do the same when adjusting for real GDP, as the CPI itself is subject to imputation and hedonization.

Of course if you made these adjustment then you would see a very different picture emerging since 1982, then you would have to shut down this site and concede to your betters that you don't know what you're doing.

Don't get me wrong, I do not think that the debt should be paid off since it is impossible other than by first massive inflation.

[Steve]

to so-called Realist:
If you have the courage to reveal your true name and email address, I'd be glad to discuss this with you via email. If you don't have the courage, so be it; I won't be a party to your anonymous grandstanding.