The two biggest myths in American conventional wisdom

Myth #2
Don't you wish all of the water we drink could be of the same pristine purity as the crystal clear, refreshing water of our Rocky Mountain streams and lakes?  Almost everybody does . . .

. . . and that included me, up until one summer twenty years ago when my family spent a week vacationing in Rocky Mountain National Park.  The beginning of that week was when I promptly changed my mind about the desirability of drinking crystal clear Rocky Mountain water.  Reason: First thing the ranger told us, in no uncertain terms, was, "Please, do NOT drink any water from the streams and lakes.  Imagine for a minute what the bears, beavers, and moose are doing in the water upstream from here." 

The national park folks have been kind enough to repeat that warning on their web page, under the heading "Hazards":

Giardiasis ["beaver fever"] is a debilitating intestinal disorder, caused by drinking contaminated water, that you will want to avoid. Do not assume that stream and lake waters are safe to drink.

The "pristine purity" of Rocky Mountain water is the second biggest myth in American conventional wisdom. 

Myth #1
The biggest myth of all, however, is in first place by a wide, wide margin.  It was repeated last night by the President of the United States, George W. Bush, in his 2008 State of the Union Address:

American families have to balance their budgets.  So should the government.

Bipartisan applause broke out.  Even Vice President Cheney—Mr. Deficits Don't Matter—was applauding along with Speaker Pelosi. 

It's a powerful idea, but it's a myth.  One to which both parties feign allegiance.

The false idea that federal deficits are bad (and surpluses are good) seems to be an immovable object.  I've been trying to chip away at that dangerous myth for three years here, but the dogma is so engrained, and so easy to exploit for applause at political events (either side's), I'm starting to wonder if anything can ever dislodge the falsehood.  Maybe not. 

The federal government will run out of excuses for not balancing its budget—as soon as General Electric and Wal-Mart stop using a mixture of growing debt and growing equity to fund their growth—and as soon as the Smith, Jones, and Rodriquez families (all generations, moving through time) stop accumulating growing debt for houses, car loans, and family businesses even as their total family incomes continue to grow.  When everybody else stops borrowing, the federal government will be out of "excuses."  [Don't hold your breath waiting for that day to arrive, however.] 

Never mind that I could support a budget goal of holding the debt/GDP ratio steady—which means the debt can grow up to the same rate the economy grows, without violating the goal.  Never mind that the goal of steady debt/GDP would itself become a big challenge soon, due to demographic shifts.  Never mind that it would be far more realistic and achievable than the sophomoric sophistry of insisting on a balanced dollar budget.  A growing economy is what we need, far more urgently than a balanced dollar budget.  It's not the money, it's what we get for the money, and it's the real wealth we create that backs up the money we print. 

But apparently, few voters want to understand it—and politicians would much rather demagogue it than explain it.  (Those who do understand it, such as Mr. Deficits-Don't-Matter Cheney, immediately get their heads bitten off by those who don't understand it, and by those who know how to play false dogma for political gain.  No wonder those who understand it tend to back off; it's just human nature.  When you get struck by lightning two or three times, you tend to get off the hill.) 

Myth #1 is still the all-time champion political falsehood—way, way ahead of "pristine" Rocky Mountain water.  Just ask President Bush.  Just ask any presidential candidate still in the running, on either side.  In fact, Myth #1 is a good bet to outlive the cockroach, which has been around for 350 million years. 

Comments

[Gil]

What a cowinkidink! I have a book gathering dust (written in the '80s) that had two cents with Myth #1 - namely people view government debt like credit card debt - the money is being wasted on frivolities and has to be paid back and if you don't well . . . Similarly the book did point out the debt should be seen as operational debt ('investment debt'?) that (as you keep pointing out) is there for leverage and not to be paid back per se.

P.S. What d'you think of that Simpsons 'futurist' episode showing Lisa Simpson as the President and the U.S.A. is apparently backrupt and the delegates of all the countries are wielding weapons in a 'pay up or else' scenario?

[Bob]

The distressing part of this is that, apparently, we've given up on economic growth. That's a recipe for disaster, worse than the debt level.

[Ken Magalnik]

Now I'm a little confused. You've stated, time and time again that
"borrowing money for good investments is sound financial practice"
And I agree with you. But surely this statement depends on "good investments" Surely, borrowing money for bad investments in a bad idea.
You compared the situation to families who go into dept buying cars. What about those who go upside down time and again trading them in for ones they cannot afford?
I think, and if I am wrong please correct me, that the president’s address had more to do with the cost of earmarks, than any other type of dept. Sure, earmarks represent a fairly small share of the total budget, but they are put with little deliberation. There is no way of knowing if they are good investments. More importantly, they create a conflict of interest, and the perception of corruption. So why is it a good idea to borrow money to worsen our management?

Perhaps I misunderstood, it is pretty early in the morning, after all, but this post reads to me like we should be loading up on national dept for the sake of loading up on national dept. Is that really what you are saying?

[Devin]

Ken, read the 6 article "Money Series" post linked under "popular posts" to the left. That should answer your question.

[Robbie]

Ken, Steve wrote that he wants to keep the debt-to-GDP ratio steady. So it would probably be a good thing to cut some "wasteful" spending, although good luck with THAT! Steve, why don't we stop taking money for entitlements out of people's paychecks and start taking it out of the general fund. Wouldn't this do a lot to grow the economy? My favorite idea is George W. Bush's: It's clearly a budget. It's got lots of numbers in it.

[Kevin]

But I don't get it. All those people who were applauding the need to balance the budget ... well aren't they the very people who, like, DO the budget?

Gosh I wonder why they don't just balance it?

[Dave Justus]

You have convinced me that we should probably have a goal of maintaining a steady ratio of debt to GDP, and that our current ratio is probably a pretty good one.

I also note that it is in fact fairly stable, sure we see it go down a little, but it also goes up sometimes.

So if we have achieved a relatively stable debt to GDP ratio with the #1 myth, perhaps we should be grateful that they myth exists, even if it is incorrect.

[markg]

I have concluded that nothing will dislodge the falsehood (short of Thomas Jefferson descending Mount Washington with a tablet that says "thou shalt not fear deficits"). The best thing to do is profit from their lack of understanding and let the deficit hawks suffer from beaver fever.

[Chris]

The idea of keeping deficits to a specific fraction of GDP sounds good. But, what do you do when GDP goes down? That's the point when politicians try to increase spending (witness the nonsensical stimulus plan).

I favor a balanced budget, but not for the reason presented by the President. I favor it because it is a relatively hard standard to break--either the budget is balanced, or it isn't. And, that encourages fiscal discipline, an area in which the Congress is inept.

The alternative--keeping the deficit to within X% of GDP--is a lot looser. Why is X a magic number? Why not X+.0001? After all, those folks in Alaska need their bridge. Why not X+.0002? Those folks in Arkansas need their teacup museum. X+.0003? Boston needs another road. X+.0004? Florida needs a new train. X+.0005? Iowa needs corn research.... X+.0184? We need an economic stimulus package.

I know that even a purportedly "balanced" budget can be massaged. But, that's harder than just changing X.

[Steve]

Ken:

I almost added that statement about borrowing money for good investments. I'll do it here.

Not every dollar taxed or borrowed is well spent, paying for itself in the long run. Waste should be isolated and eliminated, wherever possible -- and every dollar of such waste should generate a dollar of tax reduction or a dollar of effective spending in another area. But the main point is that we are talking about aggregates. As long as long run aggregate tax-receipts growth equals or exceeds aggregate interest paid to the owners of publicly-held debt, our financial health (creditworthiness) gets no worse. Debt/GDP is a reasonable enough proxy for interest/tax receipts, by the way.

Also, the government's "investment" portfolio is by nature different from the private sector's. Security, for the private sector to do its thing, is at the top of the government's list of duties. Hypothetically, let's say a president and congress came along whose budgets significantly increased spending on national security, some of which was wasted, some of which was borrowed, but most of which succeeded in eliminating the threat of global thermonuclear war between superpowers. I'd call that spending a good investment, in part because of all the capital (human and physical) it preserved, worldwide. Now let's hypothesize a subsequent president and congress, whose budgets significantly decreased the national security share of the budget, which helped create politically popular surpluses, but failed to protect our interests sufficiently to prevent new attacks and a resulting war. I'd call that fiscal policy precisely the opposite of "responsible" -- even though the vast majority of Americans would point to those surpluses as the quintessential example of "fiscal responsibility," while ridiculing previous deficits as "irresponsible mortgaging of our future." (Which president and congress would you say made a better investment in our future?)

Borrowing money for good investments is sound financial practice. War prevention is one of the best investments the federal government can make. Too bad there's NO political benefit in being able to say "Look what I prevented for you" -- but huge benefit in being able to say "Look at the dollars I saved for you."

Earmarks: Are they 100% waste? If so, we should demand that our politicians eliminate them, and either reduce taxes dollar-for-dollar, thereby letting the private sector spend those dollars better, or spend them more wisely on good investments such as effective intelligence gathering, or GI-Bill-style investments in science/engineering education subsidies, or realizing Reagan's dream of eliminating nuclear weapons from the planet, or _________ (fill in the blank). The worst reason of all to eliminate earmarks, however, would be to "reduce the deficit" -- because that logic makes "money" a higher priority than "what we get for the money."

[Aaron]

"American families have to balance their budgets. So should the government."

American families do not have to balance their budgets. They may in fact have to dip into savings some years and usually increase savings in others. College kids run massive deficits that they plan to pay back with later surpluses.

[Syphax]

Well based on the proposals of the future presidential candidates, I find it highly unlikely we will see a balanced budget anytime soon. This balanced budget talk is all... talk.

The only way I can really see a balanced budget is if a republican wins the white house and battles with democrats in congress like the 90's(only reversed).

[JIMB]

Forget all the rest: It's the spending that matters ... government spending is what uses the resources the private market is trying to use to get ahead ....

[Neocon Spin Master]

Bull Puckey!

Governments don't grow the economy. Deficit spending does not grow the economy. Government getting out of the way is what helps economy grow. Just the fact that government can tap into unlimited amount of borrowing, is the very source that helps government grow and impede growth. If goverment balanced it's book, with a 0% personal income tax and lower corporate taxes, then our economy will roar like it did in the 19th century.

Most of the households are in debt, not becuase they invest their money in starting new business, instead they commit financial suicide by buying gizmos that they can't afford.

[Fuzz]

I just came here to say that I grew up in the mountains and drank from the streams and lakes ALL THE TIME. Never once got sick. But maybe I got an immunity passed down from my parents who did the same.

As for the other myth, I just found it amusing that Bush would say that they need to reign in spending, after his 7 years of debt boosting, and he said it with such conviction! Its as if he had just stepped into office and was taking over some former president's foot-loose economic policy, and HE was going to change it! How he said it with a straight face is beyond me.

[Bob]

Enough already, okay? I mean enough.
I'm sick and tired of hearing about hunkering down, cutting this and that (some stuff should be cut and ditched)and worry, worry worry.

Isn't it getting to anybody else but me?

Where the heck is any talk, any where, about ideas and innovation to grow the damn economy faster?

You find them, let me know.

Until then we're stuck in a rut.

Ruts suck.

[Jason]

"Where the heck is any talk, any where, about ideas and innovation to grow the damn economy faster?"

Those talks occur everyday in boardrooms, conference rooms and offices around the country. No elected officials or bold speeches needed. Private individuals work everyday to increase their bottom lines, thus resulting in overall economic growth. Free and growing economies don't require collective and coerced planning.

[Kevin]

*** "American families have to balance their budgets. So should the government."

American families do not have to balance their budgets.***

And if we used consistent accounting methods, then that would mean American families far exceed their budget whenever they take out a mortgage or car loan or college loan. When the U.S. government takes out a tiny loan we call that a budget deficit.

Perhaps Bush and congress should ban mortgages and car loans?

[Aaron]

Bob,

I think if cuts in spending were actually made, it wouldn't feel like a rut. Does anyone here think that all government spending is efficient investment? I doubt it.

Was it here I quote Mitt Romney on how many programs we have for this or that program that probably could be scrapped in favor of the best performing one?

One thing I think has evolved from this blog would be the idea that we could have simple metrics for the economy that would be easy to use by the news media to keep the public more aware. My example would be some basic numbers"

Overall Tax Rate as % GDP (if we had a flat tax, this would be even better as it would represent your individual stake in any increases.)

Income Subsidy/Capita (designed to show how much people are getting in benefits)

Target Debt as % of GDP (this alone would cut off a lot of BS as this blog repeated shows.)

and so on, that could be used as benchmarks. When someone promises to increase this program or that, it could be rejiggered (oops!) to reflect the candidates', plans and then used to check on their progress, though maybe that would be hard to do in reality.

[PseudoNoise]

"Tax & Spend" is still an epithet reserved for one party (the party under which the greatest GDP growth tends to happen).

Although I'm happy to have a targeted debt/GDP ratio in the long term, it will always happen in the short term that we need to grow the debt in tough times (when GDP is shrinking), and should therefore pay it down in easy times. Locking the debt/GDP ratio works against this -- we lose latitude just when we need it.

And we need it now, but unfortunately the "easy times" were spent pushing UP the debt/GDP ratio.

The time to fix the roof is when it's sunny, but we've just been tap-dancing outside. Now it's just starting to drizzle. Oh well.

[Gil]

Who knows? Are the financial movers and shakers warning the U.S. to wind up its debt because the U.S.'s winning streak is about over? That in 20 years or so the U.S.A. is going to a mediocre economic player? That China is the new kid on the block and the one you want to be investing in?

[gilleland]

We all have a generally good idea of what we are facing in the abscense of solid GDP growth (above 3% with tame inflation) over the next 10 - 30 years.

I'm curious to know how bad / challenging things have to get before the larger majority of people realize that something has to give with our current federal governance (in particual, governance of entitlement promises and programs)?

When / if the situation gets harder due in large part to lack of economic growth and corresponding government reneues, will our reaction as a nation be to move towards more socialistic values / greater redistribution of property and/or income or more towards individual liberty and responsibility?

How much pain until there is real change? And what kind of change are we likely to get?

It will be interesting times. Personally, I'm considering (not actively yet) ways to vote with my feet if necessary / feasible. I love this country but I find it unacceptable that our national leaders can't unify to work out a more sustainable less risky future for our country knowing what we know today--part of that ought to be an economic growth strategy based on economic principles we KNOW to be effective: strong property rights, fair trade, and other incentives for individuals, families, and communities to be ultimately responsible for their own futures.

[Ethyl Added]

The myth won't die until people start managing their finances like good businesses instead of bad businesses. Good businesses are supposed to have a deficit, as Steve points out. Spend more to make more. Bad businesses burn money on luxuries, unnecessary expenses.

Isn't it obvious that America's households are run like bad businesses and that's why deficits are considered a bad thing?

[Ethyl Added]

Correction to last comment: America's households, _in large part_, seem to be run like bad businesses. Obviously there are a fiscally responsible people out there, but a significant majority apparently see their own financial woes as due to deficit spending, not bad business decisions. Thus the resonance with our dear politicians.

[Aaron]

Gilleland,

"strong property rights, fair trade, and other incentives for individuals, families, and communities to be ultimately responsible for their own futures." don't necessarily get better in other countries. In fact, they usually are worse than the USA.

And families who spend money on luxuries almost by definition get utility, i.e. happiness, from them...the point of working is to be able to buy luxuries, no? So at my company we save wherever we can so that I can buy my family a vacation.

[Don]

Isn't this theory -- that debt is okay so long as it doesn't get out of hand relative to GDP -- a bit of a red herring? When the (by nature) cyclical economy takes a dip, the debt is constant, so our ability to pay it off is compromised. This theory might be technically sound, but it seems a bit bold in its reliance on a good economy. It doesn't strike me as sound fiscal policy.

[Steve]

Don:

Picture the business cycle causing GDP and therefore tax receipts to oscillate around a mean (imagine a sine wave with a positive sloping mean). The question is whether that positive-sloping mean must equal its spending counterpart. In other words, must long run tax receipts be equal to long run spending, or can they be less? (Or, must they be greater, to "pay down" the debt?)

I've been trying to make the case that tax receipts can be, forever and ever, less than spending, as long as both lines are sloping upward (i.e., the economy is growing), such that tax receipts grow at least as fast as the interest payments grow. So far, nobody has made a case that refutes that assertion. In fact, I have asked well-known economists on all sides of the ideological spectrum, and they agree.

Let me state it clearly: The debt can grow and grow and grow indefinitely into the future, as long as the economy, and therefore tax receipts, grow and grow and grow indefinitely into the future at the same rate or more.

I'd love to hear anyone's refutation of that hypothesis. I've been searching for a valid refutation for fourteen years, but have not found one yet. I remain persuadable, however, by a sufficient argument and evidence.

[Big Daddy Matty]

Much as we're all trying to advance this idea of government maintaining a healthy level of deficit/debt, I fear that we're simultaneously continuing to peddle the primary myth upon which most of the balanced budget talk is based, namely that the budgets of families and government are somehow analogous. They are not!

A government, like a business, is assumed to be a continuing entity. Barring catastrophe, they have indefinite lifespans, and perhaps more importantly, indefinite income spans. Households enjoy no such luxury. They must, like businesses and governments, take on debt early in their lifespans. Then, however, households must make sure to pay those debts down and eventually off (i.e. run a surplus) because they will eventually run out of time to do so.

If someone doesn't ring the alarm that Americans can't think of the general fund the way they think of their checking accounts, we'll never have any chance of cracking "myth #1."

[Don]

Okay, this seems like a dumb question, so let me preface this by saying I have an Economics degree and a degree from a top-ten law school. (Not bragging or anything like that ... just saying please understand that I paid good money for the knowledge base that leads to this dumb question.)

It seems to me that GDP is a bad measure here. GDP always goes up -- it is essentially a measure of production, no? But aren't we financing more and more of what we buy? In other words, are we essentially financing the federal debt with increased personal debt?

Not sure I've explained this well, but I'm anxious to try because it seems that there's something fundamentally flawed with your proposition and I'm not sure I've quite got my finger on it.

[Steve]

Don:

If you think GDP is a bad measure, then don't accept it. A more direct indicator of any entity's creditworthiness is a ratio called "times interest earned." (Another is the ratio of debt to assets.)

For the federal government's creditworthiness, the indicator I personally like best is the inverse of times-interest-earned: net interest as a percent of tax receipts. Reasons: (1) interest is the full cost of servicing debt; and (2) both the numerator and denominator are reasonable proxies for their counterparts in the debt/GDP ratio, which most economists accept as an apples-to-apples comparison of debt load across countries. (I believe the EU has debt/GDP limits written into its constitution, but can't remember the number.)

Anyway, the federal government's net interest is the FULL cost of servicing its debt; the debt principal can be ignored. Reason: the federal debt is, in essence, perpetual debt, like British consols; the aggregate principal never, ever has to be paid back. Even though individual T-bonds must be paid back in full at maturity, they are paid back with funds derived from selling a brand new T-bond. It's called debt rollover. GE does it, Wal-Mart does it, most major firms do it, most fiscally sound nations do it, and the United States of America does it.

Financially it makes no difference whether the federal debt is (a) perpetual, or (b) paid back on an amortization schedule; no difference whatsoever. David Ricardo originally pointed out that mathematical truth. Many people still have trouble with it, but if you understand present value, you'll get it. Here's the mathematical truth:

The net present value of paying down ALL of the debt principal immediately is EXACTLY EQUAL to the net present value of NEVER paying down ANY of the principal (i.e., of paying interest only, forever and ever).

That's why net interest as a percentage of tax receipts is the most direct indicator. If it starts to grow higher, the bond market will sooner or later demand a higher interest rate. Today it is 9.5%; in the mid-90s it was 15.3%. I don't know what the all-time high is, but our so-called debt burden has DECREASED by 39% since the mid-90s.

Now, just for fun: Try to picture ANY presidential candidate, or ANYONE on Capitol Hill, with the courage to tell that particular truth about our "debt burden": i.e., that it has decreased 39% in the last dozen years. You can't; it is impossible to envision. [Reason: because it would be political suicide to tell that truth.]

Fun stuff, huh?

[Brent]

I keep seeing the word growth here used as though it's something that can be counted on and controlled. I fail to see how we can continue to count on growth in the face of rising energy costs. Our cost of production is going up, and may never come down again. If it rises above a certain level, growth will become impossible. In fact a decline is a real possibility right now. Unfortunately, debt does not decline just because income does. This debt/GDP ratio that you speak of can change very rapidly.

I was impressed with the earlier comment about good investment. I wish this question were asked more often. Some $600 million of new debt can be attributed to the war in Iraq. Is this an investment that contributes to growth? It seems to me like a simple transference of public wealth (taxpayer money) to defense industries and contractors like KBR, on credit, or am I missing something here? And finally, is this glittering jewel worth the $1 trillion+ that we are investing?