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Thoughts from the Frontline

Back to the Basics

July 15, 2011

Choose your language

This week we are going to revisit some themes concerning the problems of the debt and the deficit. I am getting a number of questions, so while long-time readers may have read most of this in one letter or another, it is clearly time for a review, especially given the deficit/debt-ceiling debate. I will probably offend some cherished beliefs of most readers, but that is the nature of the times we live in. It is the time of the Endgame, where things are not as black and white as they have been in the past.

Let’s begin with a question that is representative of a lot of the questions I have been getting, from reader John:

“John, it appears that you're arguing that two contradictory things have the same effect: adding government spending doesn't help the economy, and reducing government spending hurts the economy. Which is it? At first, you say that adding government spending doesn't help, no new jobs are actually created, it fails the sharp pencil test,…

Discuss This


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Robert Exton

July 17, 2011, 11:23 p.m.

Mr Mitchell, YOU DO NOT UNDERSTANDS Economics.
If Governmentâ??s can create all this money, then why do communist countries always fail? Look at what happened to the Weimar Republic in Germany. It printed so much money that inflation exploded to the point that it took a wheel barrel of money to buy a loaf of bread.  So there are limits.

What creates wealth is banks, business, and the ability to make a profit.  Only the private sector creates jobs and raises the standard of living. Because banks can loan money only they can create or destroy money. A business borrows money to produce a sellable product and makes a profit when he sells it.  The business man takes the risks and hopefully gains a reward. Sometime they fail, but even in failure they add a little to the economy to help the next business along.  In the early years of California, about 95% of the people going failed, but they brought or created enough resources to help those that followed. Eventually a threshold was reaches and the State became self sufficient.  There was no Government that helped, no Monetary Sovereignty.  Miners found gold, farmers raised chickens,  restaurants made food.  Items were traded there was no need for Government currency.  When there came a need for uniformity and safety, banks were created, many issued there own currency. Counterfeiters made money (much like governments) which diluted the circulating money, causing inflation. So there became a need for the Governments to create and protect the currency, that is why we went on a gold standard.  At some point the currency., backed by gold,  going through the system cannot not keep up with the wealth created. So a gold standard is dropped and the full faith of the Government stands behind the curacy created.

David Arganbright

July 17, 2011, 8:52 p.m.

“If the government â??dis-savesâ? or runs deficits, it takes away potential savings from private investments. That money has to come from somewhere. Of late, it has come from QE2, but that is going away soon.”
The money does not have to come from somewhere. The Federal Reserve can create a new account with $600 Billion in it, buy up US Treasury Bonds (QE2) and ... poof… there is suddenly $600 Billion added to the money supply. They can do this endlessly. Of course, you would eventually end up like the Weimar Republic or Zimbabwa. The money the US Treasury owes on old debt is just converted to new debt ad infinitum. It is never paid back.

Chuck Dupree

July 17, 2011, 3:29 p.m.


Your comments related to Moetary Sovereignty would indicate you don’t believe there is a relationship between the money supply and the purchasing power of the currency….is that correct?

Jim Pope

July 17, 2011, 3:18 p.m.

Is there someone who can provide the actual federal revenue for fiscal 2010 (or projected for 2011) along with the federal expenditures for the same periods? (Again 2010 or projected for 2011.)
I would like to know how much was taken in and how much was spent.
It would also be nice to know the spending by category?
Defense dept.
Medicaid support to states
Social Security
Homeland security including all agencies under this umbrella
Any other spending category that is more than 10% of the federal outlay.

Joe Toronto

July 17, 2011, 12:48 p.m.

Dear John (no pun intended):

I’ve been thinking about your last write-up, and, speaking from one optimist to another, I feel as though you’ve let the rest of us optimists down. It appears you’ve consumed a great deal of kool-aid from the debt hysteria community.

The US is not now and can never be “broke” as long as we retain our monetary sovereignty, which means, all of our federal debts are denominated in the currency over which we have total control.

The US cannot possibly be â??brokeâ? as long as we have massive under-utilized and unused plant capacity and unused human capital (the unemployed).

Please keep in mind that Japan has over twice the “debt” load of the US government, still has lower interest rates, AND a stronger and strengthening currency. Our own interest rates are the lowest they’ve been in , like, forever. Federal debt is not and cannot be our problem.

The much feared bond vigilantes are a myth of our own making and do not and cannot exist in monetarily sovereign countries.

The US is not Greece and cannot become like Greece which surrendered its monetary sovereignty to the Germans and the French. Greece can no longer manufacture its own operating currency but now must borrow it from foreign governments, the Germans and the French.

It seems as though you have gone through considerable mental gymnastics and many spurious charts which fail the cause and effect test, to convince not only yourself, but the rest of us that we all must suffer when we all aren’t even working! There’s 15 million of us without jobs because we aren’t buying stuff we used to buy!

When the unemployed finally get to work (if the austerity people ever get their act together) the deficits will disappear, just as they did in the Clinton years.

Pres. Clinton did not cut spending, nor did he raise taxes, nor did he do anything at all to run a surplus, other than to be a seriously lucky president to be able to supervise a booming economy where everyone had a job!

Today’s deficit is only partially the result of increased spending and mostly the result of tax receipts having fallen off a cliff from recession and unemployment. Cure confidence and unemployment (and it will be cured) and you’ve cured the deficit.

Our great American economy will boom once again. It may not be from steel, oil, railroads, automobiles, radio, TV, space travel, computers, internet, or cell phone magic. It will be from (in your words) some as yet unknown technological marvel that will transform our presently mundane lives.

Your ever loving dear gentle reader who has not caved to the debt hysteria kool-aid (as you apear to have done),

Joe Toronto

P. S. I submit for your evaluation, a piece I wrote sometime ago about the correct diagnosis of our problem as follows:

Deficit cutting in the current weak economy is precisely the wrong economic policy prescription in the current weak economy with high unemployment. Whether raising taxes or cutting spending, the effect is the same. It may reduce the deficit but it also removes stimulus in an already weak economy. The current Trillion plus deficit is not a cause of inflation, interest rates are at historic lows. It is not a solvency or default concern as again, the bond vigilantes are non-existent as interest rates are at historic lows and Treasury bond prices at historic highs.  The deficit is the result of a weak economy, high unemployment and reduced profits such that tax revenues have fallen off a cliff. None of this begins to address the high and growing social costs of extended unemployment in terms of welfare, crime, degrading workforce skill sets and family breakup.

What are the risks of more stimulus? A little history may help.

During the great Depression, a small recovery had begun in 1936. Unemployment had dropped from 25% to 14% and GDP had grown at 12% for 4 straight years. Because some members of Rooseveltâ??s cabinetâ??notably Secretary of the Treasury Henry Morgenthauâ??were uncomfortable with the idea of running a long-term deficit, the administration moved to eliminate it. In 1937 the federal deficit fell to $2.5 billion (or 2.8% of GDP) from the previous yearâ??s $5.5 billion (or 5.5% of GDP) as Roosevelt and Congress slashed spending by 18%. In 1938 spending dropped another 10% from 1937. The government effectively ran a balanced budget that year with a deficit of only $100 million or 0.5% of GDP. Then 1937-38 hit and the unemployment rate spiked back to 19% while GDP contracted over 6%. We had a double dip Depression.

It was only a scant 3 years later when the government began massive deficit spending to produce economically worthless products that were to be shipped overseas to be blown up, sunk in the sea or quickly abandoned. The never before seen massive deficits immediately brought full employment in addition to expanding the workforce, also with full employment. The debt was never paid off, nor was there any meaningful inflation and the resultant money in circulation fueled for several decades one of the greatest industrial expansions and the strongest middle class that the world had ever seen.

People intuitively used to understand that in hard times, money was scarce and in good times money was plentiful. In our current monetary system, money is only created by debt. Currently, the money supply is collapsing because people and business, having been burned by a massive credit crises are paying off debts. It’s called in some circles a balance sheet recession.  Even though the Fed is flooding the banking system with reserves, the money supply is not growing because there is no demand for new loans. That leaves the Federal deficit as the only remaining means of credit (and money) creation. Until someone finds and proposes a way to inject money into circulation to fuel an economic expansion, we will have extended unemployment, low tax revenues and run the risk of further economic contraction. Further reductions in Federal spending would most certainly result in a double dip recession. Fiscal austerity at this point in an economic cycle is precisely the wrong economic policy prescription and can only make things worse just as it has done in Greece, Ireland and every other nation which has had austerity forced upon it.

Having said that, despite many assertions in the media and elsewhere, the U.S. is not anything like Greece. Greece and Ireland borrow national debt in a foreign currency that they do not control (Euros). The U.S. however is the sovereign monopoly supplier of the Dollar which it absolutely controls and therefore has no risk of insolvency or default. That there may be inflationary risks, it is true, but even they are minimal when operating at levels far below the full productive capacity of our plant and labor. The risk of inflation is practically nil (barring external factors) when there is high unemployment. The vanished breed of bond vigilantes seem to understand this. It is only our politicians who still live under old discredited gold standard dogma.

Dan Shearer

July 17, 2011, 11:51 a.m.

Looking at the chart for “The Trillion Dollar Question”, everything looked fine up to about 2007. Have we really added over a trillion dollars of PERMANENT SPENDING to the yearly budget for the last four years? Seems like we should be able to get along just fine on 2006/2007 SPENDING levels today, plus any SHORT TERM stimulus that should not be as great a concern for us.

Much of the deficit is due to REDUCED TAX RECEIPTS, such as drastically reduced capital gains tax receipts from 2007 and later years. Here’s data from :

2006 Total Direct Revenue: $2,406.9 Billion (federal only)
2007 Total Direct Revenue: $2,568.0 Billion (federal only)
2008 Total Direct Revenue: $2,524.0 Billion (federal only)
2009 Total Direct Revenue: $2,105.0 Billion (federal only)
2010 Total Direct Revenue: $2,162.7 Billion (federal only)

$400 Billion/year less revenue coming in between 2007 and 2010! Our income dropped almost 16%, while at the same time we had to fund increases in unemployment benefits. One of the problems of depending on the “rich” to pay most of your taxes, they tend to vary quite a bit. While I don’t mind arguments in favor of keeping permanent tax RATES low, I also wouldn’t mind a TEMPORARY increase in order to maintain a workable level of total tax RECEIPTS near-term. And again, this shouldn’t be a PERMANENT problem. The same site shows a 2012 “budgeted” revenue of $2,627.5, a full recovery above the 2007 peak. Even if it may be wishful thinking, we shouldn’t be assuming a flat revenue stream in our budgeting.

I agree medical care is a giant concern and needs to be addressed now, and not just in terms of less government spending. And we need to watch out for politicians trying to cut taxes and increase spending at the same time. But I think the magnitude of the long-term problem is otherwise being blown out of proportion.

jim elliot

July 17, 2011, 11:08 a.m.

I note the first unsustainable budget item you identify from a “macro” perspective is Health Care.
Like most of the problems we face, the solution(s) will be micro. The problem(s) with Health Care (cost) will not be solved by reducing the amount of capital available. We have a disfunctional and inefficient system in many ways. Cutting funds will merely leave us with less of a disfunctional system. The challenge is how to create the the most benefit at the least cost. I see no indication that the “market” is going to do this. It’s going to need some help if there are going to be any significant changes. Insurance Carriers and everyone involved are all doing just fine with the current system and they have no incentive to reduce costs except relative to their competition. Cutting overall any amount, let alone by 30% or 50% is not going to be appealing.
I see the options as government invetvention encouraging or imposing changes like: uniform accounting and billing, bulk purchases of drugs, use of generics, elimination fo some treatments,  or collapse and rebuild. The private sector has proved that it will only increase costs and maximize payments from the public until the market won’t bear it.
I’d like to hear some private sector predictions regarding how and when Health Care Costs will start to decline due to technological advances and efficiency gains.

Jeff Little

July 17, 2011, 9:44 a.m.

Doh!  I just noticed that the image describes the graph as “Ratio of private sector to public sector” contrary to the article, which says “the ratio of the size of the public sector in relation to the private sector”, so it looks like the image is at least measuring what it is trying to.  Ignore that part of my previous message.

Jeff Little

July 17, 2011, 9:40 a.m.

A couple quick points.  You state:

“For some 65-odd years, we have added to the national debt â?? individually, corporately, and as governments.”

According to the numbers I have seen, National Debt actually shrank in proportion to GDP from the end of WWII to 1980, from 100% of GDP to 25% of GDP and only started to grow with the Reagan budgets.  Was my source completely wrong?

“There are only two ways to grow an economy. Just two. You can increase the working-age population or you can increase productivity. Thatâ??s it.”

I am not sure I agree with that.  One can easily come up with scenarios in which added production pushes supply from just below aggregate demand to above aggregate demand.  Work through the math and GDP actually drops.

However a more serious issue with that is the “If you build it they will come” school of thought assumes that more production inexorably leads to more buyers.  In actuality, if the middle class shrinks then increased efficiency without a corresponding increase in demand actually just reduces the number of people who can participate in the economy fully and the efficiency is wasted.

The conservative assumption that “They’ll find something else to do” is just exactly that—an assumption.

Ultimately there are two pieces to the equation—someone makes something and someone buys it.  If people are making stuff but no-one is buying, then productivity is irrelevant.  Actually, that’s not true for productivity the economic term.  Productivity does indeed decrease in this case because revenue decreases faster than costs, but it still leaves two major flaws.  a) this example belies the assumption that increased capital investment will inexorably lead to productivity gains, and b) productivity gains are frequently had for a corporation by simply reducing headcount.  When pro-large business congressmen are in charge, these productivity gains will actually be a headwind on the economy; not a tailwind.

“[the first graph] shows the rate of growth in GDP and the ratio of the size of the public sector in relation to the private sector. The larger the percentage of government in the ratio, the lower the growth. “

Actually, if you assume that the graph is reliable in the short term (the economic sweets hypothesis state that there are certain economic actions that are good in the short term, but bad in the long term), then the swings of the higher *public* ratio are shortly followed by higher GDP growth, so either you described the graph wrong, or it means exactly the opposite of what you said.

Mark Soderberg

July 17, 2011, 8:59 a.m.

AS I read the 2 comments already made here by the 2 previous readers… thought comes to mind…“NO WONDER WE ARE IN THE MESS WE ARE IN !!!!  The 2 readers views typify our brain dead citizens.  John Mauldin writes of REAL solutions, based upon factual realities and thusly comes to sound conclusions.  The points stated by the 2 previous commenters reek of unsound conclusions, based upon illogical, not well thought out ideas.  How pathetically inept our citizenry has become…..and thusly how difficult it will be to right our ship, if ever….!  Place these two commenting souls in positions of Gov’t power and one can clearly see the huge issues we have at hand and why we are in the mess we are in !!!  Nice try fellas…...

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