The Not So Big Problem of the U.S. Budget Deficit

One and a half trillion dollars in added debt per year seems like an insurmountable problem, but is it? The red ink pouring out of Washington has so many people up in arms that our economy may falter or sink into a double-dip recession. Our leaders should review the 1930s before embarking on such austerity.

After World War II, the United States had a national debt of around 120% of GDP. The United States never paid any of that debt down... ever. Okay, there were two years with a small budget surplus, but that was so small it was only a fraction of a percent and the next year it was spent. So what gives? The national debt was huge in 1945, never paid down, and became a small, manageable debt in subsequent years. Why? And more important, how?

We need to fast forward to the 1990s and the largest budget surpluses our federal government ever had. (On percentage terms President Andrew Jackson paid off 100% of the national debt. It did not last long.) How did President Clinton run so many and so much surplus? It was simple really. President Clinton understood that the budget deficit can be eliminated by increasing spending slower than economic growth. It takes a few years, but it always works and keeps the economy humming.

Let me illustrate. If your national economy is $1,000 and the government takes in $90 in taxes and spends $100, you have a budget deficit of $10. If the economy grows 5% the next year to $1,050 and tax revenue collected remains the same in percentage terms, you collect $94.50. If spending increases 2%, your government spends a total of $102. The budget deficit for the year is $7.50, a decline of 25% in your budget deficit.

When using really big numbers, like the size of our real economy and government finances, the numbers are compelling. The federal government can spend more and actually be financially in a better fiscal position as the debt is a smaller percentage of the economy. Running a budget surplus can injure a national economy, especially in weak economic times. The real trick is to increase the total national debt less than the economy grows.

During a recession the economy shrinks so the debt burden grows fast and scares politicians and guys on the street. It shouldn't and here is why. Economic performance is measured in inflation adjusted terms. If the government reports 3% economic growth and inflation is 2%, the economy grew 5%. The government adjusts the numbers to reflect real growth. However, the economy grew 5% in dollar terms. If the national debt grew less than 5%, not he 3% reported, the deficit is easier to manage than the year before.

With all this said, $1.5 trillion deficits are not something we want to repeat each year. However, the sky is not falling. The national debt of the United States is well below all-time highs compared to GDP and is currently under 100% of GDP. The concern is how fast we are increasing the debt burden.

Congress does not need to irritate the President into lowering spending. Just increase spending slower than the economy grows and in a few years we are back in the black.

Now you can smile and enjoy the day.

Inflation, Deflation, Double-Dip Recession...Ahhhhhhh

I scared myself.

Current media outlets are suffering a schizoid embulism when it comes to the economy. Half the commentators say we are in for massive inflation with all the government spending; the other half say we are in for crippling deflation, where prices decline for an extended period of time.

There is a call for a double-dip recession similar to 1980-82. Another group says we will have prolonged subpar growth with a few radicals calling for a rapidly overheating economy in the near future.

Everyone is wrong and I'll tell you why.

This is not 1980. In 1980 the economy suffered from high unemployment, high inflation, and not enough supply. President Reagan gave us "supply-side" economics. The term has been run through the mud over the decades, but Reagan was right. Lower taxes and less regulation were the exact ticket the economy needed to increase production, hire more labor, and reduce inflation. The problems of today are different.

Government spending does not cause inflation, the imbalance of supply and demand does. The opposite imbalance causes deflation.

Prices will remain stable with inflation starting a few years down the road. Not high inflation, some inflation. Demand is present, but fear is high. Banks are not lending to allow pent-up demand to push prices higher. At the same time, additional supply is waiting for work. Idle factories can fill demand when demand is able and willing to purchase. All these factors will keep prices bouncing around breakeven. There will be months of price declines followed by months of price increases. Mixed together, prices will go nowhere for the next several years.

Energy is the exception. If you review the oil bell curve you will notice a disturbing future event rapidly approaching: declining supply. I have no confidence in the American people to conserve oil until it really hurts; like 20% unemployment with $20 a gallon gas. When the world passes the United States as a low-cost, high efficiency producer, then Americans will get serious. That means Americans might as well get used to a declining paycheck and standard of living. And I'm an optimist. But there is hope.

Oil prices will rise as oil production begins to decline and then accelerates even lower. Oil prices will rise, but energy costs will not. At least not as much as oil, and eventually, energy costs will decline. Countries that cling to oil as an energy source will suffer the consequences.

China and Europe have decided on a different course. Wind and solar production  soar faster than demand, lowering their need for carbon based fuels. In less than 10 years, China wants 15% of all their energy needs filled by renewable production. Wind and solar will fill nearly all this need. To date, China is ahead of schedule.

The United States has chosen a carbon course. Policy in Washington is for energy independence from domestic natural gas and coal with a little help from solar and wind. China spends double what the U.S. does on renewable energy production each year. This is why in under five years the U.S. gave up its leadership possition in wind and solar to China, where over 50% of worldwide production now resides. Just think all those high paying jobs, and the U.S. exported them to China. Good move.

China understands that wind and solar have long-term benefits that pay back for extended periods of time. Solar panels and solar water heaters continue producing for decades at a very low cost once installed. China, and any nation that invests with the same wisdom, will enjoy an economic advantage that could last generations. China produces over 90% of worldwide production of evacuated tubes used in solar water heaters. Buy China or burn coal.

But all is not bad for the U.S. China will be the world leader and we can follow wherever they lead. China will want to cash in all those U.S. bonds they have been buying. As I write, China has nearly $1 trillion is U.S. Treasury securities. Just think of all the jobs Americans will have filling Chinese orders. We work, they consume, so we can pay our debts. All work and no play folks. American work ethic at its finest.

So you see, there will be no real deflation; there is too much money in the system ready to go to work propping up prices. Inflation has little chance because a large tract of North America will consume less than they produce for 30 years to pay for the sins of the father. No double-dip recession either. China stands ready to put us to work... at a lower pay rate.

China can even help us rewrite our Constitution. They can help us serve their values. Isn't that nice? And if we refuse, they dump $1 trillion of our debt on the market, pushing up our interest rates to 30%+ and we become a third-world nation.

Ahhhhhh. I'm scaring myself again.

I don't know about you, but I am hungry for Chinese. At least they want to speak English.