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Where Does the Money Go? Rev Ed: Your Guided Tour to the Federal Budget Crisis Excerpt from Where Does the Money Go? Rev Ed: Your Guided Tour to the Federal Budget Crisis

by Scott Bittle and Jean Johnson

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Don't Worry, Be Happy
Four Disturbingly Simple Ideas for Curing Our Budget Problems
By Scott Bittle and Jean Johnson,
Authors of Where Does the Money Go? Rev Ed: Your Guided Tour to the Federal Budget Crisis

Miracle Cure No. 1: Print More Money.

We all know that the U.S. government issues U.S. currency. What's more, the government's "ability to spend is numerically unlimited," according to Pavlina Tcherneva, an assistant professor at Franklin and Marshall.(i) Since the government can "print money," its spending is "constrained only by the inflation it can create by over-spending." The professor is one of six contributors to a mind-bending collection of economic thinking that appeared in The Huffington Post. The basic thrust: the government can keep increasing its spending without worrying about the deficit or the debt. Since the government creates all money, the "federal government neither ‘has' nor ‘doesn't have' dollars. The government spends by creating new money and taxes by destroying money, which simply involves changing numbers in bank accounts," another contributor, Yeva Nersisyan, wrote. From what we've seen, this line of thinking is manna from heaven for those who don't want to talk about our fiscal problems and want the government to spend a great deal more to spur the economy and create jobs.

There is a small (really small) grain of truth here: governments, or more specifically central banks like the Federal Reserve, can and do deliberately "loosen the money supply" when they think it makes economic sense. In fact, the Fed has done just that at historic levels throughout 2008 and 2009, to goose the economy and keep credit moving. Economists are always arguing over whether and how much the Federal Reserve should be doing this. Obviously, Fed chairman Ben Bernanke thinks he has done the right thing -- the economy wasn't growing; unemployment was treacherously high, and there was almost no danger of inflation, so he increased the money supply. But conservative columnist George Will sees inherent risks in this approach. It is "hubris," he writes, "something abundant in Washington, to think inflation can be precisely controlled, like an oven's temperature."(ii)  So the debate goes on. The Fed does have wiggle room, but most experts say it has to be used judiciously.

Could the Fed really print money in the quantities needed to offset our deficits and rising national debt? The amount of money involved is enormous. The White House is projecting a total of $8.5 trillion in deficits between 2011 and 2020. Just to give you a sense of scope, gross domestic product -- the size of the entire U.S. economy -- was about $14.2 trillion in 2009.(iii)  As former U.S. comptroller David Walker points out, "the real fiscal challenge facing the U.S. federal government is driven by the $45 (trillion) to $50 trillion [that we have promised for] Medicare and Social Security)." (iv)  Relying on the Fed to "print" that much money (actually it buys Treasury bonds with money it prints) is very different from loosening the money supply during an economic downturn. Taking an aspirin or two when you have a headache is one thing. Downing a couple of bottles every day will rip your stomach to shreds.

Why is printing so much money so dangerous? Because it unleashes inflation, which Walker calls "the cruelest tax of all" and one that "tends to harm lower income persons more than the well-off."(v) Prices for all the things you need -- housing, gas, food, electricity, etc. -- start rising; people stop saving money because they figure it will lose its value sitting in a bank. If inflation gets out of hand (and it can when governments try to cover their debts with massive fiddling with the money supply), it can generate hyperinflation. Officially, hyperinflation is when the monthly rate of inflation is more than 50 percent. Here's a comforting example: At that rate, something that cost $1.00 would cost about $130.00 one year later.(vi) Inflation may not be much of a danger now, but a little inflation goes a long way, and risking it spinning out of control is not a prospect anyone should take lightly.

Miracle Cure No. 2. Just Default.

When Glenn Reynolds, a University of Tennessee Law School professor who blogs as the "instapundit," asked why the United States can't solve its debt problems by just defaulting, he rubbed a lot of experts the wrong way. But we've heard other people musing along the same lines. What would happen?

Bruce Bartlett, an influential economist who served in the administrations of Ronald Reagan and the first George Bush, says the idea is "simply absurd" and "needs to be nipped in the bud."(vii) First and foremost, default means not paying back the people who bought Treasury bonds. Maybe you're saying to yourself that you don't care because we'll just be stiffing some bankers in China and the Cayman Islands, but that's not really the case. Americans buy Treasury bonds, too, and in fact more Americans hold them than foreigners. According to Bartlett, defaulting would "cause tremendous hardship for millions of Americans because some $800 billion in Treasury securities are owned by private investors, almost $700 billion are owned by mutual funds, more than $500 billion are owned by state and local governments and more than $300 billion are owned by pension funds."(viii) And that would probably just be the beginning. Interest rates would likely soar. As we have learned so well in the past few years, meltdowns like this can set off financial panics that can spread globally with terrible and unpredictable results.

There's a somewhat less extreme, but related idea -- that we "devalue the dollar" so we can pay back our debts with cheaper money. There is a reasonable debate about whether a weaker or stronger dollar is better for the U.S. economy, but again, we're talking questions of scale. Like "printing more money," devaluing the dollar enough to cover our current and upcoming debt risks unleashing massive inflation -- the kind of hyperinflation where your nice dollar cup of coffee costs over a hundred bucks.

Plus, to be perfectly blunt about it, if we default on our debts, why would anyone loan us more money? The Chinese and other lenders who have supported our economy and covered our deficits by buying and holding our Treasury bonds will obviously start doing something else with their money. We can't really believe that they'll continue to be patsies just because it's better for us. In the end, to win back investors' confidence, the United States would have to cut spending and raise taxes -- which is exactly what those advocating default wanted to avoid in the first place.

Miracle Cure No. 3: We Can Grow Our Way Out of This.
This is one of the most common and popular quick fixes out there, and there's more truth in it than in some of the others. Essentially, the argument goes, if the economy grows, the government takes in more tax revenue, because businesses are more profitable and people are earning more money. Plus, if the overall economy is growing faster than the government is piling up debt, then the debt keeps becoming a smaller and less troublesome part of the overall economic pie.

Part of the appeal of this is that it fits in nicely with what everyone wants to do anyway: make the economy grow. There's even some historical evidence: the booming economy of the 1990s was a major factor in balancing the budget in the second Clinton administration, and the post–World War II economic boom was fundamental in getting the national debt down from its all-time high point in just a few years.

So why can't this happen again? Because now, the projections say the national debt is going to grow faster than the economy, not the other way around. Specifically, spending driven by Medicare, Medicaid, and Social Security is going to go up faster than the overall economy will. And because of the double whammy of rising health care costs and an aging population, those are the programs that are going to drive the federal budget. That's the conclusion of the government's own auditors -- it's stated flatly in the Financial Report of the United States Government, the government's equivalent of a corporate annual report.(ix) Independent experts agree. "No reasonably foreseeable rate of economic growth would overcome this structural deficit," concluded the Committee on the Fiscal Future of the United States, a panel set up by the National Research Council and the National Academy of Public Administration.(x) The leaders of President Obama's deficit commission took this as practically a first principle for their work. Cochairman Alan Simpson was positively pungent about this. "Hell, we could have double [digit] growth for 30 years and never grow our way out of this," the former Wyoming senator snorted.(xi)

Don't get us wrong: we need economic growth. We need it to solve our fiscal problems, and we need it for the jobs and prosperity all of us want. But to get the budget under control, we'll need growth plus the spending cuts and revenue increases needed to get ahead of the problem. "We need to weed our government's garden as well as water it," said Gene Steuerle, a fellow at the Urban Institute.xii

Miracle Cure No. 4. Abolish the Fed.
The idea of abolishing the Federal Reserve pops up nearly every time we've been on radio or TV talking about the budget, and although it's clear that people feel strongly about it, we're still trying to figure out exactly why they think it would help resolve the budget problem. Congressman Ron Paul proposed abolishing the Federal Reserve back in 2002 (just after the Internet bubble burst) because he, like others, believes that its "consistent policy of flooding the economy with easy money" is leading to an artificial cycle of economic booms and busts.(xiii) Paul has impressive company when he questions what the Fed has done over the past few decades with interest rates and the money supply. Quite a few economists and experts blame former Fed chairman Alan Greenspan and his very low interest policies for the housing, mortgage, and banking bubbles that followed his tenure.

That said, most economists don't think you can really abolish the Fed. It's been around since 1913; most other countries have similar institutions, and returning to a system where you have to have gold in the bank to back up U.S. dollars would be a wrenching transition. Being on the gold standard back in the day actually wasn't much fun either. It led to frequent recessions and high unemployment, according to economists who have studied Fed history.(xiv) Moreover, the decision to try to go back to the gold standard now would be a monumental distraction from solving  our budget problems with "who knows what" consequences.

But to us, the real flaw is that this is kind of beside the point. Maybe it would be better to rein the Fed in, or at least watch it more closely,(xv) but we still have to decide what to do now about what the country owes and what it has promised. Whether you're using gold, paper, diamonds (like Michael Rennie in The Day the Earth Stood Still), or rubber duckies as your currency, you're going to get into trouble if you routinely and continually spend more than you take in.

The idea of the quick fix is always out there. Eat all you want and still lose weight. Make a fortune flipping foreclosed houses. We can listen to these "don't worry, be happy" nostrums and risk everything we have, or we can settle down, hear each other out, make some compromises, and solve our problems. What we can't do, as David Walker puts it, is continue to exempt ourselves "from the fundamental laws of prudent finance."(xvi)

(i) Tcherneva is quoted in "The Deficit: Nine Myths We Can’t Afford" compiled by Lynn Parramore, The Huffington Post, April 27, 2010, www.huffingtonpost.com/lynn-parramore/the-deficit-nine-myths-we_b_553527.html.

(ii) George F. Will, "Gambling with the Dollar," Washington Post, November 12, 2010, www.washingtonpost.com/wp-dyn/content/article/2009/11/11/AR2009111122257.html.

(iii) U.S. Bureau of Economic Analysis, Gross Domestic Product: First Quarter 2010 (Advance Estimate), April 30, 2010, www.bea.gov/newsreleases/national/gdp/2010/pdf/gdp1q10_adv.pdf.

(iv) Correspondence from David Walker, May 14, 2010.

(v) Letter from David Walker, May 14, 2010.

(vi) Michael K. Salemi, "Hyperinflation," Concise Encyclopedia of Economics, www.econlib.org/library/Enc/Hyperinflation.html, accessed May 23, 2010.

(vii) Bruce Bartlett, "Another Dumb Right-Wing Idea: Default on the Debt," Capitalgainsandgames.com, February 20, 2010, www.capitalgainsandgames.com/blog/brucebartlett/1509/another-dumb-right-wing-idea-default-debt, accessed May 23, 2010.

(viii) Bruce Bartlett, "How much does the national debt matter?" MSN.com, March5, 2010, http://articles.moneycentral.msn.com/Investing/Extra/how-much-doesthe-national-debt-matter.aspx, accessed May 23, 2010.

(ix) U.S. Department of the Treasury, "Financial Report of the United States Government 2009," www.fms.treas.gov/fr/index.html.

(x) Committee on the Fiscal Future of the United States, "Choosing Our Fiscal Future," Summary, January 2010, www.ourfiscalfuture.org/thereport.

(xi) Reuters, "Panel says U.S. can’t grow its way out of deficits," April 26, 2010, www.reuters.com/article/idUSTRE63O1WP20100426.

(xii) Eugene Steuerle, Tax Policy Center, "Why Economic Growth Isn’t Enough," May 12, 2010, http://www.taxpolicycenter.org/publications/url.cfm?ID=901349.

(xiii) Ron Paul, U.S. House of Representatives, September 10, 2002, http://paul.house.gov/index.php?option=com_content&task=view&id=313&Itemid=60, accessed May 23, 2010.

(xiv) For a good discussion of the controversy over the Fed and the gold standard, take a look at Anthony Mirhaydari, "Should the Fed Be Abolished?" MSN.com, http://articles.moneycentral.msn.com/learn-how-to-invest/should-the-fed-be-abolished.aspx, accessed May 23, 2010.

(xv) More recently, Congressman Ron Paul and others have proposed "auditing" the Federal Reserve. You can even listen to an "Audit the Fed Song" laying out their reasoning if you visit http://www.ronpaul.com/legislation/audit-the-federal-reserve-hr-1207/.

(xvi) Correspondence from David Walker, May 14, 2010.

The above is an excerpt from the book Where Does the Money Go? Rev Ed: Your Guided Tour to the Federal Budget Crisis by Scott Bittle and Jean Johnson. The above excerpt is a digitally scanned reproduction of text from print. Although this excerpt has been proofread, occasional errors may appear due to the scanning process. Please refer to the finished book for accuracy.

© 2011 Scott Bittle and Jean Johnson,
authors of Where Does the Money Go? Rev Ed: Your Guided Tour to the Federal Budget Crisis.