US Deficit to hit 2.6 Trillion?

[shanek]

I know I'm going to regret asking this, but could someone please explain, in terms that a humble little PhD chemist can understand, what a deficit of 2.6 trillion actually means? Where the money comes from to pay it?

The $2.6 trillion is over ten years. That's an average of $260 billion dollars every year.

The money comes from selling Treasury bonds. These bonds are sold through the Fed at auction. They pay a fixed interest rate over a certain period of time. The interest rate is set by the Fed, and there are various time periods for maturity offered. The longest one is 28 years.

If people and bond brokers don't buy all of the bonds (and traditionally they only purchase a small fraction of the bonds issued), the Fed purchases the rest. They do this by ordering new money printed by the Bureau of Engraving and Printing. The new money goes into the Treasury and the Fed gets the bonds.

Of course, the money needs to be paid back. Interest is paid every year, and the original bond amount is paid after the term is up. So that money goes into the Fed's coffers. But, all of the profits from the Fed go back into the Treasury. So as long as the Fed doesn't need it for operating funds (and, chances are, it won't), the Treasury is essentially paying off itself.

The effect of all this is that, essentially, it's printing the money. It affects you because it causes inflation.

Were I a six year old, I would ask something like, "Why doesn't the government just go to the mint and print out 2.6 trillion dollars in cash?"

Because they don't go to the Mint (or the Bureau of Engraving and Printing; the Mint does coins, not bills) to print money anymore; the Fed does. Constitutionally, Treasury notes have to be backed by gold and silver. When they passed the Federal Reserve Act in 1913, they were still at least pretending to follow the Constitution. But effectively, that's what's happening.

 

[shanek]

In light of Bruce's question, I'm going to follow up and ask, does the relationship between a country's debt and its GDP (abilty to repay) mean anything?

Nope. The GDP is not the ability to repay the debt. It's a measure of productivity in the economy.

 

[shanek]

Re: Re: my poor understanding

One oft overlooked downside to carrying government debt is how much money it takes out of the provate sector that would otherwise be invested in other things. It this 3.6 trillion were not held in treasury bills, it would be invested in stocks and bonds instead, providing capital for new wealth creating ventures.

And this is proven by basic economics.

GDP = C(onsumption) + I(nvestments) + G(overnment purchases) + N(et )E(xports)

For purposes of this illustration, we'll consider NE to be zero. That's called "ceteris paribus," meaning, "all other things being equal." We'll just look at consumption, investments, and government purchases. So, we have:

GDP = C + I + G

Now, let's do this:

GDP = C + I + T(axes) - T + G

So, I added and subtracted taxes. This lets us see the two parts of the function. The first part, C + I + T, accounts for all the money that consumers get. Basically, people consume and invest anything that isn't taken from them in taxes (as there's nothing else that can be done with the money, asside from stuffing it in a mattress, in which case it doesn't figure in to GDP at all). The second is - T + G, since the government takes everything that it spends in taxes.

After we do a bit of algebra to solve the equation for Investments, it looks like this:

I = (GDP - C - T) + (T - G)

I put the two parts in parenthesis to make it more clear. GDP - C - T refers to the fact that people are going to invest anything that they don't spend on consumption items and that isn't taken from them in taxes. T - G is the government spending portion; how much they spend vs. how much they take in in taxes.

If T = G, the budget is balanced and that part of the equation is zeroed out. So, we'd get:

I = GDP - C - T

This is our baseline. Now, if government runs a deficit, then G is going to be greater than T; they spend more than they take in. So the component T - G will be negative, and as a result, I will be less.

So, it is pretty much economically proven that deficits result in fewer investments. This isn't just a bunch of tricky math; it really works this way.

 

[Bruce]

Thanks, Shane.

 

[glsunder]

An extreme result of printing money to cover debts is hyperinflation .

The largest denomination banknote ever officially issued for circulation was in 1946 by the Hungarian National Bank for the amount of 100 quintillion Pengő (100,000,000,000,000,000,000, or 1.0 × 10^20). image (http://bankjegy.szabadsagharcos.org/xxcentury/p136.htm) ...
The Post-WWII hyperinflation of Hungary holds the record for the most extreme monthly inflation rate ever - 41,900,000,000,000,000% (4.19 × 10^16%) for July, 1946.

Crazy stuff.

 

[shanek]

Time for a Tim Slagle quote, I think!

"How do you run up a $5 trillion dollar debt? I don't understand that. Visa cut me off when I hit 20 grand. When I stopped sending them money, they got nasty with me! They were calling me at home. They never cared how I was before! 'Mr. Slagle, you went $20,000 in debt last year!' 'No, you've got that wrong: last year I ran a $20,000 budget deficit.' 'Well, I don't care what you call it! You owe us $20,000!' 'No, you've got that wrong, too. You see, last year you purchased $20,000 of high-yield junk bonds in the Tim Slagle Corporation. In the future, I suggest you be a little more shrewd with your investment procedure.'"

 

[CapelDodger]

Re: Re: Re: my poor understanding

So, it is pretty much economically proven that deficits result in fewer investments. This isn't just a bunch of tricky math; it really works this way.

There is such a thing as public investment, so here you should be referring to fewer private investments, not less investment overall. If the government deficit covers productive investment that leads to an increase in GDP - in infrastructure, research, education, public health and so on - it pays for itself over time. Just as a company will borrow to make productive investment that brings in a return over time.

The problems arise when the deficit is covering current spending, such as armed forces or monumental architecture. Habsburg Spain is a telling example of what lies down that road.

GDP is a pretty poor measure of an economy's real production. For instance, the US current account deficit is counted as part of US GDP, which seems a little odd. A higher oil price means higher GDP. And so on.

 

[shanek]

Re: Re: Re: Re: my poor understanding

There is such a thing as public investment, so here you should be referring to fewer private investments, not less investment overall.

Investment with regards to GDP only refers to private investments.

If the government deficit covers productive investment that leads to an increase in GDP - in infrastructure, research, education, public health and so on - it pays for itself over time.

Ah, yes, the very argument behind Tax Increment Financing. How well does that work again?

GDP is a pretty poor measure of an economy's real production. For instance, the US current account deficit is counted as part of US GDP, which seems a little odd.

It is? It shouldn't be.

A higher oil price means higher GDP. And so on.

That would result in higher nominal GDP. The GDP Deflator is there to take care of that.

 

[Solitaire]

Originally posted by shanek
That's an average of $260 billion dollars every year.

That's absurd. I'll borrow a graph.

Notice the acceleration, not the individual velocities by year.

I'd suspect when Bush goes from office in four year the deficits to rise,
oh say, arround $700 billion to maybe $900 billion a year, but it won't
matter. The dollar will continue it's decline against the euro from say 80
now to 40 per in 2010. If he runs it up to, oh say, twelve trillion dollars
by then, in euros it'll feel like six trillion now, so no worries.

 

[Bruce]

Notice the acceleration, not the individual velocities by year.

I noticed that the blue bars were the recession years.

 

[a_unique_person]

I noticed that the blue bars were the recession years.

So are you saying that deficits help a sluggish economy to get moving? Many economists think so.

 

[Bruce]

So are you saying that deficits help a sluggish economy to get moving? Many economists think so.

I don't know, really. I just remember my dad being laid-off from 1978-1980, and deciding to go to grad school because there were no jobs in 1997.

 

[shanek]

So are you saying that deficits help a sluggish economy to get moving? Many economists think so.

Many economists survive not by delivering information based on sound economic theory but by telling the government what they want to hear. That's the only reason anyone ever paid attention to the Keynesians. The truth is, as I have show, deficits stifle investments, which are exactly what you need to get the economy moving.

 

[Snide]

Many economists survive not by delivering information based on sound economic theory but by telling the government what they want to hear. That's the only reason anyone ever paid attention to the Keynesians. The truth is, as I have show, deficits stifle investments, which are exactly what you need to get the economy moving.

But...but...Bruce just proved that to be false! [/sarcasm]

Originally posted by Bruce
I just remember my dad being laid-off from 1978-1980, and deciding to go to grad school because there were no jobs in 1997.

Funny, I remember both my parents answering Ronald Reagan's famous debate question in 1980 with a resounding, "Yes! (We are better off now!)"

I also remember changing careers in 1997, back to what I used to do in IT, but hadn't done in seven years. Being a Mac guy at the time, I didn't even know how to use Windows. I guess I found the only job available...and it amounted to a 60% increase in pay.

(Aren't anecdotes fun?)