When the red team was in power, deficit spending was okay, because IOKIYAR, and besides they were running it up by cutting taxes on the wealthy and spending the money on their favorite activities: Killing people, and buying expensive equipment whose purpose it to facilitate killing people. But now that they're in the opposition, they're suddenly all repentant and stuff, and promise that they'll cut the deficit, since we're drowning in debt, and any more stim-you-less (which they speak with the disdain that goes with lib-uh-rulls and the "dimocrat party") would cause so much debt that our children and grandchildren will be paying it off forever.
Bullcrap. Much of the national debt is a lie. And the Republicans who whine about deficit spending this year are liars.
This morning's On Point with Tom Ashbrook, on NPR, featured Republicans pushing the hard-right "young gun" position. Whenever a caller pointed out that their "solutions" (privatize everything) were worse than the status quo, they just ignored the facts and repeated their mantra that the debt was too big and needed to be controlled. Never mind that their fixes would kill the economy, worsen the deficit, and kill many people in the process. They've learned that a lie repeated over and over can convince some people that it's true. They're just trying to sabotage the economy, both to make Obama look bad, and to make things better for their patrons, the Truly Wealthy. In a really bad economy, the wealthy do better; they can afford more cheap labor. Take away the social safety net and people get desperate, and may practically work like slaves just to stay alive. That's why they call it the "ownership society".
Deficit spending, like medicine, is sometimes good, sometimes bad. It depends on the state of the economy. Keynes explained this, and it's as true today as it was in the 1930s. When the government spends more than it takes in, the money has to come from somewhere. The way it works in the US is that the Treasury issues securities, like bonds. Somebody has to buy them, which is to say loan the US government the money. Since there's a "global pool of money" out there, the amount that any one borrower wants has an impact on the price of debt. Borrow too much and the price -- expressed as interest rate -- rises. Borrow less and it falls. That's one part of the equation, but not the whole picture.
When Zimbabwe had its own currency and it was inflating at hundreds of percent per day, where was the money coming from? The government had the right to print its own money. When the US had 10% inflation in the early 1970s, where was the money coming from? Only one agency has the right to put money into circulation. That's the job of the Federal Reserve.
When the Treasury issues securities, they can be purchased by anyone -- they're among the most reliable securities in the world. In order to manage the price (the interest rate, set by the demand, relative to supply), the Fed is allowed to purchase them. It is essentially creating new money. This is called monetizing the debt. And it's where money comes from. If it monetizes too much, there's inflation, which means more money being created than goods and services that the money buys. If it monetizes too little, then interest rates can rise, causing recession. The monetized debt does remain on the books. It is part of the "national debt" total. But it's only owed to the Fed, really the government itself. The Fed shows about $2 trillion in "domestic open market operation" (DOMA) holdings now. About half is mortgage-backed, largely a result of the 2008 mortgage meltdown.
If this sounds like a risky system, then think about the alternative. Before the 1930s, money was backed by commodities. One yellow metallic commodity in general was given special status. But it was just a commodity. An economy could be based on any commodity. It could be based on gold, silver, nickel, beef suet, clam shells, or anything else. It's just a substitute for barter, after all. So if the economy were based on gold, and a huge vein were suddenly discovered and the supply rose, then there would be inflation, because more gold was chasing the economy's production. And likewise, a shortage of gold would hold back economic activity. Having a central bank, like the Fed, is a lot smarter. Of course Ron Paul and many other teabaggers think otherwise, but they are frankly nuts, and their economics shouldn't be taken seriously.
Now I mentioned two cases, recession and inflation, which were the Fed's main concerns over the past few decades. But what happens if there's a recession and the Fed doesn't monetize enough debt? What happens if for some reason the money supply actually shrinks? That causes deflation. Too much inflation is bad, but deflation is far worse, as it kills economies dead lickety-split. With deflation, there is no incentive to invest -- sit on your money and it grows in value. Low but steady inflation is an incentive to take some risk and invest.
The 'bagger's lie this year is that the Obama administration is running up too large a deficit. But if that were true, then one of two things would happen. There'd be inflation (too much debt monetized), or there'd be high interest rates. That happened in the 1970s, when many of the Fed's current governors came of age, so they're still stuck in an inflatonary mindset. But right now we have very low interest rates (not for consumers, but for the bank-sized borrowers in the global pool of money). AND we have no inflation -- in fact, there's a real risk of deflation of the dollar.
Deflation's hard to measure. It's not the same as the consumer price index, though they're correlated. Short-term prices vary based on commodity markets and other conditions. True economic inflation is based on the overall money supply vs. overall production. And figuring out what the money supply really is can be the toughest one of all! The Fed has multiple standard metrics, like M1 and M2, but the boom years of the early 2000s featured non-bank loans and money that was harder to trace. Aggregate demand -- that which establishes prices -- was pushed along by creative new sources of money, mostly home-equity debt, that were largely off the Fed's radar. And that money basically suddenly ceased to exist in 2008. The depression we're in now was caused by that contraction in the money supply.
So what the economy needs now is a big shot of money. That's why Krugman was right to say that the stimulus was way too small. If what the Republicans were saying was true, then there'd be either inflation or high interest rates. But we're facing deflation and low interest. Hence the Fed has not created enough money! And the government has to create more bonds for them to buy. That means more, not less, short-term deficit spending. That is needed to get the economy going, and allow growth, and possibly higher taxes, to close the debt in the future once things really get going.