How Much Should the United States Cut the Deficit?

How much should the United States government cut its budget deficit?

This seems to be the big debate in Congress surrounding discussions/negotiations related to the new fiscal budget.

The problem as I see it is that the United States government is focused on the wrong objective! It is focused on an objective, low levels of unemployment that it cannot achieve without creating all other kinds of distortions in the economy, distortions that produce, in many cases exactly the opposite result from what the government is attempting to achieve.

Let me tell you what objective I believe the United States government should focus upon in determining its economic policy stance, which includes its fiscal budget.

I believe that the primary economic focus of the United States government should be on the value of the United States dollar. I believe that the United States government should attempt to stabilize and maintain the value of the dollar in international currency markets.

The current focus of economic policy in the United States government is employment…or low levels of unemployment. This objective was memorialized in The Employment Act of 1946 which set placed the responsibility for achieving high levels of employment, or low levels of unemployment on the back of the United States government.

In 1978 this objective was re-enforced by a new act, The Full Employment and Balanced Growth Act (known informally as the Humphrey–Hawkins Full Employment Act). This act just made stronger the government’s commitment to the achievement of low levels of unemployment.

The ability of a government to achieve full employment was contested in 1968 by the economist Milton Friedman who contended that continued governmental stimulus to achieve a “hypothetical” level of employment, called “full employment” would only achieve more and more inflation as people came to expect the government’s efforts to stimulate the economy through the creation of credit expansion…credit inflation.

Friedman’s expectations proved to be true as the government continued to promote government deficits and the expansion of government debt in economy.

From 1960 through 2010, the gross federal debt of the country expanded at an annual compound rate of more that 7% per year.

From 1960 through 2010, the purchasing power of the United States dollar declined by about 85%.

From 1960 through 2010, the United States removed itself from the gold standard and allowed the value of the United States dollar to float in foreign exchange markets. The value of the United States dollar has declined by more than 30% since it was floated and expectations are for it to decline further.

From 1960 through 2010 under-employment in the United States has gone from a relatively modest number which was not measured at the earlier date to more than 20% in the current environment.

From 1960 through 2010 manufacturing capacity has declined from about 95% to about 75%. The peak capacity utilization has every cycle since the early 1970s has been at lower and lower levels.

From 1960 through 2010 the income distribution of the United States has become dramatically skewed toward the higher levels of income earned. This is the most skewed income distribution curve ever for the United States.

I cannot see how the United States government can continue to keep “full employment” as a goal of its economic policies. Not only has “full employment” not been maintained, it has generated side effects that, it seems to me, has substantially worsened the life of many Americans.

Why should the government substitute the maintenance of the value of the United States dollar as its primary objective for the conduct of its economic policy?

Here I quote Paul Volcker: “a nation’s exchange rate is the single most important price in (the) economy; it will influence the entire range of individual prices, imports and exports, and even the level of economic activity. So it is hard for any government to ignore large swings in its exchange rate.” This quote is from Paul Volcker (“Changing Fortunes: the World’s Money and the Threat to American Leadership,” by Paul Volcker and Toyoo Gyohten, Times Books, 1992, page 232.)

Yet “ignore large swings in its exchange rate” is exactly what the United States did and is doing. The consequences of ignoring this value? I have reported those above.

By focusing on the level of unemployment the way the United States government did and pursuing an economic policy of credit inflation, the United States government actually weakened the country and hurt its citizens. The “unintended results of good intentions!”

The United States government should not, and realistically cannot, reduce its budget deficit too rapidly. Markets realize that.

But, the United States government must signal that it is changing the objective of its economic policy and is sincerely pursing a path to reduce or even eliminate the credit inflation it has inflected on its country…and the world…for the last fifty years.

My guess is that until international financial markets see this shift in policy objectives and sense a realistic change in the attitudes of the politicians in Washington, D. C. the dollar will continue to decline in value because participants in international financial markets will just see the government continuing to act in the same way it has over the past fifty years, acting in a way that will continue the policy of credit inflation.

And, if the government continues to act in this way, the economic health of the economy will continue to deteriorate and the standing of the United States in the world will continue to become relatively weaker.

In my view the government does not have to reduce the deficit by massive amounts this year. It does, however, have to signal that it is changing its goals and objectives and then provide enough evidence of this change in focus to convince the international financial markets that it is sincere.

In the current political environment, however, this may be too much to ask.