Wednesday, May 4, 2011

A Problem With Large Government Deficits

 When one discusses large government deficits the discussion generally centers on either the ability of the government to finance those deficits in financial markets or the need to “monetize” the debt, thereby creating the possibility of substantial future inflation.

There is another problem that doesn’t get as much attention yet is very, very important for the running of the government.  It is a problem the United States government is now facing. 

If a government (or anyone for that matter) is running a large deficit in its financial budget then the very existence of such an excessive budget restricts the government in what else it might be able to do.  That is, the government’s flexibility in taking on new expenditures is severly limited. 

The United States government is facing this problem in several areas at this very moment.  Let’s review a couple of them.

The United States government is facing tremendous competition from China in international trade and finance.  The United States is very limited in its ability at this time to respond to the initiatives that the Chinese are making in the world…politically and economically. 

“Flush with capital from its enormous trade surpluses and armed with the world’s largest foreign exchange reserves, China has begun spreading its newfound riches to every corner of the world—whether copper mines in Africa, iron ore facilities in Australia or even a gas shale project in the heart of Texas.”  This comes from the article “As China Invests, U. S. Could Lose,” in the New York Times. (

A “study, commissioned by the Asia Society in New York and the Woodrow Wilson Center for International Scholars in Washington, forecasts that over the next decade China could invest as much as $2 trillion in overseas companies, plants or property…”

The United States government and United States business does not have that much “dry ammunition” to combat such an investment program.  And, as U. S. government policy continues to underwrite a weak dollar, the ability to take on such an investment program internationally continues to fade into the background.  But, other BRIC nations pose such a challenge as well.

Yet, the United States cannot afford to be un-competitive in this area.

Also this morning we read about the plight of United States regulatory agencies: “US Regulators Face Budget Pinch as Mandates Widen.”  (  In effect, as Congress has given banking and financial regulators more to do, due to the recent financial crisis, the regulators find that they are finding less and less money to carry out the new charge they have been given. 

Many of us may not be upset with this situation, still it points to the fact that with the large budget deficits forecast into the future, the United States government just cannot commit to fund certain programs people have wanted to see become more aggressive. 

One final situation that has recently occurred.  This has to do with the situation in Libya.  Many have argued that the United States cannot take on more military roles in the world because it just cannot pump up the expenditures on the budget to meet such responsibilities.  Consequently, since it favors military actions in selected spots, such as the one in Libya, it cannot fully participate in the exercise and must get others, like NATO, to carry the burden of the effort.

The question then becomes, “Is this budget constraint keeping the American government from doing things in other areas it believes it should be involved in?”  Like in Yemen or Syria?

The problem is that one can’t do everything…even if that “one” is the richest and most powerful nation in the world and oversees the reserve currency of the world.  And, this is the problem with lots of debt.  It allows “one” to live beyond ones means for a while…but then there is always the possibility that “one” will need to do more…and can’t.

It is an issue of management and discipline.  One cannot constantly push debt limits to the extreme and then expect to be able to go further into debt should the occasion arise at some time in the future. 

Boy, this idea seems “old fashioned”!

But, this is exactly what the United States government has been doing…and it has been doing it for an “extended period”…it has been doing it since the 1960s.  This is the foundation of the credit inflation we have been experiencing for the last fifty years.

And this is the foundation of the decline in the value of the United States dollar for the past fifty years and for the terrible balance of trade situation the United States finds itself in which has led to the surplus of dollars in the hands of the Chinese and others. 

I know…if the value of the dollar declines, the trade deficit should get smaller.  I tried to respond to this issue earlier.  See my post “Does a Decline in the US Dollar’s Value Reduce the Balance of Payments Deficit”: 

The value of the dollar continues to decline because those in international financial markets don’t observe the “management and discipline” in the Unites States government that is necessary to change what goes on relative to the budget of the United States government. 

In my view, the United States government does not have to do much to gain the confidence of world financial markets.  The first thing the government must do is accept the goal of maintaining the value of the United States dollar in foreign exchange markets as its primary economic objective.  (I have discussed this in a post to my Instablog, “What is Needed to Reduce the Federal Deficit”:

This would allow two things to happen.  First, the United States government could get away from its current primary goal, the Keynesian goal of achieving full employment, which it cannot accomplish anyway. (See my post from yesterday:  The exchange rate goal incorporates an inflation goal within it.

Second, the government needs to focus on “good” long-term management and discipline in its budgetary practices.   Good, long-term management pays off.  My recent example of this is the efforts led by Treasury Secretary Robert Rubin in the latter part of the 1990s to balance the United States budget.  International financial markets saw this effort; believed that President Clinton and others within his administration supported the effort; and the value of the US dollar began to climb in foreign exchange markets even before a balanced budget was achieved. 

The important thing to note is that the economy also got stronger during this time so that the government achieved not only a greater balance in the budget and a rising value of the US dollar, but it also saw the US economy continue to grow.  International financial markets approved of the “management and discipline” that it believed it saw in the United States government.  Plus, this effort created some room for the Bush 43 administration to add additional “unexpected” expenditures to the budget ,as they were needed, such as the “war on terrorism.

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