

In the post Federal Debt/GDP – a useless ratio, I described the reasons why it was an apples/oranges ratio that had no descriptive or predictive value for any economist – though it is quoted often. You can read the post to see the argument.

Recently, I had a painful conversation with a 24 year old lad who, based on his vast experience, repeatedly told me I was wrong about nearly everything in economics, while providing zero data to support any of his beliefs – in other words, typical.

At one point, when he didn’t understand a basic graph I showed him, he informed me it was “obscure” and “crankish” (I have no idea), and that “most people use the federal deficit as a % of GDP,” a reference mostly irrelevant to our discussion.

Nevertheless, it occured to me that some of my earlier comments regarding Federal Debt/GDP may not apply clearly enough to Federal Deficits/GDP.

By law, the total of all federal deficits constitute the federal debt. I say, “by law,” because the federal debt, i.e. the total of outstanding T-securities, is not functionally necessary. The U.S., being Monetarily Sovereign, does not need to “borrow” the dollars it previously created and has the unlimited ability to create.

More specifically, federal “debt” is the total of all Treasury security accounts held at the Federal Reserve Bank. Essentially these are savings accounts held at “our” bank. To repay the so-called “debt,” the FRB merely debits the T-security accounts and credits checking accounts — exactly the same procedure as when you transfer dollars from your bank savings account to your bank checking account.

Banks boast about the size of their savings account deposits, and work hard to gain savings account deposits, but for reasons unknown, those deposits are not called “deposits,” when they are in the FRB. There, they are misnamed “debt,” and that misnaming has everyone all atither. T-securities are no more “debt” than are bank deposits, and place no burden on the FRB.

T-securities are optional relics of pre-Monetary Sovereignty days. But for the law, they need not exist today in any correspondence with deficits, which are nothing more than the difference between spending and tax collections.

Tweak the law and we could have infinite deficits with no debt, or we could have infinite debt with no deficits. Think about that, and if it puzzles you, feel free to comment on this post; I’ll go into further detail.

Anyway, there are vast numbers of people who not only fret about the Debt/GDP ratio, but also wring their hands about the Deficit/GDP ratio. Here is a historical graph of that later ratio:


The gray bars are recessions. What generality comes to mind about the relationship between the blue line and the gray bars? My generality is: When growth in Deficit/GDP falls, we eventually reach a recession, at which time growth in Deficit/GDP rises and we come out of the recession. If Deficit/GDP were negative to the economy, we would not expect such a result.

One could say it’s a result of automatic stabilizers or even coincidence, but I suggest there can only one serious explanation for such a dramatic graph: Reductions in Deficit/GDP lead to recessions and increases in Deficit/GDP cure recessions.

This should be no surprise, when we also look at the red line, which is deficit growth itself. It too demonstrates how deficit growth drops year after year (as debt hawks worry about deficits and force “revenue neutral” projects) until we have a recession, at which time the government spends stimulus money to get us out of the recession. Then, when we recover, we fall back on our bad, old “cut-deficits” ways.

Memo to debt hawks: If deficit growth were harmful to the economy, wouldn’t you expect to see at least a few occasions when several years of deficit growth led to recession? But that simply does not happen. Why? Partly because Gross Domestic Product = Federal Spending + Private Investment and Consumption + Net exports. And, Federal Deficits – Net Imports = Net Private Savings – two fundamental equations in economics.

Federal deficits are an important component of GDP, Private Investment, Private Consumption and Net Savings. Reduce deficits and you reduce them all.

Perhaps this post can close the book, not only on Debt/GDP but also on Deficit/GDP. The next time you see or hear either of these ratios decried, you’ll know whether the writer or speaker understands economics and Monetary Sovereignty, or is just following the popular myth.

Rodger Malcolm Mitchell

Federal Deficits – Net Imports = Net Private Savings