On Deficit And Recession

President George W. Bush and the Republican Congress he worked with, added nearly $5 trillion to the national debt during his first six fiscal years. Members of The Rational Middle will not be surprised to read that statement. Bush’s doubling of the debt is not the reason for the Great Recession. Perhaps that statement is a surprise. A singular fact of economics needs to be understood by the citizens of this democracy, and that knowledge is needed now more than ever: budget deficits do not cause recessions.

Throughout this recession and recovery, the fact that budget deficits have nothing to do with recessions has been consistently ignored by those that do understand. Linking the two items has political benefits for both sides of our rusted two party system. Democrats were able to hammer Bush for his war spending and top heavy tax cuts, Republicans are able to hammer Obama and the Democrats for social and infrastructure spending. The Tea Party is able to lash out in anger at everyone, because the political figures in that group lack even the most basic knowledge of anything fiscal.

So what does cause a recession? I know you hate economics, but this is simple stuff. Recessions happen when there isn’t enough money to go around. There are two processes that cause there to be a lack of cash;

  1. Inflation-This is a little tricky; there isn’t enough cash because prices have increased faster than normal wage growth. It is tricky because the situation is actually created by the presence of too much cash in an economy running at or near full capacity. Lots of deficit spending, over a long time, can cause inflation when the economy gets back to full steam…if it isn’t managed properly.
  2. Loss of Demand-This is the vicious circle (and the cause of our last two recessions…the big one and the shorter one around the turn of the century). Cash leaves the economy; people stop patronizing businesses; business responds by trimming cost (usually by cutting payroll); the unemployed spend even less; more businesses respond by trimming more payroll…and so on. The bursting of an asset bubble like technology stocks or houses, or the presence of a cash-draining trade deficit, are both capable of stealing enough demand from an economy to send it into recession.

It is important to understand these causes because then the citizen is prepared to understand what steps a government can take that may lead to recession, and what steps they can take to get out of recession. Currently, most citizens and the media they get their information from, take it as gospel that balanced budgets are the key to getting and staying out of recessions. They define a government as having a balanced budget when it takes in as much in tax revenue as it pays out in the form of services. They further link that to the idea that such “fiscal discipline” is the key to all successful businesses and homes. I do enjoy a good fairy tale, but this is a serious subject. How many of you know someone that does not have more currently borrowed than they earn in a year? How many people do you know whose borrowing expense is not their largest annual cost? For businesses, the example is possibly more stark.

Lets be clear on this, as a professional manager with a career spent pinching pennies, I take my fiscal discipline seriously. But I reject the notion that balanced budgets, in the current political definition, have anything to do with the success of a business or an economy. In fact, that definition of fiscal discipline doesn’t have anything to do with the reality of business. Almost all businesses use debt to start, maintain, and grow. Fiscal discipline in the business sense means ensuring the future cash flows can service the interest on debt along with current period obligations. But businesses that stop investing in their infrastructure and their future die…period.

Think of the U.S. corporate model and U.S. industry competitiveness. The CEO’s of U.S. businesses have spent decades now using lay-offs, “downsizing”, and “force reduction” to make their earnings reports look nice for Wall Street. The resulting loss of heuristic knowledge and team spirit has allowed the rest of the world to overtake American business…and take over the customers formerly serviced by American business. A similar process has been at work during America’s thirty year orgy of tax cutting; U.S. education and commercial infrastructure (roads, locks, dams, ports, electrical grids) have fallen by the wayside. Has the education your child can receive gotten better since 1980? Has your ability to move you or your products around the city in which you live gotten better during that time?

What has improved in thirty years has been corporate earnings and the Dow Jones Industrial, neither of which have anything to do with keeping us out of recessions. Wall Street has been on a tear for the last two years, how has your personal economy improved? Wall Street was moving along just fine for the first year of the recession, how did you do from early 2007 through to the summer of 2008?

If everyone agrees that raising taxes during a recovery is a good way to kill it, then why is it a good idea to cut state, federal, or municipal jobs? Killing jobs takes far more money out of the economy than raising taxes by a couple of points…it isn’t opinion, it is a fact. The forgotten fact about government spending that isn’t defense related, is that most of it is spent in the domestic economy. The deficits that most states are facing are not the results of massive spending increases, they are because of massive shortfalls in revenue. All of those government workers (you know, those evil police officers, firefighters, snowplow drivers, teachers, engineers, and judges) spend their salaries in the communities they live in. Such spending also serves to build and maintain the commercial infrastructure that the rest of us use to make money. Killing jobs in a recession or recovery makes even less economic sense than raising taxes.

A government can cause a recession by failing to invest enough in our infrastructure (physical or human); as happened in the Bush Administration. A government can cause a recession by failing to keep markets and their greed (both necessary) from getting out of hand; as happened in every administration from Reagan to Bush (yes friends, including Clinton). All of the fervor of the incoming Republican House leadership is only the tip of the fiscal insanity iceberg. Like icebergs, most of the danger lies below, hidden in the minds of good citizens who don’t know enough about the economy they live and work in. All dangerous themes in politics arise from good intentions run amok. It is time we the people recognized the boundaries of this good intention.

The Rational Middle is listening…

2 thoughts on “On Deficit And Recession

  1. Thanks for commenting Milo, and keep them coming! Currency, put simply, is based on faith. Economics is a well established and well researched social science. It is a little like meteorology in that it gives good approximations rather than exact answers.

    But the irony of a GOP regaining control of the House on the basis of fiscal discipline is a little odd. Some in the RM might argue that using fiscal responsibility as a precondition for political office, however, would drastically reduce the tribe of politicians on both sides of the fence.

    I think that, just like in your home or business, it is what you buy and when that is most important.

  2. My understanding of economics and the economy is that it is basically based on head games. If enough people lack faith in it, then it will suck. If enough people have faith in it, then it will be great. A simplistic version, yes, but still.

    I find it funny that the same people who put us in debt are being touted as the ones who will get us out of debt. It saddens me that the number of poor in this nation keep stacking up while the various institutions that will help them get back on their feet and be working citizens again are being cut down to size (or threatened as the case my be) while things like military spending in places we have no business being in in the first place keep being allowed to add to the debt. What a joke.

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