The Fiscal “Cliff” and the Real Problem

Like many others, [1] I'm not worried about the so-called fiscal “cliff,” and the ravages to the economy that are likely to occur if Congress doesn't do something about it before the end of the year. That's because a lot of the impact can be cushioned in the short run by Executive Branch manipulations while negotiations continue to go on. But if measures aren't taken to reverse the contractionary effect of the sequestration-induced changes, we're looking at deficit cuts of $487 Billion [2] over 9 months of the fiscal year.

By comparison, the American Recovery and Reinvestment (ARRA) of 2009 produced only $350 B in stimulus during its first year. And, if the full sequestration were allowed to proceed unmodified, then it would result in a “claw-back” of about 60% of the total ARRA stimulus.

Fortunately, if we do go over the "cliff" heavy pressure will then be on both parties to reintroduce the middle class tax cuts, and make them retroactive, and to restore some of the other cuts as well, so it may be possible to mitigate much, if not most, of the damage, if the Democrats are aggressive enough in pushing the negotiation advantages they appear to have now. So, the real danger of the manufactured “fiscal cliff” is more long-term.

That danger is the constant bleating from both deficit hawks and "progressives" that we have to do something long-term about the deficit/debt problem. So, they put up these long-term plans to delay deficit cutting for a year or two and then want to cut even more down the road to 'stabilize' the debt-to-GDP ratio. This is a non-existent problem, and any plan providing for deliberate polices to force deficit reduction by constraining Government spending to some arbitrary level is bound to damage the economy seriously [3] when the prescribed spending cuts and increased taxes for lowering deficits take effect.

People have to come to accept reality, which is: if we want to import more than we export; and also want the private sector as a whole to save money (i.e. bank savings, pensions, other savings) then there is no alternative [4] to having the Government deficit spend. Further, how much the deficit ought to be, without incurring the penalty of demand-pull inflation is dictated by how much we want the private sector to save, and how much of a trade deficit we want to continue to run. If we want to have a trade deficit at 4% of GDP, and we want to save 7% of GDP, then we must allow the Government to run a deficit of approximately 11% of GDP. And we must do that year after year after year, for as long as we want to save that much and import that much.

Do I need to point out that our deficits are not now anywhere near 11%? And that as a result we not only have high unemployment, an output gap of more than $3 Trillion annually [2] in GDP, but also less in both savings (financial wealth being accumulated) and imports (real wealth being accumulated) then we otherwise would have? What will happen if even the “liberal” Center On Budget and Policy Priorities (CBPP) [5] hits the economy with its proposed total of $3.7 Trillion (the $1.7 Trillion already agreed to last year and the additional $2 Trillion it is proposing) in deficit reduction? That is an average of $370 Billion per year in enforced deficit reduction which will come right out of savings and imports. That, in the absence of credit bubbles creating unsustainable demand, will condemn us to a stagnant economy as far as the eye can see.

We don't have to run those 11% of GDP deficits, and also have them drive 11% of GDP further debt accumulation. Deficits and debt accumulation are not the same things, and can be decoupled. We can have the deficits and use Proof Platinum Coin Seigniorage (PPCS) [6] to underwrite the deficit spending; or we can change the rules preventing the Fed from monetizing deficit spending by just creating the necessary credits for spending Congressional deficit appropriations and placing them in the Treasury General Account (TGA) when needed. So having the increased debt along with the continuing deficits isn't necessary. And if we don't like the debt, then we can get rid of it. [7]

But, again, if we want the imports and if we want the savings, then we must have the deficits, and we must never have deficit reduction unless we also have savings reduction and/or trade deficit reduction. So the bottom line here is: We need to have the “loser liberal” message we're hearing from Bernie Sanders, [8] Robert Reich, [9] The Center On Budget and Policy Priorities, [5] and various "progressive" pundits and organizations, just stop!

Keynes's idea that a fiscally responsible nation incurs deficit/debt in bad times, and pays it back in good times with surpluses, is wrong in the context of fiat currency nations. The gold standard's been gone since 1971. Nations have much more fiscal space. Some nations want to run trade surpluses all the time, and accumulate nominal financial wealth, and others want to accommodate them and accumulate the real wealth of their imports instead.

So, this makes it impossible for those others to have both aggregate private sector savings and full employment, without Government deficits compensating for the demand leakages. The accommodating nations need to run permanent deficits to serve their own populations. And, if other nations, object to that, then they need simply to stop having export-led economies.

We have no national debt, or debt-to-GDP ratio problem, because we are a nation with a non-convertible fiat currency, a floating exchange rate, and debts in currencies not our own. This means we can always generate new currency to pay our obligations using the methods I just mentioned. And it also means that 1) our levels of debt and debt-to-GDP ratio have no impact on the fiscal sustainability of our fiscal policy; and 2) fiscal responsibility can't mean targeting fiscal policy at particular levels of the national debt, or the debt-to-GDP ratio.

Nor can the bond markets create rising interest rates on US public debt because "we," that is the Fed and the Treasury together, control those rates and can keep them as low as they want to even if every ratings agencies downgrades US paper to its lowest rating. Put simply, our creditors have zero power over our interest rates. Reich's talk [9] about persuading our creditors that we’re serious about getting our fiscal house in order is just errant nonsense. What we really need to do about them is to use PPCS to fill the public purse, [10] repay our debt instruments as they come due, and take their bond market in USD away from them entirely. It's only a source of "welfare" payments to rich people and foreign nations anyway. What do we need it for, anyway?

(Cross-posted from New Economic Perspectives [11].)