Alternative Insight

National Debt - Anti-hero of the Free Enterprise System

A popular motif in literature features the anti-hero, a person vilified for awkward appearance or reckless behavior, but a person who displays characteristics of sacrifice and rescue. Think of Sidney Carton in Charles Dickens Tale of Two Cities, Quasimodo in Victor Hugo's The Hunchback of Notre Dame, the real life Jesse James and Clint Eastwood in almost all of his films.

Economic policies and programs can also be anti-heroes - Roosevelt's New Deal, the graduated tax system, Social Security - damned by many as wasteful and counter productive, and recognized by more as worthwhile government achievements and private survivals for masses. Not apparent is that the duality and descriptive title of anti-hero also belongs to the much maligned national debt. Perceived as a financial evil that corrodes the American government, the green albatross of ongoing federal deficits is an essential element of the free enterprise system - a partner to all other debts in an economic order that runs on debt. National debt has a decisive role in maintaining the welfare capitalist system - ballast to keep the system floating and reserve energy to prevent if from total collapse. This anti-hero is a prominent savior of free enterprise and those who rail against temporary government deficits without examining its benefits are negligent in their understanding of a capitalist economy and guilty of pushing the economic system into ultimate decline.

Government deficit spending can smooth the wild swings in the economy. By synchronizing the respective private and public debts, the total debt is maintained and demand and purchasing power are stabilized. Proper application of government debt could prevent all debt from growing too rapidly; could, but due to lack of understanding of the function of government debt by Republican administrations, this has not been the case.

During times of rising prosperity, government deficit spending can disappear and increasing tax revenues used to retire government debt. Repurchase of the debt transfers funds to the capital markets and makes them available to satisfy the growing demands for credit. When the credit markets begin to saturate, the government budget re-enters a period of deficit spending to compensate for the loss in domestic purchasing power. As tax revenues decrease, government debt increases while private debt is retired and decreased.

The alternative to this symbiotic relationship between federal and private debt has the government give inattention to the economy's credit needs and permit the economic downfall to run its course - to where? Not only is an economic decline a degenerative system that promotes further decline, it stimulates deflation where debtors go broke, bankruptcies where creditors go broke, and asset depreciation where speculators gain valuable assets at low prices, resulting in an impoverishment of multitudes and rearrangement of the social and financial system to benefit an oligarchy. Coining a phrase from economist Friedrich Hayek, who favored cleansing the economy with a drastic "let it all fall " approach rather than stabilizing it with government interference, not using government deficits to emerge from a severe recession is the Road to Serfdom.

Republican administrations have not shown awareness of the government's role in smoothing the economic cycles and preventing abrupt rises in debt. Their policies have skewed the economy to constantly acquire private and federal debts whose eventual reduction may demand drastic solutions. A quick reference to spending patterns of previous administrations validates the argument.

After the brief 1981-1982 recession, Ronald Reagan 's budgets contained continual deficits, despite the already busy domestic credit markets and a general rise in GDP. These policies left President George H.W.Bush with a huge government debt, a new recession and no recourse but to increase the debt.

Democrat President Bill Clinton wisely balanced the budget during an era of prosperity and rapid growth in consumer debt. When credit markets saturated and another recession occurred in 2001, federal deficit spending renewed and was able to stabilize demand and maintain GDP.

During another era of prosperity and rapid growth in consumer debt and GDP, Republican President George W. Bush neglected to follow the wise precedent of his predecessor and instead added fuel to an overheated economy with more government deficits. Result - an abrupt downfall to the economy in year 2008, and a Republican 2008-2009 budget that featured a deficit of $1.4 trillion, the largest government deficit in history.

President Barack Obama inherited the catastrophes - a falling GDP, escalated unemployment, disinvestment, deleveraging, deflation, sizable current account deficit, and an enormous federal debt - results from Bush's lack of attention to regulating and synchronizing public and private debt. A huge stimulus plan and another tremendous increase in government debt presented the only viable solutions to the economic problems.

The graph shows the extent to which the stimulus plan had to reach to prevent a free fall in GDP. Private debt had been growing at 0.5 to one trillion dollars each year. The coupling of the private debt increase with annual federal deficits that averaged 0.3 trillion dollars for several years and addition of a subsequent deleveraging in private debt of 0.5 trillion dollars forced government spending to increase at least 1.2 trillion dollars in order to replace the loss in purchasing power and reverse the GDP decline, which the spending did. Due to low tax rates and a declining economy, government revenues could not cover the budget increases, and large deficits occurred.

Throughout this exposition, the role of tax rates is superfluous. Tax rates are preferably set so that revenue matches normal government operating expenditures. Some fluctuations in rates may occur, but because taxes only shift spending from the public to the government and vice- versa and don't create new purchasing power, an attempt to use the tax system to guide the economy is meaningless and counterproductive. George H.W. Bush's tax cuts traded a temporary elevation in the quality of life of a sector of the public for government deficits and a rising debt. When the financial bust arrived so did much lower tax receipts and a huge government deficit; not the deficit required to increase purchasing power, but a deficit that was the result of decreased national income.

Including intra-government debt, the federal debt is expected to rise to 17.5 trillion dollars in budget year 2012-2013, of which 6.0 trillion dollars is owed to foreigners. The graph clearly shows that before President Obama entered office, the Republican administrations of Ronald Reagan and George W. Bush had added about nine trillion dollars to the government debt, escalating it from one trillion dollars to Bush's final budget in which it reached 10 trillion dollars. In order to rescue an economy that the Republican presidents and Fed Chairman Greenspan had geared to function with enormous credit, the Obama administration was forced to run high deficits, which propelled the federal debt to the expected level of 17.5 trillion dollars in 2013.

Can the public debt be reduced to acceptable levels within 20 years? If so, how? Some of it might be reduced by inflation (a counter productive mechanism), by increased tax revenues during prosperous times, sale of assets, transferring debt to the Federal Reserve Bank (FRB) (Quantitative easing or purchasing of government bonds by printing money will add $2 trillion of federal debt to the FRB in 2013), hopefully but unlikely by positive current account deficits, and by default (possible). What does a constant public debt infer? Are there dangers, especially from the $6 trillion foreign debt, which cannot be repaid without either selling assets to foreigners or crippling the dollar. Government officials have not faced or revealed answers to these questions. What we know are:

(1) Republican administrations have been responsible for the huge debt;
(2) The debt arose from greed - to elevate prosperity by pumping the economy with as much free money as possible;
(3) Presidents Reagan and Bush Jr. have endangered the United States' economy and financial position by not following a mechanism for regulating total debt;
(4) A credit driven economy cannot last; and
(5) The federal government (not the nation) is already broke.
The Federal Reserve Bank Z-1 Flow of Funds Statement has the U.S. government in 2010 possessing $3.53 trillion in assets and $12.26 trillion in debt, which leaves Uncle Sam in a negative financial position of $8.73 trillion.

Something wrong somewhere. Maybe our anti-hero of government debt is only a mask. Upon removing the mask we might find that the unmasked debt is owed by all Americans, and when added to their own financial position brings many into or close to "virtual" bankruptcy. Not as bad as it seems, but time to take heed.

february, 2013


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