Argument research and analysis

Budget Deficits and How to Finance Them

Present economics are based largely upon the economic theories of John Maynard Keynes that made up the basis of the economy of the post World War II economy. Therefore, to understand issues of budget deficits and their relations to exports, one must resort primarily to Keynesian theory. Most budgetary theory since is a reaction against and an attempt to correct the system which has guided the economy since his theories came into effect. The breakdown in this system requires that we understand the foundation theory to get the best handle on fixing the problems. The solution this author postulates is a return to the old regime that was in effect before the repeal of the 1933 Glass-Steagall Banking Act of 1933 that prohibited the mixing of speculative and commercial banking. This has substantially ruined the banking system and the individual incentive to save and invest responsibly.

Budget deficits will eventually result in a reduction in exports. This is due to the sheer size of government and the amounts of money that it can borrow. The amount of capital (like any commodity) available for borrowing is limited in quantity. Traditional economics and historical experience have shown that an accumulated budget deficit over several years (government debt) is usually financed by borrowing. If a government's debt (such as the United States) is denominated in its own currency, it can print new money to pay debts. However, this can cause rapid inflation as was Germany's experience with hyperinflation as it attempted to pay off reparation debts to the Western Allies by running the printing presses.

Governments can also sell assets to pay off this debt or they can finance debts by the issuance of long-term bonds. They also can sell shorter term notes and bills, usually at auction. They must like individual borrowers pay interest on the money that they borrow. Most Western economies (especially the United States) regulated by central banks such as the Federal Reserve System are based upon Keynsian economics. According to John Maynard Keynes, he postulated that running a fiscal deficit and increasing government debt can stimulate a country's economic activity when that country's economic output is below its potential economic output. The key is to putting money into the hands of consumers to buy unused goods and services. If that economy is running at or near its potential level of output, these fiscal deficits can cause inflation. This inflation cuts into savings and therefore decreasing the amount of money available to be borrowed. The amount of money that is left available to borrow will only be available at higher interest rates.

For this reason, in Keynesian economics, it is necessary during good times to cut budgets and increase revenues. This then can finance government deficit spending during times that are bad. Then during bad times, government spending on infrastructural and wealth building schemes (such as building roads and schools) will in the long run provide an economic incentive to those who will engage in buying goods and services that are otherwise laying dormant. This is at the heart of Keynes' Principal of Effective Demand (Keynes, 21-30).

Unfortunately, Keynesian economics also has a bitter downside. The problem is that the United States government has been borrowing for years to finance overseas wars such as the ones in Afghanistan and Iraq. The borrowing to finance this and to maintain government social programs has now maxed out. With a declining economic output, we can not financially export our way out of a government budget deficit situation. Since the oil crunch of the mid-1970s, energy costs have increasingly been a part of this equation. Trade deficits are linked to budget deficits in this way. This is best presented in a May 12, 2010 article, Donna Kardos Yesalovich documented that U.S. stock futures pared earlier gains after data showed that the U.S. trade deficit widened in March of 2010 to its highest level since December 2008 (Yesalavich).

To make matters even worse, the European economic downturn is complicating things just as the U.S. downturn has sent the world economy into an extended deep recession (or depression, before this word became unpopular). Mark Whitehouse in another Wall Street Journal article documented that markets tumbled despite upbeat reports about U.S. shoppers and factories due to the high debt portfolio of European countries and the upward pressure on interest rates specifically at a time when this borrowing capital was needed most (Whitehouse).

The high budget deficits in the United States and Europe will continue to eat into money that could potentially be available for investment. Bailouts for banks with bad investments continue to make this worse (Chan). What is necessary is to reinstitute consumer savings and help the banking system to recover. A lot of the problem is due to the toxic debt that was brought on by the dismantling of the regime that grew out of the Great Depression, namely the scuttling of the Glass-Steagall Act of 1933 that separated most speculative investing from normal banking and consumer lending. In a recent Bloomberg article, one of the primary architects of the laws 1999 repeal, former Merill- Lynch CEO Walter Komansky, says he now regrets the law's repeal (Erlichman and Mildenberg).