If Democrats and Republicans continue to miss economic fundamentals in considering deficits, we can be sure of reducing one thing: future prosperity.
There's a reason we don't advocate amputating arms as a solution for weight loss. We have to consider the loss of the limb in the context of how well the human body functions in the aftermath of its removal. The same principle applies to deficit reduction. And yet the President seems to be embracing a conservative agenda on deficit spending and "entitlement reform" that makes precisely this mistake. Like his counterparts in the UK, Ireland, Greece, Portugal and Spain, the President is lining up to ensure that his country doesn't become the next Japan, even though (irony of ironies), Japan's "lost decade" never produced a level of unemployment as high as the "recovering" US economy has today.
The President, like Congressman Ryan before him, needs to consider the budget balance in the context of the dynamics of the external sector and the private domestic sector, which are intrinsically linked by national income movements. Consider the fundamentals: there is a private sector that includes both households and firms. And there is a government sector that includes both the federal government as well as all levels of state and local governments. Then there is a foreign sector that includes imports and exports. In their discussion of government deficits, both the Democrats AND Republicans fail to appreciate that there is a relationship among these 3 sectors and that one cannot look at changes in one (say, the government sector), without considering what changes in its spending patterns will do to the others.
I recall back in 1999 that the Wall Street Journal ran two long articles, one claiming that government surpluses would wipe out the national debt and add to national saving-and the other scratching its head wondering why private saving had gone negative. There is a reason this occurred: The government's budget surplus meant that the private sector was running a deficit. Households and firms were going ever farther into debt, and they were losing their net wealth of government bonds. And because private debt is inherently self-limiting (because households and business are USERS of currency, not ISSUERS), this eventually caused a recession. Why? Because the private sector became too indebted and thus cut back spending.
Unfortunately, the President continues to push forward the idea that somehow cutting government expenditures and reducing the deficit is a good thing, but he doesn't explain how this can be the case. Clearly, deficits matter when the economy operating close to full employment and high capacity utilisation. At that stage, too much government spending clearly can be inflationary and should be reined in. But those circumstances don't apply today. The President fails to understand that government cutbacks at this juncture could well take income away from the private sector and therefore induce a higher predisposition to save (because businesses won't invest and private individuals are reluctant to consume in the face of greater economic uncertainty).
In the days before the New Deal, the problem of high private debt levels, minimal government stimulus and correspondingly declining spending power amongst the population as a whole resulted in depressions, widespread debt defaults and a lot more human suffering. It's one of the reasons we introduced the welfare provisions in the form of automatic stabilizers, now so decried by so many fiscal hawks. Automatic stabilizers are the "safety levers" that are built into fiscal policy to keep the economy on an even keel in times of stress. Things like tax revenue, unemployment insurance, food stamps, etc., put money into people's hands that help to stabilize economic activity by stabilizing demand. They are meant to provide the safety floor below which consumer spending will not fall as private spending declines. The expansion of public spending provides some relief from poverty and other major forms of social ills which flow from long term unemployment. Indeed, it is the existence of these stabilizers which have prevented the onset of another Great Depression.
The Hooverian orthodoxy of minimal government intervention and correspondingly tighter fiscal policy -- which seems to be the new orthodoxy of the Republican Party -- was tried during the early 1930s, and failed miserably. And the same mistakes are being made today in Europe. Greece, Ireland, the United Kingdom, Portugal, and Spain. All of these countries are implementing tax increases and drastic spending reductions in the form of cuts in public sector wages, government workforces, and social spending, and their economies are deteriorating. The situation is particularly misconceived in the UK, which does not operate under the constraints of the euro zone.
Perhaps the President and his economic advisors believe that higher private investment, not more government purchases, is the surest way to increase prosperity. To be sure, the President, through his financial bailout policies, has legitimized this argument because far too much of his government spending has been directed toward buying the junk of the financial sector, rather than the productive services of the unemployed.
Governments that maintain high quality health care and public educations systems will set in place the conditions for future prosperity. Conversely, governments that allow mass unemployment to become entrenched and cut back public service delivery and public infrastructure development impose significant real costs on future generations. Most governments are in that mode at present. They fail to see that a budget deficit is simply an accounting statement: a difference between revenues and expenditures, nothing more. In my view, the real goal of government is to run budget outcomes that support sufficient spending power to support full employment. Unemployment is a real cost, a budget deficit is not!
The recent crisis has been, in part, the result of policies based on the idea that nations could sustain growth based on such increases in private indebtedness. We've all too quickly forgotten the costs of that build-up of private debt. Instead, both major parties remain fixated on "unsustainable" budget deficits. Amazingly, nothing is said about the unconscionable Federal Reserve bailouts of countless foreign institutions and multimillionaires during the height of the financial crisis. The Fed itself implicitly recognized this scandalous hypocrisy if one is to judge the fervor with which it legally sought to block Bloomberg from obtaining the relevant details under the Freedom of Information Act. But the public has bought the line about the evils of budget deficits in large part because it is furious about these kinds of Wall Street rescue packages. In that sense, the financial bail-out has "crowded out" more sensible spending policies.
These programs emanated from the White House and Treasury. President Obama owns them. Just as in Afghanistan and Libya, he is doubling down on dumb domestic policies, thereby ensuring an equally tragic outcome for the country.
Marshall Auerback is a Senior Fellow at the Roosevelt Institute, and a market analyst and commentator.