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“Today’s deficits do not burden future generations…” Straight talk about government spending with Marshall Auerback

One of the most oft-deployed claims against the Obama administration, and the underlying concepts of social services, government spending, and social responsibility itself, is that deficits kill the economy. In fact, if you listened to deficit hawks from both major parties, as well as libertarian doomsayers, you’d think deficit spending was not just bad, but apocalyptic. The cries have increased in the last two years as the Obama administration has deployed relatively modest government spending in response to the latest economic crisis. And yet, mysteriously, it’s almost impossible to find detailed warrants for the deficit doomsayers’ claims. Headlines portend destruction, while actual articles contain glittering generalities and empty promises for more proof later. Why, I asked myself, is the most often-used economic meme against the left so empty of data? For answers, I contacted Economists for Peace and Security, who put me in touch with Marshall Auerback.

Marshall Auerback is Senior Fellow at the Roosevelt Institute with nearly thirty years of experience in investment management. He is a magna cum laude graduate of Queen’s University and also has a a law degree from Corpus Christi College at Oxford University. He is a fellow at Economists for Peace and Security, who graciously put us in touch with him when we had some tough questions to ask about right-wing deficit talk.

Politicalcontext.org: Every day we see a few headlines that tell us that deficits are potentially disasterous, but the articles underneath the headlines seldom say why. Before we go about deconstructing deficit hawk  rhetoric, why should we be concerned about deficits?

Marshall Auerback: We should only be concerned about deficits to the extent that they create INFLATION, not out of any misguided notion of national “insolvency”.  As a monopoly issuer of the currency, our Government isn’t going to ‘run out of money’ as our President has repeated.  It is not dependent on China or anyone else.  There is no operational limit to how much Government can spend, when it wants to spend.  This includes making interest payments and Social Security and Medicare and Medicaid payments.  It includes all Government payments made in dollars to anyone. 

This is not to say excess government spending won’t possibly cause inflation.  It is to say the government can’t go broke and can’t be insolvent or bankrupt. There is simply no such thing.

If the government doesn’t tax because it needs the money to spend, why tax at all? Answer:  The govt taxes to regulate what economists call ‘aggregate demand’ which is a fancy word for ‘spending power’   In short, that means that if the economy is ‘too hot’ raising taxes will cool it down, and if it’s ‘too cold’ cutting taxes will warm it up.  Taxes aren’t about getting money to spend, they are about regulating our spending power to make sure we don’t have too much and cause inflation, or too little which causes unemployment and recessions.

PC: Tell us, if you could, about the origins of “deficit hawk rhetoric.” Was there ever a time in American politics when conservative politicians didn’t raise fears about the deficit? Or has this been an ongoing rhetorical tool of the right?

MA: This has been an ongoing rhetorical tool of the right, but in fact, it hasn’t been a particularly successful strategy in terms of generating a solution to the alleged problem. Consider the data from the US Office of Management and Budget —  historical data which is an excellent source of long time series for US public sector data. For the 79 year period shown, the US government’s budget was in deficit of varying proportions of GDP 67 of those years (that is, 84 per cent of the time). Each time the government tried to push its budget into surplus, a major recession followed which forced the budget via the automatic stabilisers back into deficit.

These deficits have provided support for private domestic saving over most of this period. The US current account was in surplus (very small though) up until the 1970s and then has been more or less in deficit since the mid-1980s and increasingly so in the 1990s and beyond.

In times of crisis – the Great Depression and World War 2 – you can see the deficit grew relatively large and national debt followed it upwards as a percentage of GDP. Then as growth resumed and stability was re-established the deficit fell back as a percentage of GDP to the level required to support private domestic saving and maintain aggregate demand to support relatively high (but not high enough) employment levels.


Movements in interest rates and inflation rates and changes to US tax regimes bear no statistically significant relationship with the fiscal parameters over this entire period. The strongest relationship that can be established is the relationship between deficits and expenditure and hence economic growth (and employment growth).

So the question that has to be answered by those who are predicting the end at the moment is this – given the historical period experience – why are the current Deficits/GDP, which are smaller by a long way from what they were in the 1930-40s, suddenly signalling something that is unsustainable?

The first response will be the ageing society and health issues are different now. Yes they are but those issues are erroneous distractions. There are no other credible responses. The US economy will resume growth – the automatic stabilisers will go to work and eat into the budget deficit and the US will cut back stimulus spending to further reduce the deficit. Private domestic saving will stabilise as private balance sheets are restored to some semblance of sustainability following the private debt binge and the net public spending required to support that saving and maintain growth will also stabilise.

With one brief exception, the federal government has been in debt every year since 1776. In January 1835, for the first and only time in U.S. history, the public debt was retired, and a budget surplus was maintained for the next two years in order to accumulate what Treasury Secretary Levi Woodbury called “a fund to meet future deficits.”  In 1837 the economy collapsed into a deep depression that drove the budget into deficit, and the federal government has been in debt ever since. Since 1776 there have been exactly seven periods of substantial budget surpluses and significant reduction of the debt. From 1817 to 1821 the national debt fell by 29 percent; from 1823 to 1836 it was eliminated (Jackson’s efforts); from 1852 to 1857 it fell by 59 percent, from 1867 to 1873 by 27 percent, from 1880 to 1893 by more than 50 percent, and from 1920 to 1930 by about a third. Of course, the last time we ran a budget surplus was during the Clinton years. Has any household been able to run budget deficits for approximately 190 out of the past 230-odd years, and to accumulate debt virtually nonstop since 1837? As discussed above, there are firms that grow their debt year-after-year so it is conceivable that one might be found with a record of “profligate” spending to match the federal government’s. Still, the claim might be that firms go into debt to increase productive capacity and thus profitability, while government’s spending is largely “consumption”.

Fourth, the United States has also experienced six periods of depression that began in 1819, 1837, 1857, 1873, 1893, and 1929. Therefore, every significant reduction of the outstanding debt, with the exception of the Clinton surpluses, has been followed by a depression, and every depression has been preceded by significant debt reduction. The Clinton surplus was followed by the Bush recession, a speculative private-debt fueled euphoria, and then the collapse in which we now find ourselves. The jury is still out on whether we might yet suffer another great depression. While we cannot rule out coincidences, seven surpluses followed by six and a half depressions (with some possibility for making it the perfect seven) should raise some eyebrows. And, as we will show below, our less serious downturns in the postwar period have almost always been preceded by reductions of federal budget deficits. This brings us to an obvious point: the federal government is big—especially since WWII—and movements of its budget position have a big impact on the economy.

PC: Given that the House GOP neither intends to nor will reduce wasteful government spending, how is it that they get to claim ownership over the meme that they are the saviors of fiscal responsibility? Does the mainstream media do that work for them?

MA: A lot of it is the mainstream media, which is generally financially illiterate and prone to repeat the fallacies of the so-called “experts”. 

PC: Will the current budget cuts being proposed impede the slow recovery we’re in right now? Can you walk us through why that’s the case?

MA: The macroeconomics example of the fallacy of composition most often used is the paradox of thrift. Any individual can increase her saving by reducing her spending—on consumption goods. So long as her decision does not affect her income—and there is no reason to assume that it would—she ends up with less consumption and more saving.

The example I always use involves Mary who usually eats a hamburger at Macdonald’s every day. She decides to forego one hamburger per week, to accumulate savings. Of course, so long as she sticks to her plan, she will add to her savings (and financial wealth) every week.

The question is this: what if everyone did the same thing as Mary—would the reduction of the consumption of hamburgers raise aggregate (national) saving (and financial wealth)? The answer is that it will not. Why not? Because Macdonald’s will not sell as many hamburgers, it will begin to lay-off workers and reduce its orders for bread, meat, catsup, pickles, and so on.

All those workers who lose their jobs will have lower incomes, and will have to reduce their own saving. You can use the notion of the multiplier to show that this process comes to a stop when the lower saving by all those who lost their jobs equals the higher saving of all those who cut their hamburger consumption. At the aggregate level, there is no accumulation of savings (financial wealth).

Of course that is a simple and even silly example. But the underlying explanation is that when we look at the individual’s increase of saving, we can safely ignore any macro effects because they are so small that they have only an infinitely small impact on the economy as a whole. But if everyone tries to increase saving, we cannot ignore the effects of lower spending on the economy as a whole. That is the point that has to be driven home.

We can then again return to the notion of the multiplier, and show that the way to increase aggregate saving is by increasing spending, specifically, nonconsumption spending—spending on investment, spending by government, or spending by foreigners on our exports.

I don’t want to go into that particular example any further. Another example that is less frequently used concerns unemployment. The view shared by most of my undergraduate students is that unemployment is caused by laziness or lack of training. The argument they often use is that “I can get a job, therefore all the unemployed could get jobs if only they tried harder, or got better education and training”.

The way I go about demonstrating that fallacy is a dogs and bones example. Say we have 10 dogs and we bury 9 bones in the backyard. We send the dogs out to find bones. At least one dog will come back without a bone.

We decide that the problem is lack of training. We put that dog through rigorous training in the latest bone finding techniques. We bury 9 bones and send the 10 dogs out again. The trained dog ends up with a bone, but some other dog comes back without a bone (empty-mouthed, so to speak).

The problem, of course, is that there are not enough bones and jobs to go around. It is certainly true that a well-trained and highly motivated jobseeker can usually find a job. But that is no evidence that aggregate unemployment is caused by laziness or lack of training.

We could also go into the common belief that minimum wages cause unemployment. It is at least partly true that for an individual firm, higher wages reduce the number of workers hired. But we cannot extrapolate that to the economy as a whole. Higher wages mean higher income and thus higher consumption spending, which induces firms to employ more labor. So the truth is that economic theory does not tell us that raising minimum wages will lead to more unemployment, indeed, theory tells us it can go the other way—raising the minimum wage could increase employment.

Again, the reason we can reach the wrong conclusion in all of these cases when we aggregate up from the micro level to the macro is because we ignore the impacts that behavior of individuals or firms has on other individuals or firms. That can be OK for the case of the individual firm or household, but is almost certainly incorrect for firms and households taken as a whole.

PC: In the 1930s Herbert Hoover blamed the budget deficit for prolonging the Depression. Why was he wrong?

MA: While it is commonly believed that continual budget deficits will bankrupt the nation, in reality, those budget deficits are the only way that our private sector can save and accumulate net financial wealth. If households attempt to net save by spending less than they are earning, and businesses attempt to net save (reinvesting less than their retained earnings), then nominal incomes and real output will be likely to fall. Money incomes and economic activity will tend to contract until private savings preferences are reduced (with essential goods and services taking up a larger share of household income as incomes fall), or until depreciation leaves businesses and households inclined to invest once again in durable assets. Common sense suggests that a drop in private income flows while private debt loads are high is an invitation to debt defaults and widespread insolvencies – that is, unless creditors are generously willing to renegotiate existing debt contracts en masse.

In other words, such a configuration is an invitation to Irving Fisher’s cumulative debt deflation spiral. So unless some other sector is willing to reduce its net saving (as with the foreign sector recently, via a reduction in the US current account deficit as US imports have fallen faster than US exports) or increase its deficit spending (as with the federal budget balance of late) then the mere attempt by the domestic private sector to net save out of income flows, given the existing private debt overhang, can prove very disruptive.

PC: Many critics have pointed out that Obama has largely ignored the recommendations of last year’s Deficit Reduction Commission. What’s your evaluation of those recommendations?

MA: Terrible, because they are based on some sort of vague notion of national insolvency, which is inapplicable. Remember, the most important point is that the federal government is the sole issuer of our currency, and the dollar, which is nothing more than the government’s IOU, is always accepted in payment. Government actually spends by crediting bank deposits (and simultaneously crediting the reserves of those banks). These are topics to be explored in detail below. But the point is that no household (or firm) is able to spend by crediting bank deposits and reserves, or by issuing currency. Households and firms can spend by going into debt, but the debt must be serviced with the debt of another—usually a bank debt. Sovereign government only makes payments—including interest payments on its debt—by issuing its own IOU. This is why we will ultimately conclude that the notion of “Ponzi finance” does not apply to government, because unlike private debtors it can always service debt by issuing more of its own debt.

We realize that distinguishing between a sovereign government and a household does not put to rest all deficit fears. But since this analogy is invoked so often, it is useful to lay out some of the important differences. When a speaker claims that government budget deficits are unsustainable, that government must eventually pay back all that debt, ask him or her why the US government has managed to avoid retiring debt since 1837—is 173 years long enough to establish a “sustainable” pattern? Perhaps we might can go on another 173 years or so without the government going “bankrupt” even though it will run deficits in most years. In the next two sections we first present an alternative view of budget deficits and then we conclude by comparing a sovereign country like the US with a nonsovereign country like Greece or Zimbabwe.

PC: Answer, if you will, these typical deficit hawk reasons for why we should be dreadfully alarmed about the deficit:

 –“Sooner or later, the bill comes due, in the form of increased taxes on future generations. That means those future citizens will have less money to spend.”

MA: Today’s deficits do not burden future generations with debt that must be repaid. Nor do deficits today crowd-out private spending now or in the future. The findings reported in Rogoff and Reinhart cannot be applied to the situation of the US (or to the case of many other nations today—those that we will identify as “sovereign”). Both the so-called deficit hawks and deficit doves are espousing theories which are simply inapplicable to the US or any other nation that operates with a sovereign currency.

Intergenerational theft – Forget about future public debt service becoming a yoke around the neck of future generations. The retired and retiring baby boomers want their high nominal fixed incomes plus purchasing power preservation (if not deflation) now and until the day they die. The youth want jobs and the prospects of a life worth living. The fiscal rectitude wing is literally strangling the baby in the crib today by denying a sensible fiscal response for the current generation’s plight, while hyperventilating that fiscal deficits will do the strangulation of the next generation tomorrow.

Viewed from that perspective, the terms of the debate have been truly twisted around. Granted, it is obviously more difficult to make the case for more government spending when legitimate distrust reasonably exists of dysfunctional financial and governmental systems. We have failed to adequately harness that distrust (and both President Obama and his Democrat allies are hugely culpable in this regard), which is naturally a distrust the deficit hawks can easily exploit today to satisfy their own agenda.

–“Deficits cause inflation.”

MA: Yes, that is true if spending continues when the economy is operating at full capacity.

–“Creditors will demand higher interest rates, which will kill the economic recovery.”

 –“We will have to raise taxes to unprecedented levels to balance the budget if we don’t cut spending…like, 10-15% or more increases.”

 –“Deficits are bad because public spending crowds out private spending.”

 –From the dude, himself, Ludwig Van Mises: “If government spending is financed by taxing the citizens or borrowing from them, the citizens’ power to spend and invest is curtailed to the same extent as that of the public treasury expands. No additional jobs are created.”

 –“High deficits mean foreigners could lose confidence in our economy and cut off our line of credit, exposing the United States to possible big interest-rate shocks and to a collapse of the dollar.”

MA: Most of these issues are addressed in this article I wrote for Huffington Post.

After our initial interview, Marshall Aurbach let us know that many of his answered drew on the work of Bill Mitchell, University of Newcastle in Australia, and L. Randall Wray in compiling his comments. 

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2 Responses ““Today’s deficits do not burden future generations…” Straight talk about government spending with Marshall Auerback”

  1. kosmosben
    March 4, 2011 at 2:54 pm

    “This is not to say excess government spending won’t possibly cause inflation. It is to say the government can’t go broke and can’t be insolvent or bankrupt. There is simply no such thing.

    If the government doesn’t tax because it needs the money to spend, why tax at all? Answer: The govt taxes to regulate what economists call ‘aggregate demand’ which is a fancy word for ‘spending power’ In short, that means that if the economy is ‘too hot’ raising taxes will cool it down, and if it’s ‘too cold’ cutting taxes will warm it up.”

    I find these two paragraphs to be contradictory. Make no mistake: inflation IS a TAX. It is a HIGHLY REGRESSIVE tax.
    Here’s how that works: the capitalist is able to hold his assets in non-liquid forms. These items (property and other assets), in terms of Marx’s “use value,” stay the same and as inflation sets in they hold that value against the devalued currency. IE, they inflate. A piece of property worth 20k is now worth 40k, though the property has not changed.
    The POOR however, must remain liquid at all times because they have little surplus capital. This liquidity loses its value in inflation, the dollar they get in their paycheck is worth less by the time they get to the store. Additionally, there is a significant lag time between inflation occurring and wages rising.

    “Taxes aren’t about getting money to spend, they are about regulating our spending power to make sure we don’t have too much and cause inflation, or too little which causes unemployment and recessions.”

    I think you have the cart before the horse. Taxes don’t drive the train. Inflation does. The theory goes like this: The Fed prints more money, which threatens to cause inflation. Those who hold large amounts of capital are aware of this and are forced to sell their dollars and find places to put them back into the economy. This (in theory) is an attempt to avoid the over-accumulation of capital.

    Taxes are (should be) about offsetting the regressive necessity of the inflationary driver of the economy (YES, redistributing wealth). Every chairman of the Fed openly says they want about 3% inflation. WHY? To avoid your Mary forgoes a hamburger scenario on the macro scale. Money doesn’t PRODUCE anything. It is good to disincentivize just holding it and doing nothing with it on a macro scale. Taxes, then are just a tool to influence where the money in the system goes by incentivizing some things (home ownership, etc) and disincentivizing others (earning too much and not putting it to work).

    Sure, in the short term, deficits aren’t a problem. However, if the government fails to use taxes effectively, you get a long-term debt. Since Reagan this has been the result of the government failing to disincentivize the overaccumulation of capital. Taxes on the rich were reduced, and the redistributive function of taxes stopped its healthy cyclical flow. The whole economy became a ponzi scheme where profits are privatized and losses are socialized through inflation (via bailouts).

    This does pose a very real threat to the long term health of the nation. It’s just that nobody is willing to acknowledge the real problems because words like “redistributive” are toxic to the uneducated.

  2. Detroit Red
    March 4, 2011 at 7:58 am

    Thank you so much for including this interview. I agree completely that the deficit boogeyman is being used to implement IMF-style austerity. The deficit is not in the abstract a problem and it is most certainly not a problem in any kind of relevant time frame given current realities.

    But let us assume for the moment that there is some problem with the deficit (and to be fair, not all deficits are equally bad/good; contrast me buying books for my family on the credit card versus using the card to pay for a WoW subscription).

    Here is a simple, ironclad test of logical consistency.

    Can a person who claims be concerned about the deficit simultaneously call for devastating cuts in social services that are nonetheless fairly small amounts of money in relation both the budget and the deficit (say, the GOPers promised $61 billion) and also support continuing two wars overseas with a combined tab now approaching $3 trillion as well as $700 billion+ in tax cuts primarily for the wealthy?

    No, you can’t take such a person seriously. They are lying, thieving class warriors.

    The fact there is not one mainstream journalist who breaks into deep belly laughter every time the GOPers and Dems pose as deficit hawks says a very great deal about the servile nature of the corporate media.


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About Matt J. Stannard

Policy Director for Commonomics USA, longtime writer, speaker, and legal & policy consultant on economic justice and public deliberation.