Fables of Finance:
Budget: The budget deficit is expected to jump to $450 Billion this year, causing some deficit hawks to warn of a growing “crisis.” Sorry, but the crisis doesn’t exist.
Those who fear the deficit seem surpassingly immune to any lessons from history.
For history shows that most of what we hear about the deficits wrong. This deficit, in the truest sense, isn’t a “record”. It’s not even close. This year the deficit will come in at about $455 billion, or 4.2% of GDP, which is the most meaningful way to measure spending gaps. How big is that?
It doesn’t even make the top five since 1980.
Yet we’re repeatedly warned that record deficits will drive up interest rates. The logic behind that thought, while impeccable, isn’t supported by reality.
Let’s look at the record. At the start of the 1980s-another period of “record” deficits-the 10-year Treasury yield got as high as 15%.
Despite the continued presence of deficits, the 10-year sank to 8% by the end of the 1980s. Interest rates continued to fall during the 1990s. By 2000, the U.S. had triumphed, posting a record surplus. Yet the 10-year Treasury note was still over 6%.
Since then, the deficit has surged. So interest rates have surged too, right? Nope. Long rates are below 4%. It’s pretty clear. If there is any link at all between deficits and interest rates. It’s very weak.
But now that the White House, as one headline put it, “admits” to the “record” deficit, deficit foes say it’s clear something has to be done. But what? In fact, what we’re seeing right now is entirely normal. After an economic downturn, the deficit always gets worse.
It’s a pattern that can be seen in each of the last three recessions. Since 1980, the deficit has averaged 4.5% of GDP in the year after the economy bottomed-just about where it is now.
The reason for this is simple. A shrinking economy brings in less money. So the government spends like crazy to make up the difference, and the deficits gets worse.
So excessive fear of deficits is often used as a bludgeon against good ideas like tax cuts, which inarguably lead to higher growth and a healthier economy. Meanwhile, as those who opose tax cuts wail, Congress is boosting spending at an 8% annual clip.
AS president Bush’s top economist, Stephen Friedman, has noted, just holding the line on that spending for a few years- letting it grow at a pace less then GDP-would cut the deficit to zero in a decade or so. That’s the best way to erase the deficit.
In the meantime, relax. This is no record deficit. Back in 1943, during WWII, the deficit hit 30.3% of GDP. Now, that was a record.
