Categorized | Economics

Do Countries Need to Stick to a Budget?

Do they? It sounds like a rhetorical question, but many advocate deficit spending to pay for such things as infrastructure, social programs, and economic growth. Except for four crazy years (1998-2001) the federal government has spent more than it has earned every year since 1968. Is deficit spending justified, or are our politicians merely irresponsible? The White House just announced a projected half a trillion dollar budget deficit for 2009, so this question is more important than ever.

Deficit spending is a nice sounding term for borrowing money so government can spend more than it earns. Regular people do this all the time and it’s mainly considered bad. A long held virtue, and bit of financial wisdom, has always been to spend within your means, or personal budget. Does the logic change when public servants are charged with spending public funds (money that is not really theirs)?

Sources: Congressional Budget Office (CBO), Office of Management and Budget (OMB)

The chart shows that President Bush is taking the country into uncharted deficit territory in the last year of his presidency. The country has never spent $500 billion more in a year than its earned. However, in terms of gross domestic product (GDP, i.e. what the country produces) the deficit is bad, but not the worse we’ve seen. The mid 70’s through mid 90’s were generally worse.

Nonetheless, we should all have apprehensions about our country’s fiscal condition. There’s a reason why the U.S. dollar has dropped disastrously relative to other currencies over the last few years. The world is beginning to suspect that the United States is being run like a banana republic.

In The Only Three Questions That Count, Ken Fisher likens the national balance sheet to that of a company. He takes the financial axiom that as long as the return on capital is greater than its cost, it makes sense to invest. In this case, if America is earning a greater return on its borrowed capital (public debt incurred through deficit spending) then we’re collectively better off by borrowing and spending until returns approach the cost of borrowing. As a rough approximation, Fisher takes GDP and divides by total equity in the country (equity = assets – liabilities); he comes up with roughly a 12% return on equity figure. Comparing this to the cost of debt for the government, which can be stated as the 30-year Treasury rate of less than 5%, it would make sense to continue borrowing and spending!

On the negative side we’re seeing an increasing debt service requirement that’s sapping up a growing portion of our budget. For instance, in 2007 it took 13.4% of the budget to pay interest on the national debt.

The biggest potential losers are the young and yet to be born. Sustained deficit spending is akin to transferring tax liability to future generations. Current citizens benefit from spending beyond their means, while the burden of repayment is shifted to the future.

What do you think?

4 Responses to “Do Countries Need to Stick to a Budget?”

  1. Rob Viglione says:

    My respected Canadian colleague,

    Thanks for the reference to Greer’s web site…awesome stuff! I’ve yet to get too into the site, but from what I’ve seen so far I’m impressed.

    I wouldn’t say that free markets are heavily championed in the US anymore. The most eloquent obituary to even the notion of free market Capitalism in America was published in today’s Financial Times:

    http://www.ft.com/cms/s/0/739198f8-864f-11dd-959e-0000779fd18c.html

    Americans have long trended towards a socialized government, but with the collapse of the housing market, where Americans traditionally park much of their wealth, there is a clamor for safety. So many are so ready to trade their freedom for protection, so say goodbye to the cherished market economy!

  2. Well Rob,

    I’m Canadian if that helps ease your mind any ;)
    I’m also of the mindset that the free market economy that is so heavily championed around the US these days is based largely on wishful thinking. It ignores the fact that the economy it champions is a historical anomaly and assumes that this economy is a natural state when levels of resource depletion and base carrying capacity tend to point to this economic system being a highly artificial and temporary state.
    Read the work of John Michael Greer (http://thearchdruidreport.blogspot.com/) for a very in depth set of analysis on modern capitalism, resource management and societal collapse (he is not one of those people who believe we are headed for a Mad Max scenario or anything like that)

  3. Rob Viglione says:

    Long-term deficit spending is fiscally irresponsible, despite nice sounding corporate finance theories. I only posted Fisher’s argument as a counter to the doomsday scenarios I’ve heard regarding mounting debt and a fiscal snap that could occur. To be fair to Fisher, though, he was analyzing the country’s balance sheet in respect to how it can lead to a method to exploit the market.

    What scares me is when people absently dismiss “the usual market mentality” as if doing so invalidates the last several centuries of human progress and the right of every individual to freely pursue their own economic affairs.

    We often discuss theories, philosophies, and courses of potential policy as if we have a full stake in all areas of debate. We don’t. Just because I’m interested in my neighbor’s new business does not mean I have a right to impede how he engages his resources. Yet this is the result of these high-minded political discussions. We delude ourselves into thinking we have rights over others. I sincerely hope America does not head down that path.

  4. I think that this is wishful thinking. This is the usual market mentality that is actually what is sinking the American and world economy.

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