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John Hussman: Fiscal Policy Is the Key

If the monies represented by the deficits are spent on projects which increase productivity and reduce waste, the deficits are beneficial no matter how financed. The initial inflationary effects of commercial bank financing are quickly overcome by the larger output and lower unit costs. Debt incurred which reduces unit costs of production and promotes the health and welfare of the population obviously is “good” debt.

Debt incurred to finance transfer payments (interest, pensions, etc.) is of dubious quality.. Any enterprise, private or public, is in dire straits if it has borrowed in order to make such payments.

In the context of the above analysis, what are the conclusions to be drawn with respect to the management of the burden of the national debt?

Prorating the federal deficits over the entire spectrum of federal expenditures, it can be said that virtually all of the current deficits are attributable to defense spending, military and civil service pensions, interest on the debt, and welfare and unemployment benefits. Social security is not included in the above list since only a very small proportion of social security benefits are financed from nonsocial security taxes. From an economic standpoint, only interest is “untouchable”.

the monies represented by the deficits are spent on projects which increase productivity and reduce waste, the deficits are beneficial no matter how financed. The initial inflationary effects of bank financing are quickly overcome by the larger output and lower unit costs. Debt incurred which reduces unit costs of production and promotes the health and welfare of the population obviously is “good” debt.

Debt incurred to finance transfer payments (interest, pensions, etc.) is of dubious quality.. Any enterprise, private or public, is in dire straits if it has borrowed in order to make such payments.

In the context of the above analysis, what are the conclusions to be drawn with respect to the management of the burden of the national debt?

Prorating the federal deficits over the entire spectrum of federal expenditures, it can be said that virtually all of the current deficits are attributable to defense spending, military and civil service pensions, interest on the debt, and welfare and unemployment benefits. Social security is not included in the above list since only a very small proportion of social security benefits are financed from nonsocial security taxes. From an economic standpoint, only interest is “untouchable”.

Combine these factors with the constant roll-over of some of the long-term debt and it becomes obvious that the burden of higher interest rates will be compounded. The burden becomes a function of the major portion of the debt, not just the current deficits. The burden, in fact, becomes exponential. In other words, if the trend is not stopped, the debt inevitably has to be repudiated.

With the federal debt now approaching 9.2 trillion and the projected interest expense for FY2006 = $406 billion, and current and prospective deficits approximating $250 billion, it should be obvious –if the debt is not to be repudiated and all dollar obligations consequently made worthless – the deficits must be markedly reduced.