Government debt and deficits do not matter.
That statement is even crazier than last week's crazy-talk, but that idea is what will allow this secular bull market to continue running for longer than most can imagine.
Concerns over government deficits and debt are nothing new, and neither are attempts at eliminating them. After the War of 1812, there was a 5-year 'free-for-all' economic expansion that was fueled by laxness in the regulation of bank credit by the Second Bank of the United States. To compensate for this laxness, it initiated a sharp curtailment in loans, a refusal to exchange its own paper currency for gold or silver, and foreclosure on farm mortgages just as European agriculture made a sudden recovery following the end of the Napoleonic wars. The result was wide-spread bankruptcies and mass unemployment by 1819--America's first economic depression. This lasted until 1821 when Congress passed the Relief for Public Land Debtors Act and western states initiated extra relief measures for debtors.
Each time unregulated lending is allowed to overwhelm the existing resources (economic capacity and employment) it causes inflation. When fiscal tightening is implemented to combat the inflation, the removal of currency from the economy ends up "saving the banks, and ruining the public".
Depressions happened four more times in the 19th century; 1837, 1857, 1873, and 1893. In the 20th century, other than war-time, depressions were allowed to materialize in 1907 and 1929 with less severe recessions happening a number of times during that century and the present century.
In conclusion, it is indisputable that unregulated growth in borrowing leads to uncontrolled inflation, which leads to panicked-withdrawal of funds from the economy, which in turn, causes economic contractions and wide-spread misery. All this arises because government budgets are considered analogous to household budgets; spending exceeding income eventually leads to bankruptcy. But there is a new way of looking at this conundrum called Modern Monetary Theory (NYSE:MMT), promulgated by Professor Stephanie Kelton.
From the Macro Tourist :
Modern Monetary Theory is a macroeconomic theory that contends that a country that operates with a sovereign currency has a degree of freedom in their fiscal and monetary policy which means government spending is never revenue constrained, but rather only limited by inflation.
(We recommend watching Dr. Kelton's Youtube lecture on MMT)
Government Red-Ink is the Private Sector's Black-Ink
The chart below, highlights the near-perfect inverse relation between the Government deficit and the private sector's financial balance. Every time the Government reduces their deficit, the public sector reduces their balance, and recessions materialize. Clinton eliminated the deficit between 1998-2000 and caused a recession (red line above zero in the chart below).
Source: Dr. Kelton's Youtube lecture
MMT can be summarized (adapted from Macro Tourist) as follows:
- sovereigns cannot go bankrupt (as long as they borrow in their own currency).
- sovereigns can always afford to buy anything for sale.
- sovereigns can always provide people with jobs and pay wages.
- sovereigns are limited only by politics and inflation.
The last point, means that "the government can keep spending until they begin to crowd out the private sector and compete for resources" (inflation), or when policy prevents spending (politics).
What is important about government budgets is not whether they are balanced or unbalanced, but whether they are inflationary or not.
This all sounds crazy because for 200-years the received wisdom has been that government budgets must eventually be balanced, just like household budgets. However, the historical fact that every time governments try balancing their budgets and paying off their debt an economic disaster occurs, seems to have been ignored. Contrary to the majority view, as long as inflation is under control--as it has been since the great recession--deficit spending will continue to fuel an expanding economy. Maybe, last week's argument that the current bull market has years of life left in it, is not so crazy after all.
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