Balanced Budget Madness

Jul. 30, 2011 11:47 PM ET
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Contributor Since 2009

Will de Beest. Trader, investor, interest in monetary policy, federal reserve operations -- specifically why operations seem to be so misunderstood, listen to bloomberg podcasts

There is an accounting identity that most people are familiar with:

A - L = E

This says that assets, A, minus liabilities, L, equals equity, E. People understand that if liabilities exceed assets then equity must be negative. A business owner cannot successfully attempt to make E positive if the left hand side of the equation is negative.

Likewise there is a national accounting identity:

CA = (T - G) + (S - I)

This says that taxes, T, minus government spending, G, plus private savings, S, minus private investment, I, must equal the current account CA. If (T - G) is positive then the government is running a surplus, if it is negative a deficit. (S - I) can be thought of as the net private sector savings. If it is positive then wealth is being accumulated.

The USA has been running current account deficits for a very long time and it looks like it will continue to do so for a very long time. Since CA is negative it follows that the net positions of the government and private sectors must be negative by way of accounting. If the government were to run a balanced budget then T = G, so we are left with

CA = S - I

So by way of national accounting if the government were to run a balanced budget the private sector must go further into debt than otherwise would be the case -- as long as current account deficits continue.

These accounting identities are what they are independent of ideology. The identity is the same whether you are liberal or conservative, or a neoclassical or Keynesian economist. So the next time you hear someone advocating for a balanced budget remind yourself that they are actually advocating further private sector indebtedness. However should a person have an ideological position that says that the government should balance its books, they would be better placed examining the structural reasons (and, given the ideological position, the fixes) for continued current account deficits, since mandating a balanced government budget merely shifts the debt burden to the private sector rather than addressing the source or cause of the debt.

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