Is the Fiscal Cliff Really a Cliff?
The fiscal cliff debates consume our airwaves, newspapers, and social media feeds, but are we just victim to fuzzy math and archaic economics? Is the fiscal cliff really as serious as we’ve been scared to believe? We’ve been trained to assume that budget deficits are always bad and surpluses are always good; and that when the government runs a deficit, we are selling our souls to the Chinese who buy our debt in large quantities. But, according to economist Dr. Stephanie Kelton, we are being bamboozled. I recently attended a presentation by Dr. Kelton who very eloquently challenged our conventional wisdom – she argues that deficits are not as important in a country that controls its currency, and that the worst thing the U.S. can do right now is to balance its budget. For many Americans and economists, this sounds like a radical idea. But whether you agree with her conclusions or not, her analysis is well thought out and worth reading, if nothing but for the mere sake of combatting confirming evidence bias (the tendency to seek out news and research that supports your existing ideas which can lead to overconfidence).
A zero-sum game is when one person’s gain exactly equals another person’s loss. We currently believe that when the government runs a surplus, the private sector also benefits because the government is in a stronger position to help out when the economy dips again – a win/win scenario. However, according to Dr. Kelton, that’s not the case. In her view, strategically increasing the deficit has an equally and direct positive impact on the private sector (households and businesses) and that government surpluses actually equate to private sector deficits. She demonstrates this relationship with a chart showing that the government deficit is always equal to the non-government surplus (private and foreign sectors). Her point is that when one of the three sectors is in surplus, it is at the detriment of the other sectors. In the case of the U.S. we constantly run a current account deficit (we import more than we export); the only way the private sector can benefit (aka: be in a surplus) is if the government sector runs an even bigger deficit than our current trade deficit. So for example, if the current account deficit is 4.5 percent of GDP and the government runs a deficit that is only 3 percent of GDP, then the private sector balance will be exactly negative 1.5 percent.
We Control the Dollar
In 1971, President Nixon took the U.S. off the gold standard, which meant that the government was no longer required to maintain a fixed amount of U.S. dollars equivalent to gold. Dr. Kelton argued that this was a monumental positive event that was largely ignored by the general public, but most importantly, by modern economic books. By having a fiat currency (backed by the full faith and credit of a country), the U.S. can never go bankrupt because it can print as much money as it wants to finance expenditures. Even my former boss, Federal Reserve chairman Alan Greenspan stated on March 2, 2005 that “there is nothing to prevent the Federal government from creating as much money as it wants to create.” Conversely, Eurozone countries such as Spain, Italy, and Greece, don’t have that luxury; they cannot print more euros to pay their debts and must instead rely on the credit markets which are less forgiving.
One of the major arguments Dr. Kelton faces is the notion that inflation will rise dramatically from the continuous government sector deficits. Yet, she points to countries like the U.K, Japan, and even the U.S. who have pumped trillions of dollars into their economies in recent years and still enjoy record low interest rates. Even when the U.S. credit rating was downgraded, interest rates declined even further. All this being said, and although Dr. Kelton makes a very compelling argument, I still believe that excess government spending can lead to inflation because more dollars chasing fewer goods will push prices higher. It did however spark my professional curiosity to seek out all information/research, even conflicting information, and further explore her work so as to consider different perspectives. To read more about Dr. Kelton, I highly encourage you to visit her blog at http://neweconomicperspectives.org/ or follow her on Twitter @deficitowl.
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Ara Oghoorian, CFA, CFP® is the president and founder of ACap Asset Management, Inc., a “Fee-Only” investment management firm located in Los Angeles, CA specializing in helping doctors and physicians make sound financial decisions. Visit us at www.acapam.com