Deficits Matter, but Not the Way You Might Think

By Bob Veres. This originally appeared on Advisor Perspectives.

Congress is coming off of a bruising debate over the deficit ceiling – a preview of what we will experience again in a few months. The economy is growing slowly – some would say incrementally, after the 16-day government shutdown. Unemployment is a lingering problem, and the Fed’s quantitative easing (QE) program works in reverse; that is, instead of boosting economic growth in any visible way, any hint of ending it spooks the markets.

What’s to be done about this mess?

Stephanie Kelton, Associate Professor of Economics at the University of Missouri/Kansas City, believes that the root of all these problems can be found in a fundamental misunderstanding – shared by Democrats, Republicans and mainstream voters alike – about the government’s balance sheet. She argues, plausibly, that the whole idea that we should control the deficit at all is costing our nation trillions of dollars in lost output. The result is lost income, savings, wealth and prosperity.

“As a society, we don’t understand government finance,” says Kelton. “Most people – including most economists, think that it operates by the familiar rules of household finance. Therefore, we find it plausible when we hear politicians and government watchdogs urging us to balance the budget, control the urge to spend and pay down the debt.”

“As a society, we don’t understand government finance.”

– Stephanie A. Kelton

The mantra on the right: the federal government has to stop spending money it doesn’t have. The mantra on the left: we need higher taxes on “the rich” in order to balance the budget and pay down the federal deficit. Moderates call for a little bit of each.

“We act like there is some limited amount of money available,” says Kelton, “and that government competes for savings with the rest of the economy, and that too much competition for savings drives up interest rates, and higher interest rates crowd out all productive private investment. We act like the federal government is walking a fine line between solvency and insolvency – that if the debt gets too big, our creditors may begin to get nervous, downgrade our debt, our interest rates go up, and suddenly we end up like Greece.”

Yes. So? “That picture has no economic meaning whatsoever,” says Kelton. “None.”

Currency by keystrokes

These days, you might see Kelton presenting her out-of-the-box economic perspective at financial industry conferences – most recently at the Financial Planning Association’s Retreat and the Northern California Regional Conference – and you are starting to hear similar ideas expressed in the op-ed pages of the Financial Times and other media outlets. She describes herself – and a number of other influential economists – not as a deficit hawk (Pay off the debt now!), or a deficit dove (Pay off the debt as soon as the economy is stabilized!), but as a deficit owl.

The owls, she says, have a very different way of looking at our economic and policy options. They ask: What if there are no limits on how much money the government has? If that were true, what would you do differently?

Before a reasonable person answers that question, he or she would have to be convinced that there really are no limits. Kelton opens the discussion by noting that the modern financial system is very different from the one on which that many economic textbooks are based. In 1971, the global monetary system changed in a fundamental way when President Nixon took the U.S. dollar off of the gold standard. This ended a system of fixed exchange rates, where other countries pegged their currencies to the U.S. dollar, and through the dollar, to gold.

This much you know. But what were the consequences of that shift? “Uncomfortable and unsettling as it is for many people to contemplate,” says Kelton, “we have a true fiat money system. The United States government has something that households don’t have. It has the power to create the currency that we all live by.”

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Stephanie A. Kelton is Associate Professor of Economics at the University of Missouri-Kansas City. Dr. Kelton has undergraduate degrees in both Business Finance and Economics from California State University, Sacramento. After finishing her undergraduate degrees, she studied at Cambridge University, England, where she completed a M.Phil. in Economics, while on an Rotary Scholarship. She then spent a year at The Jerome Levy Economics Institute of Bard College, in upstate New York, on a fellowship she won through Christ’s College, Cambridge, that led to her Ph.D. dissertation at the New School for Social Research.

About the Author

Bob Veres’s Inside Information service is the best practice management, marketing, client service resource for financial services professionals. Check out his blog or subscribe and receive, free of charge, the recent report on how advisors are charging fees, or the report on the six dimensions of client service at: www.bobveres.com