In 1910, the relatively low level of government spending was generally fully funded by tariffs, taxes and other government income. During the early 20th century some years produced small budget deficits while some years had modest surpluses but overall they were generally balancing their budgets. There was government debt from spending over previous decades but it still was not overwhelming at just about 20% of the economy. Today is different, of course. Yearly deficits at just
the federal level, not including state and local overspending, were over a trillion dollars in 2009 and 2010 and are also projected to surpass a trillion dollars in 2011 and 2012. The total accumulated debt at all government levels is now estimated to be over $18 trillion, significantly larger than the economy as a whole.
In the past, when governments spent more than they received in tax revenues they were able to borrow – from individual investors and foreign governments. But because of the perilous health of the U.S. economy, many governments and investors are now hesitant to lend to our government to cover its debts. In fact, in the past, government spending was controlled in part by the fear that they would not be able to borrow from investors if deficits were excessive. So then why do governments today continue to sharply expand government spending when its deficits and debts are already excessive?
Well, for the last few decades especially the Federal Reserve has been in the business of printing money. It usually does more when economic conditions are weak (or there is some “crisis” to be contained) and less when economic conditions are stronger. But it has not stopped printing money since it began nearly a century ago. Over the past three years that printing machine has been going like never before. So the government has been printing billions and trillions of dollars in extra money which is then used to be up the debt of the same government.
These are just ways, but very important ones, in which the government is allowed to continue spending much more than it takes in, seemingly, without consequence. However, there are deeply negative consequences to these actions. Every extra dollar that enters the U.S. economy via government money-printing is a tax on the users of those dollars. Basic economics tells us that when we have more of something it becomes less valuable. So if the government puts 10% more dollars in the economy, each of the dollars that I previously held are now worth 10% less than before. This money printing is directly related to the inflation that the users of the money experience.
Based on the government’s own inflation statistics (that many believe severely underestimate inflation) the value of a dollar forty years ago in 1971 is worth about 18 cents today. This government money printing (or to use their preferred term, quantitative easing) is an attack on the standard of living for Americans.
A bit of a new wrinkle during the past few years is the more direct and coercive control over the banks by the Federal Reserve. Combined with interest rate manipulations and new regulations, these moves have pushed large financial companies to buy up government debt (treasury bonds and bills) when other buyers are (sensibly) unwilling to lend to the profligate government. This is obviously good for the government since it makes it easier for them to spend more money than they otherwise would. But such bond buying also takes that cash away from banks to lend to private individuals and businesses. We have heard many times over the past few years of the “credit crunch” affecting business and individuals. Basically, this is where loans were desired to purchase assets such as businesses, homes, equipment and so forth, but the banks were hesitant to lend. Essentially, banks are able to borrow at nearly 0% and lend to the government (by buying treasury bills and bonds) providing a nearly risk-free return to banks. It has been very obvious why banks have not been eager to loan money to businesses and individuals – they can earn a high return for almost no risk by lending to the federal government.
So what we have then, as a result of these concerted government efforts, is a sluggish economy combined with rising inflation. And this is exactly what basic economics would have predicted. And this is exactly what we will continue to have until these policies are reversed. In the long-term I am very optimistic that growth will return to the U.S. economy, as it already has to other countries around the world since the beginning of the recession/depression. However, there is also no reason to expect that growth will occur until these basic mistakes – interest rate policies and extreme money printing, both a response to government overspending - are corrected.