The Economic Contrarian
Deficits 101: Surpluses Take Our Money
By Mike Norman
Special to TheStreet.com
09/12/2003 01:21 PM EDT
URL: http://www.thestreet.com/p/rmoney/theeconomiccontrarian/10113219.html
Economic Analysis NEUTRAL
a.. The deficit relative to GDP is historically small.
b.. Balancing the budget would force higher private debt levels.
c.. Deficits have paved the way to prosperity.
I've written often about the deficit and how it is misunderstood. As you can see from the chart, the deficit as a percentage of GDP is still historically small.
The deficit as a percentage of GDP was much higher in 1975, when it ran above 6%, and again through much of the Reagan years, when it ran for years above 4%.
People should think of deficits and surpluses as an accounting ledger with the private sector on one side and the public sector (government) on the other side.
Let's say you have private sector savings of $100 billion on one side, and on the government side you have a deficit of $100 billion. For the government to balance its books, it's necessary to transfer those private sector savings to the government's side of the balance sheet. It does this through taxation or lower spending, which results in lower aggregate demand in the economy, and therefore weaker economic growth, less earnings, profits and, hence, less savings.
The degree to which the government wants to grow surpluses determines how much in hock the private sector will have to get. This is important because many are now calling for a return to surpluses, even as the private sector struggles with record levels of debt. Balancing the budget would strip the private sector of what little current savings it has and would force even higher -- and perhaps debilitating -- debt levels. That would surely tank the economy.
Below is a chart of what I call transfers of savings between the public and private sectors. I arrive at this by subtracting gross savings (net public and private sector savings) from private sector savings alone. It gives a picture of when the private sector has a savings surplus (a positive reading on the chart) and when government has a net savings surplus (a negative reading on the chart).
From the period of 1959 through 1974, there was a very small net transfer of private sector savings to the government, interrupted by a brief saving swing to the private sector in 1975. However, when we move into the Reagan years, there is a significant and sustained shift in savings from the public sector to the private sector. This was due to the prevalent deficits in those years.
While those deficits were roundly criticized, even their detractors don't argue that they paved the way for a long period of prosperity that was not financed by heavy public sector debt accumulation, as was the case with most of the so-called boom years of the Clinton administration.
More recent, we see that net savings transfers to the private sector peaked in 1993. What followed were the Clinton tax increases, which were the largest in history. This set in motion a steady decline in private sector savings through 2000. The result was more than $600 billion in net private sector savings transfers to the government. Yes, the government balanced its books and went into surplus; however, the private sector went into debt up to its eyeballs to replace lost savings, and that triggered the economic downturn.
Luckily, this destructive process is now being reversed as a result of the Bush tax cuts and high government spending (which is raising aggregate demand in the economy). As you can see, there has been a huge shift of savings -- thanks to the deficits -- back to the private sector. These flows have been nearly equal to those seen at the peak transfer period in 1992, which preceded the big bull market rally and economic turnaround. What's different this time is that the boom, if it occurs, will be driven with a rising private sector savings base, as opposed to a collapsing one, i.e., as long as policymakers don't screw it up again. -------------- next part -------------- An HTML attachment was scrubbed... URL: <../attachments/20030912/3120ab1d/attachment.htm>