One More Time, the Government Is NOT Like a Household or a Business

Ron Dzwonkowski of the Detroit Free Press ran a column today urging people to participate in various “town hall” discussions to help figure out the US can deal with it’s “deficit” and the “debt” that must “lead to collapse”.

Mr. Dzwonkowski adopts the posture of  “reasonable, practical man” – not that of an ideologue.  In fact he appeals to “basic math and logic”.   But again, we see that Keynes was right:   Practical men, who believe themselves to be quite exempt from any intellectual influence, are usually the slaves of some defunct economist. Mr. Dzwonkowski is the slave of defunct economists from the late 1800’s and early 1900’s when gold and bankers reigned supreme.  This is not the world we live in today.  The following is the text of the email I sent him.

I was most disappointed in your column on Sunday, June 20. There are many reasons for my disappointment, but the greatest is your repetition of economic nonsense that is flatly, factually wrong.

I quote your opening:

Basic math — and logic — says you can’t keep spending almost $2 for every $1 in your pocket. However, neither rules in Washington, where our national government now adopts budgets that authorize spending more than $1 trillion beyond tax collections and has accumulated a debt in excess of $13 trillion, a simply incomprehensible number…..This can’t go on; it’s a formula for collapse.

Actually basic math and accounting (and “logic”) brings the exact opposite conclusion. I believe you have fallen prey to a very common error, an error that is promoted by people who know better (or should) but have reasons to keep people believing the error. The error is simple:

You assume that the national government is the same as any household or any business or any corporation. It is not.

Households, businesses, corporations, and even state governments are all “financing-constrained”. This means that before they can spend, they must raise the funding through either revenue (income or taxes depending on the entitity), borrowing, or selling assets. SImply put, they must have something in the checking account before writing the check to spend.

A national government is NOT the same as these other entities. A national government CAN and DOES spend without any restriction on raising the funds first.

For these purposes, I’m using a “national government” to mean one that is:

a. sovereign in it’s money (in other words, it is the sole source of determining what is money/legal tender inside it’s territory)

b. let’s it’s money float in exchange rate and doesn’t promise a fixed conversion rate into any other currency or gold

c. borrows money in it’s own currency (when it chooses to borrow) and not a foreign currency.

Who fits this definition? The U.S., Japan, Canada, the U.K., Australia, India, among many (most) others. Who doesn’t fit? Anybody in the Euro Monetary Union (Greece, Spain, Italy, France, Germany, etc). Who else doesn’t fit? Anybody that borrows in foreign currencies (Russia & Argentina in the 1990’s).

What I am explaining is not “an economic theory” – it is basic, fundamental national income accounting and fundamental banking procedures.

The blunt truth is that the U.S. can indeed continue to run deficits. The same people who claim that we are on the verge of collapse (as you claim is obvious) said exactly the same thing about Japan in the mid-1990’s. A decade and a half later Japan is still running “high deficits” and has no problem with either it’s budget or “solvency”.

The blunt truth is that when unemployment is well in excess of 9% nationally, any attempt to reduce deficit spending now by cutting spending or raising taxes will only further contract the economy, reduce actual tax collections and make the actual deficit bigger (see Ireland over the last 2 years).

The fundamental economic reality (again, basic math and accounting, not “theory”) is that if the private sector, you and me and private businesses, want to get financially richer, that is if we want to see our bank balances and 401K’s get bigger over time, the government, the public sector, must run a deficit. It is simply impossible for the private sector to net save money AND have the government run a surplus at the same time. (technically, there is one situation where it is possible, but that can ONLY happen if net exports is so large – think 20% or more of GDP – Chinese scale. Such large net exports cannot happen in all countries at once).

These are not the thoughts of sole “crank professor”. I could provide plenty of support for everything I’ve said. In fact, if you are interested, I would be happy to discuss it further and help you learn.

I am distressed because I work so hard to educate students to think critically, evaluate the evidence, and make sound “logical” conclusions. But I can only reach maybe 150 students per semester. You, however, reach thousands of people and you repeat what are eggregious errors of math, logic, and accounting, while repeating these fallacies while posturing as a neutral adult voice of reason. I could leave it at that, except that this epidemic of illogical thinking about government budgets has consequences. Social services will be sacrificed on an the alter of 1800’s economics theory where governments were constrained by what gold the bankers would lend them.

44 thoughts on “One More Time, the Government Is NOT Like a Household or a Business

  1. Sure the US can continue to run deficits as long as another country is willing to loan credit and those loans don’t ever get called in. Many US citizens are for the gold standard and against the “New Deal”. A buy now pay later mentality is also popular with business and homeowners, just as financial prudence is with others. Yes they can operate the same fancy accounting as Fannie and Freddie working the housing market, where all is well and good until the unforeseen happens, right?

    Economists are split and the split is probably down party lines. When Reagan cut taxes, the job market grew and that translated into more government revenue due to a larger pool. Please do explain your theory/logic about the private sector not being able to grow financially when the public sector runs a surplus. I appreciate your passion, thanks for the lesson.

    • That is not correct. The US can continue to run deficits as long as there are creditors–be they public or private, foreign or domestic–willing to lend it money. For instance, most U.S. government debt is owned by American citizens and businesses, not by (say) the dreaded Chinese. Furthermore, having loans “called in” is not a worry for governments the way it is for households for precisely the reason the original poster lays out: the government is not a household. A household can be compelled to pay a debt, whereas enforcement is more difficult or even impossible when it comes to states (see Argentina, for example). And, a household cannot print money, which the sort of government described above can.

    • “When Reagan cut taxes, the job market grew and that translated into more government revenue due to a larger pool.”
      Really ? What country were you in at the time? WE did not experience any job growth until Clinton’s first term.

  2. Very interesting Mr Luke. Here is my question that I didn’t see get answered, what if the entity buying the government bonds, for instance the Chinese gov’t, call for payment? Does the US gov’t just print more money since that is what they borrowed in?

    I think that as a society right now, we have too much jumping to the simple answer instead of looking at the “big Picture”

    • Larry, I apologize for not answering sooner. I’ve largely been absent from the blog this summer due to a reduced teaching load and a home renovation.
      It really makes no difference who the entity is buying government bonds, or for that matter whether there is anyone interested in the bonds.
      The reason is because the sovereign government (US, not a state govt), does NOT have to have any “money” before it spends. It simply writes a check. The “checking account” is at the central bank. Government let’s say, pays a govt employee $1000. The check gets deposited at the employee’s bank. Let’s call that bank Citibank. Citi credits the employee’s account with $1000. As part of the check clearing process, Citibank presents the check to the central bank (The Federal Reserve in the US). The central bank then credits the Citibank with $1000 worth of bank reserves. The Fed then destroys the check. End of story. Government does not have to have money in order to spend it. Yes, $1000 of new money has been created and is now in circulation in the economy. That’s one of the functions of government: define and provide money, a universal means of exchange, to the economy.

      You may ask why governments borrow money then? Why do they issue bonds? Bonds are issued to help manage interest rates. If the Government and the Central Bank decide that there’s too much money in circulation (keep in mind that raw government money is in either the form of currency or bank reserves) and banks are re-lending/multiplying that money too fast for a healthy economy, they may want to change short-term interest rates. In that case they make an offer to the public to exchange plain-old, non-interest bearing paper money (currency and bank reserves) for a form of money that pays interest if you don’t spend it. This other form of government issued money that pays interest if you don’t spend it is called a “government bond”.

      I understand the ideas are tough to grasp at first because we have so many deeply embedded false assumptions that are rarely challenged, even when the basis of the assumption in reality changes. For example, much of the common view that governments have to “finance spending” by borrowing or taxing first is really a relic of the old times when gold or some other physical commodity was the real money. Today gold is not the real money.

      • this is true as long as thr farmers produce enuff food to feed a bunch of people that dont earn there own keep..if the farmers fail so will the US sovernty…
        abdo chingko…

  3. Robin> The U.S. only borrows because it wishes to. We have a monopoly on the dollar, it is a sovereign fiat currency. If we wish to we can simply add more zeroes to the balance of the banks and more money is available.

    We stopped having to borrow about the time we freed our money from the gold standard. Now it may simply be a matter of intertia (been doing it so long we don’t realize we can step off anytime we want to).

    The government runs in a much different way than a household budget, and it is an fallacy of composition to compare the two. More here – http://neweconomicperspectives.blogspot.com/2009/08/teaching-fallacy-of-composition-federal.html.

    There may be something here on Dr. Luke’s site, I just haven’
    t found it yet ;)

    • Thanks, I understand why you would call it a fallacy of composition but if you reduced the size of government,ie. cut out all the excess fat from the public sector that just consumes wealth and send those employees back into the private market where they create wealth seems to be a more effective composition to me. Adding zero’s and printing money as they need it just reduces the value of the currency already in circulation, doesn’t it?

      • Inflation, which is the debasement of the currency, happens when the combination of money available (in circulation or by credit) AND the demand for buying real stuff (goods and services) consistently exceeds amount of real goods and services available. Printing more money, or “adding zeros” to it does not, by itself, imply inflation or debasement of the currency.

        Right now in the US and most of the developed world (and much of the developing world), we are nowhere near that problem. We have plenty of excess capacity to produce more goods and services. In the US nearly 10% of available workers aren’t being used. Another 8-12% of workers want to work more but can’t. So we don’t have a limitation on the supply of goods and services. On the other hand, we have a distinct mismatch between the quantity of money and willingness to spend/buy stuff. Right now, those who do have money (financial resources, not physical wealth) aren’t spending. They are hoarding their money. Corporate cash coffers are near record levels even as corporate profits have returned to pre-recession levels. Yet, they aren’t spending. They aren’t investing in real goods and services to expand. Why not? Because they don’t have customers. People aren’t willing or able to buy. Those that are willing (the approx 90-95% that live from labor & wages) aren’t able – they don’t have money. Those that are able because they have money (corporations, the banks (excess reserves), and a very narrow elite of wealthy individuals) aren’t willing. Foreigners aren’t buying (exports) either. So all that’s left is government.

    • Jim, you’re right.
      When gold was the real “base money”, then the amounts of bank issued-credit (paper money and what we call M1 these days) was limited by a nation’s and a bank’s store of gold. The world is different now. The real “money” is are the credits issued by whatever central bank the government decides has the authority. These “credits” are a lot more like the “credits” used in a Star Trek or sci-fi movie than they are like gold or silver. Today these credits are held as either paper notes (“Federal Reserve Notes” – look at your currency) or as bank reserves at The Fed (numbers in some database on some computer).

  4. Pingback: The Misunderstood National Debt « EconProph

  5. Wow..excellent article. I’m a science student who knows nothing about economic theory (aside from what I pick up on the web and TV), so I’m having a great time reading through your posts.

    What I’d really like to find is a social group (be it a website, an actual physical group, whatever), where people like me can come and learn and discuss these types of issues without devolving into a ‘libtard’/’repubtard’ shouting match. I don’t care much for the left-right continuum (since imo there is such a difference between left/right socially, and left/right fiscally), but most internet discussions always fall into that trap. I just want to learn the information as is, and use my critical thinking skills to decide for myself what policy would be best or that i agree with the most.

    The amount of misinformation and bias on the news is crazy…I have no idea what is ideological posturing and what isn’t.

  6. “It is simply impossible for the private sector to net save money AND have the government run a surplus at the same time. ”

    This is asinine. Explain the years 1999 and 2000 using this theory. In both years, the Federal government ran with a surplus and the economy grew (7.1 and 7.4%, respectively). If you can’t get something this basic correct, what else did you get wrong?

    • I said it’s impossible for the private sector (households + firms) to

        net save money

      while the government runs a surplus. There was nothing in my statement about growth in the economy. Net savings is an increase in owned financial assets. It is the difference between income and spending. If income > spending, then there is net savings. If income < spending, then there's negative savings, which is more commonly called "borrowing". In 1999 and 2000, when the US government ran a small surplus, the private sector was net going deeper into debt. The private sector was borrowing. Does the housing/mortgage boom, the dot-com bubble speculation on borrowed money, and the growth in financial leverage on Wall Street ring a bell? The U.S. private sector went deeper into debt (negative savings) in part to maintain their level of spending (hence the GDP growth) even though the government was cutting it's net spending by running a surplus.

      Strictly speaking, my original statement that "private sector cannot net save when government runs a surplus" also requires that a current account deficit (trade deficit) also be happening. In discussing the U.S., I take a trade deficit as pretty much a given since it's been true for well over 40 years.

    • What metric are you using to claim the economy grew by 7.1% in 1999? Generally people say “the economy grew” to reflect on the GDP, which did not grow that much in 1999. However, your criticism is meanderingly wrong because GDP/the economy can grow (the private sector is hardly the only contributor to the GDP) while the private sector takes on more debt which is actually what happened in 1999.

    • Um, not every fiat currency has failed. The yen, USD, British pound, CND, Australian dollar, etc. are all doing just fine and they’re fiat. In the late 1800’s the US “greenback” did quite well – trading at par with the silver-backed and gold-backed currency. I believe a lot of the currencies that you believe were fiat currencies (the ones that “failed” due to alleged “overprinting” were in fact paper currencies issued under a gold-standard system such as Reichmark in 1923 or Zimbabwe dollar in 1990’s-2000’s. Their failure was due to aggregate supply issues that led to massive inflation – not the simplistic “overprinting” of the gold bugs’ fairy tales.

  7. So you’re essentially telling me that a fractional lending system and borrowing debt from a pool 99 times greater than the equity on deposit is sustainable indefinitely and that government borrowing from the Fed at interest *is* the way a sovereign state should operate, that Nixon taking us off of the Gold Standard was a good thing (when Forbes says: “The dollar has fallen in value by more than 80% from the day when Richard Nixon took the world off the tattered remnants of the gold standard.  Aug. 15 marks the 40th anniversary of the avowedly ‘temporary’ abandonment of the gold standard by President Richard Nixon.” (See http://www.forbes.com/sites/ralphbenko/2011/08/15/fiat-money-the-root-cause-of-our-financial-disaster/ ) and several presidents have spoken out against it – that they’re all wrong and you’re right?

    • No, I am not saying that “government borrowing at interest” is “sustainable indefinitely”. The question is one of real resources. So long as there are slack real resources available in the economy that could be put to productive use, then government borrowing will not generate inflation. The total amount of government debt is irrelevant.

      BTW, the government doesn’t borrow from The Fed. It borrows in the primary public bond market. The Fed chooses whether to buy government bonds or not to buy in the secondary market. Any government bonds held by The Fed that collect interest add to The Fed’s profits. The Fed’s profits, in turn, are returned to the U.S. Treasury.

    • As regards Mr. Benko’s article, he’s totally out of it. A return to a gold standard is a genuine recipe for economic disaster for all but the bankers. Contrary to his assertion, there’s no real evidence that a return to a hard-money gold standard would restore any kind of economic growth or employment.

  8. Please forgive me, I’m just trying to understand, but should we ever try to bring down the deficit at this point? Should we always increase it? Doesn’t there have to be a point where we have a surplus to pay down the debt or at least balance spending so it doesn’t increase? At what point does the debt become too large?

    • Hi. Let me try to help briefly. First, we always need to be careful to distinquish between the “deficit”, the yearly difference between taxes collected and spending, and the total “debt”. The total debt is the total amount of bonds outstanding. The deficit in any given year will add to the debt. There is no practical financial limit to what the “Debt” can be. Yes, we can add to the debt every year as we have done since 1938. There is however, a limit to how big the “deficit” should be. The limit on the “deficit” is how much slack (unemployed or unused) resources such as labor exist. If there are plenty of unused resources, such as when we have high unemployment, then increasing the deficit is good thing and will put people back to work. If, however, there is very little available unused resources (unemployment is very low), then we should reduce the deficit, although it’s unlikely that we need to eliminate it totally. The only danger from deficits is that increasing a deficit when there is low unemployment will increase inflation.

  9. Your stupid idea, will increase inflation, cause the price that is paid for products increase beyond what is reasonable and affordable. Stop spending! Living within in our means includes the Governemnt!

    • Inflation increases when the total (aggregate spending) exceeds the capacity of the economy to produce. As long we have high unemployment we have (by definition) unused capacity. We can increase spending without inflation. Yes, increasing deficit spending will increse inflation BUT ONLY ONCE WE ARE AT FULL EMPLOYMENT. Many folks have asserted that the government deficits of the last 4 years would lead to inflation soon. The results are clear. They have been wrong.

  10. That was a very clear explanation, even for me – who does not understand monetary policy at all! But I am an English teacher and I can’t help but point out that you used “it’s” when you needed to use “its”. Remember that apostrophe-s with “it” is ONLY for “it is” and never as a plural. So that’s my expertise. Thank you for sharing yours and giving me a valuable lesson.

  11. What about the fact that an increasingly large percentage of the revenue is now judt paying for the interest on the debt? Does that have no negative impact on the economy? As long as the government has to pay the debt and can’t just outright repeduidate it. There is a breaking point. We may or may not be near it but when the interest payments exceed tax revenue is that not a problem in your view?

    • First, the U.S. is a very, very long way from the point at which interest payments exceed tax collections. There could conceivably be a problem at that point depending on the specifics of who owns the bonds and therefore receives the interest payments and who is taxed and at what rates. However, keep in mind that the interest payments are themselves income received by taxpayers. Finally, the government, as an issuer of a fiat currency, with debt denominated in it’s own currency, can always simply create the money needed to pay interest and principle. That’s why government is not like a household. You (and I and other households) cannot create the money to pay our debts.

  12. You would do yourself and your readers a great service by learning the difference between “it’s” (it is) and “its” (posessive). For me, anyway, it’s hard to take someone seriously on such complicated issues when he or she can’t keep simple grammar straight.

  13. Ronald Regan did not cut taxes. He reduced tax rates and eliminated deductions which resulted in a net INCREASE in taxes. Yes, we were paying taxes at a lower rate but credit card interest, three martini lunches, vacation home interest, accelerated depreciate… were eliminated resulting in a simplier tax system but HIGHER taxes.

  14. Pingback: One More Time, the Government Is NOT Like a Household or a Business « Economics Info

  15. Jim, I think there are other reasons for ‘living within our means’. For me, one of the more pressing concerns is that the deficit expansion is often tied to ‘government’ expansion. As a general rule, I think it makes sense to live within our means, even at the federal government level, for reasons beyond the accounting/economic arguments you have made. First, I think it sets a terrible example when the government lives by a set of rules that are typically concerned bad for the general populace. People see the government living beyond their means and they want to do the same thing. Second, when spending is done via expansion of the government, it makes it much more difficult for the government to contract spending. It also makes it much more difficult to distinguish between what is ‘necessary’ and what is ‘desirable’. When there is no limit to spending, everything starts to fall in the ‘necessary’ category. Also, when there are no boundaries, it makes it that much more likely that the populace will demand more of the government. Extend unemployment to 5-years. Provide everyone w/ healthcare. And cell phones (which we now do) and whatever else. It just gets harder to say ‘no’ to anyone.

    These are difficult arguments to articulate and understand (your arguments as well as mine). It require folks to really try to understand them without viewing them as partisan issues.

    Anyway, thought your article was good. We need healthy and RESPECTFUL debate on these issues. We are all pawns to partisanship. We are played for fools by those who direct the debates and discussion. We need to break out of that so clear and open dialogue can occur… as is happening here.

  16. Thank you for the article and discussion. I admit that I can’t quite follow all of it, but I understand this: when you create your own currency and those who you’ve borrowed from get payment in that same currency, you can essentially pay it off whenever you want by just printing/ creating more money. OK.

    My real question then is: Is there a point where a deficit becomes too much? I mean at some point there has to be repercussions for a “buy it now, pay later” mindset?

    ps. to the people who found the “its” vs “it’s” …. get help. Normal people care about the content of the discussion and we don’t care if someone screws up their its with their it’s, or we at least have the tact not to post it for discussion.

  17. let the good times roll.
    this can go on forever…!!!!
    or can it …?????
    do some folks benefit more from this system than others….????
    who gets the good stuf and who doesn’t,,, and who gets the shaft….????

  18. Pingback: Does Anybody Understand Debt? « EconProph

  19. Ok govrrnments can borrow with out end, but whst happens when no one will lend. We will become Greece. .is that a good oiutcome?

    • You miss the point. The U.S. cannot become Greece. Greece does not have control of its own currency. It does not borrow in its own currency. It is bound to the Euro. The U.S., like the UK, Japan, Canada, Australia, and many others is totally sovereign in its own currency. It can always create the money to pay the debt as it becomes due. Thus, lenders are always willing to lend because repayment is a certainty. Debt of the U.S. is really less like private debt and more like just currency that pays a tiny amount of interest.

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