Why the Federal Debt and Deficit Matter
In 2007 while he was campaigning for President, Barack Obama called George W. Bush irresponsible and un-patriotic for adding $4,000,000,000,000.00 to the US debt during his eight years in office.
President Obama was correct in his estimation. That has not prevented him, however, from increasing the debt by $5,000,000,000,000.00 in less than half the time it took George W. Bush.
Why does it matter? Why all the gloom and doom about ever increasing debt and deficits? The government can just print more money, so why does it matter?
The problem goes to the definition of the word inflation.
1. Economics . a persistent, substantial rise in the general level of prices related to an increase in the volume of money and resulting in the loss of value of currency ( opposed to deflation).
By definition, increasing the money supply (printing money, now called quantitative easing) is inflation. It is inflating the money supply. Anytime the money supply is increased, the value of each dollar is lessened, causing prices to increase.
Suppose instead of dollars, we traded in slices of pizza. You get paid at the end of the week in slices, and when you go to buy gas at the service station, you pay with slices of pizza.
Now consider the term value. Suppose the value of a whole pizza cut into six slices is what a tank of gasoline costs for your car.
All of the sudden, suppose the government decides that pizzas will be now cut into eight slices instead of six. You get paid in slices, remember, not pizzas. The value of things has not changed, however. A tank of gas still costs a whole pie, meaning you now have to earn two more slices to fill up your tank.
Each slice is smaller now, and buys less. This also means that if you have loaned the government pizza slices, by buying treasury bonds, the slices you get back when you cash in your bonds are worth less than the ones you lent them. With interest rates kept artificially low, as they are now, it may even mean that the slices you get back including interest will buy less than the slices you lent them.
Since the dollar is no longer tied to anything of physical value, like gold, its value is purely arbitrary. It depends only on the total number of dollars in circulation. As our government continues to spend money it doesn’t have, it has to borrow the difference, either by selling treasury bonds to it’s citizens, to other countries or to the federal reserve. In order for the federal reserve to purchase enough debt to keep the country going without interest rates going up and greatly increasing taxes on everyone, it has to print more money. At some point, price inflation will start to increase rapidly, what is known as hyperinflation. Prices will skyrocket as in the case of Brazil in the early 1990’s. At its peak, Brazil’s inflation rate was somewhere around 4,000%.
In America, we are already seeing prices on food and energy rise rapidly. There is no question that a fair portion of the rise in energy prices is due to the decreasing value of the dollar. As energy prices rise so does the cost of everything else, especially food.
This relation to quantitative easing (printing money) and price inflation can be illustrated quite easily by comparing the value of silver to the value of gasoline. In 1907 an ounce of silver would buy about 3 gallons of gasoline. In 1984 gasoline was about $1.20 per gallon and silver sold for about $8.14 per ounce meaning that 1 ounce of silver would buy about 6.8 gallons of gas. Today gasoline sells for about $3.83 per gallon and silver for $30.27 per ounce meaning that 1 ounce of silver today will buy 7.9 gallons of gas.
By the gasoline example we see that if silver were used as money, the cost of a gallon of gas today would actually be less than HALF of what it cost in 1907!
In a report titled “The Realities of Modern Hyperinflation” produced by the International Monetary Fund, authors Carmen M . Reinhart and Miguel A. Savastano point out;
“Chronic high inflation does not necessarily degenerate into hyperinflation. But, in the five countries reviewed here, hyperinflation did ensue, triggered by an uncontrolled expansion in the money supply that was fueled by endemic fiscal imbalances.”
One of the reasons for Ron Paul’s insistence on a return to sound money is to avoid a hyperinflation cycle brought about by an ever expanding money supply. If we continue to spend money that we do not have at the federal level, we are headed for exactly the kind of hyperinflation which is devastating to the poor and middle class. Simply taxing the rich will not fix our debt and deficit problem. The rich only have enough money to keep our government spending at its voracious rate for several months at best, even if we confiscate ALL their money.
Currently all revenue the federal government receives is spent on mandatory programs, social security, medicare, medicaid, food stamps, welfare and debt service. All discretionary spending including defense, is borrowed money. If we do not deal with the entitlement programs we are doomed to an inflationary spiral that will quickly spin out of control.
The IMF report leaves us with seven lessons to remember about hyperinflation.
Policymakers would do well to bear in mind the seven lessons that emerge from this overview of modern hyperinflations.
1. Hyperinflations seldom materialize overnight and are usually preceded by a protracted period of high and variable inflation.
2. Stabilization may take years if fiscal policies are not adjusted appropriately. Even when fiscal adjustment is implemented, it takes time to achieve low inflation, especially when money is used as the nominal anchor.
3. Sharp reductions in fiscal deficits are always a critical element of a stabilization program, regardless of the choice of monetary anchor.
4. Unifying exchange markets and establishing currency convertibility are often essential ingredients of stabilization, irrespective of the choice of main nominal anchor.
5. Output collapses during, and sometimes in the run-up to, hyperinflation. Although stabilization measures cap the implosion in economic activity, there is little evidence to suggest that they kindle a robust rebound in economic activity.
6. Hyperinflations are accompanied by an abrupt reduction in financial intermediation.
7. Stopping a hyperinflation does not restore demand for domestic money and domestic currency assets to the levels that prevailed before the hyperinflation began. Capital returns to the country when high inflation stops, but dollarization and other forms of indexation dominate financial intermediation for many years.