Oh No! Here Comes Another Deficit

How will continuing to run deficits affect the US economy? It will have a deleterious effect, because deficit spending (spending more than is taken in) increases debt, which increases sales of Treasury bonds (actually borrowing) to cover the deficit amount, which increases money in circulation, which increases inflation, which decreases bond sales because investors (bond buyers) don’t want to be repaid with inflated money so they cease buying bonds, which ultimately hurts the economy because borrowing is curtailed. Running deficits is circular in nature. The only way to escape the deficit spending circle is to stop doing it.

Deficit Projection

The non-partisan Congressional Budget Office (CBO) projects that the 2012 federal budget deficit will be about $1.1 trillion, the economy will continue to be sluggish, with unemployment remaining above 8%, both this year and in 2013. The CBO predicted that deficits will decline over the next ten years, but only if the George W. Bush-era tax cuts expire as scheduled. But recall that Congress and Obama extended those tax cuts in 2010, so any predictions are difficult to make given the whims (spelled politics) of this administration and Congress. zFacts.com has a good chart of deficits as a percent of Gross Domestic Product (GDP) since FDR. As you can see, regarding deficits, there is plenty of blame to go around.

Obama’s Deficit Record

What is Obama’s deficit record? Not very good, as it turns out. What is most glaring about the chart cited above is that, in 2008, one of President Barack Hussein Obama’s campaign promises was to cut the deficit in half during his first term in office (see promise #11). If you are interested, you can see what else he promised.

Obama’s current excuse: we had no idea how bad things were. Let’s examine what really happened when Obama took office. Obama was less than completely honest (some would say he out-and-out lied) when he said that the budget deficit he faced “when I walked in the door” of the White House was $1.3 trillion. In 2008, George W. Bush started with a deficit of $600 billion (bad enough). Then, when the economy collapsed, Bush passed the Troubled Asset Relief Program (TARP), which cost $700 billion. Under the federal budget, a loan and a grant are treated the same way, so the TARP loans increased the deficit to $1.3 trillion. But in reality the $700 billion for TARP was a short-term loan, and $500 billion of it has, as of now, already been repaid. So the real deficit Obama inherited was $600 billion plus the TARP loans of $700 billion. He promptly increased the deficit to $1.4 trillion in 2009, more than doubling it if you consider the deficit Bush proposed. He ran a deficit of $1.6 trillion in 2010, and $1.27 trillion in 2011. The projected deficit for 2012 is $1.1 trillion. He had better hurry if he wants to keep his campaign promise!

Specific Effects

How will sustained deficits affect the US economy? Just like a personal credit card, deficit spending increases debt. We all know the final outcome of not being able to pay debt accumulated on a personal credit card. Well, the US Government works the same way. Deficit spending can stimulate economic activity in the short run, especially in a recession. But (and there is always a “but”), in the long run, the resultant debt increase, caused by deficit spending, is damaging to the economy because of higher interest rates that result from increased dollars in the economy, thus causing inflation. Foreign governments and investors will be less willing to buy Treasury bonds because of repayment in inflated dollars. The ultimate effect of continuing to run deficits is that it crowds out jobs because there is less money to hire people. Debt service (paying interest on the debt caused by deficits) comes ahead of job creation if the US is to avoid default. To add to the deficit in the hope of creating more jobs is simply not going to happen. Additional deficit spending harms small businesses that are trying to borrow money to create jobs and consumers who are seeking credit to buy cars and homes. Why? Because debt service reduces the amount of money that can be borrowed.

So what does all of this mean? Well, as long as foreign governments will continue to sustain us, nothing. But China, the largest US debt holder, is not pleased with the US, particularly with the Standard & Poor’s downgrade of US long-term debt rating. If China reduces buying Treasury bonds, the dollar will weaken and America’s borrowing costs will increase sharply because the Treasury will have to increase the percentage rate (yield) of bonds to attract buyers. As long as China (and any other foreign government) keeps buying our debt, we are just fine and can keep living beyond our means. But at some point economics says that the “piper must be paid.” The question now is, “How ugly will the payment be?” Does what is currently happening in Greece and across Europe come to mind?


So continuously running deficits are harmful to the economy because of the circulatory nature of borrowing to pay the interest on increasing debt caused by deficit spending. And when the money people refuse to lend more money by refusing to buy more Treasury bonds, the “house of cards” will come tumbling down. Just like with a personal credit card, you can for a short time live beyond your means. But, sooner or later, the debt must be paid. And borrowing from another credit card will only make matters worse by sinking you deeper in debt.

But that’s just my opinion.

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