Still waiting on that hyperinflation.

In 2009, there was a crazy, wild-eyed passion spreading among conservatives and the Teabagger.  Here are some choice quotes from prominent conservatives and teabagger favorites.

Glenn Beck and Ron Paul

Ron Paul:  [snip] So the bailout is a disease, it’s contagious, it’s ongoing, and the result of this will be the destruction of the dollar, which to me means runaway inflation, and political chaos. It’s very, very dangerous.

Glenn Beck: OK, hang on, because you are saying “runaway inflation”. You’re meaning Weimar Republic, wheelbarrow full of money type of stuff to buy a loaf of bread. Is that the kind of inflation you are talking about?

Eric Cantor

Finally, we must ensure that vast government spending doesn’t lead to rampant inflation in the future. At $825 billion, this Democrat stimulus proposal causes us great concern. While the Fed remains rightfully concentrated on fighting deflation, uncontrolled spending and borrowing will most ultimately lead to inflation if the spigot is not turned off in time. That could trigger a flight of foreign capital and a steep drop in the purchasing power of the dollar for the American consumer. As interests rates rise to keep foreigners financing our debt, the pain dealt to businesses and families alike promises to be sharp.

Michele Bachman

Make no mistake. This stimulus bill has very little to do with stimulating the economy and helping the average American . This is a bailout for big government. And let’s get ready. We are looking at massive tax increases and we are looking at massive inflation or both. In fact, we could be looking at hyperinflation.

Arthur Laffer (The “Father of supply-side economics” or Reaganomics)

With the crisis, the ill-conceived government reactions, and the ensuing economic downturn, the unfunded liabilities of federal programs — such as Social Security, civil-service and military pensions, the Pension Benefit Guarantee Corporation, Medicare and Medicaid — are over the $100 trillion mark. With U.S. GDP and federal tax receipts at about $14 trillion and $2.4 trillion respectively, such a debt all but guarantees higher interest rates, massive tax increases, and partial default on government promises.

But as bad as the fiscal picture is, panic-driven monetary policies portend to have even more dire consequences. We can expect rapidly rising prices and much, much higher interest rates over the next four or five years, and a concomitant deleterious impact on output and employment not unlike the late 1970s.

We are a couple of months away from the close of the third year of the Obama Administration.  Before that we will mark the 4 year anniversary of the start of the Great Recession(Dec 2007).  And, most importantly we’ve just finished our third fiscal year in a row of having more than a trillion-dollar budget deficit.

So based on all the hyperbole of conservatives, and the fact we’ve had such huge budget deficits, one might think we were facing huge bouts of inflation.  So let’s take a look at the inflation rate for the last three years.
As you can see, since the stimulus and other government spending brought us out of a recession, month to month changes bounced around between .4 and negative .2 and only briefly went higher than .5 percent.  However, is that a lot?  Let’s compare it to the previous years.  Let’s take at the data since January 2001.




As you can see, after officially exiting the recession, inflation has actually been consistently lower than in the earlier, non-recession ,years.  The only spike you see was from earlier this year and was almost entirely driven by energy costs.  How do I know?  Let’s lay over the cost of energy in general and gasoline into the graphs.




Remember these are month-to-month changes.  As you can see, the energy costs went up so much higher and faster that I had to adjust the scale of the graph to show the increase.  General Prices(blue line) barely looks like a bump while Gas Prices(Red) and general energy costs(Green) went up about 10 times as fast.  So those price increases weren’t driven by general inflation, they were driven by an increase in energy costs.

So in spite of these billion and trillion-dollar budget deficits, how has there been such low inflation?  Didn’t Weimer Germany prove that always happens?  The assumption that a large budget deficits will automatically lead to high inflation is deeply ingrained in our politics.  Based on the last 3 years, you would think that this belief would be re-examined.   And yet, republicans and conservative allies are still warning that the sky is falling inflation is coming.  The whole theory of oncoming inflation is based on the flawed quantity theory of money.  A theory rendered even less relevant since it was developed when we were still on a gold standard.

So what is an alternative explanation?  Does this mean that government can spend and spend without consequence?  MMT (which evolved from keynesian economics) provides an alternative economic framework for understanding why a government can have a trillion dollar deficit 3 years running and still have inflation that is lower than it was when deficits were less than 400 billion.  First of all, inflation comes from spending money, not creating it.

As long as all spending is matched by an equal increase in the amount of goods and services produced by an economy, that spending won’t be inflationary.  Here’s the macro economic implications:  During a recession dollar savings tends to increase – i.e. people tend not to spend their money.  People are afraid of losing their job, and businesses are afraid to expand, leading to reinforcing recessionary effects. One thing that doesn’t change right away is the capacity in the economy. Therefore, when people save dollars, they open up room for the federal government to deficit spend money that won’t be inflationary.  In fact, if the government doesn’t spend it’ll cause deflation which is really bad for an economy.

To better understand the macro economics, let’s take a look at a micro economic example:  Presumably, even during a recession, a factory that produced 100 cars yesterday, can still produce 100 today.  If all the people in the economy bought 100 cars yesterday, but only bought 99 today, then that means that the government can come in and buy an extra car and it won’t be inflationary because the factory can produce it.  Now, of course I’m not suggesting that the government start asking factories how much it can produce and directly buy what it doesn’t sell.  Instead, I’m just trying to give a micro example of what is happening across an entire economy.  The economy has excess capacity that the people producing the items aren’t buying because they are saving their dollars.

The take away is that the federal government has the ability to have deficits until the economy can no longer increase the amount of goods the economy is capable of producing, then inflation happens.  The size the budget deficit can be depends on many things.  One of the things as explained above is the rate of private savings which tends to be higher during recessions.  That is why the federal government can run a trillion dollar plus deficit 3 years running and the economy can still have a lower inflation rate than when it was running sub 400 billion dollar deficit.

The Purpose of Taxes

The story of taxation usually goes like this:  You earn your dollars, then give some portion of it to the government.  The government then takes your money and buys tanks, builds roads, and gives food to the poor.  For local and state governments, that is a true story.  However, for the federal government, which creates the currency, this story remains just that: A story.  Despite what most people in Washington believe, the government doesn’t need your tax dollars to fund it’s activities.  Since the federal government can create money at will, then how does it make sense to say that it needs your taxes to fund all the things that it does?  Obviously, it doesn’t.  So what is the purpose of taxation? The purpose is two-fold:  To control inflation and maintain demand for the currency.

Taxes are needed to regulate inflation.

Since you already know that government spending is constrained by inflation, not revenue, then this should make sense.  If everything else were to remain equal, then taxes would always have to rise with spending to regulate inflation.  If the government kept injecting large amounts of spending without taxation you would eventually see inflation.  However, there are several reasons that inflation and budget deficits don’t always correlate.

There are many reasons that they do not always correlate.  A high savings rate is a good example.  If people are saving dollars instead of buying items it can cause deflation.   Another is fluctuations in foreign exchange markets.  In fact, we are currently living in an age of astronomical budget deficits, and yet we are still seeing very low inflation.

The other reason for federal taxes is to maintain demand for the currency.

Once a currency has already been established, this reason isn’t as obvious.  To understand this concept you we must go back to the launch of a brand new currency.  Let’s say Ireland decided to dump the Euro and create a new currency called ‘quid’.  The Irish government would make a bunch of quid and then try to use it hire someone to sweep the streets of Dublin.  What they would find is that no one was willing to word for quids, no matter how many were offered because everyone would still be using Euros.

Ireland finds that it must artificially create a demand for quid.  They do this by declaring that all taxes must be paid in quid.  Suddenly, people need quid.  People are now willing to work for the government in exchange for quid.  They can make the quid they need to pay their taxes and then sell their excess quid to people who don’t work for the government, but must still pay their taxes in quid.  In exchange for their quid, the workers could get Euro’s(an example of a foreign exchange market) or goods and services(a plain old money transaction).  The amount of Euro’s and goods they get for their quid is negotiated by the market.  After a time the currency will take hold and the Irish government will find it can pay for anything it wants in quid.  As long as people MUST pay their taxes using quid, there will be a demand for quid.

Upon reading this I hope that you come away with a better idea of what taxes are really used for.  Most people believe that the federal government must tax people to fund itself.  When you point out that’s silly because the government can create money at will, many people will start to think you’re suggesting doing away with all taxation(which would be equally silly).  That’s why it’s important to know and to explain to others the purpose of taxes:  Regulate inflation, and maintain the currency.

Jon Stewart Must be Reading This Blog

Wednesday morning I wrote about how ridiculous it is to fight over non-security discretionary spending in order to “balance” the budget when it only accounted for 13% of the budget last year. Then, later that night, Jon Stewart did a little skit pointing out the exact same fact. You can watch the video below(the important part starts at 3:45) or just read the transcript below the video.

You know what? It’s clear that none of you guys, Republican or Democrat, are taking this seriously. I’m going to do it myself. I’m gonna go Charles Grodin in Dave on your ass.  And that is my last reference for the night.  All right, how big is the budget?

GWEN IFILL: President Obama’s budget proposal for the next Fiscal Year came in at more than $3.7 trillion.All right, $3.7 trillion.

What’s the deficit?

BILL O’REILLY: The deficit, $1.1 trillion.

OK, so it’s… you know what though?  Hold on.  Yeah, that’s better.  Sometimes they need to warm up.  All right, so we got $3.7 trillion up for grabs.  How much…?

AL HUNT (2/16/2011): 88% of the budget is not affected by these cuts. … They are only focusing on the cuts on 12% of the budget.

Oh, so we can only cut from 12% of the budget?  All right, well, 12% of $3.7 trillion is… $440 billion.  So here’s what we need to do.  We need to get $1.1 trillion of spending cuts out of $440 billion. So I’m just going to very quickly, um… Watson?  Watson??

That’s all the proof I need to be convinced that he reads my blog :) Now hopefully he’ll keep reading, and he can learn that the federal budget is constrained by inflation, not revenue. If so maybe he can find a hilarious way to show why all this deficit hysteria isn’t a real issue.

We Save When the Government Spends

As you know, for you to save money, someone else must go into debt.  As i explained last time, if 300 million people save one dollar, than one person must go into debt 300 million dollars.  One person who could do this is the federal government.  So if the entire private sector wants to save money, the federal government can be the entity that goes into debt.  In fact, the total savings of the private sector cannot go up unless the federal government goes into debt.

By total savings, I mean that if you add up how many dollars everyone has and then subtract the total amount everyone owes.   Since all money is created as a debt, this will net to 0 dollars.  However, if you pull out just one entity, say the federal government’s treasury, then you can say that one entities debt must equal the others savings because eventually it all must equal zero.  That’s why federal debt equals private saving.  In fact, I understand that most economics students learn this their first year of study.  Macroeconomics 101 teaches that government deficits = private savings.  This doesn’t appear to be a secret.

A couple caveats about this.  I’ve used the term “private sector” pretty broadly here.  I’ve taken it to mean everybody except the federal government.  Most people further divide up the private sector into foreign entities and then domestic private sector.  It still doesn’t change the fact that for these groups to save money, then the federal government must run a deficit.  Again, this is something economists already know.  They learn it as a math equation:  federal income + foreign income + private domestic income = 0.

Another caveat is that this only works for total dollars in the economy.  Some people try to dispute this concept be getting other assets mixed up with money.  An example might be that someone might be in debt, but they have a house that is worth the amount of their debt.  That is a good thing because it increases their networth, but it does not increase the amount of actual money that they have.  Somebody else, like the federal government, will have to go into debt for that person’s amount of money to go up.

So what is the point of all this?  The point is that if we want the private sector to save money, we must be prepared to let the federal government run budget deficits.  It is the only way that the total savings of everyone in the country to go up.  It also means that for anyone calling on the government to balance it’s budget, they are also calling for everyone else to start spending every dollar that they make.

Think of the consequences of this:  For the federal government to have a balanced budget, and for everyone to save money for their own retirement, everyone who is young must go deeply into debt.  While a system such as this is theoretically possible in a free market, it doesn’t seem like it would be very stable.  Another consequence is that for the federal government to run a budget surplus, the private sector has to spend more money than it makes.  Think about that.  If you thought budget deficits are unsustainable, budget surpluses are even more unsustainable because the private sector has to sink into debt for them to happen.

Therefore, anyone who advocates for balancing the federal budget is also arguing for the private sector to stop saving money.  Anyone who thinks the private sector should save money, must also be for the federal government to run budget deficits if they are to remain consistent.

Anyone who advocates that the private sector needs to save money and that the federal government to balance it’s budget is arguing for two mutually exclusive goals.  And yet, this is what politicians and think tanks on both sides advocate for.  While they all have different ideas how to achieve both, I don’t think many of them realize that they are mutually exclusive goals.  Back in 1999, they were patting each other on the back for balancing the budget at the same time op eds were being written that excoriated Americans for having a negative savings rate.  Now it’s the opposite.  We’re thrilled that the private savings rate is so high, at the same time politicians are trying to figure out ways to lower the federal budget deficit.  If politicians and media know that these two goals are opposed, they sure don’t act like it.

How the 2009 Federal Budget Could Have Been Balanced.

Our government collected fewer taxes in FY2009 than it did in FY2000 – this can be said without adjusting for inflation. In 2000, the government took in 1.54 trillion dollars in on-budget taxes, but only took in 1.53 trillion in 2009.  This is despite spending twice as much money in 2009 than in 2000.   Tax receipts during the 90s grew fast.  That was partly do to higher taxes and also with a phenomenal increases in GDP and wealth.  Then came the 2000s.  Tax receipts languished from lower taxes, a recession, more tax cuts, another recession, a slow recovery, and then the Great Recession.  So as an academic exercise, let’s see where the budget deficit would be if tax revenue had grown instead of diminished during the 2000s.  You can see how revenue has slowly, but steadily, gone up during the 80s and 90s, but then went sideways during the 2000s.  I included the raw numbers, plus numbers that adjust for inflation.

(Click chart for larger image.  Click here for the numbers)

I always read some pundits claiming that the Clinton-era tax and GDP growth was unsustainable(see here for example).  Therefore, I calculated the tax revenue increases of 1993-2000.  The average growth was 8.78%.  However, since I’m adjusting for inflation now, I adjusted everything to 2009 dollars.  This yielded average growth of 6.01% in tax revenue from 1993 to 2000.  However, since people accuse that being unsustainable and unrealistic, I decided to chart out the slowest growth in tax revenue from the Clinton Era.  It was 5.9% if using non-adjusted numbers and 3.61% if using adjusted numbers.  Here’s what revenue would’ve been like if the 2000s had averaged the slowest rate of the 90s.

(Click chart for larger image.  Click here for the numbers)

Whether or not you adjust for inflation, it would’ve put on-budget revenue at approx 2.6 trillion$ in 2009 and 2.74 trillion in 2010.  What that means is that the on-budget deficit would’ve only been 400$ billion dollars in 2009 if our spending patterns had been exactly the same.   However, if you strip out all the spending that was done because of the great recession, but keeping stimulus spending, that would’ve been 397$ billion in spending cut.  The 2009 budget could’ve been balanced if revenue had grown at the slowest rate it grew in the Clinton Era, and there had been no Great Recession.  No other adjustments necessary.

Now let’s explore another scenario.  Let’s say that tax revenue had grown even slower than the slowest rate it did during Clinton’s presidency.  I decided to take a look at what the average growth rate for tax revenue has been since 1962.  When adjusting for inflation, the average growth rate from 1962-2000 was 3.16%.  However, if you exclude the Clinton era completely it’s even lower.  From 1962-1992, the average growth rate was 2.4%.  You can see my raw numbers and other statistics here.  I added to the graph what would’ve happened if the 2000s had maintained revenue growth in accordance to the historical averages.  This time I only included the adjust for inflation numbers.

(Click chart for larger image.  Click here for the numbers)

If 63-2000 average tax revenue increases had occurred in the 2000s, the 2009 revenue would’ve been about 2.55 trillion.  That means the 2009 budget would’ve only had a 50$ billion dollar deficit once you take away the Great Recession spending.  That probably would’ve been easily covered if you eliminated the 2009 stimulus spending.

If 63-1992 average tax revenue increases had occurred in the 200s, the 2009 revenue would’ve been about $2.38 trillion.  That would mean that the 2009 budget would have to have been about 620 billion dollars lighter.  If, once again, we assume no Great Recession and remove $400 billion, that still leaves 220$ billion to cut from spending.  Not an easy task, but much less daunting than the 1,500 billion dollars we actually had because of sideways revenue.

If there had been no recession, where would you cut that 220$ billion from the 2009 budget?  Remember – I already removed the direct costs of the recession(and only those costs).

Decreased Spending Alone Can’t Fix the Budget Deficit

As we all know the size of the budget deficit has grown enormously in the last couple years. One only has to look at the increasing size of the budget deficit over the last decade to see why there’s cause to be concerned about it. Starting in 2008 the deficit has shot up several hundreds of billions of dollars.


(Click Chart for larger view. Click Here for the Numbers )

If you ask most people why this is, they would tell you it’s because of an increase in spending. Both pundits and voters will tell you that. They would tell you that for good reason, spending is increasing pretty drastically as you can see below.


(Click Chart for larger view. Click Here for the Numbers )

However, you’ll notice that government spending has not increased as sharply as the deficit. Thanks to (presumably) the recession and tax cuts, government revenue has decreased just as drastically as spending has increased.


(Click Chart for larger view. Click Here for the Numbers )

While spending has increased every year since 2000, revenue(tax receipts) is about the same level as it was in 2000. Accounting for inflation, that means that in 2009, people and companies paid fewer taxes than they did in 2000 when the budget was balanced and there were far fewer tax payers.

Looking at these numbers it’s hard to see how cutting spending can be the only strategy to cutting the budget deficit. Especially, when decreases in revenue has every bit to do with how we got here. If you don’t believe me, let’s look at the data another way. See the chart below.

The chart may require a little explaining. The Blue line is how much the budget deficit increases every year or the “rate of increase”. For example, in 2001 the “deficit’s rate of increase” went up by 119 billion when we went from an 86 billion surplus to a 32 billion deficit.1 The red line is the amount of increase in spending. The orange is the decrease in tax receipts. Therefore, adding blue and orange together will get you the blue line. If you want to decrease the budget deficit, you want all 3 of these lines to be negative.


(Click Chart for larger view. Click Here for the Numbers )

In 2001 to 2003, the budget deficit was increasing quickly because spending was going up at the same time tax receipts were going down. Then in 2004 through 2007 the deficit started decreasing despite an increase in spending. This was because of an increase in tax receipts. For 3 years the budget deficit was heading in the right direction. In 2007 the amount of government spending increased, but not as dramatically as in previous years.

Then in 2008 when the recession hit, both the rate of spending increase and the rate of lost tax receipts increased rapidly. Once both were positive, the rate of the deficit increase skyrocketed. In 2009, the gigantic increase was caused by a 500 billion in increased spending and 400 billion in lost tax receipts.

It’s hard to see how any plan to balance the budget can work if it doesn’t somehow recover that 400 billion lost in tax receipts. It might be a tough pill to swallow for many, but increased spending wasn’t the only thing that got us here, therefore decreasing spending can’t be the only thing that gets us out.

(1Numbers don’t appear to match because of rounding)

(The source for all these numbers is the Public Budget Database)