“Deficits don’t matter,” we were told in the 1980s, as the Reagan Administration started running what seemed at the time to be huge budget deficits ($200 billion!) to defeat the Russians. We had seen much smaller deficits associated with price inflation in the 1970s (‘too much money chasing the same goods’), but were told not to worry.
Remarkably, it seemed to work. The Russians were defeated (although, in fairness, the Reagan defense buildup had relatively little to do with it), the economy generally prospered, and prices for consumer goods remained stable. The Federal deficit moderated, and even came close to running a surplus in the late 1990s.
But since the turn of the century, the government has been running larger and larger deficits. Under the Bush (43) administration, deficits ran around a half-trillion dollars per year, and the Obama administration introduced the trillion-dollar deficit. President Trump campaigned that he would not only eliminate the deficit, but would retire the entire debt in eight years. (In fairness, that was one campaign promise I didn’t take very seriously.) In fact, deficits under Trump have gone back into trillion-dollar territory.
And yet price inflation has been moderate. Yes, the government figures understate the case. But while today’s Federal deficits, as a percentage of GDP, are at least twice what they were in the 1970s, real price inflation has been less severe. What happened?
One of the most basic equations of economics is:
- M is the quantity of money in the system
- V is the velocity with which money changes hands
- P is a price index
- Q is the value of goods and services transacted (in some unit of measure unaffected by transient price changes)
So, since about 2000, M has gone way, way up; Q has stagnated, rising very slowly; P has gone up moderately. V, in consequence, has dropped like a rock. Money doesn’t change hands like it used to. It disappears out of the economy almost as fast as it’s created. How does that happen?
For starters, every year, there are roughly $700 billion in imports that have no corresponding export. Once one of those dollars leaves the country, it isn’t coming back. That, in itself, will make a big dent in the effects of a trillion-dollar Federal budget deficit.
Perhaps a bigger factor is the inequality that has overtaken the American economy since 2000. Another place the money can go to have no further effect for ordinary people is into the pockets of the very, very rich. The rich have relatively little need for consumer goods (how many Lamborghinis can one drive at once?) but will seek to invest their new-found gains to at least preserve their value. So the stock market rises, independent of the productive values of the corporations on it, and real estate goes up, which causes some incidental problems for ordinary people who want to live in places like New York and San Francisco, but nothing major.
Yes, it’s a bubble. Bubbles usually pop when people realize that the object of the bubble isn’t returning value and they want their money back. But the essential difference this time is that the money won’t stop. As long as there are huge new debts, the money has to go somewhere. This bubble is made of Kevlar, and so far, is puncture-proof.
About 30 years ago, I read The Great Depression of 1990 by Ravi Batra. At the time, its essential premise seemed ludicrous: that the very rich would suck all the money out of the economy and impoverish the rest of us. Yet that’s exactly what’s happening now. The vast Federal deficits, nominally intended to help the people, are in fact helping the very rich become even richer.
Yet it works, for now. The Federal government borrows money that doesn’t exist; the money passes through ordinary people, but doesn’t really circulate very much before it ends up in the hands of a big bank and its owners, who effectively sequester it so it can’t do any further damage in terms of price inflation, or the money simply leaves the country, never to return.
It’s a delicate balance. If you cut budget deficits, suddenly banks and big corporations would have to work for a living, and the stock market would plummet. If people became more prosperous and traded among themselves, rather than buying imports, money wouldn’t be flushed out, and prices would rise. And if, as some of the Democratic candidates for President imagine, you mobilize millions of people and pay them union wages to go out and fix climate change, they will find that their new paychecks won’t actually buy very much.
A while back, I entertained in these pages the notion that the economy we experienced was a simulation of sorts that had become divorced from the economy of the stock market and the Federal government. No, it’s not quite a simulation, but it’s pretty close.