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Do Deficits Even Matter? Why Yes, Yes They Do

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Do deficits even matter?

They used to — at least in conservative circles. And even in some progressive circles when Republicans were in control of Washington D.C. But today, the federal government is running record deficits and has pushed the national debt over $22 trillion and virtually nobody even bats an eye.

In a recent Wall Street Journal article, John Yarmuth, chair of the House Budget Committee summed up the attitude toward the spending and debt in Washington D.C. He said he rarely hears from constituents concerned about rising deficits and debt. Many voters’ attitudes, he says:“There haven’t been any cataclysmic consequences, so why worry about it?”

Why indeed?

David Stockman explained why the debt actually does matter in an article published at David Stockman’s Contra Corner and reprinted at Stockman served as Office of Budget Management Director under Ronald Reagan.

Stockman started out by pointing out that the massive federal debt wouldn’t even be possible without that a helping hand from the Federal Reserve.

The central banks of the world have expanded their balance sheets by upwards of $22 trillion since the turn of the century, thereby massively monetizing the erupting public debt of the US and most of the world via fiat credit snatched from thin air. So did that massive $22 trillion “buy” order from the central banks weigh heavily on the supply of funds side of the scales in the fixed income market, thereby driving bond prices skyward and yields ever lower? Why, goodness gracious, yes it did!”

But that still doesn’t really explain why it actually matters. After all, we’ve had debt for decades and nothing bad has happened.

Stockman says you can catch a glimpse of the problem by looking at the current bond yield. Over the last few months, it has fallen precipitously. The chattering pundits on the financial news networks blame this on increasing pessimism about the global economy and the rising expectations of a recession. But Stockman says this doesn’t really account for the current level of bond yields. Not only that, virtually none of the financial analysts saw this coming.

Apparently, not a single one of the hundreds of high paid Wall Street analysts who cover or strategize on the fixed income markets came within a country mile of guessing where the 10-year UST yield would be today in their start of the year projections. That is, as of January they were essentially blind, deaf and dumb as to what would materialize in a mere 180 days. And the utterly hideous level of forecast error shown below is not due to the fact that the Trade War and global growth outlook have deteriorated since the beginning of the year.”


As Stockman explains it, you might expect to see some dip in yields in the face of a recession, but it shouldn’t happen in today’s world because everybody knows government borrowing explodes during a recession “by a far larger magnitude than any offsetting reduction in demand for business working capital credit or long-term debt.”

In sum, US Treasury demand for funds rose by $2.62 trillion during the 2007-2009 recessionary decline, but private household and business demand also rose – by a net of $474 billion. There was no weakening of demand for borrowings at all, meaning the theory that private demand for borrowings falls during a recessionary downturn is belied by the relevant facts from the last go-round. Whatever may have been the case back in the Keynesian heydays of the 1960s and 1970s is no longer relevant. That’s because the American economy is now entombed in $72 trillion of public and private debt – upon which the daily turning of the economic wheels vitally depend.”

Enter the Fed. The central bank’s easy-money policies keep the wheels greased and the debt-piles growing. The market trades on the Fed, not on actual economic realities.

[The market] is now pricing-in a biblical flood of new liquidity that is expected to monetize the $1.5 to $2.0 trillion Federal deficits that are sure to emerge during the upcoming recession; and to do so without any “crowding out” of the now massive $31.2 trillion mountain of household and nonfinancial business debt. But here’s the thing. The implicit assumption that indefinite and virtually infinite levels of public debt can be monetized can’t be true. Nor can the implicit assumption that the real yield on the 10-year bond can remain at virtually zero (it was 0.09% today) for the indefinite future with no harm, no foul consequences. After all, that amounts to one epic free lunch proposition: Namely, that no one needs to save or defer gratification in the private sector because the central banks can always print enough new credit to monetize the public debt and keep interest rates aberrantly and irrationally low.”

Stockman points out the US savings rates have fallen to abysmal levels. This makes sense given that consumers saddled with debt and “stimulated” to borrow can’t put money away for a rainy day. According to Stockman, net national savings in Q1 2019 came in at only $506 billion at an annual rate. Adjusted for inflation, national savings is 50% below where it was 20 years ago.

This is extremely problematic. It erodes the very foundation of the economy because capital is built from savings. Stockman explained summed things up this way and revealed exactly why debt and deficits matter.

In a word, the radically artificial bond rates that have been generated by massive central bank debt monetization have fostered the foolish belief in the Imperial City that the public debt is benign and that borrowing a trillion dollars at the tippy-top of the business cycle is no sweat at all. In truth, it has led to a financial metastasis down below the surface. To wit, America has been eating its seed corn (private savings) to fund the most irresponsible spree of fiscal excess in recorded history. The public debt has gone from $5.5 trillion to $22 trillion during that 20-year period, and after 30-years based on current built-in policy, the public debt will be $42 trillion or nearly 8X higher. Stated differently, today as the economy struggles to grow after the longest, weakest business expansion ever, the private economy has 50% less in real terms to invest in future productivity and growth than it had two decades ago.”

But nobody cares. The powers that be just keep kicking the can down the road. But as we’ve said – eventually you run out of road.

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