When Are Federal Deficits Dangerous?

Here, Michael Boskin writes about his view of the looming danger of a growing federal deficit and debt. Professor Boskin's analysis and information is fabulous, but doesn't go far enough, really.

I invite readers to consider an even sterner standard for when federal debt is dangerous. I argue that federal deficit spending is dangerous whenever it is financed by money creation instead of through the savings of the household sector. In other words, deficit spending today is just fine, so long as households increase their savings today to pay for the debt plus interest in the future.

Deficit spending certainly makes sense for financing investment spending. That's what businesses do. It makes sense because the investment repays the debt, plus interest, plus additional real growth in the economy. For example, ABC corporation borrows $100 million to build a new factory. The new factory produces goods that sell for $150 million over the next 10 years. $100 million repays the loan; $10 million pays interest on the debt; $40 million is pure economic growth.

Deficit finance often makes sense for spending on durable goods that deliver services into the extended future, even though the spending isn't an investment. A good example at the consumer level is buying a house. After all, the house provides "housing services" to the home owner over several years. It makes sense to pay for those services over several years.

Deficit spending to finance current consumption spending can even make sense, provided consumers are merely moving consumption to the present with every expectation of forgoing consumption in the future when the loan is repaid plus interest. A good example is taking a vacation this year, with the expectation that there will be no vacation next year.

Does the federal deficit spending called for by Obama match up with any of these three cases? No, not at all. Instead, federal deficit spending is financing current consumption with absolutely no expectation of forgone consumption in the future.

Does anyone seriously doubt that the huge federal budget deficits proposed by Obama for the next few years will be financed by money creation, not saving by households? I have no such doubt; I'm utterly confident that the Fed will finance the U.S. Treasury's deficit spending, if increased tax collections fail to do so.

Will the economy grow sufficiently fast to allow greater tax collections without raising tax rates? That has happened in the past. Will it happen over the next decade? Anyone that claims they know the answer is kidding themselves (including the CBO and all other economic forecasters).

Is Obama proposing policies that favor real economic growth? He is not. Obama is all about "spreading the wealth"; he is not about growing wealth. Can he kill the goose that's laying the golden eggs? He can if the American people let him. Let's see what happens in November of 2010.