Critics of government deficit spending correctly point out that perpetual debt accumulation is not sustainable. They’re right. But before they criticize an economic policy that aims to use inflation to whittle away the real value—and hence the actual burden—of accumulated debt, they’d be wise to consider the alternatives. Because there aren’t any.
Deficit spending has been touted as a potential driver of inflation, because only with devalued (inflated) currency can Americans hope to erode the real value of mounting levels of government debt. Continuing to print U.S. dollars, the argument goes, can only lead to too many dollars in the system, and hence a devalued dollar. We should be so lucky.
When American households join the federal government in spending more than they make, the only way to keep this up is to cut interest rates and increase the value of the underlying collateral. This second factor, the value of collateral, is particularly important for the American consumer, who has relied on home-equity appreciation to enable ongoing borrowing which, in turn, enabled ongoing spending beyond their means. The so-called financialization of the American economy over the past few decades has been aimed specifically at boosting the value of assets in order to stimulate more borrowing and spending.
The deflationary risk caused by debt accumulation becomes most acute if and when this asset-price bubble bursts. When the market value of the collateral suddenly becomes worth less than the amount of the loans outstanding, banks cannot extend new credit to the private sector, even at very low interest rates.
If America’s policymakers return to the feckless cowardice of the Obama years, appeasement will again define federal policy.
Another way to put this is as follows: Liquidity is a function of two factors, money supply and collateral. But the impact of available collateral is far more critical to maintaining liquidity than the money supply. According to the most recent data from the U.S. Federal Reserve, in the first quarter of 2019 the total U.S. wealth, all sectors, totaled $98.3 trillion. What happens to the value of that collateral if banks cannot extend new credit? How is a deflationary spiral avoided when no new borrowing is possible, causing a collapse of demand to purchase assets, causing a compounding drop in the market value of those assets?
This is the cascading collapse of liquidity that was narrowly avoided in 2009. But with total market debt in the United States still hovering at approximately 343 percent of GDP, or not quite $80 trillion, it remains a threat to the American economy.
Raising interest rates at this time risks the catastrophic possibility of a deflationary collapse, because if interest rates rise, borrowing and spending slow down, asset values drop because of reduced demand, and one after another, bank balance sheets show loan balances that exceed collateral value. Yet this is the alternative that deficit hawks apparently prefer to managed inflation. It is neither a more virtuous solution, nor is it necessary, nor would it work.
Even if raising interest rates does not trigger an economic calamity, it would merely continue the relentless transfer of wealth in America from the middle class to the investor class—Americans would not have borrowed so much if the economy had not become financialized, making everything cost far more.
Inflation transfers wealth back from the investor class to the middle class, by eroding the value of their debt. Those responsible Americans who didn’t succumb to the debt temptation should think twice before rejecting the inflation choice. It won’t matter if your bank savings are intact when the banks fail.
How Can Inflation Be Managed to Benefit Ordinary Americans?
If one is willing to assume that inflation is a better pathway out of excessive debt than deflation, the prevailing challenge becomes how to ensure this inflation will benefit ordinary Americans. Since the 1970s, wage inflation has not kept pace with asset inflation. The challenge is to flip that ratio so that asset inflation (and debt devaluation) does not keep pace with wage inflation.
If this can be accomplished, the cost of living for ordinary Americans will actually go down, even in an inflationary environment. Their wages will be increasing faster than the consumer price index, and the real value of their debt and interest payments will be declining. How can this be done?
As I noted in a previous article, two key policy shifts are necessary to ensure wage inflation outpaces asset inflation and the CPI. First, get immigration under control so there is a seller’s market for labor instead of a buyers market for labor. Second, relax the extreme environmental laws that prevent Americans from developing their own natural resources and upgrading their infrastructure. Relaxing these ridiculously excessive, punitive, misanthropic, misused and extreme environmental regulations would also dramatically lower the price of new homes.
Not only does increasing mining and drilling operations within the United States create more jobs, it is a necessary step to take as domestic inflation equates to currency devaluation. By devaluing the dollar through inflation fueled by deficit spending and low interest rates, in-country development of natural resources becomes cheaper than importing them.
Managed Inflation Is the Only Alternative
Critics of deficit spending act as if there is a choice to make, that somehow the circumstances and givens that confront America’s policymakers are not unyielding, that somehow by harping on the virtue of living within our means, they can bend reality. But they can’t.
The harsh reality is this: America’s federal government is locked into a pattern of deficit spending that cannot be stopped in the near future. America’s accumulated debt either will be smoothly resolved via managed inflation, or resolved catastrophically via unmanageable deflation that will cause an economic meltdown.
Moreover, federal deficit spending needs to increase. Now. Because putting aside the fantasies of all who would wish this weren’t so (libertarians, socialists, and nationalists all have such wishful thinkers well represented within their ranks), America is in a battle for global supremacy with the Chinese, who must be contained by the United States waging an expensive cold war that will last for decades. One does not have to be a “neocon shill” to recognize this sad fact. One need only study history, and then observe the actions of the Chinese regime.
None of this macroeconomic reality is meant to absolve the American consumers who decided to sink into debt up to their eyeballs. It doesn’t excuse the students who chose to pay obscene amounts for college tuition, using borrowed money, nor does it excuse the loan sharks who extended them credit, or the criminals who turned higher education into a money-making scam.
It is not meant to ignore the costly, useless “solutions” demanded and received by poverty pimps and identity fascists. It doesn’t let off the hook all those environmentalist fanatics and their opportunistic “green” crony capitalist puppeteers who tied our economy up in knots, nor does it forgive the public sector unions who made government services unaffordable and inefficient.
It just is what it is. So, where do we go from here?
There is no palatable alternative. If America’s policymakers return to the feckless cowardice of the Obama years, appeasement will again define federal policy. Appeasement of the Chinese by neglecting our military readiness and a firm commitment to containment. Appeasement of the deficit hawks by raising interest rates, as if somehow without inflation we’re still going to whittle away $80 trillion in government and household debt. Appeasement that will turn the fate of the world over to President Xi, and turn America into a debtors’ prison.
The United States needs to spend more on its military, it needs to spend more on its infrastructure, even if that means increasing the federal deficit. The United States then needs to restrict immigration and roll back extreme environmental regulations in order to ensure that wages inflate faster than the consumer price index. This managed inflation would not only whittle away the real value of American debt, but it would serve as a tool to reduce the real value of non-military, non-infrastructure related entitlement spending.