Snarky Behavior

Dropping Knowledge: The US Deficit

September 14, 2007 · 3 Comments

Dropping Knowledge: where I “laymenize” an important aspect of social science.

I like the idea of “dropping knowledge” because I can share some of the (extremely expensive) information I’m obtaining via my Ivy experience with my friends who are bored out of their skulls while still in the “working” world.

I feel it necessary to preface every one of these posts with “I’m not an expert” and “I haven’t yet been exposed to all of the sides of this issue.” Nevertheless, I strongly disdain the assumption that one must first be “an expert” to participate in what turn out to be extremely important discussions about the current and future states of affairs of our country and world. Moreover, that’s what the comments section is for.

Wednesday in economics class my professor went on an extremely interesting tangent while discussing the “Wealth of Nations” (specifically Balance of Payments).

Everyone should know, if not understand, that the United States government is running a massive deficit of over $9 trillion dollars. The human brain isn’t wired to understand numbers that big, but it calculates out to about $30,000 per US citizen.

The deficit that is referenced in this instance is related to an economic term called “Government Savings,” which is calculated by taking tax revenue and subtracting government spending, transactions and interest payments. This creates a running balance over all years. Pretty straightforward.

There is another “twin” deficit that most people are familiar with to a lesser extent, which measures the “Current Account” balance of the US. This balance is calculated in several ways, but the easiest way to understand it is as follows: the US imports way more than it exports, it saves (both as a government [see above], and as individual citizens) less than it invests, and it issues bonds to the rest of the world (most notably China and Saudi Arabia) to finance its spending.

The US is therefore the world’s biggest borrower. We borrow from the rest of the world to finance our consumption and government expenditures (including the war in Iraq, which is about 5% of our current annual budget).

What typically happens to borrowers that continue to spend, without the ability to pay of their debts, is that they are slowly denied credit. First their interest rates jump. Then, the money flow stops. Their assets are repossessed and sold. And their standard of living is adjusted downward, accordingly.

It’s a scary thought to recognize that our current standard of living in the US is financed on borrowed time. If at any point China decides that it’s militarily ready to assume the unipoloar position of the world’s hegemon, it could (hypothetically) collect full payment on all of the US treasury notes it’s snatched up over the past decade, and bankrupt the US. 1929 all over again.

So someone asked our professor: should we be worried?

“Yes,” he said.

I was shocked. You never get definitive answers from economists.

Of course, he qualified himself: there are factors in play that make the US a “most favored nation,” and “dark-matter” components that aren’t being factored in when calculating the US’ deficit.

The most favored nation concept is easy enough to understand: China wouldn’t want to financially bankrupt the US, because the US is such a huge, integrated part of the global economy that the world couldn’t sustain its collapse. Moreover, countries continue to consider the US treasury bond the safest way to diversify their portfolios, and can’t invest fast enough (at extremely low rates, by the way).

This foreign investment concept ties into the “dark-matter” factors: the largest of which is cash liquidity. You see, the most diversified of all US liabilities is the dollar note itself: many countries prefer to use the dollar as a stable currency, and the dollar bears no interest. The US is providing a liquidity service to the rest of the world that is not being taken into consideration when calculating the “Current Account” balance above. Moreover, the US provides the rest of the world with various “intangible” services such as intellectual property, higher education and “the American brand.” It seems we haven’t squandered all of our good will by haphazardly starting a war in the Middle East.

So these are the high-falutin issues that economists discuss amongst themselves. They all seem to agree that a high deficit is risky, but there is no consensus of just how risky it really is.

As for myself, I’m one to believe that the Bush tax-cuts have served their purpose in stimulating the economy post-9/11 (even though he proposed them pre-9/11), and that their roll-over nature is extremely dangerous. It’s time to nip this deficit in the bud.

Moreover, there’s a national discussion going around after the census released data showing that GDP was up, but real incomes at all but the highest brackets remained stagnant… and last month saw the first net job loss in God knows how long.

Since when did Democrats become the party of fiscal responsibility?

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3 responses so far ↓

  • misha // September 16, 2007 at 1:31 am | Reply

    1) who’s your prof?
    2) I believe $9trn is the debt, not the deficit – you should drop some knowledge on the diff. between the two. But the deficit is still scary. If you want to be really worried, read this: If like me you don’t like macro models skip to p. 239, where you can read that the fiscal gap (present value of projected future deficits) is in the ballpark of $65trn, over 5x GDP. Now THAT shit is scary.
    3) Assuming ricardian equivalence, I’m moving to Canada before that bill comes in.

  • misha // September 16, 2007 at 1:33 am | Reply

    and do you really believe the Bush tax cuts did ANYTHING? Or that repealing them will do anything to the fiscal gap? B/c neither is the case. But we should discuss some other time – I’m off to the city.

  • Jon // September 16, 2007 at 1:42 am | Reply

    Good catch, I was imprecise with my terminology.

    YOU’RE the economist Misha. I’m giving due credit to tax cuts for stimulating the economy post-9/11 with no particular boom in any given sector (aside from the financial sector), is that inaccurate? And no, I don’t think repealing them during a recession is a wise move, but certainly writing fiscal legislation with sunset provisions is politically dangerous.

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