The riddle of the deficit (or deficits for Dummies)

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Riddle: When is a ‘deficit’ not actually a deficit?

Answer: When it’s a Government budget deficit.

 

 Dear [insert name of virtually any Journalist or Politician]

It seems that you’re still having a bit if a struggle to understand what a budget deficit is, and what it does.

Let me try and explain.

Imagine that I’m the ‘Government’ and you are the ‘Private Sector’.  I give you a bar of chocolate.  Now, I (the ‘Government’) am in deficit to the tune of one bar of chocolate… but you (the ‘Private Sector’) are in surplus to the sum of one bar of chocolate.

Are you with me so far?  The government sector and the private sector or non-governmental sector, are opposite sides of the same coin.  A deficit for the government means a gain in the private sector and vice versa.  (The private sector means everything in the domestic economy, which is not government – I’m leaving out exports/imports to keep it simple).

One way or another, Government spending all goes into the private sector … payments for the NHS, Education, the military, unemployment benefits, working tax credits, child benefit, the Police, the judiciary, pensions, motorways, new infrastructure, grant to local governments and much more, are each paid for out of government spending.

OK?   So government doesn’t just spend, it also taxes.

So I’ll be the ‘Government’ again, and I’ll give you (the ‘Private Sector’) a bar of chocolate and then take back half of it, as a tax.   Now both the ‘Government’ and the ‘Private sector’ have half a bar of chocolate each but the government has a budget deficit of half a bar of chocolate whilst the private sector is increased by half a bar of chocolate.

With that extra half a bar of chocolate you have a lot of options.  For example, you could eat it (i.e. consume goods and keep someone in a job replacing them); give it to someone to mend your bike (i.e. create employment); put it in the cupboard for another day (i.e. save) or repay your friend the chocolate you owe him (i.e. pay off debts).

The way to work out if the government has a budget deficit, a balanced budget or a surplus is simply to subtract the total amount collected in tax from the total amount that government spends.   At the moment, the UK has a budget deficit, which means that the amount spent is greater than the amount of tax collected.

However, George Osborne says this is absolutely ‘frightful’ and that under his new policies, the UK will be in surplus by 2020 (!)

So what does a surplus mean for those of us in the private or non-governmental sector?

Well, if I pretend to be the ‘Government’ again, and I give you (the ‘Private Sector’) a bar of chocolate and then take it all back again … the budget will be balanced. Government spent a bar of chocolate and collected a bar back again… but you in the private sector have nothing more than you had before the ‘Government’ started spending!   (How great does a balanced budget sound now?)

To be in surplus, I as the ‘Government’ would give you a bar of chocolate and then demand a bar and a half of chocolate back from you (the ‘private sector’).  Now you have the problem of how you are going to get me that additional half a bar of chocolate?  Maybe you have some saved bars of chocolate which you can use for a year or two but eventually you may have to go into debt or even sell your house to give me, the Government, that extra half bar of chocolate!

As J.D. Alt writes in his excellent US post:

 If [government] runs a “budget surplus” for long, the Private Sector will either have to diminish its economic activity in general (go into recession)—or plunge hopelessly into debt (borrowing bank money it can’t repay, possibly causing a banking crisis)—or both.

 

Instead of creating jobs by spending, paying off debts or saving, a surplus budget eventually leads to redundancies, greater household indebtedness and greater precariousness of the workforce.

Obvious questions are raised by this simple story, like where did I (the ‘Government’) get the money to buy the chocolate in the first place?   Answer: I created it – that’s what Governments do if they’re the sovereign issuer of its own currency!   This is an incontrovertible fact – only the UK government can create Pounds Sterling – anyone else is committing the criminal act of counterfeiting.

If sovereign governments can create as much money as they want, why does the UK government need to collect tax to fund public spending?   Answer: It doesn’t – there are many essential reasons* for the government to collect tax but taxes do not pay for anything.

Think about it, if government kept on spending into the private sector without having a means of also draining the economy, we would have rampant inflation. (Literally, if it was all in bars of chocolate!)  So tax is one of the means of keeping the amount government spends into the private sector equivalent to the number of goods and services available for people to buy… thus preventing price inflation.

That is probably enough for now. I would recommend this and this for more information but please don’t hesitate to contact me if you need further explanation as to how the economy really operates.

Kind regards

Yours sincerely

Syzygysue

* Tax is important for lots of reasons including giving value to the currency but it does not fund government spending.

PS.  We’re constantly told that the deficit means that future generations will have to pay off our debts. This is simply rubbish.  Which would your children really benefit** from?   Half a chocolate bar (deficit budget), no chocolate bar (a balanced budget) or increased household debt and a potential recession (a surplus budget)?  It would be no contest in my family!

(** Obviously, caveats re: inflation apply)

 

DIAGRAMS & DOLLARS: modern money illustrated (Part 1) 

DIAGRAMS & DOLLARS: modern money illustrated (Part 2)

 

Why do politicians tell us Debt/Deficit myths which they must know to be untrue?

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The New Economic Perspectives’ video clip on the Government budget, Deficits and Debt presented below (produced for educational purposes), debunks the myths that politicians tell their populations to justify ‘austerity’.  In the case of the clip, it starts with 3 full minutes of American politicians misinforming the electorate.  An identical montage aimed at the UK electorate could undoubtably just feature George Osborne’s utterances from his forthcoming Autumn statement scheduled for this Thursday (5th December 2013).

However, the reality is that all economists know that the deficit and debt mythologies are not true and ‘have long known that the idea of balancing budgets over the cycle is a bit like a fairy story we tell to frighten the kids’.  Economists, and Central bankers like Mervyn King, Ben Bernanke, Alan Greenspan, all know that:

The UK government can never ‘run out’ of money;

The UK government can never be forced to default;

The UK government can never be forced to miss a payment;

The UK government is never subject to the whim of ‘bond vigilantes’.

In fact, the St Louis Federal Reserve, from the heart of Western capitalism in the US confirms the same for the US dollar (and any other nation that creates its own currency) :

‘As sole manufacturers of dollars whose debt is denominated in the dollar, the US government can never become insolvent ie. unable to pay its bills.  In this sense, the government is not dependent on credit markets to remain operational.  Moreover, there will always be a market for US government debt at home because the US government has the only means of creating risk-free dollar-denominated assets.’

Paul Samuelson, ‘father of modern economics’ and Nobel Prize winner, suggested the reason for perpetuating the mythologies in a 1995 interview:

“I think there is an element of truth in the view that the superstition that the budget must be balanced at all times [is necessary]. Once it is debunked [that] takes away one of the bulwarks that every society must have against expenditure out of control. There must be discipline in the allocation of resources or you will have anarchistic chaos and inefficiency. And one of the functions of old fashioned religion was to scare people by sometimes what might be regarded as myths into behaving in a way that the long-run civilized life requires. We have taken away a belief in the intrinsic necessity of balancing the budget if not in every year, [then] in every short period of time. If Prime Minister Gladstone came back to life he would say ‘uh, oh what you have done’ and James Buchanan argues in those terms. I have to say that I see merit in that view.”

It may be that politicians fear the ‘anarchic’ demands of the electorate were the public to understand that the UK economy is not like a household and can never be bankrupt.  However, these distortions of reality have been carried to a new pitch by George Osborne and the Coalition government:

The scale of the Coalition government’s intended austerity measures are on a scale never seen in modern Britain. What is planned here will dwarf anything that was undertaken by Thatcher in the 1980s. There is already massive unemployment in the public sector….Massive unemployment and lower wages mean lower tax receipts, and even bigger budget deficits and debt loads…It is now clear that the austerity policy in the UK is not a matter of economic necessity but of political choice… It is obvious that the cuts of this scale are about much more than just deficit reduction… The cuts are part of an agenda to transfer services from the public sector to the private sector. The pretence of ‘there is no alternative’ is a means for the Conservative project to radically transform the state.

http://www.globalresearch.ca/uk-economy-falls-into-double-dip-recession/5313842

It would be just as well to remember this week, when listening to George Osborne and Danny Alexander, that Keynes said:

’Capitalism is the extraordinary belief that the nastiest of men, for the nastiest of reasons, will somehow work for the benefit of us all.’

 

New Economic Perspectives on the Government Budget, Deficits, and Debt

Published on Nov 28, 2013

The video clip features the following speakers, in order of appearance:

L. RANDALL WRAY
Professor, Economics, University of Missouri-Kansas City
Senior Scholar, Levy Economics Institute
Author, Understanding Modern Money, Modern Money Theory
http://www.economonitor.com/lrwray/

STEPHANIE KELTON
Professor, Economics, and Chair of the Department of Economics, University of Missouri-Kansas City
http://stephaniekelton.com/

WARREN MOSLER
President, financial services firm Valance Co. Inc.
Author, Soft Currency Economics, The Seven Deadly Innocent Frauds of Economic Policy
http://moslereconomics.com/

For More Information:

University of Missouiti-Kansas City, Economics Blog:
New Economic Perspectives
http://neweconomicperspectives.org/

The Modern Money Network
http://www.modernmoneynetwork.org/

Other posts from Think left:

George Osborne says we’re running out of money ..

The fundamental deceit of ‘There’s No Money Left’

The UK needs 8 million New Jobs

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The latest data shows the economy is smaller today than it was in in the first quarter of 2010 and now 4.5 per cent below the previous peak in the first quarter of 2008.

The jobless total in the UK was 2.5 million people at the end of December, while the unemployment rate stood at 7.8%.  However, this figure does not include people who are on workfare placements or are underemployed in part-time work.  The true figures wanting  a job is likely to be 8+ million.  This is a desperate waste of the real wealth creators.

At the same time ‘We are stumbling into a lost decade, serious long term damage is being done to the economy and any recovery looks like it will be based on a lower wage, lower productivity model with serious implications for living standards.  As for the claim that austerity has brought us low interest rates – I’m amazed anyone bothers to argue this nonsense anymore.’  Duncan Weldon ToUChstone blog

Keynes said  ” Look after unemployment and the budget will look after itself. ”  We need a government committed to full employment and a jobs guarantee for everyone who wants to take one.  Rooseveldt showed how it can be done – back in the 1930s.  But we have a Tory/LD coalition government that is doing the opposite in the name of a recovery that never comes.

From  KC’s JobsNow! Hat-tip – New economic perspectives

http://touchstoneblog.org.uk/2013/02/losing-aaa-the-complete-failure-of-the-governments-economic-strategy/

Related posts:

Economics in crisis – it needs a ‘Reformation’

The Future Jobs Fund: One of the most ineffective job schemes there’s been?

BRIBING THE PRIVATE SECTOR TO INVEST ISN’T WORKING

George Osborne says we’re running out of money ..

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First a quiz:

Q1.  The UK economy is just like a household and the government has to finance spending out of its income or through borrowing.  True or False?

Q2.  The role of taxes is to provide finance for government spending?  True or False?

Q3.  The UK government needs to borrow money from the private sector to finance the budget deficit. True or False?

Q4.  If the Tory/LDs were running a budget surplus instead of a budget deficit, pressure would be taken off interest rates because the private sector would have more funds available for investment projects. True or False?

Q5.  If the budget deficit persists it will burden further generations with inflation and higher taxes. True or False?

Q6.  We need to run budget surpluses now, to help build up the funds necessary to cope with an ageing population in the future. True or False?

The answer is that they are all are false …not true… misleading… erroneous… fictitious… incorrect… deceitful… dishonest… sham… bogus… unreal… and yet we are fed these lines, day after to day, to justify George Osborne ‘shrinking the state’.  And worse still, Ed Balls and the LP are going along with an austerity-lite economic strategy.

Don’t believe me?

Listen to what the St Louis Federal Reserve, from the heart of Western capitalism in the US says:

‘As sole manufacturers of dollars whose debt is denominated in the dollar, the US government can never become insolvent ie. unable to pay its bills.  In this sense, the government is not dependent on credit markets to remain operational.  Moreover, there will always be a market for US government debt at home because the US government has the only means of creating risk-free dollar-denominated assets.’

The same is true of Sterling.  Economics Professor Randy Wray explains :

L. Randall Wray — MODERN MONEY: the way a sovereign currency “works”

Published on Sep 23, 2012  ModMonPubPurpose

The UK government can never ‘run out’ of money;

The UK government can never be forced to default;

The UK government can never be forced to miss a payment;

The UK government is never subject to the whim of ‘bond vigilantes’.

So why are we told that there is no money left; that it is imperative to reduce the deficit and debt; and that we have to keep the ‘bond markets’ happy?

The scale of the Coalition government’s intended austerity measures are on a scale never seen in modern Britain. What is planned here will dwarf anything that was undertaken by Thatcher in the 1980s. There is already massive unemployment in the public sector….Massive unemployment and lower wages mean lower tax receipts, and even bigger budget deficits and debt loads… It is now clear that the austerity policy in the UK is not a matter of economic necessity but of political choice… It is obvious that the cuts of this scale are about much more than just deficit reduction… The cuts are part of an agenda to transfer services from the public sector to the private sector. The pretence of ‘there is no alternative’ is a means for the Conservative project to radically transform the state.

http://www.globalresearch.ca/uk-economy-falls-into-double-dip-recession/5313842

If George Osborne was serious about reducing the deficit and balancing the budget, he wouldn’t be cutting jobs, benefits and reducing corporation tax.

‘So even if you are obsessed with reducing deficits, the best way is to engender growth. The dumbest thing a government can do if it wants a lower deficit is to impose fiscal austerity. There are a lot of dumb governments out there. The problem is they are aided and abetted by criminal types who know full well it is dumb to cut net public spending but pressure governments to do so as long as the space for spending on them expands.’

http://bilbo.economicoutlook.net/blog/?p=22186#more-22186

The 2011 Budget Control Act, initiated by the Republican controlled House, is one of the most foolish pieces of legislation ever passed into law by Congress, as it forces the government to attempt to “balance” its budget and reduce the budget deficit.  National government budget deficits, which are the net contribution of government spending to economic growth, are actually integral to economic growth, contrary to the anti-scientific conventional budget lore upon which deficit hysteria has been built.  Without government budget deficits, the economies of nations with trade deficits CANNOT accumulate net financial wealth  due a matter of simple arithmetic; those few nations (China, Germany, not the US) with large trade surpluses MIGHT be able to accumulate net financial wealth without a budget deficit but always with the cooperation of other nations financing those surpluses through trade and, in most cases, government budget deficits on the side of the net-importing nation.

A fiat currency-issuing national government, unlike a local government, business or a household, does not depend upon tax or other income and therefore is not and should not pretend to be bound by conventional balance sheet accounting, which was perhaps a more applicable, though not particularly successful, means of national government accounting during the gold standard era. The reasons for transitioning away from the gold-standard, the rigidities which it imposed on aggregate demand and the money supply, have been suppressed from public discourse in an era in which deficit hysterics like those at “Fix the Debt” hold honored seats at the policymaking and policy advocacy tables.  These deficit hysterics, funded by Wall Street tycoons freelancing as economic pundits, would like Washington insiders and the media to believe that the gold-standard never went away, specifically for the purpose of cutting social programs that stand in the way of Wall Street’s expansion into new markets.

I have recently proposed that we rename the so-called budget deficits specifically of currency-issuing governments, the government’s “net contribution to monetary/economic growth” so that the confusion no longer persists that these so-called deficits are by their nature “bad” and to be avoided.  The fiat currency issuer can never run out of its own money, can never be in “deficit” in it; “net contribution” is a better formal description of the excess of spending over taxes for specifically a fiat currency-issuing government.  The government spending over taxes collected becomes the incremental increase in the money supply for the real economy as it grows in real terms, underneath the pro-cyclical expansion and contraction of money available from bank credit (i.e. expands in a boom and collapses in a bust).  Too much price inflation is a possibility with too much government spending over-and-above taxes collected but demand-led inflation in our current situation would be a “high quality problem” indicating that we have reached full capacity in our economy, which is not nearly the case.  Right now we have a very large output gap as well as high demand for government-led expenditures on things like infrastructure, public services and education, making increased government expenditures very unlikely to cause inflation.

http://neweconomicperspectives.org/2012/12/fueled-by-deficit-hysteria-obama-and-the-republicans-are-choosing-the-path-of-economicide.html

The deficit is the government’s ‘net contribution to monetary/economic growth’ .. so who in their right mind, would want to reduce it?  We should be increasing it until the UK has jobs for all who are willing and able to take them.  As Keynes said:

Look after unemployment and the Budget will look after itself”

Keyes also said:  ‘Capitalism is the extraordinary belief that the nastiest of men, for the nastiest of reasons, will somehow work for the benefit of us all.’

(My emphasis in bold)

Related posts:

The big lie – Governments cannot run out of money!

How to be a Deficit Owl

Cameron and Osborne dwell on Bullshit Mountain, UK

The fundamental deceit of ‘There’s No Money Left’

Why does the Structural Deficit remind me of LIBOR?

Osborne and Cameron’s Big Deficit Myth

What is George Osborne playing at?