Pub. 9 2021 Issue 2 12 DO FEDERAL DEFICITS MATTER? “M odern Economic Theory” (MET) has drawn increasing interest as the federal government accumulates record deficits and the national debt grows into the trillions of dollars. Traditional economic theory says deficits are bad because they cause inf lation and impose unfair burdens on future taxpayers to repay the debts. MET says federal deficits do not matter. They are just accounting. Twenty years of record deficits with no inf lation is the first hint MET may be right. If anything, interest rates are too low. MET says the federal government’s primary role is maintaining the optimal balance of supply and demand in the overall economy, not balancing government collections and spending. MET says the most basic economic factor is the capacity of the economy to supply goods and services. Depressions and recessions happen – indeed are defined – as farms and factories and other businesses remain idle due to lack of demand and lack of money to spend. The government’s goal should be to manage the level of demand by regulating the money supply. MET evolved due to a change in money itself. Consider from where money comes. The rules are different for the federal government because it creates the money and everyone else spends it. The government still taxes and borrows, but those now play different roles in fiscal management. For the federal government to spend money, Congress must first pass an appropriations bill and then the Treasury directs the Federal Reserve to issue the payments. The Fed creates the money with a few keystrokes that add numbers to the payees’ bank accounts. Taxes are used to inhibit or encourage certain kinds of spending, draw money out of the economy if it overheats, and redistribute wealth. U.S. government securities continue to be sold because they are useful to entities needing very safe investments. Ultimately, federal deficits are just accounting, not real debts. That was not always the case. Balancing the budget was necessary when the dollar was, theoretically, at least, based on the “gold standard.” Each dollar used to be backed by gold or silver. The paper money – then named gold and silver certificates – was technically a receipt for a certain amount of gold or silver. Creating additional paper money would only devalue the existing currency if the amount of gold or silver remained the same. In theory, spending power was based on the amount of gold backing the currency, not the amount of currency circulating in the economy and the amount of goods and services it could buy. The federal government didn’t even issue paper money until the Civil War. Before that war, paper money was issued by state- chartered banks. It was a weak system that worked because there was so little commerce compared to today’s economy. Most people lived on farms and grew or made most of what they used and consumed. The federal government began issuing paper dollars in the 1860s when a single national currency was needed to pay for the war. Dollars were needed after the war because so many people left the farms for factory jobs in the cities and required a reliable currency to pay rent and buy food and clothing. The gold standard was adopted to build trust in the new currency. From the beginning, the gold standard was more an illusion than reality. The amount of gold backing the dollar was always less than the total amount of dollars in circulation, and that ratio declined over time to virtual insignificance. The government’s gold reserves were a symbol of value, while the real value was a developing belief in the economy and the competent management of money by the government. By George Sutton, Jones Waldo