It’s the Spending, Stupid: Budget Deficits Really Don’t Matter
The deficit is not a meaningless figure, only a grossly overrated one.
—Robert L. Bartley, The Seven Fat Years
In April 2013, Apple, Inc., easily floated a seventeen-billion-dollar debt offering. Investors eagerly lined up to buy the company’s debt in what was the largest non-bank deal in history.1 That Apple could take on so much debt surely surprised no one. The success of its offering reflected a broad market consensus that the technology colossus, one of the most valuable companies in the world thanks to its sleek iPhones and iPads, would have little problem repaying what it had borrowed. In 2011, Google successfully completed a three-billion-dollar debt offering.2 The rate of interest that both companies had to pay on their debt was only slightly higher than the rates that the U.S. government has to pay when it borrows.
Why is it that the federal government can borrow so cheaply? The U.S. Treasury’s debt is backed by the richest economy in the world—that’s why. Whatever problems the United States faces, its private economy still claims some of the world’s most economically dynamic individuals and companies. The enormous productivity of Americans makes it easy for the Treasury to borrow money at very low rates of interest, enabling the federal government to spend at a deficit. Because the government can tax those economically dynamic individuals and companies, investors know the Treasury is a good bet to repay the money it borrows.
It’s easier to think about government debt if we take it down to the individual level. Let us say someone wins fifty thousand dollars during a lucky weekend in Las Vegas. When he announces his windfall to some friends, three of them ask if they can borrow the money. The first friend is a hard-working investment banker who earns two million dollars per year. He receives most of his pay at bonus time, much of the bonus is paid in company shares that can be sold only after one year. Short on cash in the near term, the banker promises to pay the money back once the share lock-up is lifted.
The second friend is a mid-level paper salesman. He earns a hundred thousand dollars in a good year, but in a volatile economy his pay some years dips to seventy-five thousand. And as the economy becomes increasingly paperless, he could lose his job at any time.
The third friend is a fun-loving free spirit who constantly tinkers with new business ideas. Too unorthodox to put on a suit each day and work in a corporate bureaucracy, this risk-taker has happened on an exciting new iPhone app and desperately needs capital to get it developed in time for meetings with some Sand Hill Road venture capital firms.
Logic dictates the investment banker is the best lending bet. With his high annual income, he could easily repay the fifty thousand dollars at year-end. Both parties know this is a low-risk loan. With plans in place to sell a quarter-million dollars’ worth of bank shares when the lock-up ends, the banker merits a 3 percent rate of interest.
The paper salesman is a higher risk. Technology is making paper less necessary, as the lender knows. More worried about the salesman’s creditworthiness, he would charge him 6 percent to borrow the fifty thousand.
The intense competition in the technology industry makes the developer of the next “killer app” the riskiest borrower. Yet it is precisely that risk that lets the lender charge a princely rate—say 12 percent—for the use of that money.
Ultimately, the owner of the fifty thousand dollars decides that each of his friends is a good bet relative to the interest he will pay, so he divides the money unequally among them on conservative grounds—$33,500 to the investment banker at 3 percent, ten thousand to the paper salesman at 6 percent, and sixty-five hundred to the high risk–high reward entrepreneur at 12 percent.
The question of government deficits is as basic as this story. The U.S. economy is the largest in the world, and the U.S. Treasury annually receives nearly three trillion dollars in tax revenues. It should be easy for the United States to run large deficits.
The United States is not the only nation that can float its debt with relative ease. The countries with the next-biggest budget deficits include Japan, England, China, and France.3 It is not shocking that countries whose treasuries are showered with tax revenues can run up big deficits. More to the point, rich countries have no problem borrowing in debt markets made up of some of the most sophisticated investors in the world.
By contrast, poor countries are largely shut out of those same debt markets. Nicaragua and Honduras have almost no annual debt, while the perennial economic laggard Zimbabwe actually posts a budget surplus in some years. No reasonable investor would bet on governments in countries with such weak economies. It doesn’t matter what their tax rates are because there is so little to tax.
Back to Apple and Google for a moment. Both of these private-sector companies operate far more effectively than the U.S. government, so why do they pay slightly more to borrow money? Because they might have a bad year, or years. But the federal government never has a bad year. Although its revenues rise and fall with the economy, they’re always so abundant that investors view Treasury debt as riskless. Buyers of government debt are betting on the ability of the nation’s private sector to generate the wealth necessary to pay back the money borrowed. Nosebleed government deficits, paradoxically, are a market signal that investors are confident about the economic future of the United States.
Just as the lucky gambler would lend the most at the lowest rate of interest to the investment banker, a smaller amount at a higher rate of interest to the salesman in a shaky industry, and the smallest amount at the highest rate of interest to the serial entrepreneur still aiming for the big score, sophisticated institutional investors allocate credit to companies and governments according to the risk involved. Those with the best prospects are able to borrow the most money at the cheapest price, and then those deemed the least creditworthy must pay seemingly usurious rates in order to attract lenders.
Yet even though sophisticated lenders the world over line up for the privilege of lending to the U.S. Treasury at the lowest interest rates in the world, we could fill several Rose Bowls with all the commentators who for decades have been predicting fiscal doom for the United States. What is even stranger is that many of these commentators would agree that markets are rather wise.
The British historian Niall Ferguson is a well-known right-of-center economic thinker who has written many excellent books on economic history. But writing about the U.S. budget deficit in October of 2013, Ferguson warned,
[T]he fiscal position of the federal government is in fact much worse today than is commonly realized. As anyone can see who reads the most recent long-term budget outlook—published last month by the Congressional Budget Office, and almost entirely ignored by the media—the question is not if the United States will default but when and on which of its rapidly spiraling liabilities.4
The popular and market-friendly commentator Mark Steyn writes in his 2012 book After America that “the prevailing political realities of the United States do not allow for any meaningful course correction,” and “without meaningful course correction, America is doomed.”5 National Review’s roving correspondent Kevin Williamson declares in his 2013 book, The End Is Near and It’s Going to Be Awesome, that the United States’ insurmountable budget deficits are driving us broke.
Ferguson, Steyn, and Williamson could all be right. But pessimists have been predicting disaster for America since before it was an independent country. And although each of these men would agree that markets in general are rather smart, implicit in the commentary from each is that the markets for debt are stupid. That seems unlikely to me. Excessive government spending unquestionably hurts growth, but debt markets are not exactly composed of people who majored in basket weaving. Buyers of government debt are just as careful as people who lend to individuals.
Even if Ferguson, Steyn, and Williamson know something that investors don’t, worries about government debt still miss the forest for the trees. Government borrowing is, on its face, a problem since governments compete with entrepreneurs and companies for limited capital. But as I’ve pointed out in earlier chapters, a dollar is a dollar is a dollar.
Don’t ever forget that we live in a global market. Whether the federal government borrows money or takes it in taxes isn’t the point. Both actions reduce the amount of capital to which the private sector has access, and that hurts growth. Which is preferable, annual federal deficits of five hundred billion dollars on one trillion dollars in annual spending or a balanced budget of three trillion dollars? The economic logic says the former is better. What’s important is the amount spent on an annual basis.
Indeed, it is of the utmost importance to reduce government expenditure in total. Entrepreneurs cannot be entrepreneurs without capital. If the federal government is consuming less of the capital stock, then the productive will have a bigger pool of capital to bid on.
Returning to the individual example earlier in this chapter, what if the guy in Vegas wins $100,000 instead of $50,000? The entrepreneur with visions of a world-changing app is now a more attractive borrower. With an extra fifty grand, it makes sense to risk a larger share of the total amount lent on a borrower who promises a bigger reward. Now he might lend fifty thousand to the banker, $30,500 to the paper pusher, and $19,500 to the next great software developer.
You can see why government spending deserves more attention than deficits. Economic growth is about the leap, experimentation, and taking risks on new ideas. When government consumes more capital, investors will be more cautious about how they allocate what’s left. Yet the riskiest ventures offer the greatest potential benefits to the economy. Sports Illustrated’s annual swimsuit edition, which brings in forty million dollars each year to Time, Inc., “began as a lark, a what-the-hell, nothing-else-is-working improvisation” back in the early 1960s.6
In 2002 the classic 1984 film This Is Spinal Tap was included in the U.S. National Film Registry, “which preserves films deemed ‘culturally, historically or aesthetically significant.’” Christopher Guest, one of the film’s creators, recounts that “we went around Hollywood showing our little movie, trying to get somebody to give us the money to finish it, and we were met with a resounding, ‘We don’t get this. What the hell are you doing?’” Eventually the legendary television producer Norman Lear provided the financing, and an eminently quotable movie was born.7
In 1986, Russell Maryland was a lightly recruited high school football player who, thanks to his dad’s sending a tape to the University of Miami late in the recruiting process, was awarded the football power’s final scholarship for that year. After his senior year for the Hurricanes, Maryland was the number-one pick in the NFL draft. He went on to win Super Bowls with the Dallas Cowboys and was inducted into the College Football Hall of Fame in 2012. Most college coaches overlooked him, but with an extra scholarship, the Miami Hurricanes took a winning risk.8
It’s hard to achieve the big economic leaps if capital is scarce. The script for The French Connection lies idle, This Is Spinal Tap never gets made, Sports Illustrated doesn’t take a risk on a swimsuit issue, and Russell Maryland’s football career ends after high school. On the other hand, restrained government spending means there is more capital available, and a small amount of the bigger capital pool can go to the risk takers.
Excessive government spending is a real but unseen cost. The unseen is all the brilliant ideas that never get funded. To reduce the burden that is government spending is to increase the slice of capital that will migrate to the riskiest ideas, and by virtue of being risky, the ideas that can truly transform the economy. Because we want to live better, let’s get to work on slashing federal outlays; deficits be damned. They really don’t matter.