Deficit Spending: a Subsidy for the Old Money Rich

If the federal government were to buy up 50 billion dollars of cheese, you might think that the government was trying to subsidize dairy farmers. If the federal government were to buy up 50 billion dollars of arugula, you might think that the government was trying to subsidize arugula farmers. If the federal government were to buy up 50 billion dollars of solar cells, you might think that the government was trying to subsidize solar cell manufacturers. If the federal government were to buy up 50 billion dollars of capital you might think that the government was trying to subsidize…capitalists.

But we’re not talking 50 billion dollars here, we’re talking 1.1 TRILLION dollars for fiscal year 2012. Yet hardly anyone is talking about the subsidy to capitalists.

Oh, people talk about subsidies to capitalists, when it comes to bailouts and Solyndra, but that’s not what I’m talking about here. A $1.1 trillion deficit is a $1.1 trillion subsidy to those who have money to lend regardless of how it is spent. If it is spent on progressive liberal programs, you might also help out the poor at the same time you help the very rich. But is that the truly liberal thing to do?

Bill Clinton got it, at least partially. While Republicans whined about being over taxed, he had a few words about surpluses going to lower mortgage rates or some such. (Maybe I’ll dig up the quote in a future update of this article.) The Obama administration did not get it.

The government takes from the economy when it spends the money. When it gets the money from taxes, it’s somewhat clear who pays: the taxpayers. (I say somewhat, as we still need to study some supply-demand charts to figure out how much of a business tax gets passed to consumers and how much is comes out of the business, etc.) When it gets the money by floating bonds, other borrowers pay, including the implicit borrowers: i.e., labor. Government deficit spending is a major factor in the decline of the working middle class in this country. Liberals should care.

Labor as Implicit Borrowers

If you work for someone else, odds are good that you are a borrower, even if your mortgage is paid off and you have no credit cards. For the majority of jobs, paychecks are issued before the money comes in. A retailer has to lease a location, set up an accounting system, get permits, and buy inventory all before the first customer enters the door. Cashiers get paid before the business pays off these other expenses. For industry, the delay is longer: product must be designed, factories built, suppliers lined up, and customers acquired before the first item is sold. It can be years before gross profits pay for the overhead. Until then, all paychecks are coming from borrowed money: borrowed from banks, bond holders and/or stockholders. The working class pays the interest on this borrowed money in the form of lower wages.

If you want to boost worker wages, balance the federal budget. Better yet, run a surplus and pay down some debt. For an extra trillion dollars per year, the markets could refinance the Rust Belt and throw in a few solar cell manufacturing plants in the bargain.

This is not a new idea, by the way. The idea here comes from none other than Adam Smith, who was far more liberal in the modern sense than most people today realize. From the beginning Chapter IX of his famous book on economics:

The rise and fall in the profits of stock depend upon the same causes with the rise and fall in the wages of labour, the increasing or declining state of the wealth of society; but those causes affect the one and the other very differently.

The increase of stock, which raises wages, tends to lower profit. When the stock of many rich merchants are turned into the same trade; and when there is a like increase of stock in all the different trades carried on in the same society, the same competition must produce the same effect in the all.

Or later in the same chapter:

Since the time of Henry VIII the wealth and revenue of the country have been continually advancing, and, in the course of their progress, their pace seems rather to have been gradually accelerated than retarded. They seem not only to have been going on, but to have been going on faster and faster. The wages of labor have been continually increasing during the same period, and the greater part of the different branches of trade and manufacturers the profits of stock have been diminishing.

Did you get that? As capital (stock) increases, profits drop and wages rise. This has been the historical trend going way back. Alas, today we have Keynesian economics, with its call to diminish society’s stock (savings), and thus support profits, all in the name of stimulus.

Why Interest Rates Aren’t Higher

Government is slurping up capital to the tune of a trillion dollars a year. And even before the current recession, the federal government was running deficits on the order of hundreds of billions of dollars save during part of the Clinton years. So why haven’t we seen higher real interest rates? Is there something wrong with Adam Smith’s reasoning?

No, there are several offsetting factors, which hide the damage from deficits, but these offsets come with a price.

1. Just-in-time inventory control. Manufacturers must get financing for both capital goods and inventory. If you can shrink inventory, you need less financing. Just-in-time manufacturing dispenses with warehouses full of parts. This approach to manufacturing improves quality: a defect in an incoming part can be remedied without tossing out a warehouse full of defective parts. But this approach also comes with prices: transport must be more frequent, and the supply chain is vulnerable to disruption. If ever a terrorist or rogue state launches a high altitude nuke for its electromagnetic pulse, we will lament our lack of inventory.

2. Trade deficits. When a trading partner sells us stuff, said partner can either buy stuff from us with the dollars, let the dollars fill up a warehouse, or use those dollars to buy U.S. financial instruments, including federal bonds. The budget deficit subsidizes the trade deficit. If you are a Rust Belt laborer out of work or suffering a pay cut, you are paying the price for profligate federal deficit spending. Our nation as a whole is selling its seed corn in return for cheap plastic stuff at Wal-Mart.

3. Financial wizardry. One sector of the economy has bloomed during the past decades: high finance. The wizards of Wall St. have had successfully converted short term savings accounts and even checking accounts into long term loans – the legal equivalent of kiting checks. Our leaders on both sides of the aisle celebrated these innovations as they led to lower mortgage rates and more business capital. But, as we now see, such wizardry was not sustainable.

And finally, interest rates are high for many. During the Great Recession, bank lines of credit dried up, forcing many businesses to close. And many a startup business was not able to get money from a bank in the first place. Read how many have had to rely in credit cards, loans from relatives, and angel investors. And then there are other lower tier forms of financing such as factoring and PIPES; check out the effective interest rates there. While you are at it, check out the effective interest rates paid by the poor for payday loans and advances on tax refunds.

But Don’t we Need Fiscal Stimulus?

When a financial bubble pops and boom turns to bust, government bailouts can stem the panic. Where the markets are too shortsighted to finance long term projects, government finance can outperform the market. Think of the Internet and the many spin-offs from the space program. But:

  1. Governments are often prone to more than keeping a crash from bottoming out. Governments are tempted to maintain bubble price levels, preventing full economic recovery.
  2. When governments invest in too many projects, government gets stupid due to information overload. We have but one Congress and one President.

Balance the budget and the capital markets will have to find other uses for that trillion dollars the government is currently borrowing annually. That’s a pretty big stimulus in and of itself. We’ll look into other ideas to get the economy in future articles.

For now, remember: deficit spending is regressive. Deficit spending is a price support program for the rich. Tell your friends. Tax the rich. Rein in spending.