Thursday, February 15, 2018

Watch the economy take off in the next two years as the Trump budget takes effect. The GOP knows what it is doing to try to get him re-elected in 2020.

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How does the United States fund budget deficits? The government does not "print money" despite the hysteria of some irrational claims.

When any government in the USA runs a deficit, it funds the deficit by selling bonds. The federal government issues bonds, selling them on the open market, to raise cash. T-bills are short-term debt with a face value ("par") of $1,000 to $5 million that matures in 4, 13, 26, or 52 weeks. These are sold at zero interest, but their purchase price is below the face value ("discount"), creating the illusion of interest ("yield"). T-bills are issued only when there is a short-term need, like when tax revenues fall a teensy bit short of expectations.

T-notes are another kind of bond. These are medium-term debt with a par value of $1,000 that matures in 2, 3, 5, 7, or 10 years. These are sold at a fixed interest rate, issued semi-annually. Add in the discount rate, and the yield can be much higher. (For example, a 10-year $1,000 T-note with 3 percent interest is purchased for $950. When cashed in at maturity, the purchaser has received $350 not just $300.)

T-bonds are long-term debt with a par value of $10,000 or more that matures in 20 to 30 years. These are also sold at a fixed interest rate, issued semi-annually.

Bonds are constantly resold on the secondary market. In good economic times, investors want to invest in things with a higher yield (like stocks or real estate). To attract buyers, the federal government will raise the yield -- by either raising the interest rate on the bonds, lowering the discount price, or both. The opposite happens in bad economic times, when worried investors seek a safe investment like federal bonds. Setting the yield on bonds is an art, not a science. It's all about guessing what the market will bear.

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Is the federal government going to go BANKRUPT incurring huge deficits?? Are we "mortgaging our children's future" with them?

Probably not. That's because the federal government isn't actually paying much interest on the debt. Federal debt payments are $266 billion a year -- just 6.5 percent of the 2018 U.S. federal budget. That's about what a person making $25,000 a year would pay on their $6,000 in credit card debt ($150 a month). Bankrupt? Not even close.

In fact, the federal government could double this debt payment overnight without worry merely by cutting back a little bit on military spending. (For example, the F-35 budget is nearly $400 billion -- some $200 billion over its original budget.)

Almost all budget experts agree that federal debt payments do not begin to "crowd out" other spending until interest payments reach 15 percent. And we're far, far, far away from that, even after the massive deficits caused by the GOP during the Great Recession.

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What's the effect of all that debt?

It depends on HOW the debt was created in the first place. Was the debt created by tax cuts, or by increased spend, or both?

Let's look at what happens when tax cuts cause deficits. Let's say there is a $1 trillion tax cut. Most of that money goes to the very rich and corporations. That causes a deficit of $1 trillion. The government must sell bonds (of some kind) to fund that deficit. Who buys these bonds? It's not the janitor in your office building, the factory worker, or the nurse's aide. It's the rich and corporations. That deficit sucks the tax cut right back out of the economy. Moreover, the yield on the bonds serves as a gigantic transfer of wealth to the rich and corporations.

Does this distort the economy? We'd have to know what the rich and corporations would have spent their $1 trillion on, if there wasn't federal bonds to buy. We know that bonds attract only the most risk-averse investors -- those who can't lose their money (like pension plans) or those who fear an economic downturn in the immediate future and want a safe haven for their cash.

If the economy is in bad shape, a deficit funded by tax cuts tends to pull money away from risky investments -- things like new businesses, new products, new kinds of services. They can inhibit the economy, and hinder development.

If the economy is booming, a deficit funded by tax cuts tends to pull less money away only from risky investments.

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Let's say there is a $1 trillion increase in spending that is NOT funded by tax hikes. Once again, the federal government sells bonds to fund that deficit. Again, most of that money goes to the very rich and corporations. Once again, the yield on the bonds serves as a gigantic transfer of wealth to the rich and corporations.

Does this distort the economy? Yes. Is this distortion good? Depends.

First, the government spends that $1 trillion on something. If it spends it on benefit payments (Social Security, Medicare, Medicaid, welfare, Food Stamps, etc.), that's a direct cash payment to the needy. There's pretty much a 1-to-1 impact on the economy, and it can be a wash.

But if the government spends money on buying things -- bridges, roads, airports, broadband, repairs to infrastructure, etc. -- then contractors supplying these things increase the pay of their workers and buy more supplies. Workers, in turn, buy more things and other suppliers much pay their workers more and buy more supplies. Suppliers, too, must buy more raw materials and pay their workers more. On and on it goes, the effect becoming smaller each time.

This is called the multiplier effect. The size of the multiplier is dependent on several factors, but is almost always positive. That is, more economic value is generated (for every $1 in deficit spending, there's more than $1 of value generated).

If the economy is doing poorly, investors keep their money in cash to keep it safe. Investors often purchase U.S. government bonds during bad economic times, since these bonds are both super-safe and offer the only yield possible (even if low). This gets money moving in the economy instead of being idle cash. As money flows, the economy does better, and idle cash becomes investment.

If the economy is doing well, this kind of deficity spending can easily overheat the economy for the same reasons. Moreover, government now begins to compete with the market for supplies and contractors, making it harder for consumers to meet their own needs.

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Let's say there is a combination of tax cuts and deficit spending. That makes the multiplier hard to calculate, and much depends on how the economy is doing.

Right now, the U.S. economy is growing at a moderate pace, about 2.6 percent a year. Real unemployment (those who want a job but are so discouraged to have stopped looking, plus those who are working part-time even though they want a full-time job, plus unemployed actively looking for jobs) is 8.5 percent -- double the "official" rate.

If we looked just at the growth rate and "official" unemployment rate, Trump's deficit spending (a $1.5 trillion tax cut plus $1 trillion in increased spending) would be a recipe for overheating the economy. That would mean high inflation, followed by high interest rates to stop it.

But with so much slack in employment numbers, it's clear the economy can take a pretty big stimulus and still not overheat. For example: The economy had to add 205,000 jobs a month between 2010 and 2020 to recover all the jobs lost by the GOP-caused Great Recession as well as absorb new workers due to population growth. In 2017, it added about 146,600 a month. Only a few times in the past eight years has the economy added more than 200,000 jobs a month.

What will this mean? As the economy improves but does not heat up, employment numbers will rise. The public will feel better. "Trump promised jobs, and now we've got 'em!" Consumer spending will rise, further improving the economy.

When the crash comes -- and it will come, because no one has repealed the business cycle -- it will be after the 2020 elections.

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