The Harmful Effect of Oversimplifying

From the 1950s through the mid-1980s, peptic ulcers were thought to be caused by lifestyle, not a bacteria. Ulcers started appearing in large numbers after World War II, and the over-simplified concept in use was that the change in lifestyle created ulcers. There was no correlation between ulcers and stomach cancer.

A billion-dollar-a-year industry for drug companies, therapists and surgeons grew around treating the symptoms, but not curing the disease.  Gastroenterologists cut out part of the stomach, SmithKline Beecham sold $1 billion of Tagamet (the wonder drug that reduced stomach acid so that ulcers became less severe), and nothing was done to cure the disease. Bacteria continued to wreak havoc and often led to stomach cancer.  The doctors involved in breaking the moat around a misconception with ulcer treatment won a Nobel Prize in 2005.  The suffering of millions of Americans and hundreds of millions around the world decreased dramatically.  It is estimated that 85% of all stomach cancer was caused by the bacteria.

You may be asking yourself, what does a story about urban myths and concepts in the medical industry that caused great pain to patients have to do with the US economy? Plenty!

We have a myth circulating amongst many voters and US taxpayers that the US government should be run like a household.  Usually these people think we should decrease spending by the US government and reduce the deficit.  However, the reality is very different. Households receive wages, pensions, Social Security, and then spend.  Very simple and easy to understand.

Governments who can print their own currency, (not the Euro), operate by a totally different set of rules.  Governments print money and then spend; that spending goes into circulation to households, and the economy grows.  The only time the US has had zero debt and a balanced budget, was under Andrew Jackson around 1835.  Jackson paid off the debt by selling US assets (Western land), and by decreasing spending (mostly on infrastructure).  By 1837, the US experienced one of the worst economic contractions in its history, and the US has not been debt-free since!  And, despite the US having had debt for the past 180 years, the US economy has grown, and we are now, by far, the largest economy in the world.  Maybe that is not an accident!

Every so often, we hear a speaker who reminds us, or you read an article that reminds you, that the US government budget and the US economy is more sophisticated than a household budget, and that solutions based upon household budgeting are harmful, not helpful!  One of those people is Professor Stephanie Kelton. Her research areas include monetary policy, employment policy, public finance, international finance, and European monetary integration. A well-known policy expert, she has served as Chief Economist of the US Senate Budget Committee.

In a conference attended by Gayle and Rich Colman, Dr. Kelton discussed how the result sought by those wanting to reduce spending by the Federal government harms the US economy, and that government spending on infrastructure, education and research grows the economy.  I made note of a few points she made that may sound contradictory, but after thinking about her points, both Gayle and I agree, she is correct:
1. Government spends first; taxes and borrowing come second.
2. Taxes do not fund the government. Due to spedning first and revenue later, government can just issue currency and spend.

In 2009, Europe and the US, as well as China, diverged on how to deal with the recession. The Euro zone chose austerity, as did the US Congress. Congress balked at the Obama stimulus package and reduced spending greatly. The actual stimulus package that passed Congress did little in the way of stimulus, and mostly resuscitated the economy.

In stepped Ben Bernanke, and we saw interest rates drop to about zero. Then, quantitative easing further stimulated the US economy, by buying US Treasury bonds. Basically, quantitative easing is the equivalent of the US just printing money. There was nothing backing the currency except for the fact that the Federal Reserve used its money to purchase US government Bonds. The Federal Reserve has the ability to print currency when it deems necessary. The net result was that the US economy suffered less than Europe, and its recovery came sooner. The bottom line, from an empirical view, is that the deficit spending in the US expanded the economy, lessened the worst effects of the 2008 recession, and helped the US economy lift itself out of the recession sooner than it would have otherwise.

China reacted differently than the US. China spent the equivalent of almost $590 billion in 2009. Because the US GDP was $14.4 trillion in 2009, and the Chinese GDP was $5.1 trillion, China spent the equivalent of the $1.7 trillion US stimulus package. The US spent $800 billion. China never experienced a downturn; its growth halved from better than 15% to just under 7%. As we know, the US GDP shrank in 2009 from 2008. China’s spending was rewarded with a larger economy and so far, China has not experienced a collapse.

The empirical data: the US has had deficits and debt for over 180 years, and the US economy has continued to grow. During that period and even in the last 30 years, the US standard of living has continued to improve for the average household. Perhaps we need to look at our assumptions regarding deficit spending, and what is best for the US economy, with new eyes, and without old assumptions.
Dr. Kelton’s graph, shown below, illustrates that when the US government runs a deficit, the private sector and foreign countries run surpluses.  There seems to be a correlation between the government running surpluses and/or smaller deficits, and the private sector running deficits.  Unlike the federal government, the private sector cannot print money and that situation often leads to a financial crisis.
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