Balanced Budget Amendment Idiocy – An Economic Suicide Pact

The Balanced Budget Amendment Task Force, better known as “Task Force Stupid”, is once again living up to their name. The tile of their thoroughly idiotic petition that you can ignore here says: “Email the Idaho Legislature in Support of a U.S. Balanced Budget Amendment! Destroy the U.S. Economy!” What follows is the technical reason why the Balanced Budget Amendment Task Force is run by complete morons.

Fig 1: The Logo of The Balanced Budget Amendment Task Force

 

An unassailable fact of macroeconomics: Somebody’s spending is somebody else’s income.

We will learn in the course of our discussion that at the macro level the same is true for the three sectors in the economy.

To understand the function of income as it relates to the economy as a whole, we must look at the aggregate level, or what is known as the macro level of the economy. The microeconomics viewpoint, as it relates to federal spending, results in the Fallacy of Composition.

Microeconomics and the Fallacy of Composition

The federal budget is in no way representative of a household budget, because the federal government is the sole constitutionally authorized issuer of U.S. dollars, which are free-floating, non-convertible fiat and a household is restricted to being a user of the government’s currency. Thus, because of the mechanics of fiat currency systems and the federal government’s infinite issuing capacity, the U.S. government requires no income to enable it to spend, whereas, a household or a business does. The microeconomics conflation of federal budgets with household budgets is not analogous.

Secondly, the microeconomics viewpoint again commits the fallacy of composition on the subject of saving. As it equates household budgets with the federal government’s budget, it also equates household saving and federal government saving with economic growth. A sovereign currency issuing government, such as the United States government, cannot save in its own currency, because, as we understand, it is the issuer of the currency that the economy uses. Therefore, the microeconomics viewpoint commits the fallacy of composition and is thus, invalid.

But what about consumer saving? Again, within the private sector, where everyone is a currency user, all cannot save. To demonstrate this reality, let us look at a brief example.

Barb wants to save money. Barb decides that she will eat at McDonald’s only one day per week. Barb sticks to her plan and so, Barb saves money. But, what if everyone in the nation decided to do the same and only eat at McDonald’s one day per week? The impact on the income of McDonald’s would prove catastrophic. McDonald’s would lay off large numbers of its employees in an attempt to neutralize the rapid fall in income. Applied to all businesses across the economy, if everyone saved, the action would result in high unemployment levels and recession.

Therefore, not all can save, because somebody’s spending is somebody’s income, confirming the fundamental rule in macroeconomics. The microeconomics viewpoint of saving equals economic growth commits the fallacy of composition and is rendered invalid. Only the federal government can attenuate the negative effects of reduced aggregate demand levels in a stable manner when the private sector desires to increase its net savings.

Let us begin our examination of the Sectoral Balances and how they relate to the fiscal position of the federal government with an overview of the Flow of Funds and National Accounts.

The Flow of Funds Accounts

The Flow of Funds Accounts provides us with a view of the flow of funds through sectors within a particular economy. The total sources of funds for each sector of the economy must equal the total uses of those funds.

The National Accounts and Deriving the Sectoral Balances Equation

The National Accounts separates the economy by expenditure. In conjunction with the flow of funds, we can derive two linear equations based on this information. The first equation expresses the sources of total spending of national income (GDP), while the second expresses the uses of national income (GDP). Let us construct the first equation.

GDP = C + I + G + (X – M)

The above linear equations states that the total sources of national income (GDP) is equal to consumption (C) plus investment (I) plus government spending (G) plus exports minus imports (X – M).

Let us now construct the second equation:

GDP = C + S + T

The above linear equation expresses the total uses of national income (GDP): consumption (C) savings (S) and taxation (T).

As we can see, both equations equal GDP (national income) and as we remember from the Flow of Funds Accounts section: The total sources of funds for each sector of the economy must equal the total uses of those funds.

Thus, we can express both outcomes as one equation:

C + I + G + (X – M) = C + S + T

Time for basic algebra. To derive the sectoral view, we then cancel like terms from both sides of the equation and in doing so, we derive:

I + G + (X – M) = S + T

The above expression now reveals the three sectors in the economy. Two sectors are not yet clarified by pairing, namely the government sector and the domestic private sector. To clarify, we can arrange the equation to derive:

(I – S) + (G – T) + (X – M) = 0

Where investment minus savings (I – S) is the domestic private balance, plus government spending minus taxation (G – T) which is the government balance, plus the external balance; exports minus imports (X – M). The three sectors when added together must equal zero, because the sum of all income must equal the sum of all the uses of income. Hence, the above equation is the Sectoral Balances equation. An unassailable fact: Somebody’s spending is somebody’s income. We understand now that the same applies across all three sectors of the economy.

In its current form, the Sectoral Balances equation does not clarify the federal government as the currency issuing authority which funds the other two sectors via the process of net spending (deficits). Again, we rearrange the equation and can express the Sectoral Balances as:

(G – T) = (S – I) – (X – M)

The above linear equation states that government spending (G) minus taxation (T) will equal savings (S) minus investment (I) minus exports (X) minus imports (M). In general terms, whatever the federal government spends minus taxation, that exact amount will be deposited in and distributed between the domestic private sector and the external sector as income. We can now aggregate the right side of the equation and define two sectors:

The government sector: (G – T)

The non-government sector: (S – I) – (X – M)

Defining Federal Budget Deficits

The relationship between a currency issuing government and both the domestic private sector and the external sector, aggregated as the non-government sector, is now clear:

The federal government issues the currency that the non-government sector uses.

In other words, the federal government is the source of US dollars, or more expansively, it is the manufacturer of currency and injects US dollars into the non-government sector via the process of deficit spending. We can express a federal budget deficit as:

(G – T > 0)

Where government spending (G) minus taxation (T) is greater than zero.

When the federal government deficit spends, it is injecting net financial assets (U.S. dollars) into the non-government sector and so, the result is income for the non-government sector. Within the framework of a modern monetary economy where the sovereign government issues the currency, there is no other means for the non-government sector to derive income in net financial assets, except through federal budget deficits, or more descriptively, through vertical transactions between the government and non-government sectors which result in the injection of net financial assets. Therefore, if the government sector is in deficit, the non-government sector will be in surplus. The implications are quite obvious. The operational result of a federal budget deficit of $1 trillion would be:

A $1 trillion federal deficit will equal, to the penny, a $1 trillion surplus for the non-government sector.

Defining Federal Budget Surpluses

In addition to the federal government being the currency issuing authority, it is also the taxing authority. When the federal government’s level of taxation is greater than that of its spending, the government’s fiscal position is one of surplus, which we can express as:

(G – T < 0) Where government spending (G) minus taxation (T) is less than zero. As a federal budget deficit injects net financial assets into the non-government sector, a federal budget surplus drains net financial assets from the non-government sector. In general terms, a federal surplus removes US dollars from the economy. When the federal government runs a budget surplus, it is draining net financial assets out of the non-government sector and so, the result is dissavings for the non-government sector. Thus, if the government sector is in surplus, the non-government sector will be in deficit. The operational sequence is clear. Government first spends, then it taxes. A surplus removes all current injections of currency by the federal government and then proceeds to extract the net savings of the non-government sector, resulting in a destruction of non-government sector wealth built up from previous deficits. The implications are quite obvious. The operational result of a $1 trillion federal budget surplus would be:

A $1 trillion federal surplus will equal, to the penny, a $1 trillion deficit for the non-government sector.

In the following section, we will examine how to determine the correct fiscal position a sovereign currency issuing government should assume. The Net Savings Desire of the Domestic Private Sector The domestic private sector possesses a desire to net save in US currency. The external sector can affect the flow of income both into and out of the domestic economy. The level of net savings varies and affects the level of aggregate demand. If the level of net saving is high enough to reduce aggregate demand sufficient to stall or reverse a condition of economic expansion, a critical non-government spending gap exists. At this point, (G) injections must be greater than the leakages arising from (T), to offset the domestic private sector’s desire to net save. Therefore, a federal budget deficit is required (G – T > 0). To understand why such a fiscal stance is desirable, we must consider the condition of the external sector (X – M).

The External Sector Consideration (X – M)

The financial position of the external sector, comprised of exports, which we define as (X) and imports defined as (M), is a determining factor for whether a federal budget surplus (G – T < 0) or deficit (G – T > 0) is desirable. If there exists a current account deficit (X – M < 0) where imports are increasing the outflow of US currency, the external sector cannot finance the private domestic sector’s desire to net save and thus, this determines whether or not the federal government should assume a fiscal position of a budget deficit or a surplus. A problem occurs when the federal government attempts to alter its fiscal position in a discretionary manner, without regard for external sector considerations, reflecting a need for the federal government to fund future spending and thus, a need to save in its own currency, which is an impossible condition for the federal government of the United States. At no time, can a sovereign currency issuing government save in its own currency, because all spending by that government is the creation and issuance of currency which is necessarily initiated prior to taxation. Furthermore, as to the financial standpoint, taxation functions operationally as a reserve maintenance procedure and not a mechanism for revenue when the currency is free-floating, non-convertible fiat, as is the case for the United States, the United Kingdom, Canada, Japan, Australia, et al. The condition (X – M > 0) is sufficient, provided that the size of the surplus is large enough to finance (S – I) desire to net save and exceed it. The determining factor being whether or not the inflow of currency is large enough to both support the private domestic sector’s desire to net save and also illicit economic growth. If the level of (X – M > 0) is sufficiently high, then a federal budget surplus (G – T < 0) is possible on the basis that a federal budget deficit (G – T > 0) would exceed the real ability of the economy to produce, resulting in an undesirable demand-pull inflationary episode.

The condition (X – M < 0) (current account deficit) clearly being insufficient to finance (S – I) as the outflow of the nation’s currency is greater than the inflow of the nation’s currency. Therefore, whenever a current account deficit coincides with a federal budget surplus (G – T < 0), the domestic private sector must be in a condition of deficit. It is clear that (G) injections must be greater than the leakages imposed by taxation (T), and so, the federal government’s budget stance must necessarily be one of deficit (G – T > 0). We therefore conclude that a federal budget surplus (G – T < 0) is an undesirable fiscal stance when (X – M < 0) as the drain of net financial assets from the non-government sector would result in a recession.

Which, finally, brings us to the sheer stupidity that is a balanced budget amendment.

Balanced Budget and Federal Balanced Budget Amendment Considerations (G – T = 0)

As we understand, from the sectoral balances view, the non-government’s position determines the appropriate fiscal position of the national government in a modern monetary economy as it relates to whether or not a federal deficit or surplus is desirable. .

Yet another problem occurs when the federal government seeks to balance its spending to equal that of taxation without any consideration for the condition of the external sector and when no real economic necessity is pressing the federal government to do so. A federal balanced budget manifests itself in the expression:

(G – T = 0) or (G = T)

Where government spending (G) minus taxation (T) is equal to zero and thus, the amount of net financial assets, or in more general terms, the amount of U.S. dollars added to the economy, equals zero. In such a condition, the federal government’s budget is balanced and thus, the non-government sector’s budget is also balanced. If (G = T) then clearly, there are no net financial asset savings accumulating in the non-government sector.

As (S – I) is spending exactly what it earns overall in a condition of balance, it must then seek some other avenue for financing, since the injection of needed net financial assets from the federal government is not possible when (G = T). Credit expansion, therefore, remains the only alternative at the onset of (G = T), and so, private debt dramatically rises to unstable levels. The oppressive regime of a federal balanced budget amendment would result in a depression, sustained until such time as the federal budget could exit balance and return to a proper fiscal position of deficit, enabling growth.

As we can now understand, a federal balanced budget amendment is never appropriate. The federal government must always be in a position to add net financial assets to the non-government sector to support economic growth as economic conditions warrant.

The condition of (G = T) balances the non-government sector’s budget and within the framework of a federal balanced budget amendment, which would initiate a permanent state of (G = T), private debt would expand dramatically when the amendment took effect until the domestic private sector could no longer absorb any further debt, resulting in a catastrophic spending collapse, plunging the economy into a deep, prolonged depression; an intolerable condition and so, a federal balanced budget amendment would constitute an act of “economic suicide” by the federal government.

So, all of you Balanced Budget Amendment true-believers need to repeat to yourselves one hundred times per day: I will not support the Economic Suicide Amendment.