By William K. Black
October 24, 2016 Quito, Ecuador
Pete Peterson is back, and his message and rhetoric are always the same. The federal budget deficit is a disaster and – any day now – will produce massive inflation. Peterson has written his 20,000th version of this fantasy in the NYT with Paul Volcker. The first rhetorical game that Peterson plays is to assert that it is bad for a sovereign nation to run budgetary deficits because they are not “sound and sustainable.” Except that the U.S. has run deficits for most of its existence without ever suffering hyper-inflation. For a nation like the U.S. with a sovereign currency, a federal budgetary deficit is not unsound and it is not unsustainable. Federal budget deficits can, depending on the circumstances, be the very definition of “sound” fiscal policy – a policy that is often essential for “sustainable” recovery and growth of the economy.
Peterson asserts that his latest warning of fiscal disaster might, for the first time in his career be correct. Peterson claims that this time his warnings are real because the “widely respected” Congressional Budget Office (CBO) says its model predicts a growing deficit. The CBO is not “widely respected” by economists. It uses macroeconomic models that produce nonsense results. Economists know that the CBO models cannot predict reality because they were constructed out of ideological nostrums that have repeatedly been proven false by reality. The CBO has gotten credit in the past from Democrats because it declined to use even more flawed “dynamic scoring” models favored by many Republicans that falsely predict that tax cuts lead to magical, spectacular growth.
The ultra-right-wing Republicans that control Congress chose an ultra-right-wing fanatic to run the CBO who has a track record of being spectacularly wrong. He is the opposite of “widely respected.” Even before his appointment, the CBO functioned as a barrier to the vigorous stimulus policies that we have known for over a half-century to be essential to respond to a Great Recession. The result was a much slower and weaker recovery.
The financial markets price the risk of Peterson’s repeatedly promised, imminent hyper-inflation. They price that purported risk as essentially zero. Japan is praying for exceptionally low inflation (it suffers from deflation) despite budget deficits roughly three times larger than Peterson is warning about.
The Grandchild Guilt Gambit (G3)
Peterson knows he cannot win the economic argument because he is zero for 20,000 in his predictions of hyper-inflation in the United States. Instead, his second rhetorical game is to infuse parents with guilt about the fate of our grandchildren. Here is one problem with the G3 – and it comes from Peterson’s own attempt to induce grandkid guilt. Peterson warns that:
[T]he national debt [will be] about 75 percent of the gross domestic product, a ratio not seen since 1950, after the budget ballooned during World War II.
Why Peterson Does Not Discuss the Great Depression or World War II Deficits
The reasons why Peterson did not analyze either the Great Depression or World War II deficits is that studying either would destroy his G3 myth. The grandkids of the economists and bankers who advised running budget surpluses during the Great Depression had their lives brutally diminished by that economic malpractice. Further, they did not escape budget deficits because attempts to run a budget surplus made the Great Depression far worse and added to the deficit.
Peterson did not discuss the World War II deficits because they falsify his arguments to an even greater extent. The U.S. ran very high, in historical terms, budget deficits in World War II. Further, inflation was likely to be more of a problem than in peacetime because critical real resources (labor and material) were in fact desperately short to support the unbelievable production levels of material for the war effort. Women played a vital role in this success, reducing greatly what would have been devastating bottlenecks. FDR’s generation of officials chose to run massive deficits in order to fight and win World War II. It was the grandkids of FDR’s generation who fought World War II. A journalist famously labeled them our Greatest Generation.
Should we have surrendered to Germany and Japan instead, rather than face the terrible fate of nations that run budget deficits? Would surrender have been preferable for our grandkids? Did those budget deficits in the 1940s and 1950s crush our economic growth in those years? The result of the war time expenditures was such a sharp increase in demand due to vastly increased government spending that the economy quickly recovered and operated at levels far above what conventional economists would have considered “full employment” without generating harmful levels of inflation.
But even more importantly, the deficits were essential to win the war against the Axis. That was superb for the grandkids.
To help win the war, the U.S. adopted price controls – and put John Kenneth Galbraith in charge – the ultimate nightmare of neoclassical economic ideologues. What they will never forgive Galbraith for was his contribution to the success of the war effort through a program that was anathema to their dogmas. More generally, planning proved essential and effective in developing the arsenal of democracy and in operations such as D-Day, causing von Mises and von Hayek to gnash their teeth. The Soviet Union was able, with substantial aid from the U.S., but overwhelmingly from its own troops and resources, to develop what many consider the world’s best main battle tank (the T34) and to inflict the decisive losses on the Nazis.
During the few years where FDR actually adopted significant stimulus the economy recovered rapidly from the Great Depression. Government programs brought hope and jobs to millions of Americans, reduced malnutrition, and developed tens of thousands of public gems we continue to enjoy 80 years later.
After the war, President Truman created the Marshall Program that was critical to the economic and democratic revival of much of Europe. A Republican President, Eisenhower, led the U.S. to fund a stupendous infrastructure program, the interstate highway system, that transformed the Nation. The GI bill began the process of making university educations for their children the normal aspiration of middle class parents for the first time in our history. Scientists at U.S. universities, many of them immigrants, dominated the Nobel Prizes in science and medicine.
Instead of harming their grandkids, the huge budget deficits devised by their grandads and great-great-grandads during World War II were critical to their grandkids’ lives and accomplishments.
- The grandkids were harmed when Hoover and FDR tried to run budget surpluses and instead made the Great Recession far more severe and led to unintentional deficits.
- The grandkids’ lives were helped immeasurably when FDR deliberately ran budget deficits and provided social programs during the Great Depression.
- The grandkids’ lives were helped immeasurably when the deficit spending during World War II rocketed the economy to full recovery from the Great Depression.
- The grandkids’ lives (and the lives of hundreds of millions of people globally) were helped immeasurably because we spent vast amounts of money to defeat the Axis powers. Had the Axis forces won the results would have been horrific. Yes, it was the sacrifice of blood by the grandkids that made this possible, but they could not have gone to Europe and Asia to shed their blood without the U.S. government providing the financing.
- Hundreds of thousands of the grandkids’ lives and limbs were saved during the war because the U.S. funded such vast amounts of men, material (much of it given to Allies), and intelligence. Without that vast funding of resources our service members would have gone into battle in situations where they would have lost or prevailed only through catastrophic levels of injury and death.
Peterson ignores the brilliant successes made possible by the large federal budget deficits during World War II because they would falsify his G3 myth by proving the opposite.
A Brief Historical Note on Federal Deficits in the 1930s-1950s
As Brad DeLong explained in his 1998 article on fiscal policy in the shadow of the Great Depression, the Hoover and Roosevelt administrations sought to run “balanced budgets” in response to the Great Depression, but a severe depression dramatically reduces tax revenues and produces involuntary budget deficits. FDR went through three stages on his approach to fiscal policy as I explain briefly below.
DeLong was writing during a period when he was hostile to government deficits, so his article is congenial to Peterson at a number of points. DeLong explains that President Hoover heaped scorn on his own economic team as a group of do-nothings who thought the Great Depression was a healing storm that would “liquidate” economic poisons such as unions. Hoover’s economic advisors told him not to act. Hoover believed that it was vital for him to act to combat the Great Depression – by trying to run a budget surplus! Hoover asked Congress to approve a raft of new taxes. Hoover’s economic malpractice was a double failure – it deepened the Great Depression and failed to even come close to balancing the budget. Hoover was enraged that the Federal Reserve refused to deliberately produce serious deflation. Had the Fed done so, it would have materially worsened the Great Depression.
FDR was, by instinct, a great believer in austerity. He campaigned against Hoover’s “failure” to balance the budget. FDR’s early efforts to balance the budget were doomed for the same reason that Hoover’s efforts were doomed. Eventually, as DeLong put it, the Roosevelt administration decided to make a virtue out of necessity and stress the benefits of government spending to the recovery.
Once FDR embraced fiscal stimulus the recovery from the Great Depression became robust. Unfortunately, Treasury Secretary Morgenthau, who detested budget deficits, convinced FDR to reverse course and inflict austerity in 1937. Austerity did not balance the budget because it crushed the recovery and hurled the economy back into an acute phase of the Great Depression.
The economists’ malpractice in the 1930s did not simply fail to protect the grandkids – it brought economic terror to the parents, kids, and grandkids. G3 has always been cynical propaganda that produces disastrous austerity policies whose principal victims are our kids and grandkids.
Indeed, it was the malpractice of austerity that helped produce World War II by bankrupting Germany and discrediting its democratic leaders. John Maynard Keynes famously warned that such economic malpractice would lead to economic ruin and enrage the German people. The grandkids of those European leaders who inflicted ruin on Germany were the ones who died by the tens of millions in World War II. It is common for those who share Peterson’s dogmas that purport to be protecting our grandchildren to be the ones savaging our grandchildren. Peterson is another in a long line of pretended protectors of our grandkids who actually advance economically illiterate policies that prey on our grandkids.
When Should We Run a Budget Surplus?
There are times when we should run a budget surplus, but they are unusual times for an economy like the U.S. with a sovereign currency that is very likely to continue to run substantial balance of trade deficits. We could achieve an economy running so “hot” that many millions of Americans who dropped out of the labor force reentered and employers were looking so aggressively for scarce workers or scarce resources such as rare minerals that prices for such workers and rare minerals rose sharply. Alternatively, demand could so outpace supply that the general price level rose sharply and produced harmful levels of inflation. Running a budget surplus could be an excellent idea shortly before either condition arose. None of those conditions is true in the U.S. today as we can see every day by observing the data for inflation, federal interest rates, and labor force participation rates.
The circumstances in which a Nation like the U.S. that has a sovereign currency, borrows solely in that currency, and allows the value of its currency to freely “float” needs to “balance” a budget or run a budget surplus are historically rare. As we have seen from the horrific errors of the 1930s under Presidents Hoover and Roosevelt, the grotesque pattern of economic malpractice in the eurozone of inflicting austerity in response to a Great Recession, and the slowing U.S. recovery once Obama and the Republicans began to inflict austerity, it is critical for everyone’s welfare, particularly our kids and grandkids, not to inflict austerity except when it is really needed.
Even extremely conservative central bankers now admit that modest inflation is desirable. The U.S. and the eurozone have failed to provide sufficient demand to achieve even the Fed and ECB’s modest inflation targets. Moderate inflation, in nations with functional governments, does not lead to hyper-inflation. Moderate inflation does not cause significant harm to an economy. We should have been so lucky to have experienced moderate inflation in the last ten years, it would have meant a superior economic environment. But the same is not true of disinflation (negative inflation rates). Even modest deflation poses a material, albeit far from inevitable, risk of pushing an economy into a long-term recession or locking it into a long period of weak growth.
Economists now broadly recognize that the problems of disinflation versus inflation are not symmetrical and it is essential to adopt macroeconomic approaches that put far greater weight on avoiding modest disinflation than modest inflation. This means we can and should err on the side of not inflicting austerity for the purpose of preventing inflation that has not even become modest.
This also means that the third major rhetorical gambit that Peterson launched is false. Peterson claims it is an “immutable” fact that delaying inflicting austerity always makes life “more painful and difficult.”
Delaying action now will make the needed changes only more painful and difficult later on, while also increasing the risk of financial crisis before the reforms are even made.
Austerity, when inflation is already too low, when many millions have dropped out of the labor markets, when there are no real resource constraints to stimulus, and interest rates are often negative is a dogmatic act of economic malpractice. The deficit was brought down too far and too fast by President Obama and the Republicans’ embrace of austerity, slowing the recovery. Peterson’s proposal to inflict still more damaging austerity on our kids and grandkids poses a serious risk of forcing our economy into recession.
Delaying running a balanced federal budget or a fiscal surplus has long proven to be desirable in U.S. history. Trying to run budget surpluses is highly associated throughout U.S. history with producing economic crises, not preventing them. Trying to run a surplus, as Presidents Hoover and Roosevelt discovered, often failed because it exacerbates the economic downturn and increases the deficit over the course of the business cycle.
Peterson is a direct ideological inheritor of the economists of the 1930 and 1940s. That generation of economists convinced presidents Hoover and Roosevelt to commit what was economic malpractice even in the 1930s, but Peterson’s failure to learn from reality puts him into a special category of malpractice.
Peterson is a Wall Street billionaire. He has admitted that his dream is to privatize Social Security. Privatization would mean Wall Street obtaining hundreds of billions of dollars in fees administering private savings schemes that would put our retirements at serious risk. His op ed calls on us to support Wall Street’s goal of unravelling the safety net by making what he euphemistically refers to as unspecified “adjustments” to reduce Social Security benefits.