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I Remain a Budget-Deficit Hawk

Here’s a letter to my friend Steve Conover:


Thanks for your thoughtful e-mail explaining why you believe that I and others who object to large and now-endless U.S. government budget deficits are wrong.

You correctly note that we Americans benefit enormously from the U.S. dollar being the global reserve currency. In return for ‘mere’ dollars – dollars that non-Americans willingly hold and use for international commercial purposes – we get from abroad lots of real goods and services. But you incorrectly give credit for this happy effect to Harry Dexter White’s ’victory’ over John Maynard Keynes at the 1944 Bretton Woods conference.

While it’s true that White was perhaps instrumental in formalizing the dollar’s post-WWII role as global reserve currency, people worldwide continue to accept the dollar in this role only because of its relative stability combined with the size, openness, and dynamism of the American economy. If the dollar were to be ravaged by inflation and the U.S. economy became stagnant relative to that of some other large country, global investors and business people would stop using the dollar as a reserve currency. This reality is is one reason why I cannot share your calmness about massive U.S. government indebtedness.

Unless the government defaults (which would bring its own obvious calamities), it must repay its debts. And unless its ability to repay its debts with newly created money is unlimited, this repayment will either be done in a way that devalues the dollar or that requires the government to marshal more real goods and services from American taxpayers to be transferred as payments to bondholders.

If the government were to default or to run high rates of inflation, there would be a global flight from the dollar (which of course would only further accelerate inflation). American living standards would suffer greatly as the dollar’s purchasing power falls and global investors flee the U.S.

If, instead, the government actually repays, it must ultimately transfer to bondholders real goods and services produced with scarce American resources and labor.

While I agree that there’s nothing inherently wrong with government borrowing, the core problem is that this borrowing enables today’s citizens-taxpayers to consume real goods and services the bill for which is handed to future citizens-taxpayers. This ability to spend other people’s money leads today’s citizens-taxpayers to spend excessively and imprudently – a fact that does not disappear just because interest rates are low or even zero. One result of this irresponsible government borrowing is massive resource waste which reduces economic growth. And this latter, baneful consequence remains real even if the U.S. government somehow manages for decades to run up the real value of its indebtedness.