Wednesday, February 15, 2023

Yes, Uncle Sam Can Now Run $1+ Trillion Deficits Forever

Click here to read the original Cautious Optimism Facebook post with comments

5 MIN READ - The Cautious Optimism Correspondent for Economic Affairs and Other Egghead Stuff regrets to inform CO Nation that $1+ trillion federal deficits are now sustainable—forever.

The Economics Correspondent by no means endorses this trickery method of financing the federal government and is only demonstrating the sinister power of economic growth plus a little inflation for maintaining the national debt.

Yes, the U.S. economy has reached a point where even $1+ trillion deficits are sustainable indefinitely. And policymakers know it.


To explain, here are a few facts and assumptions.


-The current federal debt is $31.5 trillion

-US nominal GDP is $26.1 trillion

-Therefore, the current debt-to-GDP ratio is 120.7%


-Going forward the Federal Reserve System produces an average annual inflation rate of 2.5%

-Going forward the U. S. economy averages 2.5% real GDP growth, except…

-Every eight years a recession interrupts that growth. We’ll assume after two or three quarters of negative growth and another five or six quarters of subpar growth the two-year interruption averages GDP growth of just 0.5%. Meaning…

-Over the 10-year cycle real GDP growth is lowered to an average of just 2.1%.

(anyone who wants to double-check the math can verify at the end of the article)

Therefore, if the federal government runs a $1 trillion deficit every year for the next decade the federal debt will grow from $31.5 trillion to $41.5 trillion.

Unthinkable. Right? A disaster. Right?

But over the next decade real GDP will grow at an annualized compounded rate of 2.1% per year. Therefore real GDP will grow from $26.1 trillion to $32.12 trillion.

And most importantly, atop real GDP growth the Federal Reserve will drive up prices with an average inflation rate of 2.5%. Therefore GDP will grow from a real $32.12 trillion to a nominal $41.1 trillion.

Hence in ten years, with a national debt of $41.5 trillion and nominal GDP of $41.1 trillion, the debt-to-GDP ratio will be just 101% or a decline of 19 percentage points.

Yes, running ten straight years of $1 trillion deficits and never balancing the budget the debt-to-GDP ratio will actually fall.

The math is unrelenting. The federal government can actually run even higher deficits - $1.81 trillion for the next decade - and the debt-to-GDP ratio will remain unchanged at 120.7%.

And if the official inflation numbers are understated and prices are actually rising faster than the government says, well... that's better for the politicians because nominal GDP (and by extension the IRS's tax collections) rise even faster.

That’s the dark magic of growth plus inflation. Governments, particularly central banks, treasury departments, and finance ministries, are well aware of how the math works and have been playing this game for nearly a century.


Actually the growth part is not so bad. It’s honest, it’s hard work, and everyone benefits from more stuff.

The inflation part? Not so much.

Yes, the sleight of hand is successful because holders of U.S. dollars are silently drained of 2.5% of their money’s value year after year—the proceeds being a gift quietly transferred to the federal government by watering down the real value of its past debts.

As if direct taxation wasn’t tribute enough to Washington, DC.

If we stretch our horizon out to twenty years, maintaining the same assumptions, the federal deficit will increase to $51.5 trillion, but thanks to growth and inflation nominal GDP will be $64.8 trillion.

The debt-to-GDP ratio will have fallen yet again, this time to 79.5%.

Which is why Congress and future presidents won’t stop at $1 trillion deficits. They know that over time they can borrow more and more. Soon it will be $1.5 trillion deficits. Within some of our lifetimes the Treasury will be consistently borrowing $2 trillion a year or more, never balancing a budget and never running a surplus, yet maintaining a manageable debt-to-GDP ratio.

And if their appetites grow too large and they borrow so much that the debt-to GDP ratio starts to get worrisomely high? No problem, the Fed can have a few “accident” years where inflation hits 6% or 7%--like 2022—and the debt-to-GDP ratio will be cut back down to size.

Just the inflation of the 1970’s alone watered the dollar down to 38 cents from 1971 to 1983. The Federal Reserve said “Oh we’re sorry, but we’ve learned our lesson” while the federal government’s debt-to-GDP ratio was reduced by 62%--from 35% of GDP to 11% (not including new deficits).

And holders of U.S. dollars got to foot the bill.


This sleight of hand has been practiced by western governments going back to at least World War II. They all went off their domestic gold standards during the Great Depression, giving their central banks a great deal more room to inflate the money supply.

America’s national debt in 1945 was $260 billion or 120% of GDP, both astronomical figures at the time, the result of massive borrowing for World War II.

Not to worry. By 1980 it was reduced to 30%.

But not by paying down debt. The federal debt had actually grown by 1980 to $860 billion, over triple its size in 1945.

But through the magic of growth and especially inflation the original $260 billion was no longer so much money anymore. Thank you holders of devalued dollars!

And boy were they devalued. The Federal Reserve went off the last vestiges of the gold standard in 1971—gold redemption for international central banks—and there was no longer any limit as to how much inflation the Fed could create.

It’s no surprise that in the 51 years since 1971 prices have risen 623% (if you trust government statistics) and the dollar’s purchasing power has declined to 13.8 cents.

Even in Ronald Reagan’s day, when the federal debt reached $2 trillion, the number was unimaginable. People said “$2 trillion? We’ll NEVER pay that off!”

They were more right than they knew. The federal government already knew that with growth and inflation there was no need to pay it off. Because today a $2 trillion debt is also nothing—a mere 7.7% of GDP—thanks to growth plus inflation.

Presidents who enter office determined to balance the budget and do something about the national debt are quickly educated by the Treasury Secretary that growth and inflation will always be there to bail out the government, so there’s no need to tighten any belts.

And the moment the first budget standoff with Congress happens, the first time partisan fingerpointing begins, the moment a government shutdown looms, all sides agree: “Hey, why are we fighting? Let’s just borrow another trillion dollars and future generations will pay it off with growth and inflation. And the best part is most of them won’t even realize they’re paying.”

For those who want to check the compounded percentage math

1) $1 trillion deficits

-2.1% real GDP growth over ten years = 1.021^10 = 1.231 = 23.1% growth
-Eight years of 2.5% GDP growth + two years of 0.5% GDP growth = 1.025^8 x 1.005^2 = 1.231
-(1.231^(1/10) = 1.021 = 2.1% annualized GDP growth)
-2.5% inflation growth over ten years = 1.025^10 = 1.280 = 28.0% price increase
-$31.5 trillion debt + ten years of $1 trillion deficits = $41.5 trillion
-$26.1 trillion nominal GDP plus ten years 2.1 % GDP growth and ten years 2.5% inflation = 26.1 x 1.231 x 1.280 = $41.1 trillion
-New debt-to-GDP ratio = $41.5 trillion/$41.1 trillion = 101%

2) $1.8 trillion deficits

-Current debt-to-GDP ratio = 120.7%
-$31.5 trillion debt + ten years of $1.81 trillion = $49.6 trillion
-$26.1 trillion nominal GDP plus ten years 2.1 % GDP growth and ten years 2.5% inflation = 26.1 x 1.231 x 1.280 = $41.1 trillion
-New debt-to-GDP ratio = $49.6 trillion/$41.1 trillion = 120.7% (unchanged from today)

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