Unfortunately Chait misses two important points. First, Keynes’s argument for why his view of fiscal policy need not mean a larger government ignores the incentives facing the politicians who must implement it. Those incentives would lead to a larger government. Second, Keynes called for the socialization of investment as part of a broader vision of how to prevent the crises that necessitate stimulus spending in the first place. The result of both arguments is larger government. Thus Chait’s claim about Keynes just ain’t so.

Chait rightly notes that while Keynes argued that deficit spending was necessary as a stimulus during recessions, he also argued that governments should run surpluses in good times to pay off the debt. Chait concludes: “This policy is perfectly compatible with any level of government and does not require higher aggregate levels of debt than maintaining a regular balanced budget.”

Indeed, in theory it is compatible, but the problem is that the theory does not comport with reality. Keynesian ideas have ruled fiscal policy for at least 50 years, fewer than five of which had budget surpluses. During this time the debt has gone up to more than $14 trillion and the size of government has expanded enormously. Surely the economy was not in recession all but those few years. Apparently Keynesian policy is not compatible with any level of government and does seem to necessitate higher levels of aggregate debt.

What Chait overlooks is that regardless of what Keynes believed government should do, what it in fact will do is another matter. As James Buchanan and Richard Wagner argued in their classic critique of Keynesian fiscal policy, Democracy in Deficit, by removing the preexisting moral and institutional constraints on deficit spending as a way to balance the economy, Keynes and the Keynesians unleashed the perverse incentives of the political process into policymaking. The problem with Keynes’s analysis is that he paid no attention to the real incentives facing politicians, who now had the green light to deficit-spend in the name of economic stability.

Buchanan and Wagner argued that vote-seeking politicians will always prefer spending to taxing because the former gets them votes and the latter does not. As long as there are no institutional or moral impediments to this (such as a balanced budget amendment or a deeply held norm against deficit spending, except during wartime), politicians will always take deficits over surpluses, especially when economists such as Keynes have given them theoretical support. The result is that rather than the offsetting surpluses Chait focuses on, politicians continue to deficit-spend even during periods of economic growth because none wish to raise taxes or cut the flow of government benefits to their prospective voters. The result is exactly what Buchanan and Wagner predicted in 1977: large and increasing deficits and debt, and a growing danger of higher levels of inflation to pay it off.

In addition it’s worth observing that government stimulus spending simply does not work. Part of the Keynesian story is that deficit-financed spending will end recessions and generate the growth that will lead to the later surpluses to pay off the deficits. But what if stimulus spending doesn’t generate growth, or even prolongs or deepens recessions? In that case deficits beget deficits, debt begets debt, and government grows out of control. When Chait wrote in May unemployment was about 9 percent three and a half years after the recession started and around two years after it officially ended. As I write this two months afterward unemployment is unchanged. Massive stimulus spending is not just the path to larger government but also to permanently low rates of growth, which will only worsen the deficit and debt.

What Not To Do

In his article Chait also claims that defenders of Hayek cannot tell us what should be done when an economy is stuck in a recession. That’s an unfair charge. First, Hayekians can tell us what not to do: engage in large-scale stimulus spending, for the reasons noted. Second, Hayekians do have positive advice: Government should get out of the way so entrepreneurs and others who have a better idea of what to do can try things and see if they work. Chait claims it’s a cop-out for Hayekians to criticize Keynesian solutions for relying on government without specifying what the alternative is. The Hayekian perspective is that neither Hayekians nor Keynesians know what to do. That’s why we have market competition, which in Hayek’s words is a “discovery procedure” that helps us figure out how to revive a moribund economy.

Finally, Chait overlooks the broader context of Keynes’s fiscal policy recommendations. These were really only stop-gap measures rather than a long-term solution to what Keynes saw as the chronic tendency of capitalist economies to fall into recession. In his view there would never be enough profitable investment opportunities to match the public’s saving. So he proposed a fix for this oversaving/underconsumption problem. That fix was the socialization of investment through the State.

In trying to argue that there’s nothing in Keynes to suggest larger government, Chait is correct, but only if he’s referring to “fiscal policy” in its narrowest sense and ignoring the political incentives discussed above. But Keynes’s fiscal policy analysis was part of a larger story of the instability of capitalism, which requires that government play a more prominent role in allocating money for investment to avoid future recessions. This element of fiscal policy clearly calls for a bigger government.

The claim that Keynesianism doesn’t necessarily imply bigger government and greater debt is shown to be mistaken when we consider the implications of Keynes’s argument for countercyclical fiscal policy, the record of Keynesian policy in the last 50 years, and the broader context of his views on fiscal policy in The General Theory.

The U.S. government has defaulted at least twice before: once in 1933 when it reneged on redemption of gold certificates and in 1971 when it stopped redeeming dollars for gold.

One certainty is that the outcome of this debate will have a lot to do with the course of the U.S. economy and the global status of the dollar. The bottom line is that a continued increase in America’s government debt, aided by a higher debt ceiling, will lead to more quantitative easing (QE). And that the monetary pumping associated with QE will almost certainly lead to a nasty bout of consumer price inflation that will sweep the globe.

Overpaying for Assets

Central bankers use QE as a scheme to prop up deteriorating asset prices by overpaying for them. In the United States an initial round (QE1) pumped in new money to support the prices of so-called toxic assets; this was followed by QE2, which aimed principally to support Treasury bonds.

While the primary goal of QE was to offset deflation, it also supported an unprecedented spending binge by the U.S. government. Despite claims of independence, the Fed shifted from being “lender of last resort” for the U.S. financial sector to become the “buyer of first resort” for government debt. Fed purchases have amounted to 85 percent of all U.S. government debt sold by the Treasury since QE2 began in November 2010.

This means that the Federal Reserve monetized about half the federal budget deficit for FY2011 with QE2 and reinvestment returns from asset purchases of QE1.

While raising the debt ceiling may avert a conventional notion of default on U.S. government debt, it will only work if the Fed steps up when historical buyers for Treasuries shun dollar-based debt.  And that will require more quantitative easing and interest rates kept artificially near zero – which will build more instability into the U.S. economy and beyond.

Ignorance or Disregard?

Arguments for QE reveal either fundamental misunderstanding or wanton disregard for the impact of monetary policy on the real economy in the United States and elsewhere. It starts with central bankers primarily focusing on how monetary policy impacts price levels, usually measured by consumer price indices (CPIs). If consumer prices rise within a “targeted” range, there is no reason to alter monetary policy.

Based on low reported rates of increase in consumer prices, the Fed refuses to budge from an unprecedented growth of money and credit with historically low interest rates. Nor is it in a hurry to stop ramping up asset prices  or propping up real estate prices.

An inflated money supply finds its way into the economy in other ways. These include higher commodity prices, rising bond prices, a weakened currency, or a distortion in production from changes in relative prices.

Consider the nature of supposedly benign changes in the CPI, which almost certainly understate the impact of excess liquidity from the Fed’s expansionary monetary policy. Technological progress and China’s depressive effect on product prices should have caused a deflationary trend in consumer prices.  Even a zero rate of increase implies that that they have actually been rising. To be sure, however, the Fed’s payment of interest to banks on idle reserves since 2008 has muted CPI increases, no matter how it is measured.

Dollar Down

As the Fed purchases Treasury bonds or other such assets, it creates new dollars that tend to undermine the currency’s foreign exchange value. Indeed, the dollar is more than 9 percent lower against a broad basket of currencies than it was a year ago, the lowest point since 2008 and down more than 40 percent against the same basket over six years. Federal Reserve data indicate that when adjusted for inflation, the dollar is at its lowest value against major trading partners’ currencies since it began fluctuating in January 1973.

The impact of the glut of global liquidity from QE and artificially cheap credit has also pushed up asset and commodity prices. In April, gold and silver set records due to hedging against a weakening dollar, with the price of gold up by 32 percent in the past year and the silver price more than doubling.

Other financial assets are bubbling up. After the initial announcement for QE2 of $1.5 trillion of purchases of government debt in August 2010, investors moved towards riskier investments, leading to a rally in corporate bonds. Since then Standard & Poor’s 500 stock index gained 28 percent, and prices of generally riskier shares listed on the small-company Russell 2000 Index went up 41 percent. Even subprime mortgage securities are back in demand!

Given that many polls show that a majority of Americans oppose any increase in the debt limit, it would be a smart political move not to raise it. But more important, it would be a wise economic move to decrease federal spending since it will lead to significant improvement in economic activity by removing the impetus for more QE. And the end of QE will lead to a stronger dollar, an improved balance sheet for the federal government, and less uncertainty about future price increases.

One thing they all want us to believe is that a default on government debt is unthinkable. Hence the game of chicken now being played. With an August deadline looming, each side seems to believe that the others will either give in or compromise in a major way rather than see the government unable to pay its creditors.

In the end they might patch something together in time and pass a new debt limit with token spending cuts and even some “revenue enhancement.” It will be presented to the public as a grand statesman-like compromise, and the sober voices that emanate from the New York and Washington Post will praise the “grownups” who finally prevailed and averted catastrophe.

Big Con

It will be one big con on the public. At best the “statesmen” will have kicked the can up the road, leaving it for others to grapple with in the not-too-distant future. But those others will likely be no better able to solve the problem than their predecessors.

Does that mean default is in the U.S. government’s future? Economist Jeffrey Rogers Hummel, San Jose State University, thinks so. He writes in “Why Default on U.S. Treasuries Is Likely”:

Almost everyone is aware that federal government spending in the United States is scheduled to skyrocket, primarily because of Social Security, Medicare, and Medicaid. Recent “stimulus” packages have accelerated the process. Only the naively optimistic actually believe that politicians will fully resolve this looming fiscal crisis with some judicious combination of tax hikes and program cuts. Many predict that, instead, the government will inflate its way out of this future bind, using Federal Reserve monetary expansion to fill the shortfall between outlays and receipts. But I believe, in contrast, that it is far more likely that the United States will be driven to an outright default on Treasury securities, openly reneging on the interest due on its formal debt and probably repudiating part of the principal. [Emphasis added.]

Whether this would be good or bad is beside the point. (Let’s not forget that taxation – fiscal force — is how governments usually pay their debts.) Hummel makes a persuasive case that the powers that be will decide that default is the best of the available alternatives.

Other Alternatives

The other potential alternatives are inflation, taxation, and spending reductions. None, Hummel writes, will save the day. As he wrote in The Freeman, inflation, because of fractional-reserve banking and other factors, has long stopped providing substantial cash benefits – seigniorage — to the State.

Outside of America’s two hyperinflations (during the Revolution and under the Confederacy during the Civil War), seigniorage in this country peaked during the Civil War under the Union, when it covered about 15 percent of the war’s cost. By World War II seigniorage was financing only a little over 6 percent of government outlays, which amounted to about 3 percent of gross domestic product (GDP). During the Great Inflation of the 1970s seigniorage was below 2 percent of federal expenditures, or less than half a percent of GDP.

Monetizing the debt through inflation theoretically would reduce its real value, but what about in practice? Hummel notes that in the 1970s, the federal government did make some money that way, but the inflation was unexpected.  However,

investors are much savvier these days. Globalization, with the corresponding relaxation of exchange controls in all major countries, allows them easily to flee to foreign currencies, with the result that changes in central-bank policy are almost immediately priced by exchange rates and interest rates. Add to this the ability to purchase from many governments securities that are indexed to inflation, and it becomes highly unlikely that investors will be caught off guard by anything less than sudden, catastrophic hyperinflation (defined as more than 50 percent per month) — and maybe even not then.

So much for inflation as a way out of the debt crisis. This doesn’t mean there will be no inflation whatever. There might be lots of it but, Hummel says, it won’t obviate default.

Structural Limit

What about taxes? No good. Aside from the libertarian objections to raising taxes, there is the fact, as Hummel points out, that “federal revenue … has bumped up against 20 percent of GDP for well over half a century”:

That is quite an astonishing statistic when you think about all the changes in the tax code over the intervening years. Tax rates go up, tax rates go down, and the total bite out of the economy remains relatively constant. This suggests that 20 percent is some kind of structural-political limit for federal taxes in the United States….  [F]ederal tax revenue at the height of World War II never quite reached 24 percent of GDP. That represents the all-time high in U.S. history, should even the 20-percent-of-GDP post-war barrier prove breachable.

Well, can’t the politicians cut their way out of the debt? Not likely: “[P]ublic-choice dynamics tell us that politicians have almost no incentive to rein in Social Security, Medicare, and Medicaid.” Polls show that even self-described tea partiers oppose cuts in those programs. “[A]fter more than forty years of subsidized health care in the United States, how likely is it that the public will put up with severe rationing or that the politicians will attempt to impose it?” Hummel asks.

Another big budget item is “national security” (not to be confused with defense), which all told comes to about a trillion dollars a year, according to Robert Higgs’s calculations. The potential for cuts is great there, but what are the chances? Powerful interests make fortunes off that budget and the endless wars it funds — and that spending is easily protected by stigmatizing cutters as “weak on national security.” It’s an old story.

So spending is going nowhere but up. But with the structural limit on revenues already noted, that only means a growing debt. When interest rates rise, as sooner or later they will, the government will face higher interest payments – and even more debt.

“Still unconvinced that the Treasury will default?” Hummel asks.

Declaring “broke” a “hollow cry,” the Times says that recent statements to the contrary by prominent Republicans are false:

It’s all obfuscating nonsense, of course, a scare tactic employed for political ends. A country with a deficit is not necessarily any more “broke” than a family with a mortgage or a college loan. And states have to balance their budgets. Though it may disappoint many conservatives, there will be no federal or state bankruptcies.

The problem, the Times says, is that government does not tax people enough, nor does it spend enough money.

Filmmaker Moore recently agrees He told protesters in Madison, Wisconsin, that the only problem is that taxes on wealthy people are too low:

America is not broke…. Wisconsin is not broke. The only thing that’s broke is the moral compass of the rulers.

Moore added that America is “awash in wealth and cash” and all that is needed to put the economy back on track is for the government to seize additional property from Americans who make more than he deems “moral.” (Note that Moore, a millionaire many times over through movies that trash capitalism, does not offer to give all his wealth to the needy.)

I suppose that both Moore and the Times are correct that if the government were to seize most or all of Americans’ cash and property holdings, the federal budget most likely could be balanced. For now.

The problem here is obvious on its face. If people had all their earnings confiscated by the State, they would no longer be willing to work and the government then would have nothing or almost nothing to tax in the future.

Borrowing to Pay Debts

There also is a huge problem with the Times’ mortgage analogy. The Treasury is borrowing money to make payments on previously borrowed money. If I were paying for my groceries with a credit card and borrowing money to make my mortgage payments, and it was clear my projected income over many years would not cover my expenses, that would be the very definition of “broke.”

No doubt the Times editors and Moore would counter that the government can ramp up tax rates and also create money to pay its bills (unlike you and me since the law forbids us to steal and counterfeit). But by forcing up taxes government would consume even more wealth produced by private individuals, and creating new money to pay its bills is a fraud that steals purchasing power from the rest of us.

I suspect these things are lost on the Times and Moore, who declared that wealth is “a national resource” to be confiscated by the State.

The wealth Americans produce does not come from a bottomless well, and it is clear that the current fiscal crisis is not due to government’s undertaxing the people. Rather the crisis exists because government spends too much, while taxation, regulatory, and monetary policy prevent economic recovery.

Any entity that has to borrow money to stay afloat because long-term income prospects are dismal is broke. True, government can temporarily hide the crisis by more borrowing and inflating, but in the end the bankruptcy cannot and will not be hidden.

Just contemplate some of the numbers. The total federal debt is nearly $13 trillion, $8.6 trillion of which is held by the public, with the rest held by government entities. (These are conservative estimates, since many government obligations are not counted.) GDP is something over $14 trillion. That ratio of debt to GDP isn’t pretty. “The CBO estimates that at the end of 2020 publicly held debt will be a staggering $20.3 trillion—90 percent of GDP—with total debt being notably higher than that,” Horwitz writes.

As for the budget deficit, the Congressional Budget Office projects it to exceed a trillion dollars this year and next, bringing it into the neighborhood of 10 percent of GDP. This comes on top of a 2009 deficit of $1.88 trillion—the government spent a buck-ninety for every dollar it collected. The deficit is projected to fall in the years following 2011, before resuming its growth in 2015 and beyond. By 2018 it will be back over $1 trillion, assuming these estimates are not wildly optimistic. Remember, ObamaCare has not kicked in yet.

According to the CBO, the Obama administration will create $9.75 trillion in deficits over the next decade.

Compare this with Greece: Its accumulated debt is 113 percent of GDP, and its budget deficit last year was 12.7 percent of GDP. Greece needed to sell bonds to obtain the money to pay debts come due, but lenders were too nervous to lend the money at rates the Greek government can handle. So Greece needed a bailout in the form of cheaper loans from the European Union and International Monetary Fund (a.k.a. American taxpayers), conditioned on budget austerity (spending cuts and tax increases), which in turn incited violent street demonstrations by government employees, who have benefited from high deficit spending for years.

The Need for Cuts

If we want to avoid the Greek experience, which could spread to other EU countries in the future, the U.S. fiscal house will have to be put in order. Contrary to what the policy elite is thinking, this does not mean raising taxes, which would impede economic activity and make conditions worse.

So if the deficit is to be eliminated it will have to be through dramatic budget cutting. In the current fiscal year the federal government is planning to spend $3.55 trillion. Among the largest categories of spending are Social Security (19.63 percent); unemployment/welfare/other “mandatory” spending (16.13 percent); Medicare (12.79 percent); Medicaid and the State Children’s Health Insurance Program (8.19 percent); and interest on the national debt (4.63 percent).

Of course I’ve left out a category, but deficit hawks often ignore it: the Department of Defense. It comes in at 18.74 percent of the budget, or $663.7 billion. (More about this number below.) For some context, the 2009 Pentagon budget was almost as much as the rest of the world’s military spending combined.

For fiscal 2011 President Obama has asked Congress to appropriate $719 billion for the Pentagon, a 4.5 percent increase over the current year. But as Robert Higgs points out, “few appreciate that the total amount of all defense-related spending greatly exceeds the amount budgeted for the Department of Defense.”

Writing about the 2009 Defense Department budget of $636.5 billion, Higgs states: “Lodged elsewhere in the budget, however, other lines identify funding that serves defense purposes just as surely as—sometimes even more surely than—the money allocated to the Department of Defense. On occasion, commentators take note of some of these additional defense-related budget items, such as the Department of Energy’s nuclear-weapons program, but many such items, including some extremely large ones, remain generally unrecognized.”

Those other items include the departments of Homeland Security and Veterans Affairs, and programs within the Energy, Justice, and State departments. Higgs also calculated the share of the interest on the debt attributable to past Pentagon spending: “Adding this interest component to the previous all-agency total, the grand total comes to $1,027.8 billion, which is 61.5 percent greater than the Pentagon’s outlays alone.”

The grand total will be well above a trillion dollars in the current fiscal year also.

Guns and Gravy

“Owing to the financial debacle and the ongoing recession,” Higgs sums up, “millions are out of work, millions are losing their homes, and private earnings remain well below their previous peak, but in the military-industrial complex, the gravy train speeds along the track faster and faster.”

It’s no mystery why so much is spent on the military. The U.S. government maintains close to a thousand military bases around the world and is engaging in two foreign occupations, not to mention less formal campaigns in Pakistan and elsewhere, including covert operations that never make the papers. Intervention has gone on at least since World War II. This costs money. The Iraq and Afghan occupations consume over $12 billion a month. USA Today reported recently that the Pentagon had spent $620 billion on the Iraq invasion and occupation and more than $190 billion on the operation in Afghanistan, America’s longest military adventure ever. Other estimates last summer were higher, as much as $300 billion for Afghanistan, according to U.S. News and World Report. Last summer, more spending was approved in Congress. It’s safe to say the combined price tag is over $1 trillion.

The fiscal question is whether, in the face of the huge national debt and multiyear trillion-dollar budget deficits, we can afford a “defense” establishment more befitting an empire than a republic. That’s not the only question, however. We must also ask if a society that claims to value free enterprise can long endure the economic disfigurement that inevitably accompanies a large military-industrial complex, as President Eisenhower warned of as he left office.

Small-government men from Richard Cobden to William Graham Sumner to Robert Taft would have said no, as does their political heir, Ron Paul, today. As for whether slashing military spending would deny us needed protection, one could as well ask whether we are safe today with policies that risk “blowback,” bankruptcy, and monetary disarray.

One cannot help but conclude that James Madison had it right:

“Of all the enemies to public liberty war is, perhaps, the most to be dreaded, because it comprises and develops the germ of every other. War is the parent of armies; from these proceed debts and taxes; and armies, and debts, and taxes are the known instruments for bringing the many under the domination of the few. . . . No nation could preserve its freedom in the midst of continual warfare.”

If this all seems too amazing to be true, you are on the right track. It’s obviously not the whole story. In fact, major taxes were simply left out of the account.

Most egregiously, Social Security “contributions” were treated as insurance payments not taxes. (This is improper since the government does not think of Social Security as insurance; no citizen has contractual rights in the matter.) BEA also left out state sales taxes. Inclusion of these additional taxes pushes the total tax burden to over 20 percent, which is quite a bit more than 9.2 percent. Federal, state, and local tax receipts added up to $3.3 trillion in 2009, 27.5 percent of personal income, as Kevin Drum of Mother Jones points out.

But that is not the largest problem with the BEA estimate.

Last year’s Recovery and Reinvestment Act (the “stimulus”) included tax credits that temporarily reduced the amount of money Americans pay in taxes. However, spending increased by over $500 billion, and this has been financed by record deficits. The deficit for 2009 was $1.6 trillion, and the one for 2010 is projected at $1.88 trillion. Deficits are deferred taxation. Taxpayers will pay interest on the additional debt the Obama administration has run up until we pay off the principal. The claim that the tax burden has fallen is, to say the least, disingenuous. Increased government spending is being financed in a way that will make its true burden apparent only at some later date.

Further difficulties arise with the BEA estimate of the tax burden when you recognize that business taxes ultimately get passed on to some group of consumers.

Real Resource Costs

Moreover, this account fails to include government’s real resource costs. The true costs of the State include not only money taxed and spent on resources, but the effects of increased regulation. In economic terms regulation is de facto taxation. There is no economic difference between the State controlling resources through tax-financed spending and its taking effective control of resources by regulation. There was already heavy regulation of American industry before Barack Obama entered office, and regulation has increased since then. (The cost of all regulation was estimated to have exceeded $600 billion in the 1990s.) The Omnibus Land Management Act of 2009 added over two million acres to the National Wilderness Preservation System. The Fraud Enforcement and Recovery Act and the Credit Card Accountability Act increased regulation over banking. We must also add in the takeover of GM by the Treasury, leaving out the part that went to the UAW.

More to Come

Obama’s policies will increase taxes even more in the future. So-called health care reform will result in heavier explicit and implicit taxes. High rates of taxation and regulation correlate with slower economic growth. Increased government borrowing deprives private investors of capital for projects. Since government borrowing crowds out private investment, deficits amount to a tax on future economic growth in private industry. Of course, Obama expects the Recovery and Reinvestment Act to propel America’s economy forward but his expectations are wholly unwarranted. Government has an extremely poor track record of investing money productively. One need only look at the record of countries like Sweden and West Germany after World War II to see how taxes stunt economic growth. They grew rapidly when they had low effective tax rates. Then expansion of the tax burden in the 1960s and 1970s corresponded with slower economic growth. The Swedes enjoyed improved economic performance during the 1990s but only after tax and welfare reform lessened the load.

The BEA staff itself estimates that the tax burden was 30.2 percent of national income in 2009 (as opposed to personal income). Taxes were 23.8 percent of national income during Truman’s presidency. Summing up all the aforementioned figures on spending and regulation leads to the conclusion that the real economic burden of government in America is over 50 percent, and rising.

The BEA is playing statistical games. In real economic terms the costs of spending and regulation have gone up substantially since Obama entered office. Worse still, Americans can expect to bear even higher burdens in the future. Concern over rising taxes is justified not merely because taxes are actually higher, but because higher taxes mean less prosperity and less freedom. Increased federal spending and regulation constitute real and unnecessary burdens for the American public. These burdens can and should be reduced. It might first, however, be necessary to educate more Americans as to the true nature of taxation.

Just contemplate some of the numbers. The total federal debt is nearly $13 trillion, $8.6 trillion of which is held by the public (with the rest held by government entities). (These are conservative estimates, since many government obligations are not counted.) GDP is something over $14 trillion. That ratio of debt to GDP isn’t pretty. “The CBO estimates that at the end of 2020 publicly held debt will be a staggering $20.3 trillion — 90 percent of GDP — with total debt being notably higher than that,” Horwitz writes.

As for the budget deficit, the Congressional Budget Office projects it to exceed a trillion dollars this year and next, bringing it into the neighborhood of 10 percent of GDP. This comes on top of a 2009 deficit of $1.4 trillion — the government spent a buck-ninety for every dollar it collected. The deficit is projected to fall in the years following 2011, before resuming its growth in 2015 and beyond. By 2018 it will be back over $1 trillion, assuming these estimates are not wildly optimistic. Remember, ObamaCare has not kicked in yet.

According to the CBO, the Obama administration will create $9.75 trillion in deficits over the next decade.

Compare with Greece: Its accumulated debt is 113 percent of GDP, and its budget deficit last year was 12.7 percent of GDP. Greece needed to sell bonds to obtain the money to pay debts come due, but lenders were too nervous to lend the money at rates the Greek government can handle. So Greece needed a bailout in the form of cheaper loans from the European Union and International Monetary Fund ( a k a American taxpayers), conditioned on budget austerity (spending cuts and tax increases), which in turn incited violent street demonstrations by government employees, who have benefited from high deficit spending for years.

If we want to avoid the Greek experience, which could spread to other EU countries in the future, the U.S. fiscal house will have to be put in order. Contrary to what the policy elite is thinking, this does not mean raising taxes, which would impede economic activity and make conditions worse.

So if the deficit is to be eliminated it will have to be through dramatic budget cutting. In the current fiscal year the federal government is planning to spend $3.55 trillion. Among the largest categories of spending are Social Security (19.63 percent); unemployment/welfare/other “mandatory” spending (16.13 percent); Medicare (12.79 percent); Medicaid and the State Children’s Health Insurance Program (8.19 percent); and interest on the national debt (4.63 percent).

Of course I’ve left out a category, but it’s one often ignored by deficit hawks: the Department of Defense. It comes in at 18.74 percent of the budget, or $663.7 billion. (More about this number  below.)  For some context, the 2009 Pentagon budget was almost as much as the rest of the world’s military spending combined.

More than a Trillion

For fiscal 2011 President Obama has asked Congress to appropriate $719 billion for the Pentagon, a 4.5 percent increase over  the current year. But as Robert Higgs points out, “few appreciate that the total amount of all defense-related spending greatly exceeds the amount budgeted for the Department of Defense.”

Writing about the 2009 Defense Department budget of $636.5 billion, Higgs states: “Lodged elsewhere in the budget, however, other lines identify funding that serves defense purposes just as surely as—sometimes even more surely than—the money allocated to the Department of Defense. On occasion, commentators take note of some of these additional defense-related budget items, such as the Department of Energy’s nuclear-weapons program, but many such items, including some extremely large ones, remain generally unrecognized.”

Those other items include the departments of Homeland Security and Veterans Affairs, and programs within the Energy, Justice, and State departments. Higgs also calculated the share of the interest on the debt attributable to past Pentagon spending: “Adding this interest component to the previous all-agency total, the grand total comes to $1,027.8 billion, which is 61.5 percent greater than the Pentagon’s outlays alone.”

The grand total will be well above a trillion dollars in the current fiscal year also.

“Owing to the financial debacle and the ongoing recession,” Higgs sums up, “millions are out of work, millions are losing their homes, and private earnings remain well below their previous peak, but in the military-industrial complex, the gravy train speeds along the track faster and faster.”

Worldwide Presence

It’s no mystery why so much is spent on the military. The U.S. government maintains close to a thousand military bases around the world and is engaging in two foreign occupations, not to mention less formal campaigns in Pakistan and elsewhere, including covert operations that never make the papers. This costs money. The Iraq and Afghan occupations consume over $12 billion a month. USA Today reports that the Pentagon has spent $620 billion on the Iraq invasion and occupation and more than $190 billion on the operation in Afghanistan, America’s longest military adventure ever. Other estimates are higher, as much as $300 billion for Afghanistan, according to U.S. News and World Report. More spending has just been approved in Congress.

The fiscal question is whether, in the face of the huge national debt and multiyear trillion-dollar budget deficits, we can afford a “defense” establishment more befitting an empire than a republic. That’s not the only question, however. We must also ask if a society that claims to value free enterprise can long endure the economic disfigurement that inevitably accompanies a large military-industrial complex?

Small-government men from Richard Cobden to William Graham Sumner to Robert Taft would have said no, as does their political heir, Ron Paul, today. As for whether slashing military spending would deny us needed protection, one could as well ask whether we are safe today with policies that risk “blowback,” bankruptcy, and monetary disarray.

One cannot help but conclude that James Madison had it right:

Of all the enemies to public liberty war is, perhaps, the most to be dreaded, because it comprises and develops the germ of every other. War is the parent of armies; from these proceed debts and taxes; and armies, and debts, and taxes are the known instruments for bringing the many under the domination of the few…. No nation could preserve its freedom in the midst of continual warfare.

But this didn’t prevent President Obama from urging the assembled government heads to expand government spending — in order to create jobs and economic growth, of course.

In other words, spend more now, reduce the deficits later.

We shouldn’t expect the emergence of sound economies  — or even coherent statements — until the politicians drop their presumptuous belief that they can produce prosperity.

First I think we have to agree that a discretionary spending freeze would be a step in the right direction. If Obama follows through on this promise we should be willing to pat him on the back, “good job old chap!” and maybe even buy him a beer. Yes I know that it would only apply to 17% of the economy and that the entitlements, which are really sinking the ship, are left untouched, but I’m trying to be positive. After all, it isn’t every day that someone as ideological as Barack Obama steps back from the brink of radicalism.

But these are bizarre times in which definitions of words like “job creation” and “spending freeze” are not always clear and could be hiding something sinister. So we have to ask: What is a spending freeze anyway?

It’s a law being passed that forbids the increase in funding for any discretionary program, right? Except no report I see says anything about the spending freeze being statutory. “President Barack Obama intends to propose a three-year freeze in spending … ” says the Wall Street Journal. According to the USA Today the freeze will be part of the yet unreleased budget. But isn’t the budget supposed to be the thing being frozen, so it’s a little unclear (a) how a budget freezes itself and (b) why you would need one if it could.

Things become clearer (and yet foggier) if you read the WSJ article closely. A spending freeze, if not statutory, should at least mean the spending is held down across the board, right. Regardless of the perceived value of the program? Otherwise, you aren’t freezing the budget, you’re just freezing the programs you don’t like, which should happen every year anyway right?

But in the WSJ article we have this little nugget:

The administration officials said the cap won’t be imposed across the board. Some areas would see cuts while others, including education and investments related to job creation, would realize increases.

So a non-statutory (and probably non-binding) freeze isn’t even an across the board cap. It’s merely a pledge to prioritize spending, which should be done every year, but clearly is not.

So it appears, at least according to the press reports, that Obama is offering the American public a non-statutory, non-binding promise to cut a few programs to pay for the expansion of other programs, but overall saving the taxpayer “10 to 15 billion” in 2011 which is just about 0.7 percent of the projected Federal Budget Deficit in 2010.

Is that Hope and Change you can believe in or what?

Neither the government nor anyone else can spend future dollars. In reality all current spending must come from current revenues and can use only existing resources. Every dollar the government spends, even if borrowed, has to come out of some existing person’s pocket and therefore preempts the use of that dollar somewhere else in the economy—not in the future, but here and now.

The government can obtain its borrowed money by selling Treasury bonds to either American citizens or foreigners. If it borrows from domestic sources, it is getting money that Americans would have either invested somewhere in the economy or spent on goods and services. Government borrowing simply diverts the cash from other uses, just as if its spending were financed by taxation. Economists call this the “crowding out effect.” 

A typical response is that most of the government borrowing will be from foreigners and that the Obama deficit won’t crowd out economic activity in the United States. Thus we are said to be mortgaging our children’s future to people in other countries. The first thing to notice is that we can’t know who the bondholders will be in the future when the loans come due. Treasuries are sold and resold many times over. This is also true of debt originally issued to Americans. 

The real problem has nothing to do with who holds the note at the time of repayment. A good economist asks what else these foreigners would be doing with their dollars. Because they are lending dollars, as opposed to euros or yen, this money would ultimately be either spent on American goods, thereby increasing exports, or invested in the U.S. economy. We reach the same conclusion regardless of who lends the government the money. The real costs of government spending, no matter how it is financed, are experienced here and now.

Government Spending Always Competes with Private Spending

Also, regardless of where the money comes from—taxation, borrowing, or printing press—government spending always preempts other spending in the economy. Those who get the borrowed money have purchasing power transferred to them that will increase the demand for the resources they use. That will increase the cost of those resources to other buyers. Government spending thus always competes with private-sector spending for scarce resources and preempts growth.

This is not to argue that deficit spending is the same as tax-financed spending. It is not. Deficit spending creates the occasion for coercive wealth transfers from future taxpayers to future government bondholders. When the bills come due, most of our children and grandchildren will have part of their incomes coercively transferred through higher taxes to those who hold the Treasury notes. Government debt makes our children less free.

Furthermore, deficit spending obfuscates the true cost of government, not only in lost liberty but also in lost productivity and wealth. Deficit spending is dishonest because it leads people to believe they are getting something for nothing while in reality their wealth is diminished just as if the spending were covered by taxation. But that cost is not seen in the tax bill. This is why politicians find deficit spending so appealing. It is a tool for pulling the wool over citizens’ eyes while rewarding special-interest groups and expanding the state’s control over the private sector.

Ultimately, the real choice is not between deficit-financed and tax-financed spending. The moral question is whether we should have more spending and bigger government with less liberty or less spending with a smaller government and more liberty. The hand-wringing on the left and right about passing the cost of “stimulating” our economy onto future generations is misplaced. No matter how it’s financed, Obama’s new spending has the potential to stimulate only one thing: the size, scope, and power of government.