Noted economist James K. Galbraith has penned an article in The Nation entitled “In Defense of Deficits.” I’m going to admit my bias up front; I read Galbraith in my college econ classes, and I never thought he made much sense. So I’m hardly objective, but really, who is?
Anyway, as you can expect from the son of John Galbraith (one of the 20th century’s leading interventionist Keynesian economists), he talks about how government spending is necessary to cure economic ills and how deficits aren’t a problem at all. But unlike others who take the position that the U.S.’s debt load is manageable because of its small size relative to its GDP, he boldly states that any debt load is manageable provided the holder controls the currency in which the debt is denominated!
It’s an audacious claim, and I encourage you to read the article, but I believe that everything Galbraith claims flows from a fundamentally flawed assumption that he articulates early on:
To put things crudely, there are two ways to get the increase in total spending that we call “economic growth.” One way is for government to spend. The other is for banks to lend. Leaving aside short-term adjustments like increased net exports or financial innovation, that’s basically all there is. Governments and banks are the two entities with the power to create something from nothing.
Galbraith is of course right about governments and banks being the only entities legally permitted to create money, but there’s an implicit assumption in his claim that they are the sole drivers of economic growth: that wealth generation itself is the process of creating something from nothing. Galbraith is backing the idea that the total amount of wealth is fixed, so true economic growth occurs only when money is somehow miraculously pulled out of thin air, by either wily bankers or instead hitting the government printing press.
It doesn’t take a genius to see how wrong-headed this is. In the 1600s, it was commonly believed that supply of wealth was finite and constrained by the amount of gold present on planet Earth. But by the 1850s, crude oil had been discovered to have a use after all and was a fantastic new source of wealth; 100 years later, nuclear plants permitted entire nations to be powered by a few small facilities, and today, we can harness the renewable power of the sun, the wind, and the tides to create wealth. We are constantly discovering new resources that were previously considered useless, and more efficiently using the resources available to us. The notion that wealth is a finite quantity that everybody must scrabble and fight over entirely discounts human curiosity, ingenuity, and inventiveness.
This is how wealth is generated; not fraudulently when bankers or treasury officials play the part of the magician, but instead when ingenious humans discover how to make better use of the tools and resources all around them.
It’s easy enough to demolish most of Galbraith’s more complicated points once this critical distinction has been established, as they all rest upon his flawed assumption. But there’s one bit he just throws out there that literally stunned me when I read it:
Nor is public debt a burden on future generations. It does not have to be repaid, and in practice it will never be repaid.
If this is true, then how can Galbraith explain why creditors lend money to governments they apparently know full well will never pay them back? This is a mystery he makes a feeble effort to explain by claiming that China buys U.S. treasury bonds in exchange for the U.S. importing cheap Chinese goods, but this completely discounts the most basic arguments of supply and demand. The U.S. is a fertile export market because Americans desire cheap goods, not because politicos made backroom deals to dump bonds in exchange for subsidized imports or some other nonsense. A quick trip to Wal-Mart will confirm the demand easily enough.
Moreover, if the debt will never be repaid and lenders can somehow be expected not to revolt over this state of affairs, what’s to stop it from growing indefinitely? Galbraith claims that a government with control over own currency never faces the risk of default because it can simply print more of it. One wonders if he remembers Germany after World War I, which followed his exact prescription, producing disastrous inflation. Galbraith’s icon Keynes himself in fact decried this strategy in his his 1920 book The Economic Consequences of the Peace.
Galbraith continues to explain that Social Security and Medicare therefore cannot go broke because by definition, as they are funded by an infinite pot of borrowed or printed money, and he goes to great lengths to explain why this makes their stability guaranteed. But if we take his assertions at face value–that these programs are made safe by the bottomlessness of their sources of funding–why then are they funded by taxes at all? If the government and banks can conjure money from thin air safely and indefinitely, why not do it? As Galbraith even says at one point, “Your family needs income in order to pay its debts. Your government does not.” If the government requires no income, then what explains national taxes on income, payrolls, goods, corporations, and investments, to name a few? Why does the government bother taxing the money of its citizens at all if it can just as easily print or borrow it forever? Needless to say, this is another unanswered question.
And this guy is a well-respected economist? It boggles the mind.