Quora Answer: In 2015, is the US Budget Deficit Good or Bad from an Economics Point of View?

The following is my answer to a Quora question: “In 2015, is the US budget deficit good or bad from an economics point of view?”

The US government defines the budget deficit as the amount by which the government’s total budget outlays exceeds its total receipts for a fiscal year.  In and of itself, it is neither good nor bad since it does not actually tells us much.  This is not even the total deficit, or public debt, since it does not include items such as Social Security, payroll taxation, and benefits.

As of this year, 2019, US government debt exceeded US$22 trillion.  Two-thirds is this debt is actually held by the public, the vast majority in the US.  The government owes this to buyers of Treasury bills, notes, and bonds.  These buyers are individuals, companies, and foreign governments.  The final third is intragovernmental debt.  The Treasury owes this to various departments holding Government Account securities.  The biggest creditors are Social Security, and other trust funds.  These trust funds, especially Social Security, have been running huge surpluses.  The federal government borrows from these surpluses to pay for other departments.  

As seen, a high US public debt in and off itself is also not a concern since much of the debt is actually owed internally.  Foreign holdings account for just over a third of public debt.  The US currency is the de facto reserve currency.  And as a going concern, there is negligible risk that the country is going to collapse and default anytime soon.  Unless there is a change in the world order, the US could simply print more money, and get away with it.

In the immediate term, the economy benefits from deficit spending, since it drives economic growth.  The federal government gets to pay for programmes it would ordinarily not afford.  This then feeds economic growth because it contracts out these programmes, and procures equipment and services.  This expands the GDP, and boosts the economy.  This looks like a good thing, and it should work.

The problem is that in the long term, this spending gravitates towards services and bloated sectors such as the military industrial complex.  The spending is inefficient in areas such as healthcare and education.  Most of that money is not used in infrastructure spending, which generates wealth over a long period, and helps the economy pay back that constantly accruing debt.  This works because the world market is such that the US dollar is the default currency for many transactions, such in the petroleum sector.  This is also helped by American domination of supranational organisations such as the IMF and the World Bank, directly or indirectly.  The problem with this is that as the dynamics of international relations change, there will be an eventual shift towards a truly multipolar world, a shift exacerbated by the current Trump administration’s belligerence.  Since 2015, that shift has become more distinct.

Also, from a purely economic perspective, as the debt-to-GDP ratio increases, the debt market will gradually demand a greater yield to consume more debt.  As the US government becomes more protectionist in trade, there is less incentive for governments such as China to buy Treasury bonds to balance their trade deficit.  This will put pressure on the market for an increased yield for future issues, and this will eventually slow down the economy.  Market sentiment works both ways.

This decreased demand for government bonds puts downward pressure on the dollar, since the dollar’s value is tied to the value of Treasury securities.  This means that as the dollar declines against major foreign currencies, foreign holders get paid back in a currency, the US dollar, that is worth less.  That further dampens demand.  This is a vicious cycle, and is unsustainable.

The US is already almost at the stage where it pays out an obscene amount just to service the interest on these securities.  As the economy gradually contracts, this becomes more and more difficult until we arrive at the point where market confidence collapses, and the country defaults.  That is the end of the US economy as we know it.  However, this may take decades.