Paul Krugman has done it again. This time, he is up in arms claiming that the American people do not know that the federal budget deficit has declined. His clear implication is that the deficit is no longer a problem to be considered. The truth, however, is far from what Krugman describes.
To give Krugman his due, let's first acknowledge that the deficit has indeed shrunk this year compared to last. This is for three main reasons. First, Fannie Mae and Freddie Mac, those two quasi-federal companies that soaked up hundreds of billions since 2009 to cover their huge losses, have finally started to earn back some of those losses as the mortgage markets have reversed the ongoing trend. As a result, these two began to pay back a small portion (about 80 billion dollars) of the debt they owe the federal government. Second, the spending limits forced through by the Republicans in the Summer of 2011 have stayed in place despite constant pressure from president Obama and the Democrats to raise spending. Third, the automatic cuts of sequestration have also kicked in. Overall federal spending is about 200 billion dollars less than it would otherwise have been because the GOP insisted on addressing the problem of the deficit.
That being said, the deficit is still a huge problem. The USA this year -- after all these cuts -- will still have the largest budget deficit in history except for the crazy mega-deficits of the previous four years. To make matters worse, the Federal Reserve continues to monetize the debt. In other words, the Federal Reserve is essentially printing more dollars to cover the deficit.
Let's consider what the Fed is doing. You probably have heard of what is called "Quantitative Easing". It is a fancy word for pumping out new dollars to cover the debt. Each month the Fed buys 85 billion dollars of Treasury debt. This is an annual total of 1.02 trillion dollars spent on obligations of the federal government. That means that on a net basis, the federal government does not have to borrow any money; it just spends the excess dollars printed by the Federal Reserve. This conduct by the Fed is going to be a disaster some day soon. Indeed, many years ago, Congress actually passed a law that specifically bars the Fed from doing this, but like so many other things in Washington these days, that law was ignored. The law says that the Fed cannot buy Treasury securities to cover the federal deficit. To get around this law, the Fed only buys from third parties rather than the Treasury. Think about that. Suppose there were a law that convicted felons out on parole cannot buy guns from gun vendors. Then suppose that a bunch of murderers find a retired school teacher to go and buy forty assault rifles and then resell them to the murderers. That is the same logic that the Fed uses in Quantitative Easing.
One of the funny side effects of Quantitative Easing is that it is currently causing a major increase in the budget deficit. The Fed now owns trillions and trillions of federal bonds and notes. As interest rates rise (they are up about one percent in the last few months), the value of the Fed's holdings is dropping like a stone. The Fed's portfolio probably sank by a quarter of a trillion dollars. And this drop will soon get added to the budget deficit.
The long term economic effects of the Quantitative Easing are the subject for another post. Suffice to say that they are not good. For present purposes, though, what you need to know is that contrary to what Krugman writes, the federal budget deficit is a major problem that cannot be ignored.
To give Krugman his due, let's first acknowledge that the deficit has indeed shrunk this year compared to last. This is for three main reasons. First, Fannie Mae and Freddie Mac, those two quasi-federal companies that soaked up hundreds of billions since 2009 to cover their huge losses, have finally started to earn back some of those losses as the mortgage markets have reversed the ongoing trend. As a result, these two began to pay back a small portion (about 80 billion dollars) of the debt they owe the federal government. Second, the spending limits forced through by the Republicans in the Summer of 2011 have stayed in place despite constant pressure from president Obama and the Democrats to raise spending. Third, the automatic cuts of sequestration have also kicked in. Overall federal spending is about 200 billion dollars less than it would otherwise have been because the GOP insisted on addressing the problem of the deficit.
That being said, the deficit is still a huge problem. The USA this year -- after all these cuts -- will still have the largest budget deficit in history except for the crazy mega-deficits of the previous four years. To make matters worse, the Federal Reserve continues to monetize the debt. In other words, the Federal Reserve is essentially printing more dollars to cover the deficit.
Let's consider what the Fed is doing. You probably have heard of what is called "Quantitative Easing". It is a fancy word for pumping out new dollars to cover the debt. Each month the Fed buys 85 billion dollars of Treasury debt. This is an annual total of 1.02 trillion dollars spent on obligations of the federal government. That means that on a net basis, the federal government does not have to borrow any money; it just spends the excess dollars printed by the Federal Reserve. This conduct by the Fed is going to be a disaster some day soon. Indeed, many years ago, Congress actually passed a law that specifically bars the Fed from doing this, but like so many other things in Washington these days, that law was ignored. The law says that the Fed cannot buy Treasury securities to cover the federal deficit. To get around this law, the Fed only buys from third parties rather than the Treasury. Think about that. Suppose there were a law that convicted felons out on parole cannot buy guns from gun vendors. Then suppose that a bunch of murderers find a retired school teacher to go and buy forty assault rifles and then resell them to the murderers. That is the same logic that the Fed uses in Quantitative Easing.
One of the funny side effects of Quantitative Easing is that it is currently causing a major increase in the budget deficit. The Fed now owns trillions and trillions of federal bonds and notes. As interest rates rise (they are up about one percent in the last few months), the value of the Fed's holdings is dropping like a stone. The Fed's portfolio probably sank by a quarter of a trillion dollars. And this drop will soon get added to the budget deficit.
The long term economic effects of the Quantitative Easing are the subject for another post. Suffice to say that they are not good. For present purposes, though, what you need to know is that contrary to what Krugman writes, the federal budget deficit is a major problem that cannot be ignored.
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