Opinion: $9 Trillion Deficit? “Great News!”


OAKVILLE, Ontario (TheStreet.com) -- Stories abound regarding the projected addition of $9 trillion to the U.S. federal debt over the next decade after the White House and CBO updated their budget forecasts Tuesday.

If you listen closely, you can hear wailing, gnashing of teeth and the gentle whimpers of young children as the news is digested. Everywhere you turn, faces are drawn and heads bowed down as we struggle to come to grips with the horrific news and terrible implications of such massive government deficits.

I used to react to news of a deficit in a similar way, being a libertarian-leaning proponent of small government. How could one not be pessimistic when there seems to be no answer to the questions of "How can we pay for this?" and "Are we mortgaging our children's future?" Clearly, large government deficits are an unspeakable evil and bullishness in their face is naivety in the extreme.

Or not.

The funny thing about investing is that harsh reality so frequently gets in the way of elegant theory. To date, despite some eye-popping deficits in the past, there is no recorded instance of America's schoolchildren being forced to work in sweatshops merely to pay off the debts of their parents. And there has also been little discernible impact on the stock market from the size of the government's budget deficit.

Quite possibly, this is because the deficit doesn't actually exist, and, to the extent that it does, the bigger, the better, is my view. Lest you think I've adopted a less stringent standard than the yardarm having been crossed before commencing the day's imbibing, I shall explain my views, which remain consistent with my libertarian leanings.

I say the deficit doesn't exist because it is not a thing in and of itself, but merely the numerical difference between two other things that do exist -- government revenues and government expenditures.

Government revenues are largely determined by the run-rate of the economy and the taxation structure in place. They fluctuate quite a bit, given that the economy also fluctuates quite a bit.

Government expenditures are largely determined by a combination of Parkinson's Law, the chutzpah of the governing party and the degree to which the populace pays attention to the spending.

The first two factors are largely fixed (sadly), but the latter does vary. Every now and then, the water in the pot is turned up too quickly and the frog notices what is happening, causing a shift in the populace toward voicing opposition to spending plans and toward supporting politicians who mouth the platitudes of fiscal conservatism.

In the private sector, failed ideas and failed execution die their deserved deaths and capital is allocated to more productive uses. In the public sector, capital is generally allocated toward the solving of problems.

Failed ideas and execution leave the problem intact, if not expanded, and thus get allocated more capital. It is for this basic reason that I worry mostly about not whether there is an accounting difference between government revenues and government expenditures, but whether government expenditures are high and rising.

Increased government expenditures are bad and an economic negative. Whether a shortfall is dealt with through currency debasement, borrowing or taxation is more a question of "who" pays the burden than "if" it is paid. And it is paid, as it happens through inflation and relative wealth transfer, not by future generations.

So, why, then, do I like large government deficits? Because, although a deficit is not really a thing, it is currently perceived to be a thing by politicians, the media and the public. And, at extremely high levels, it is actually perceived to be a very, very bad thing. Once that happens -- once the water is heated to the right level -- it becomes politically untenable for a politician to be seen to be a proponent of increased government spending because that would lead to increasing "the deficit," and when the public isn't buying that, the politician doesn't want to be selling it.

Politicians of all stripes believe they can fix problems, generally by spending other people's money. Due to the inherent motivational flaws of the public sector, they spend money inefficiently, reducing the overall output of the economy below what it might otherwise be.

Only when the reported budget deficit is huge and perceived to be a large problem by the public is there any reining-in of the tendency to spend, spend, spend. The bigger the deficit, the greater the impact on the public consciousness and the lower the future spending.

Right now, we have a great, big honking deficit, and it is widely perceived to be so. That's great news! It will have a positive impact from here, lowering the trend line of public expenditures, possibly killing both cap-and-trade and health care reform on its own. Getting there might have been bad news, but that's in the past. Investing is about the future.

Huge deficits out "as far as the eye can see?" Music to my ears.

-- Written by Michael A. Lyons in Oakville, Ontario. Mr. Lyons is the chief investment officer and founder of Lyons Asset Management.

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