Balance the Budget and Unbalance the Economy

You hear it all the time: "We've got to balance the budget." Everyone says it. Leaders in Washington, folks on the street, even the president himself has jumped on the bandwagon -- but why? Why is there such a universal belief that balancing the budget is a good thing? Those who say we need to do it rarely, if ever, say why. It's almost become a sort of rote expression. We repeat it reflexively. Not a single person has come out to say what sort of terrible thing is going to happen if we do not balance the budget.

That's because nothing bad would happen. Not a single thing. In fact, balancing the budget might be the thing we should fear most if history is any guide. Over the past 106 years, every major economic downturn has been preceded by a budget surplus or a sharply narrowing deficit. The numbers don't equivocate. From 1900 to 2006 there were 31 times that the budget was in surplus and 76 times that it was in deficit, yet U.S. GDP rose from $20 billion back then to $13.5 trillion today. That is a compounded annual growth rate of 6.28% despite the fact that most of the time we ran deficits. Not bad.

What's the big deal?
Why, then, all the screaming that we have to have a balanced budget? Persistent deficits over the course of our modern industrial history did not hinder us from becoming the wealthiest nation on earth. Moreover, if we grow anywhere near that fast over the next 20 or 30 years, all those worries about Social Security and Medicare will be moot.

What's amazing about this is that the data is there for everyone to see. You can get it from a variety of places, such as the Fed, the Office of Management and Budget, or private sources. It's not secret and it's pretty clear, once you look, that deficits have had absolutely no adverse impact on our economy. Indeed, the opposite has been true. Growth was far stronger in periods when we ran deficits (e.g., 1940-1944, 1960-1967, 1983-1989) then when we didn't and, as I mentioned earlier, surpluses or sharply narrowing deficits actually preceded major economic downturns in every case (1927-1929, 1973, 1997-2000).

Sometimes the deficits were truly gargantuan, not like the puny bit of red ink we have today. For example, in 1942 the deficit was 34% of GDP. That's a stark contrast to the deficit we have now, which is only 1.2% of GDP. The deficit was not only big during World War II, it swelled rapidly. From 1939 to 1943 the deficit grew 100-fold. Imagine if that happened now? It would mean the current deficit going from negative $170 billion to negative $17 trillion ... in just four years! Just the idea is unimaginable.

By the way, what effect did this huge ballooning of the deficit have on the U.S. economy? Did it cause inflation to spiral out of control? Did America go bankrupt? Nope. Growth surged to levels never seen before (or since).

True, there were some price controls in place and that kept overall inflation rates lower then where they otherwise would have been. However, most price controls were on strategic goods and commodities and that was to prevent profiteering during times of war. When the price controls were lifted after WWII was over there was a brief spike in inflation that quickly subsided. As for the budget, it went back to surplus and the economy went into recession.

Myths about interest rates
Some say that deficits cause interest rates to rise. That, too, is hogwash. From 1999 to 2003 the budget balance experienced nearly a $650 billion negative swing (from a $236 billion surplus to a $412 billion deficit), yet interest rates declined. The rate on the Treasury's benchmark 10-year note went from 6.28% in December 1999 to 4.80% now, and it was as low as 3.3% when the deficit was at $412 billion in 2003.

When Ronald Reagan ran the largest deficits in postwar history (and they are still the largest as a percentage of GDP), interest rates had already peaked and were on the decline. The big deficit years of 1982-1985 saw the yield on the 10-year note go from nearly 15% to around 9%. Rates continued to fall all through the 80s and 90s, eventually bottoming at 4.65% in 1998 when the budget balance went to surplus. Then guess what happened? Rates actually rose as the surplus increased.

All this is verifiable. It is an analysis based on fact. In contrast, those who casually and curtly say, "We must balance the budget," give us no reason why it must be done. There is no pointing to some negative consequence if it is not done, and if there is, then there is no thoughtful, cogent analysis of the facts to support that outcome.

From time to time the idea of a balanced budget amendment has been floated, but so far it has never come to pass. Thankfully. For if it were to happen, then the U.S. economy would look a lot different. Gone would be the days of strong growth and low unemployment. Instead, we'd have to get used to economic stagnation, sustained double-digit unemployment rates and a declining standard of living. So, if you thought a balanced budget amendment sounded like a good idea, think again. Next time we start having silly ideas like that as a nation, be part of an electorate that says, "No, not here! Leave that for the Europeans, thank you very much."

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Fool contributor Mike Norman is the founder and publisher of the Economic Contrarian Update and a Fox News business contributor. He is also a radio show host at BizRadio Network. The Fool has a disclosure policy.


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