Beware of deficit fetishism.
Last week we learned that the national debt is expected to rise by $9 trillion in 10 years — or $2 trillion more than the White House earlier figured. That’s not great news, but cleaning up the economic mess that President Barack Obama inherited from the Bush administration isn’t going to be cheap.
There are no easy options. When financial crises strike, economic growth declines and living standards drop, resulting in lower tax revenues and greater need for government assistance — all of which leads to higher fiscal imbalances.
What really matters is not the size of the deficit but how we’re spending our money. If we expand our debt in order to make high-return, productive investments, the economy can become stronger than if we slash expenditures.
There are other consequences, however, that we’re missing in the debate over all this red ink. Our budget deficit, as well as the Federal Reserve’s ballooning lending programs and other financial obligations, will accelerate a process already well underway — a changing role for the U.S. dollar in the global economy.
The domino effect is straightforward: Higher deficits spark market concerns over future inflation; concerns of inflation contribute to a weaker dollar; and both come together to undermine the greenback’s role as a reliable store of value around the world. Right now, with so much unused capacity in the American economy and so much unemployment — likely to persist for at least another year or two — the more pressing worry is deflation (a general decrease in prices), not inflation. But as the economy eventually recovers, the possibility of inflation will loom, and with forward-looking markets, worries about the future often play out in the present. Anxieties about future inflation can lead to a weaker dollar today.
So, are these anxieties justifiable? And what do they portend for the global financial system? The worries are justified, even though Fed Chairman Ben Bernanke, recently nominated for another four-year term, assures us that he will deftly manage monetary policy to keep the economy on an even kilter.
This is a tough balancing act — move too quickly or too vigorously, and you plunge the economy into another downturn; too slowly or too weakly, and inflation can be unleashed. Anyone looking at the Fed’s record in recent years will be skeptical of its forecasting skills and its ability to get the balance right.
Holding dollars today represents risk without reward: The returns to U.S. Treasury bills are near zero, and even those most confident in the Federal Reserve must acknowledge the chance that things will not go smoothly. For decades, other nations have held dollars in their central bank reserves, seeking to give confidence to their country and currency.
But in a globalized economy, why should the entire financial system depend on the vagaries of what happens in America? The current system is not only bad for the world, it is bad for the United States, too. In effect, as other countries hold more dollar reserves, we are exporting T-bills rather than automobiles, and exporting T-bills doesn’t create jobs. We used to offset this drag on the economy by running a fiscal deficit. But going forward, we won’t find it as easy to do this. And the Fed may not be able to do the trick — as we have learned, expansionary monetary policy poses its own risks.
Like it or not, out of the ashes of this debacle a new and more stable global reserve system is likely to emerge, and for the world as a whole, as well as for the United States, this would be a good thing.
It would lead to a more stable worldwide financial system and stronger global economic growth. The current system entails developing countries putting aside hundreds of billions of dollars a year — only weakening global demand and contributing to our economic difficulties.
The United States has resisted changes, but they will come regardless, and it’s better for us to participate in the construction of a new system than have it happen without us.
Joseph Stiglitz, the 2001 Nobel Prize winner in economics, is a professor of economics at Columbia University.
