Budget deficits are an enormous can of worms if open for inspection, especially, now days with more heterodox theories, such as Modern Monetary Theory (MMT) influencing policy makers not to tame budget deficits. The argument of MMT is that because modern governments control their own currencies, they can never “run out of money.” (However, the qualifier is as long as said government controls a reserved currency)
Notwithstanding, the effect of deficits and money printing to pay bills has had many national economies collapsed from excessive leveraging. The collapse of Germany in 1930’s is a well-documented case that led to World War ll. In the 1960s, Lyndon Johnson refused to raise taxes to pay for the Vietnam War and his Great Society, when the private sector economy was booming. The result was reflected on rising inflation in the 1970s, which resulted in the election of Ronald Reagan.
To simplify Godley’s theories, modern economics considers two major sectors: the private sector and the public or government sector. “When the government spends more than it taxes, it runs a deficit. And that deficit in the public sector inevitably means a surplus for the private sector.” Basically, the private sector does the work required to achieve the government development goals, for instance if the government pays $100 for work and then taxes back $90, it leaves $10 in the private sector’s hands which results in the government running a deficit or spending more than it receives back in taxes. But the private sector has $10 it didn’t have before.” The theory continues that In order to accumulate money, the private sector needs a government deficit that runs in two cycles. Writers refer to a temporary deficit as a deficit that is related to the business or economic cycle, which, is the period of time it takes for an economy to move from expansion to contraction to expansion and so on. This cycle can last for several months or many years, and it follows an unpredictable random pattern.
The overall government budget balance is determined by the sum of the cyclical deficit and the structural deficit. Therefore, a cyclical surplus could mask an underlying structural deficit, as the overall budget may appear to be in surplus if the cyclical surplus is greater than the structural deficit. Australia was a case in point when its structural deficit was caused by a mining boom leading to extremely high revenues and large surpluses for several consecutive years, which the “Howard Government used to fuel spending and tax cuts, rather than saving or investing them to cover future cyclical downturns.”
Nevertheless, the economic consensus is that a structural or permanent deficit is not the same as a cyclical deficit in that it exists regardless of the point in the business cycle due to an underlying imbalance in government revenues and expenditures as is presently the case in the US economy. It follows that even at the apex of the business cycle when revenues are high the country’s economy may still be in deficit. Thus, the total budget deficit is equal to the sum of the structural deficit and the cyclical deficit.
Keynesian economics, dictates that when the government changes the levels of taxation and government spending, in order to influences aggregate demand and the level of economic activity. Changes in the level and composition of taxation and government spending can affect macroeconomic variables that are managed by fiscal and monetary policy.
Fiscal policy deals with taxation and government spending and is often under an executive governed by laws of a legislative branch of government, whereas, monetary policy determines the money supply and interest rates and more often than not it is administered by a central bank. Fiscal policy and monetary policy are the two tools used by the state to achieve its macroeconomic goals. The most commonly used tool is the IS/LM model which is used to depict the effect of policy interactions on aggregate output and interest rates. In market economies fiscal policies have a direct impact on the goods market and monetary policies have a direct impact on the asset markets; since the two markets are connected by the two macro variables — output and interest rates — the policies interact while influencing output and interest rates. This model, was first published in 1937, and it seeks to explain the relationship between interest rates on one hand and output, in goods and services and money markets, on the other. Hicks’ IS-LM model as an Alfred Marshall and Irving Fisher formalized the quantity theory of money nearly a hundred years ago. The quantity theory of money predicts that an increase in the supply of money will cause a proportional increase in the price level.”
The explanation of our economic condition today lays in the assumption that a floating exchange rate regime is in use, which would indicate the domestic interest rate must be equal to the world real interest rate, in order to bring equilibrium to goods and money market.
The United States debt ceiling is a legislative limit on the amount of national debt that can be incurred by the US Treasury but the new argument is that the executive branch can choose to prioritize interest payments on bonds, which would avoid a default on sovereign debt.
The Washington Post reported that during the debt ceiling crisis of 2011, Treasury Secretary Timothy Geitner argued that prioritization of interest payments would not help since government expenditures would have needed to be cut by an unrealistic 40% if the debt ceiling is not raised. Furthermore, the CBO notes that prioritization would not avoid the technical definition found in Black’s Law Dictionary where default is defined as “the failure to make a payment when due.” Therefore, for any type of debt, one cannot simply calculate an absolute amount of debt, but rather the ratio of debt to income capacity or capacity to repay. In economics of finance the measurements come as debt to income ratio — debt to assets ratio — debt to profits ratio — debt to short-term assets ratio, and debt to long-term assets ratio for businesses and corporations. For the government, this is consider — debt to revenue ratio — and debt to GDP ratio. Also, it is important to assess sustainability of debt in the case of a debt-servicing payments as a proportion of income. Financial collapse, is set when debt is so high relative to the size of repayment capacity and all assets are represented in the banking system and to investors. “Modern Monetary Theory” states that in this situation, the debt burden leads to widespread default” however, a heterodox school of monetary policy has emerged to peddle the line that the US can never suffer a debt crisis because the US government can always print more dollars — which as a as a reserve currency it can — to cover its budget deficits. In contrast with this policy the financial crisis in Iceland banks were so highly leveraged that it made impossible for a government to rescue them. Venezuela is currently another case in point where and printing money only exacerbates the level of inflation for the Bolivar is not recognized as a reserve currency.
In conclusion the real danger to the US economy is Trump’s drunken sailor spending behavior and giving money away to his cronies and judging from his past business record will probably chose to default on the debt than pay obligations which would be similar than he bankrupted his casino.
Just talking about sovereign default can cause international turmoil and a collapse of world financial markets. Countries like China holding over 2 trillion dollars of US obligations could decide to dump part or all of it in the world financial markets generating a snowballing currency panic. However, Trump might see this as an advantageous opportunity to buy back US obligations at a deeply discounted price. This action would be disastrous to say the least as one derivative of a trade war leading perhaps to another derivative of kinetic war. This might be considered an alarmist scenario but we’ll know for sure when the big guns start firing.