Deficit Spending Powers Economic Recovery

I thought I’d share with you some data that, I believe, explains the rebound in the economy that’s been gathering momentum in recent months.  The following is a chart that tracks the growth in the national debt vs. the cumulative trade deficit (expressed in current dollars) since 1976, the first year following our last trade surplus in 1975.  Highlighted in yellow are recessions. 

My theory is that, if you draw a line around the economy, periods of expansion occur when the money flow into the economy exceeds the money flow out, and recessions will occur when the inflow falls below that level.  Deficit spending by the federal government is the most significant flow of money in.  The trade deficit has steadily grown into the dominant outflow of money. 

Here’s the chart (use your browser “back” button to return to this post):  Cumulative Trade Deficit vs Growth in National Debt

Beginning with the first trade deficit in 1976 that followed our last surplus, the trade deficit began to gather steam until, for the first time in 1979, the cumulative trade deficit surpassed the growth in the national debt.  (In other words, at that point, there was a net outflow of money from the economy.)  A double-dip recession soon followed, lasting from January, 1980 until November of 1982. 

Ronald Reagan took office in January of 1981 and cut taxes, which then propelled federal deficit spending that again overtook the trade deficit, and the U.S. enjoyed about 7-1/2 years of expansion.  However, the trade deficit continued to worsen and the rate of deficit spending was slowed by President Bush’s increase in social security taxes.  By the late ’80s, the trade deficit threatened to overtake federal spending once again.  By July of 1990 we were back in recession.

Deficit spending took off again but, by this time, it was too late to salvage Bush’s presidency.  Bill Clinton was swept into office in 1991, thanks primarily to voter anger over the state of the economy.  Fate, and an explosion in deficit spending, were  kind to President Clinton.  The ’90s were marked by the rise of the  high tech industry – cell phones, personal computers and the dot-com boom all helped drive down the trade deficit and create a new flow of foreign money into the stock market, supplementing the flow of deficit spending.  The result was the longest period of uninterupted expansion in U.S. history. 

But Republicans made serious political inroads on growing concern over the explosion in the national debt, so President Clinton worked with Republicans to eliminate deficit spending, bringing the growth in the national debt to a halt in 2000.  In that same year, China was granted “most favored nation” status and was admitted to the World Trade Organization.  Immediately, our trade deficit began to explode in a way that had never been seen before.  And, at the same time, the dot-com bubble burst. 

But, aside from a very brief recession caused by the events of 9/11, real economic recession was held at bay by a new flow of foreign money into the housing market.  Upon the collapse of the stock market in March of 2000, investors promptly concluded that real estate was the safest place to be.  Foreign investors’ money poured into real estate and mortgage-backed securites, feeding a completely irrational housing boom.  Thanks to this new flow of foreign money, filling the void created by the slowdown in federal spending, the economic expansion continued, although it was hailed as a “jobless recovery.”  Virtually all of the recovery was concentrated among the top few percent of incomes while, truth be told, the rest of the economy was probably stuck in a mild recession. 

By 2006, the growth in the national debt once again fell behind the cumulative trade deficit.  That, coupled with the bursting of the housing bubble that dried up that flow of money into the economy, lead to the worst recession since the Great Depression, beginning in December, 2007.  President George W. Bush responded with an unprecedented explosion in deficit spending, a program continued by his successor, President Obama, to this day.  The growth in the national debt is now further ahead of the cumulative trade deficit than at any point in history.  The result is that the economy is slowly beginning to expand once again.

Look again at the chart.  Each time that deficit spending has begun to slow relative to the trade deficit, a recession has soon followed.  Each time, the government has responded with greater deficit spending, often in the form of tax cuts, leading to recovery.  Now look at the tail end of the chart.  The rate at which growth in the national debt outpaces the trade deficit has never been greater. 

This is a great strategy for an incumbent president in an election year.  But it’s not sustainable.  Both parties will tell you so.  Neither party will act on it.  Both parties use deficit spending to sustain an illusion of prosperity.  Democrats place the emphasis on taxing the rich to fund spending programs to curry favor with low and middle income workers.  Republicans favor cutting spending and cutting taxes for the wealthy to curry favor with upper income workers and those aspiring to an upper income.  The end result is the same – a growing national debt.  Until someone has the courage to address the real driving force behind deficit spending – the trade deficit – our national debt will continue its march skyward.

3 Responses to Deficit Spending Powers Economic Recovery

  1. ClydeB says:

    The folks down the street who are using their credit card capacity to “spend money they don’t have to buy things they don’t need to impress people they don’t like” are pikers compared to the federal government.
    When we add the misguided advice of folks, such as a Nobel prize winning economist, to accellerate the rate of borrowing, disaster is just around the corner.
    Top that with the P-D article this morning of another significant increase in the trade deficit.
    Not good now and none of the pundits and politicians appear to have a clue for doing anything about it in the future.

    • Pete Murphy says:

      While deficit spending may pump up GDP and some economic activity, I don’t think we’re going to see significant job creation continue as long as the trade deficit is ignored. We’ll see.

  2. ClydeB says:

    By all means, if your particular job is one of those directly bolstered by the stimulus spending, and all you care about is today, then the deficit spending is fantastic. After all Socialism works just fine until you run out of other folks money.

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