Budget Deficits Don’t Matter

by Byron on November 7, 2011

Okay, budget deficits do matter. BUT, budget deficits as an isolated variable don’t matter. Only budget deficits in conjunction with other factors, namely the purchasing power of the currency denominating the shortfall, matters.

In other words, if you have budget deficits into perpetuity, but the currency still buys the same amount both within the economy and when trading with other economies, did the budget deficit really matter? I don’t think so. (I’m not being flippant, I truly only think I’m correct about this point.)

This explains why all the hyperinflationists and tea partiers think the way they do. They posit that currency created via deficit spending will have an equal and opposite reaction on the value of the dollar. Create a lot of currency, it’s worth a lot less.

However, the relationship isn’t linear. I don’t think it can be modeled. The reason it’s not linear and can’t be modeled is because the worldwide market dictates the value of one currency vs. another. If the market believes dollars are worth more than other currencies EVEN AFTER all the new currency creation, then not only was it not terrible to have deficits, it was, in fact, a good thing. More currency units were produced without sacrificing any incremental purchasing power. In essence, those currency units would have been wasted without creation via deficit spending.

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