Living by Deficit


THE present fiscal situation in the United States is the most extraordinary in our history.

We have been running peacetime deficits so consistently that they have become a national habit. We have embarked on a defense program which may double that rate of deficits for the indefinite future. We have raised the price of gold 60 per cent, accumulated something round 22,000 tons of the precious metal, run our bank reserves up to levels inconceivable ten years ago, and begun to teeter on the edge of war.

All these things, by all historic precedents, spell runaway commodity prices, and yet commodity prices calmly stay put. Nothing like this has ever been seen in American history, and nothing remotely like this was forecast, before it happened, by any of the practitioners of the art of economic forecasting. Something new and novel has happened in monetary matters, and it behooves us to examine it.

At the present writing the President has not yet presented the budget for 1941-1942 — the fiscal year to begin next July 1. Unofficial guesses are that non-defense outlays, which had come to run somewhere between 8 billion and 9 billion dollars, will be cut to 7 billion, while defense outlays will run up to another 7 billion, perhaps to 10 billion, for a total outlay of from 14 to 17 billion. Against this there should be an unprecedented Treasury income. The grapevine rumors from Washington, however, are now putting our total outgo as high as 18 billion dollars and our total income at only 8 billion, which would mean a deficit of 10 billion.

But even if that comes close to the official estimate, there are several reasons for supposing that the Treasury may be wrong.

First is the fact that it has been pretty consistently wrong in the last ten years, once with a gross overestimate, usually with a gross underestimate. Again, a 10-billion-dollar official deficit estimate for 1941-1942 may be exaggerated for the further reason that it takes a long time for a defense program to get under way. It has taken the present program over six months to expand from approximately 150 million dollars a month to about 450 million a month. For the Treasury to spend, say, 17 billion dollars in the fiscal year beginning in July 1941, it would have to step up defense costs, by the end of that period, to something like a billion dollars a month — and by that time most of the original construction of factories to build the machines of war will have been completed. On the side of those who hold to the larger deficit estimate, however, allowance should be made for extensive outlays for Britain’s defense, plus heavy credits — at United States Treasury expense — to China and South America, and perhaps Canada and other portions of the British Empire.

The most decisive influence on the size of the deficit is public opinion. If the public is not afraid of a 10-billiondollar deficit, it will put no pressure on Congress for more taxes, and will tolerate no curtailment of the present nondefense spending schedules. On the other hand, if it wants a deficit something nearer the standard of deficits to which it has become accustomed, it will, through Congress, impose more taxes and pare down the present outlays for farm and urban relief, and so forth.

In any case, it is safe to say this: that we shall, during the present emergency, run deficits certainly as large as those of recent years, and probably much larger.

After the war is over, we can look forward to no end of deficits. Business will have heavy inventories to liquidate; millions of men will be released from the armament industries and from the armed services, to find what jobs they can; and an unprecedented business depression is likely to be avoided only by a Gargantuan pump-priming program.

After that, perhaps we shall get back to normalcy. And normalcy today is a deficit of 3 1/2 billion dollars a year.

So there is no prospect of budget balancing. And according to all classical economic theory this can only mean inflation — runaway commodity prices and a booming cost of living, sooner or later.

Perhaps the permanence of the budget deficit outlook may be put another way. In the days of Life with Father, nearly everybody who mattered held the notion that the national budget, like a personal or household budget, was something to keep balanced as to income and outgo. Today, however, we have grown up to — or slid down to — an entirely different idea of the first duty of the Treasury. The government has become socialminded. Protecting the needy, the unemployed, and the underemployed has come to be a first duty of government. Budget balancing is generally considered a poor second in importance.

There is no reason to suppose that these two objectives can be made consistent; indeed, the evidence all goes to show that, given the present temper of the electorate, the social-minded ideal will override budget balancing indefinitely.


As if budget deficits had not been enough of a hostage to offer to inflation threats, we have made plenty of others through our monetary policy. In the early thirties the price of gold was lifted from $20.67 an ounce to $35. The intention was to raise commodity prices. The chief result was to set in motion a flow of gold to this country, which was urged further by the decay of political conditions abroad, until the unprecedented flow drained most of the world’s central banks into this country, mopped up all the world’s new production, and is now ramming up our gold holdings to a book value at the new price of something like 22 billion dollars, and no top in sight.

The secondary result was to raise bank reserves to well over 13 billion dollars and excess reserves to nearly 7 billion. Compared to this, the member banks were ‘into the Federal’ in 1929 to an average of around one billion before the crash; in other words, they were short one billion of reserves at the time of our previous greatest business expansion, instead of being long by more than 6 billion as they are now. Bank deposits have risen to over 60 billion dollars, well above the old peaks, and this money has more purchase power, for prices are lower.

Still and all, prices do not rise. They haven’t made up the drop they suffered in the three years 1929-1932. They aren’t back to 1937 levels; in fact, they aren’t even back to the levels reached just after World War II broke out. And prices, particularly on the futures market, discount the future, not merely the present.

This is all in violent contradiction to precedent and tradition. It used to be a cliché that consistent deficits mean inflation. The proofs could be laid out in standard textbook form — the spree of John Law and the Mississippi Bubble; the deficits of the Continental Congress; the rise and bursting of the assignat money during the French Revolution; the greenback inflation during the Civil War; the fourfold rise of post-World War French prices driven up by reconstruction deficits, and the astronomical explosion of the German mark and the Soviet-controlled ruble into microscopic bits between 1917 and 1923.

To be realistic, we must draw a historic dividing line at about the year 1932. Before that time, these precedents worked. Since then, they haven’t. Germany long ago abandoned all pretense of a balanced budget, and has hidden an incalculable deficit in a multitude of banking devices, without appreciable rise in the cost of living. France, whose budget is normally a shade out of balance and in the last generation has been balanced only between 1929 and 1932, did all her expensive rearming on the cuff, suffered a 66 per cent drop in the external value of the franc and a heavy capital outflow, yet underwent no conspicuous inflation in the cost of living. Britain balanced her budget up to shortly before World War II by heavy taxes, but is now spending double her intake. She has, it is true, suffered a 25 per cent increase in prices, but this is in substantial part due to her heavy dependence on imports, which have to be marked up to allow for external sterling depreciation, ship losses, convoying costs, and material losses due to bombing.

The outstanding difference is that since 1932 modern governments have discovered vastly greater powers over economic activity than ever before — powers which enabled the governments to begin this war virtually where they left off the last. These powers include meticulous control of production, consumption, prices, profits, and public opinion. The one thing that has remained politically out of control is wages, and even that, in the most advanced totalitarian country, Germany, has come under rigid control. From mine and field, through processing and distribution, commodities are clocked by cautious bureaucrats who, if they don’t know their business, at least know their powers. There were no such governmental powers in French and American revolutionary times, in the American North during the War of the States, or in France, Germany, or Russia after World War I. In fact there never have been any such powers before in the history of the world, directed from a central authority.


This larger government power has forestalled inflation. For one thing, the heavy hand of reform has kept business from expanding vigorously into new fields of technical venture. Regulation has prevented the building of another of those ever-new, ever-old ramshackle credit structures such as in the past financed every great material prosperity and then collapsed.

As a result, available man power has backed up, unused, while idle field, factory, mine, and workshop capacity has accumulated. The social-minded ideal of the budget has permitted the government, in taking care of this by-product of its zeal, to support in partial idleness millions of men for whose employment nobody wanted to go in debt in the oldfashioned enterprising ways. This backed up surplus producing capacity for our leading farm and mine products. During the decade of the 1930’s, for example, we had a net movement of about two million people back to the farms, instead of the hitherto normal movement into the cities. And this occurred during a period of extraordinary improvement in farm machinery, which normally would have released men from the farms by the millions. The notion became popular that the farmer’s purchasing power should remain indefinitely at the same level, as though the nation were to abandon the benefits of the progress of the industrial arts which normally permit, decade after decade, its food and fibre requirements to be met by a shrinking farm population.

In fact, the government went much further. It not only subsidized people to stay put, but it began accumulating, by operations of which the original Farm Board was the prototype, an everswelling granary of farm products. It now has over a billion dollars invested in inventories of farm products, and is the largest holder of food surplus in the world and in all history, not excluding ancient Egypt.

All these supplies now ‘hang over the market.’ Farm prices can’t go far above ‘loan values,’ or some of these holdings, now on ‘non-recourse loan’ with the government, will come on the market. If the market went on through that, the government could simply quit paying the farmers to restrict production; then it could abolish the present high tariffs on raw materials like wheat, corn, copper, oil, and so on, or circumvent them as it is now doing in the case of copper. Twenty-five years ago it took about $2.25 a bushel to bring the last required bushel of wheat to market; today $1.00 would probably do it if the brakes were taken off production, and somewhat the same holds good right down through the commodity list, with rare exceptions like scrap steel, coke, and paper.

And the government has two other important sedatives for inflation. In the first place, it could turn around and use the budget deficit to finance production instead of restriction. It could subsidize farmers to grow more raw material. It could subsidize a marginal, high-cost manufacturing plant that would not need to receive higher openmarket prices in order to keep going. It could even build government plant to take care of growing requirements. It has begun to do so in two major industries where interest, depreciation, and taxes are major items — the utility business and housing. It threatens to go into other industries in connection with the defense program, and government officials are now putting pressure on many industries to expand plant from here on, so as to be able to meet our added military requirements without having to curtail civilian wants.

The government’s second sedative for the calming of prices is its power to ration goods and services. In the case of industry, this means imposition of priorities. It is already under way in the machine-tool, aviation, steel, zinc, and aluminum industries, and is likely to go much further. And it is an obvious alternative to price increases. If there are too many buyers, price increases will head some of them off, but rationing and priorities can do it just as effectively.


Old-fashioned experience with deficits, money, and prices went somewhat as follows.

Continued deficits forced a government to sell bonds. After a while private lenders wouldn’t take any more except at excessive coupons. The government then had to go into the short-term money market. Surplus cash there was soon mopped up, and the central bank had to be ‘asked’ to issue its circulating, legaltender notes of hand to the government in exchange for the government bonds, notes, and bills that nobody else wanted. This process, continued indefinitely, put so much money into circulation that, despite output increases, government threats, and everything else, demand outran supply and prices started mounting, beginning with the prices of imported commodities. To put the story another way, the government fell into the habit of financing itself by borrowing printing-press money to take into the market to compete with its own citizens. When two buyers thus grew where one grew before, prices rose.

In ten years’ time we have not yet reached the first stage of this process. Quite the contrary — we have moved away from it. Government bonds are now selling at prices far and away higher than anything ever seen in this country in the days of budget balancing. As for short-term money, the cost to the Treasury of borrowing it is microscopic. It actually costs the Treasury less to borrow a million dollars on its discount bills than it does to keep in circulation the same amount of legal-tender currency.

What happened was that the government corralled, almost entirely for itself, the book gains from its mark-up in the price of gold. First it took a chunk of about two billion dollars —the Stabilization Fund — as its original cut. Then reform discouraged private enterprise from capitalizing the easier money rates resulting from the increased United States monetary gold stock, and has continued to do so as the gold has poured in for the better price. The government has been far and away the chief borrower — and, with other borrowers scared away, it has had the money market largely to itself.

Now where in the world do we go from here? It looks as though we should have budget deficits indefinitely, and it looks as though they would not be followed by the traditional consequence of a painful increase in the cost of living and industrial prices.

But, if that is so, is there no limit to the total debt which the nation can ‘stand’? Or, if there is, is it 65 billion, 100 billion, or 300 billion? How much is a safe annual deficit — 3 1/2 billion? Why couldn’t it be twice that amount, and who is to gainsay the Washington hopefuls who say that the stimulating effect of the defense program on everything but prices proves that in the peaceful past ‘we didn’t prime the pump enough’?

We shall get nowhere with the problem if we try to think in these terms, however. It is purely arbitrary to pick some figure out of the air, and say that an annual deficit of 3 1/2 billion is safe and anything more is dangerous, or that the national deficit can safely go up to 78 billion but not any farther. There is already far too much of that kind of thinking inherent in all our calculations about money and credit, and such static estimates are always being pushed around because they never stay put. For instance, when excess reserves started rising, there was a feeling as each billion was added that the next billion would be about the safe limit. By the time excess reserves pass the next billion mark — 7 billion — the estimated safe limit will probably be put at 8 billion. For all these things some other totally different kind of calculation is needed.

For this purpose the man in the street has, in the last analysis, a better answer than the erudite economist. He skips all the old-fashioned and laborious calculations involving the money market, cost of borrowing, effect on the gold standard, and so on, and holds one firm conviction. Things are all right with him unless the cost of living starts to pinch. And since, at the polls, he has the last word, we may say that it is politically safe for the United States Government to continue financing by deficits until, despite all its powers of control, and despite all the excess producing capacity and all the overstock of raw materials we now have, prices start to rise uncomfortably for the ultimate consumer with the decisive vote. Deficits can continue until the cost of living rises painfully; then they will have to stop. Perhaps next to the word ‘totalitarianism’ the actual threat of inflation is the most unpopular thing in the modern world. In fact, some people seem willing to embrace the first to avoid the second.

But though this is a more realistic, practical way of looking at the deficit problem than the traditional way, which became useless when balanced budgets and free enterprise went out the window, it is vague. How high a price level will people stand for? When should Congress feel free to increase the deficit and when should it feel called on to cut it down?

It would be a great advance in the socalled science of economics if some working formula could be devised for the control of the deficit. Then the energy spent on ceaseless theoretical budget quarrels could be saved for more useful purposes, and what remains of private business venturing would have more certainty of the future, and something more definite in the way of future price levels and government budget policy to adjust to; for, of all things, business most needs certainty.


In looking for such a price-level-deficit formula, we may draw on our experience with the old free gold standard. At least in theory, the master formula then was fairly simple. The credit structure consisted of valid, or supposedly valid, golden promises. It was safe for this structure to expand to the point where the validity of these golden promises came in question. The one trouble with the arrangement was that nobody had any effective way of telling when this point had been reached. The demand for gold was extremely fickle and not subject to ordinary trade forecast.

For credit expansion in the old-fashioned picture, substitute expansion of the national debt. Debt and credit are merely the obverse of each other. The perennial borrowings of the Federal Government are no different, intrinsically, from the perennial borrowings of business and government during former times.

And for golden promises substitute something like ‘ promises of a reasonable, fairly constant amount of the necessities of life.’ To the propertyless man it never did matter that his twenty-dollar bill carried a golden promise. What mattered to him was that it carried more or less of an implied promise by the government that he could get a certain amount of groceries, shelter, clothing, or transportation for that bill. To him it was always a ‘commodity dollar.’

So we have a new formula, analogous to the old. The national debt-credit can continue to expand, with political and economic safety, as long as the validity of the dollar, as a promise of a given quantity of commodities, remains reliable.

Now how shall we work out that formula? The gold standard had machinery. The United States Treasury and the Federal Reserve System pegged the price of gold for all time (in theory) by freely buying and selling gold for dollars at a fixed price. Huge gold reserves or inventories were maintained for the purpose, so that any bulge in demand could be readily met. By and large, the fluctuations in that ‘ monetary gold stock ‘ or inventory of gold gave a clue as to whether the credit structure could be safely expanded or should be contracted.

The modern equivalent consists in the Treasury’s holdings — through its filials the Commodity Credit Corporation, the Federal Surplus Commodities Corporation, the Defense Metals Corporation, the Defense Materials Corporation, the Defense Rubber Corporation, and so on — of basic commodities. By and large, though so far only roughly and informally, those corporations work like the old-fashioned gold-reserve machinery. They hold prices from falling by taking in the excess offerings, and they could hold prices from rising, by letting the excess out. The changes in their holdings signal whether prices are safe or not. They not only are a guarantee to producers that they can get something near a ‘fair price’ for their products, but also are a potential guarantee to consumers that their dollars will not shrink in purchasing power in these commodities. The ups and downs of the inventories held by these Treasury affiliate corporations will at any time give a better clue to the possibilities of further deficit (‘credit expansion’) than the fluctuations in the now politically outmoded ‘United States monetary gold stock.’ So long as their holdings continue to increase, no ‘inflation’ impends and no budget balancing is politically likely or economically necessary.

The most important fact about the whole situation is that new, adventurous thinking is required. To stick to oldfashioned concepts is like thinking about warfare in terms of World War I. There is intellectual dry rot among the monetary strategists of Wall Street, and, as has happened in warfare, imaginative men without orthodox financial preconceptions have seen the new possibilities and capitalized them to the discomfiture of the old-fashioned monetary generals. But, as might be expected, these bright new strategists are using the new possibilities only for the greater glory of the Washington administration, by doling out deficit-financed Treasury subsidies to true believers for a political price, while discouraging private business from taking any advantage of the new credit-expansion possibilities. Thus, for example, Jesse Jones, pseudo-conservative, loans out federal funds for peace and war while Marriner Eccles, pseudoradical, would put the credit brakes on private business for old-fashioned reasons.

Among the questions on which we need adventurous thinking is how to crystallize the new circumstances into actual formal machinery such as we had with the gold standard. Another is whether, in order to avoid the indefinite accumulation of debt service, the government might not defray some of its deficits with non-interest-bearing, legal-tender notes. The inhibition on them used to be their danger to the gold standard. The inhibition today would be their effect on commodity prices. That might be a fruitful subject for economic speculation, if a path could be cleared to it through the clutterings of outmoded monetary preconceptions.