Our Fiscal House Isn’t An Actual House

The US Government is NOT just like your household

The US Government is NOT just like your household

Much political hay is being made these days about the government’s out-of-control spending, deficits, and the national debt. You don’t have to go far to find a politician or a pundit saying something that amounts to comparing the nation to a household, or that government should be run like a business. The Web sites of many politicians, political organizations, and news outlets feature a “debt clock” – showing purported amounts of the national debt continuing to rise. Both Democrats and Republicans do it (though Libertarians tend to be the biggest deficit and debt hawks, and Tea Party activists are making the most noise along about Federal spending today).

The problem is, Government is not a household, and Government is not a business.

If you’re one of those people who is enamored with the idea that the government should run like a household – e.g., save its money, incur as little new debt as possible, pay off old debt as quickly as possible, invest in order to make a profit, and so on – then this article is for you.

Here are five important ways in which the United States Government is different than your household, when it comes to fiscal and monetary policy:

1. You don’t have your own household currency.
There is not a Smith Family currency.  The Jones Family does not pay its debts in Jones Dubloons. However, there is United States dollar.  That’s the currency used by the Smith and Jones and Martinez families (and every other family and business) to settle their debts and obtain goods and services on the open market. The issuer of the dollar is The United States of America – specifically, dollars are Federal Reserve Notes.

The Federal Reserve, or the Fed, was created in 1913. Prior to that, people actually could print their own currency, and they did.  It was backed by gold, silver, depository notes in various institutions, bonds issued by companies and regional governments, or – in some to many cases – by nothing at all. A “run on the bank” was a common occurrence. There were no reserve requirements; banks could lend out every bit of currency they had from depositors. When people lost confidence in banks or in the banking system, they would all show up and demand their deposits back – and banks often had little or nothing in their vaults to pay angry depositors (it was all invested or loaned out). Banks could also invest any deposits in highly risky and speculative ways, or simply leave town with the money that people deposited. The Fed has both a public component (the Board of Governors – also known as the Federal Reserve Board) and private components (12 regional Federal Reserve Banks and 25 Branches); together, the public and private components of the Fed govern monetary policy.  The Fed is part of a larger system that includes (principally) the Treasury, the Federal Deposit Insurance Corporation, and private banks nationwide; while the Fed acts as a central bank, it was set up with both public and private components such that no one component actually has central control.  The mission of the Fed, in controlling monetary policy, is to prevent inflation, and to also avoid recession. The Fed does this by controlling the amount of currency available in the banking system, and by affecting the interest rate that banks pay to borrow money from one another.

WARNINGThere is A LOT of VERY BAD INFORMATION on the Internet about how the Federal Reserve system works. I am going to present just a few bare minimum facts here, and I will try to correct any bad information that comes up in comments. But, please, do not assume that everything you see in a YouTube video criticizing the Fed is accurate. It’s not. Mostly, it’s the type of ‘theory’ that is postulated by folks wearing tin foil hats and pulling out their own teeth so that the Government cannot hear their thoughts through their metal fillings. Reliable resources include The Federal Reserve Education Web site, federalreserveeducation.org, and if you really like videos and don’t want to comb through YouTube to find one that you can believe, the Federal Reserve and You video series, published by the Federal Reserve Bank of Philadelphia.

2. You have a finite amount of resources (you are resource-constrained).
The reason why you (or me, or anyone) must control debt in the first place is because we only have, and can only obtain, so much money. This is not the case for the Federal government. The government is not constrained by the amount of money it has – but by what that money is worth.

Hyperinflation is a subject that we all probably understand at an intrinsic level. While the government could just add money to pay for whatever – if it added too much money, the money would lose value. Continuing this pattern to a logical extreme, the currency could become essentially worthless. There are plenty of current and historical examples of currencies that became worthless because of hyperinflation (think about the Confederacy after the Civil War, or post World War I- and World War II-Germany).

Man with a wheelbarrow full of currency from The Weimar Republic

Man with a wheelbarrow full of currency from The Weimar Republic

You and I are constrained by the amount of money we have or the amount of money we can obtain. Governments that issue their own currencies and control those currencies (what economists call a flat currency) are constrained by what their currency is worth. Essentially, the job of the Fed is to control the amount of money in the financial system and what people pay to obtain that money, to prevent recession on one hand, and worthless currency on the other.

3. You don’t get more resources when you spend more money.
If you spend five hundred dollars on a flat screen TV, you’ve spent your five hundred dollars. It’s gone. In exchange you have a flat screen TV. You may derive satisfaction from your purchase, but short of selling that asset off to someone else (say, in a yard sale or on Craig’s List), you will never derive monetary value from having purchased a flat screen TV. Likewise when you give little Billy his allowance, he either saves it, or blows it on whatever video game or toy he wanted – but regardless of what he does, that money is gone. You may derive satisfaction from teaching little Billy something about handling money, but the money you gave him is gone.

By contrast, when the government spends money (for example, to build a road, or repair a bridge, or to operate a dam), people get paid to provide the goods or perform the services that the people needed and the government acquired. Those people (the ones building the road or repairing the bridge or operating the dam) pay taxes on the income they earn – which then help to pay the operating expenses of the government. Also, other people (the ones who needed the road or the bridge to move goods from producer to market, or the ones who use the electricity produced by the dam to run a business) actually make money, or make more money, as a result of the goods and services provided by the government. This grows the economy, which increases revenue yet again (and probably in much bigger ways, at least when it works), and that revenue also helps to pay for the operating expenses of the government.

When you spend money, it is spent. When the government spends money – at least some (hopefully more than some) of the time – that money comes back.

4. You would be better off without debt (but the government needs debt).
I am a huge fan of Dave Ramsey. While it is true that society would suffer in some ways if consumer debt loads decreased, I think the right answer for anyone, individually, is to try to minimize, if not totally eliminate, debt. People are best off when they follow the advice of Polonius – neither a borrower nor a lender be. It is an obvious and easily defensible proposition that people are better off with less debt, and probably best off when they have no debts at all.

If our government ever paid off all of its debt, though, our economy would be in real trouble. Generally, the government will always have to maintain debt in order for the economy to operate well or properly.

How the Fed uses debt to control the value of money

How the Fed uses debt to control the value of money

Recall that the purpose of the Fed is to prevent inflation and recession. The Fed does this in a couple of principal ways – by controlling the amount of money in the system, and by controlling the cost of borrowing within the financial system. One of the ways the Fed does this is by issuing debt (bonds), and by buying up debt.  When the Fed wants more money in the system it buys securities (trading money – which flows into banks – for debt); conversely, when the Fed determines that there is too much money in the system (risk of inflation), it sells securities, trading debt for money from banks). Thus, if the Fed immediately canceled all debt, that would lead to hyperinflation, and, in principle, the Fed must always be in some amount of debt in order to be able to control the amount and value of money in the system at any given time.

Economists can disagree about what amount of debt is acceptable, healthy, etc. for various economic conditions.  That’s not the point.  The point is, although you and I are better off without debt, all economists would agree, the government pretty much needs to be in debt all the time.

5. Your motivations are fundamentally selfish.
… and there is nothing wrong with that. You want to acquire more money, to have the ability to get more goods and obtain more services and have better things for you and your family. Greed is the primary motivation of your economic life. Likewise, businesses are in business to be in business – they have a profit motive (and that is also just fine). They create value for their owners and shareholders.

There are things in the world on which all people depend, more or less equally; that are owned by everyone (or by no one in particular); and that exist specifically because of everyone’s collective interest, and no one’s individual interest. Economists call those things a “public good” – examples of a public good would include libraries, police forces, fire departments, professional military forces in a state of readiness, local and interstate roads, public transit systems, economic oversight functions, parks, funds to provide for emergency food and shelter, and various public utilities such as sewer and water systems. The common thread is this: Everybody needs it – but it is not anyone’s responsibility, alone, to provide it.

Regardless of your political stripe – from the most liberal progressive to the most conservative libertarian – this is the purpose of your government. Not to make a profit. Not to have or to make as much money as possible. To provide the public good as efficiently and effectively as possible. Or, as written in the preamble of the Constitution:

in order to form a more perfect union, establish justice, insure domestic tranquility, provide for the common defense, promote the general welfare, and secure the blessings of liberty to ourselves and our posterity

… THAT is the purpose of government.  THAT is its motivation.

So, the next time you see some boneheaded picture or video or quote comparing your government to your household, set people straight. People can, and will, reasonably disagree on what the right thing is, with regard to the direction of the country; however, people cannot argue their point about that direction using an analogy so fundamentally flawed as comparing our government to our households. Governments, it turns out, aren’t households; they don’t work like households, they don’t spend or borrow like households, and they aren’t motivated to do the same things that households do. When people claim that a government budget is like a household budget, or like a business budget, they aren’t providing an insight. They are perpetuating a myth – or, worse (and too often the case), telling a lie.

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