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Warren Buffett's recent op-ed in the New York Times is making a stir because it calls for a minimum tax on high incomes above $One million annually. But I was much more interested in some deficit targeting he proposes which exposes his ignorance about the sectoral financial balances model of macro-economics, and reveals him as a deficit hawk whose advice, if followed would be unsustainable and lead the United States into another deep recession. I'll comment on a couple of paragraphs in Buffett's op-ed.

Our government’s goal should be to bring in revenues of 18.5 percent of G.D.P. and spend about 21 percent of G.D.P. — levels that have been attained over extended periods in the past and can clearly be reached again. As the math makes clear, this won’t stem our budget deficits; in fact, it will continue them. But assuming even conservative projections about inflation and economic growth, this ratio of revenue to spending will keep America’s debt stable in relation to the country’s economic output.
So, our goal ought to be running deficits of 2.5% and this is Warren Buffett's idea of fiscal responsibility. Now here's an accounting identity from macroeconomics, called the Sectoral Financial Balances (SFB) model in which the economy is divided into three sectors, and in all the balances are financial flows over a period of time:

Domestic Private Balance + Domestic Government Balance + Foreign Balance = 0.

There's plenty of empirical evidence showing that the real world interpretation of this identity works. But, there's NO negative evidence refuting it.

Now, let's say that the income of the private sector exceeds the amount it pays to the other two sectors by 6% of GDP, so that the private sector has a surplus. And let's say that the income of the foreign sector in dollars exceeds what it spends on US goods and services by 4% of US GDP, leaving it with a surplus, and the US with a current account (trade) deficit, then what does the formula say MUST happen to the Government balance?

Government spending will have to exceed its income from taxation by 10%. That is, it will have to run a deficit of 10% to support the foreign surplus and the domestic savings. i.e. 6% + 4% + (-10%) = 0.

Now, what happens if we refuse to let the deficit be 10% of GDP, and that we either cut Gov spending or raise taxes to make that happen? Let's say we want to hit Warren Buffett's target, so that we try to force that -10% to become Buffett's - 2.5% of GDP. Then we have choices.

We can force a zero trade balance, by refusing to import more than we export. But that still leaves us with the need to DECREASE the private balance surplus from 6% to 2.5% of GDP to get the Federal budget to a deficit 2.5%. This is a decline of 3.5% of GDP in savings the private sector might have had, if Mr. Buffett's deficit target was, say, - 6% of GDP.

There are other options here of course. We could leave the foreign sector balance where it is at 4% of GDP, and decrease the private sector balance to -1.5%, of GDP, actually increasing the private sector's debt by 1.5% of GDP. But, do we really want to do either of these first two options or anything in between?

I really don't think so. Do you? Why would we want a policy that would impoverish the private sector over time, or minimize its accumulation of nominal wealth? Is this really consistent with the public purpose?  

So, is there any way we can retain those private sector savings of 6% and keep Buffett's recommended budget deficit of 2.5% of GDP? Yes, there is. We can decrease our imports and increase our exports so that the foreign sector has a negative trade balance. That is, we can get more income from trade than we spend on it by 3.5% of GDP, a shift of 7.5% of GDP from that -4% trade balance, placing the rest of the world in a trade deficit with us, provided we can increase our foreign sales (exports) by that much.

Of course, it would be very difficult for us to do that without engaging in a trade war since our attempt to decrease the foreign trade sector's balance so drastically and quickly would trigger such a war with all our major trading partners, who rely on trade surpluses with the US. There would be an international race to the bottom, which, for us to win, would require US companies to cut prices and costs to the bone in order to export more. This would be likely to result in lower wages, which, in turn, would be likely to reduce domestic sales, and tax revenues, leading a to a higher Government deficit which would work against Buffett's goal of a 2.5% budget deficit.

But getting back to eliminating the positive foreign sector balance through greater exports, the Government can neither do this for the private sector, nor maintain control over such a process once it starts. And, in any case, a change like this isn't beneficial in terms of adding to the real wealth of Americans, since even though imports cost money, they increase real benefits/wealth, as opposed to financial wealth. But that's a story for another time.

For now the important thing is that the SFB model, tells us that trying to enforce a Federal Budget of 2.5% of GDP, would be a negative for the private balance, and a disaster for private sector accumulation of financial wealth over a period of years, unless we could develop a foreign sector balance surplus by selling more than we import.

Even more, if you think about it, you can see that if we want to save 6% in the private sector and import more than we export by 4%, then the Government would have to allow at least a 1.6T deficit in the coming fiscal year, and even better would not target the budget deficit at all, but just let it float against private savings and import desires.

However, assuming the President and Congress compromise on a deficit reduction plan, we may end up with a plan for this fiscal year that is $700 - $800 billion smaller than the Government deficit we ought to have if we want to support our savings and desires for more in imports than we can export. That's too bad, because it's likely that if Congress and the President passed a full payroll tax cut, a State Revenue sharing plan and a Federal Job Guarantee Program, then this could produce the additional $700 - $800 billion Government deficit we need, given our current savings desires and import levels, to create a full employment economy.

The programs would cost more than that, of course, but we'd be spending a lot less in unemployment insurance, income support programs, Medicaid, and other welfare programs than we are now because of the effects of these other initiatives. So for an additional $700 - $800 billion in deficit spending we could have complete recovery from the crash and full employment, at last. We're crazy, and maybe evil, for not going for this, and letting more than 28 million people looking for full-time jobs hang out there, instead.

Buffett adds:

All of America is waiting for Congress to offer a realistic and concrete plan for getting back to this fiscally sound path. Nothing less is acceptable.
And, he clearly thinks that his 2.5% deficit target is that more realistic and concrete plan for getting us to fiscal responsibility. But, unfortunately for him and all of us, it is a profoundly unrealistic plan, because it adopts a deficit target based on Buffett's expectations about reasonable growth in US GDP over time, and his belief that the debt-to-GDP ratio must go down and not up over time, which is what would happen if his deficit target of 2.5% was met.

However, the debt-to-GDP ratio is just a number. It has no causal relationship to government solvency in nations like the US, that have a non-convertible fiat currency, a floating exchange rate, and no debts in a currency not its own. So, fiscal responsibility in deficit spending has nothing to with the debt-to-GDP ratio, and nothing to do a 2.5% deficit target.

It depends, instead, completely on the impact of deficit spending on real things like employment, price stability, economic inequality, economic growth, and many other societal outcomes that are aspects of public purpose. To achieve good results in these areas we need, in our present rather stagnant economic state, much larger deficit spending than we currently have. And the advice that Mr. Buffett should be giving is that we ought to enact the MMT-based fiscal policy program mentioned above, and let the budget deficit float until we reach full employment.

At that point, when the private sector economy is strong enough to have hired away most people working for the job guarantee program, or receiving unemployment benefits, we can cut back government spending, further to avoid demand-pull inflation if, as expected, private sector savings desires, and the current account balance in the foreign sector both have declined as a percent of GDP. And, if they haven't, then we can just keep the deficit spending where it needs to be for full employment, without worrying about either government insolvency or demand-pull inflation, Mr Buffett and other austerians, notwithstanding.

(Cross-posted from New Economic Perspectives.)

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Comment Preferences

  •  Everytime i see warren's last name (0+ / 0-)

    i think it's an all you can eat.

    every single damn time.

    95% of all life forms that once existed on earth are now extinct. It is only a matter of time until the Republicans follow suit.

    by PRRedlin on Wed Nov 28, 2012 at 07:25:20 AM PST

  •  Buffett seems to suggest (1+ / 0-)
    Recommended by:
    misslegalbeagle

    that government spending should exceed taxation by 13.5%.

    A conservative is a man with two perfectly good legs who, however, has never learned how to walk forward. Franklin D. Roosevelt

    by notrouble on Wed Nov 28, 2012 at 08:22:19 AM PST

  •  So, MMT means printing money. Does that (0+ / 0-)

    affect your SFB identity?

    Might and Right are always fighting, in our youth it seems exciting. Right is always nearly winning, Might can hardly keep from grinning. -- Clarence Day

    by hestal on Wed Nov 28, 2012 at 09:20:44 AM PST

    •  Sure (1+ / 0-)
      Recommended by:
      hestal

      The money goes somewhere.  If the government starts an employer of last resort program, for instance, the digits in those workers bank accounts tick up, the related account on the goverment side ticks down.

    •  Hestal (0+ / 0-)

      Our only money is "printed"! There is no other money!

      •  I know, I know, but thanks for reminding me. As (0+ / 0-)

        Mr. Crabtree, one of my two best teachers said, over and over: "Repetition is the essence of learning."

        I am working on a synthesis of this and other related ideas. You have been working on a narrative to help people like me to understand MMT, and I have followed your efforts closely. I think you are doing a very good job. Keep it up.

        But in my working life I had to constantly try to understand new processes and their ramifications so that I could computerize them. This required me to develop a process of my own so that I could do my job. I have been applying that process to the concept of money and the theories of economics for decades. It has been difficult for me, but that is largely a consequence of my own intellectual weaknesses. Anyhow, my process has been to try to find a way to automate the management of our economy. I know that sounds nutty, but that is what I do: automate things to the extent possible and if such automation is worthwhile.

        My father introduced me to the idea of money as a pure medium of exchange many years ago and his idea has always been in my mind. I felt that there had to be some better economic process that is superior to the one(s) that I have seen for decades, and apparently you think the same thing. So, when I saw people starting to explain MMT I felt greatly encouraged, and have doubled my efforts in my search to find a way to computerize the management of our economy.

        Please believe me, I am not as nutty as I sound. This kind of thing is a hobby for me and it started in 1946. Well, after rereading this comment, I guess I have to say that I probably am as nutty as I sound, but it has been a lot of fun along the way. I hope you are having as much fun from your work on MMT as I am having watching you do it.

        Might and Right are always fighting, in our youth it seems exciting. Right is always nearly winning, Might can hardly keep from grinning. -- Clarence Day

        by hestal on Sat Dec 01, 2012 at 02:19:46 AM PST

        [ Parent ]

    •  Sure, MMT means printing money but ANY (1+ / 0-)
      Recommended by:
      Calgacus

      fiat currency means the same. It's ALL JUST PAPER and data entry. The difference between the US and the EU is that it's all our paper. As hard as it is to wipe out the thinking that was part of the gold/silver standard, the fact is that ever since the Nixon shock the whole thing, the only thing has been pieces of paper to which we award value and we actually get to have complete control over how that value is managed.

      That we do not control it, that we allow it to control us is due to a sore lack of education across the society. It is our own fault and the crime of the Grand Bargain will be one of many payments against that sin.

      MMT and SFB are only a description of what already exists. I'll repeat that. They are only describing what has been happening since 1971. MMT doesn't make the rules. MMT isn't an advocate for policy. MMT is describing the ginormous train that is already on the tracks.

      Paying attention and stepping off the tracks? That is up to us.

      "When in doubt, do the brave thing." - Jan Smuts

      by bunnygirl60 on Fri Nov 30, 2012 at 12:00:06 PM PST

      [ Parent ]

  •  One thing . . . (2+ / 0-)
    Recommended by:
    psyched, Swoof

    I've seen this macroeconomic equation printed a number of times now, and it does remind me of what I was taught in the subject many years ago.  And the export/import variable seems to be fairly robust in this era of free trade and floating currency, so it would require some major legislation to change the factors driving it.  But about decreasing the Domestic Private Balance . . . most of that is not household savings by members of the 99%.  That's accumulation (aka hoarding) by the financial class and corporations (legal "persons").  It's money that is a "balance" precisely because it's not being spent into the general economy to provide monetary "flow" and "velocity".  Given that, mightn't it be reasonable to enact taxes that would lower that "private balance" while reducing the government's debt (negative balance)?

    •  I think I've seen some talk recently (0+ / 0-)

      of trying to split out that private savings balance but the diarist might have more information on that note.

      It's akin to the huge private debt starting at the sweet spot of the Clinton surplus and assigning all that to households while most of it was institutions swapping debt back and forth and creating what we got in 2007.

    •  No! (2+ / 0-)
      Recommended by:
      psyched, bunnygirl60

      But it might make sense to tax the hell out of the 1% and spend more on the rest of us. The point is that the Government's debt is only a problem because it mostly pays "welfare" to the financial sector and foreign nations holding bonds. We ought to get rid of it using Coin Seigniorage, not tax revenues. See here.

      •  The limitation, then, would be political capital. (0+ / 0-)

        Everything always comes down to politics, so what about this? We leave the f%^&ing 1% alone to wallow in their billions and instead we focus limited political energy on $60T proof platinum coin seigniorage. If the real limitation is political, why even bother to keep fighting with the 1%. The negotiation would be like this: "Ok, we will lower the tax rates on ALL Americans but you sit down and shut-up about the PPCS because it's going to happen regardless of your input. What we are buying in this negotiation is your cooperation."  FOX could still melt down but they are the chicken little of media so I'm not sure that really matters.

        What WILL matter to all Americans are the programs and spending the government would be able to put in place to reach full employment along with capital asset upgrades and educational system investment which would change the future for all coming generations in a markedly positive direction.

        "When in doubt, do the brave thing." - Jan Smuts

        by bunnygirl60 on Fri Nov 30, 2012 at 01:02:16 PM PST

        [ Parent ]

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