For the past 30 years fiscal deficits have been a big financial nothingburger because the Fed and other central banks gutted their sting. So doing, they drastically and dangerously falsified the market for government finance by weaning politicians of the one element that kept modern Big Government fiscally contained.
We are referring to the historical fear among politicians that fiscal deficits cause “crowding out” of private investment and rising interest rates. Indeed, that proposition was universally understood during your editor’s sojourn in the Imperial City between 1970 and 1985 as a staffer, Congressman, and budget director.
As it has turned out, however, there was implicitly a crucial qualifier. To wit, it was naturally assumed that fiscal deficits would be financed in honest capital markets and that yields in the bond pits were free market prices which cleared the balance between the supply of private long-term savings and the demand for term debt.
The very notion that it could be otherwise—-that the central banking branch of governments could swoop into capital markets to scoop up and sequester in their trillions the debt emissions of the fiscal branches— was scarcely imaginable among anyone reasonably educated and minimally informed.
After all, had Lyndon Johnson, Tricky Dick, Jimmy Carter or even Ronald Reagan suggested that the Federal Reserve buy government debt at rates which exceeded annual issuance by the US Treasury, as was the case during the peak years of QE, they would have been severely attacked—if not subjected to impeachment—-for advocating rank financial fraud.
Nor is that mere conjecture. For instance, after his “guns and butter” deficits had breached an unheard of 3% of GDP (outside of world war), LBJ essentially concluded he had no choice except to commit political hara-kiri by forcing a 10% surtax through the Congress in the 1968 election year.
Likewise, upon inheriting the Oval Office in August 1974, Jerry Ford famously attempted to curtail excessive fiscal stimulus with a “WIN” tax, and Jimmy Carter never let his deficits get above 2.5% of GDP—-even though he had a big spending domestic agenda.
But the most dispositive case of all was that of Ronald Reagan. Notwithstanding his reputation as the scourge of taxes, the Gipper signed three consecutive tax increase bills in 1982, 1983 and 1984 after the deficit exploded to 6% of GDP owing to the original Reagan tax cut and huge defense build-up.
Nor were those increases window dressing. On a combined basis, they rolled back fully 40% of the 1981 tax bill and amounted to 2.7% of GDP or $500 billion per year in today’s economy; and they were enacted with little resistance by deficit-fearing politicians from both parties on Capitol Hill.
Even as late as 1986, the fear of “crowding out” was fully operative in the Imperial City. In fact, Ronald Reagan’s signature tax bill—the reform act of 1986—-was strictly deficit neutral.