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Deficite, who against whom

29/08/2014

Every economic policy tries to cope with three major economic problems, stability of prices,  economic growth which is needed if the policy is to achieve full employment due to continuous  increase of efficiency in the economy and the last “Fair” distribution of income and wealth. But who will tell “What is Fair???”. To those, with less skill to generate wealth, who are on the lower level of the economic income, fair is more even distribution of income. On the other side, those skilled, who are also more sophisticated to cover their real intentions, see just fair, that they are rewarded much more than the lower classes.

Public deficit, sometimes wrongly called budget or government deficit, includes government deficit but also deficit of not governmental institutions, whose source of income is certain kind of non-governmental taxes. Such institutions are for example the national social security institution, with high propensity to deficit mainly in pension insurance and medical insurance, due to increase in the life expectancy. These institutions even if legally independent are managed by politicians, who naturally are not to interested in insurance risks calculations of some actuaries. Other institutions are the local or municipal institutions, who have the right to collect taxes too, and have tendencies to create deficits. Why so? Because it is generally believed, that the government at the end of the day will not let them down, and will cover their deficits. The reason for this believe is a subject to a whole essay if not a whole book.
But then how can the government cover these deficits? Of course by printing money.  If government needs money, first it takes loan from the central bank, then the central bank issues securities against this government loans, and sells these securities on the market. If too much securities are issued, their price tends to decrease and with it the interest rate increases. This is not very good for investments and subsequently for economic growth. No economic growth, no profits, no profits no taxes, and subsequently the deficit growths even more. So this kind of spiral can’t go forever.

Alternatively the government can intervene in the market, to purchase its own securities at high price and not to increase the interest rate, or even decrease it as it happened under the policy of quantitative easing. But then will it not decrease the value of money? The deficit itself means more money printed and more abundance of money. It is well known everything abundant has less value than something scarce. Take diamond jewelry against glass one. To me they both look just the same, except of their price. This price decrease of money can come in form of inflation, but also in form of new taxation, or long term process that degenerates the value of the savings connected to money relatively too other forms of holdings.

But printing of money doesn’t necessarily mean more money circulating in the economy. The government and central bank have many instruments how to decrease the money in circulation. Just to remain you, most of the money in circulation is created by the commercial banks and not by the central bank. Policy change  of central bank towards the commercial banks can have bigger effect on liquidity than new money printed due to public deficit. The very best example is the Basel III accord, that unfortunately for the banks is about equity credit ratio. This ratio can be improved only by increasing equity or decreasing credit. But increased equity can come either from profits or from new investors. But how can the banks increase profits if they must reduce their borrowings? And as to the new investors, who wants to invest in a risky business with reducing profitability? The result is the credit squeeze of the banks exceeds the central banks capacity to print money.

As to the distribution of the wealth and income, the deficit is not neutral. Most of the public spending, (except of military) goes to the lower level of the society. But also the biggest purchasers of these securities are those who have money and “hate risk”. The pension funds are the biggest among them, where are deposited most of the savings of middle and lower income segment of the population.

Conclusion; If the value of the money goes down, so does the value of the assets connected to the money. Public deficit is good for those who enjoy most of the public money, and not so good for those who live on wealth accumulated in the past. This are mostly rentiers, and pensioners.

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