Deficit Doesn't Necessarily Mean Dumb

Back to Fisher.  Ok, deficits are bad, maybe--deficits in bank accounts, deficits in grades, deficits in general.  The giants of all deficits is the government deficit.  And the politicians, some of them, wail against deficits while they vote for more spending, especially in their districts. 

First, here is how deficits occur.  Federal income (taxes) is offset by Federal spending.  If spending is greater than income then you have a deficit.  And that is bad.  Maybe. 

In some of my categories I have railed against debt.  But not all debt.  If you get a job that pays 20% more than your old one but you need a car to get there then borrow the money at 5% or 6% and buy a Civic.  Don't buy a Hummer and say it is a good financial move.  If you can buy a house and fix it up and make a profit, go for it.  If the government has to borrow money to make sure a B-52 can get up in the air, I'm all for it since my son is in it.  Debt is not bad if the purpose is good.  If the purpose is to borrow money on a credit card to buy lunch, I'm against it.  Take your lunch. 

Back to the facts.  Fisher says that deficits are not bad, at least not bad for the stock market.  They did a bit of historical analysis and the stock market performs better after a borrowing binge than a surplus binge.  They tracked surpluses and what the market did 12 months and 36 months after the high of the surplus.  Did the same for deficits.  The stock market was up an average of 3.5% 12 months after a surplus peak and 4.2% after 36 months.  After a deficit peak, the markets were up 22% after 12 months and 35.7% after 36 months.  Coincidence?  Maybe.  But I don't think so because deficits spur spending that spurs production that spurs profits that spurs stock gains.  A simplistic analysis but hey...

Then you hear on the news and in the papers that the DEFICIT is a record.  Depends on how you measure records.  In absolute dollar terms, yes, no question.  But Fisher and most economists and finance people look at it as a percentage.  Percentage of what?  Gross National Product.  If you think of the US as a company then the debt is financing the company.  How much debt is being used.  As a percentage of GNP, the deficit is 2.3%.  Is that a lot?  Not really.  The deficit in 1975 was 6% and that period was a mess.  And got worse.  Believe me, you don't want to go there.  So the deficit is not out of control if viewed as a percentage of what it buys.

So what is the optimal percentage of GNP?  Well, the percentage was last 2.3% ( same as today) in 1950 and the '50's (economically speaking) were gangbusters.  Also, the deficit was pretty high in the Reagan years as he pumped up the pressure on the Russkies and we know what happened to them.  Also, know what happened to the stock market which took off like a rocket.  Till we had surpluses in the late 90's that led to...the biggest crash since the Great Depression.  This is not to say go hog wild for deficits.  Check out Argentina or Brazil for that school of finance.  But a certain level of debt is good for companies as well as countries.

Why?  Because there is an optimal level of debt vs equity in countries as well as companies.  I will not go into the finance theory on this but most companies have about 65% debt and 35% equity.  Just how it works.  Any less and you are vulnerable.  I went to work for a company and the first thing I looked at was the debt/equity ratio.  Not enough debt.  We got taken over in less than a year.

That goes for countries as well.  Too much equity (taxes) is bad because it takes money out of the pockets of the citizens.  Too much debt is bad as well because the lenders will say Hold It after a while and then you can't borrow any more.  You're stuck.  So watch the deficit as % of GNP.  Right now we are ok.

What about the Children?  I am so sick of this.  We are passing on a huge debt to our children.  Good, the ungrateful little brats.  Actually we are not.  First, again, it is not so huge as a percentge.  Secondily, nobody rings a bell and says pay up.  If the debt does not get too large as percentage of GNP and the economy can service the debt, then the debt will never be called and our Children will be ok.

That's a lot of finance.  If somebody has a better answer to the Deficit, let me know.