Phony Money for Worthless Promises

Recently by Gary North: An Exchange of Empires



There are two deficits that we hear about most: the federal government’s deficit and the balance of payments of the United States. They are linked, but they are very different in their effects.

The federal deficit is seen by Keynesians as mostly a benefit and by Austrians as mostly a liability, and for the same reason: higher government spending.

The balance of payments deficit is seen by virtually all economists as a benefit for Americans and their creditors. Otherwise, the exchanges would not take place.

At some point, the twin deficits will become unsustainable. Then the debtors will have a choice: either default or else adopt a systematic reversal of policies: debt-repayment. This means a federal budget surplus and a balance of payments surplus. Balanced budgets won’t do it. There will have to be surpluses.

That day is coming. That will be the day of reckoning – of counting up.

The participants give no indications that they believe that day is coming.

Neither did Greece’s politicians in early 2010.


The heart of the disagreement between Keynesians and Austrians is easy to state. Each group has a unique selling proposition or USP. I have boiled them down into four words each.

Keynesians: Federal deficits overcome recessions.

Austrians: Tax cuts increase liberty.

If you are a glutton for punishment, you can view my presentation on this at the Mises Institute in 2010.

If you think about this, the positions can both be used to justify federal deficits in the short run. The federal deficit exists because tax revenues do not cover expenditures. Austrians favor lower taxes, no matter what. So, Austrians are concerned with the deficit because spending cuts do not match – or, better yet, exceed – tax cuts. The government continues to expand its operations. The goal of Austrians is to shrink the state. This means spending cuts.

The assumption of the Austrians is as follows. The government is not ready – will never be ready – to cut spending prior to a crisis that forces them to cut spending. They recognize that only a financial crisis will stop the government from spending. So, in the meantime, it is best to take whatever tax cuts we can get. This increases the deficit. But, the Austrian says, there are two ways to have a deficit: (1) with higher taxes, or (2) with lower taxes. Congress is going to spend. Which way is better for liberty? Austrians generally conclude: the lower tax/high deficit way.

But doesn’t this mean there will eventually be a Great Default? Yes, it does. But there is going to be a Great Default in either case: high tax or lower tax. So, let us keep more of our after-tax money today and prepare for that default. Congress is going to spend every dime that comes in, and then borrow against future revenues. Nothing will change this, short of a financial crisis when lenders will no longer lend at low rates. Call this the “Greek event.”

Keynesians applaud the deficit for a different reason. They see increased government expenditures as an enormous advantage for the economy. Federal borrowing enables the government to increase expenditures in the short run without tax hikes. There is therefore no tax revolt by voters. The government can therefore spend more as a result.

Austrians want less government spending. Keynesians want more government spending. Both sides accept a rising deficit. Keynesians think the deficit gives consumers a chance to increase spending, even if this means taking on more personal debt. They also think there will never have to be a Great Default. They trust deficits and central bank inflation to defer the Great Default forever.

Austrians think the deficit gives future-oriented people time to prepare for the Great Default, which is inevitable in a world dominated by Keynesian economics.


An analogous pair of attitudes separate Keynesians and Austrians over the long run, yet unites them temporarily.

Both schools of opinion favor free trade, meaning no sales taxes on imported goods and no import quotas. Both see this as an advantage for customers on both sides of a border, just as they see benefits from people trading across the street or even next door. Both schools of opinion favor customer authority. The difference is this: Keynesians think that economic planners, especially the federal bureaucracy, know best what is good for customers. Austrians think customers know best what is good for them. Keynesians want to use state coercion to benefit certain voting blocs over others. Austrians do not.

So, both groups look at the trade deficit, which is a subset of the balance of payments, and conclude: “no problem.” If some customers want to buy more than they sell – that is, if they want to borrow – that is their business.

Both groups of economists know there are limits to this process. A payments imbalance can exist only while lenders agree to lend to borrowers at rates borrowers are willing and able to pay. Loans must eventually be repaid.

But isn’t this also true of federal debt? Keynesians admit that, in theory, the U.S. government should run surpluses in good economic times, to reduce the debt. But, in practice, Keynesians never say “Congress should run a surplus next fiscal year.” I do not recall that any Keynesian in the last 50 years has recommended this in public. They may admit in theory that there should be surplus years, in which principal should be reduced, but that is always a theory only, never actual policy.

Austrians, understanding Congress and understanding Keynesians, recognize that federal surpluses cannot last long. So, the debt will grow. The goal, then, is to let taxpayers keep more of their wealth. Run the deficits. Let taxpayers keep more of their wealth. The losers will be the short-sighted lenders who let the U. S. Government borrow at historically low rates.

The economists have the same view of trade deficits. It’s up to customers to decide where to put their money. If they want to buy imported goods, that is their decision. If exporters want to sell on credit, that is their decision. This is what customer authority and seller’s authority is all about.

But isn’t it better to be an exporting nation? That is irrelevant for economic theory, say Austrians. What is relevant is individual authority, not political authority. What is relevant is for the government to butt out.

What about government-funded trade subsidies by exporting nations? Austrians say these are a bad idea. The government should butt out. But these subsidies do exist. The Austrians say, “So what?” But doesn’t this make American customers dependent on subsidies from foreign governments? The Austrian responds: “Flat-screen TVs are not heroin. If the exporters’ subsidies from their governments ever end, Americans will buy fewer imported goods. There will not be widespread withdrawal symptoms. It is silly to think of families’ budgeting as a de-tox program.” Again, this goes back to the Austrians’ view of individual responsibility. People should be responsible for what they do with their property. Governments should butt out.

Show me an advocate for tariffs as a tool of social planning, and I’ll show you a person with a central planner deep inside, trying to get out. “Tariffs must save customers from themselves.” So, the tariff supporter wants the government to send out people with badges and guns to tell citizens that they are not allowed to buy imported goods at “unfair” low prices. “I’m from the government, and I’m here to help you.” To which an Austrian-influenced shopper asks: “Then why are you pointing that gun at me?”

The critic of trade deficits says: “This can’t go on forever.” The Austrian says: “Then it will stop.” The critic says: “I think the government should use force to make it stop now.” The Austrian says: “Why is Congress competent to decide?”


The reason why there is a trade/payments deficit is this: foreign central banks buy U.S. debt. They create their own domestic currencies and use them to buy U. S. dollars. Then they use these dollars to buy U. S. government debt.

Why do they do this? Because it subsidizes exports. Their domestic currencies do not rise. Foreigners can buy more imported goods,

Every administration wants this to continue. Each Administration wants buyers of the government’s IOUs. Each Administration thinks that there will never be a time to pay off this debt. “Federal debt is forever. Federal debt will grow forever.” So, foreign central bank purchases of T-bills at 0.01% is free money for the Administration.

Politicians like free money even more than customers do. There is a reason for this: the all-or-nothing position of most members of Congress. Congress wants the export nations’ subsidies, which holds down Treasury debt interest rates. Unlike Congress, a customer can cut back on his spending and still muddle through. He cuts back at the margin. The politicians cannot cut back on their spending without being threatened by a loss at the next election. It’s all or nothing for members of Congress. It’s not all or nothing for a buyer of imports.

If a defender of tariffs wants to take a free market position, he should call for a ban on the sale of all government debt to foreigners. That is where the main export subsidy is. The government should pass a law: “As of [date], the United States government will no longer make interest payments on its debt to any owner of this debt who is not an American citizen. It will also no longer redeem its debt held by non-citizens.” Foreigners would start selling their U.S. debt on the day some Congressman begins sending the draft around to other House members. Interest rates would soar. The depression would begin. The Great Default would be next, either openly or by Federal Reserve hyperinflation.


This is why the twin deficits are connected. The U. S. Government is running massive deficits. Foreign central banks buy U. S. Government debt. This is the main form of their export subsidies: holding down their domestic currencies’ price in relation to the U. S. dollar.

There are other links. The main cause of the trade deficit is the cost of imported oil. The U. S. Government offers a military safety shield for Saudi Arabia. It allows the Saudis to buy American jets and weapons. The Saudi military is dependent on these exports from the U. S. So, the government accepts dollars for oil. It gets OPEC to do the same.

Again, the connecting links are made at the highest level: government to government.

This is good for American consumers of energy. It keeps oil prices low. It is a subsidy from OPEC.

The Austrian economist says, “Make hay while the sun shines. Consume cheap oil while it is still cheap. If Saudi bureaucrats want to sell us their only valuable resource in exchange for government promises to pay, good for American consumers.”

It is true that Americans may squander this cheap oil. They may not use the savings to save money the way intensely future-oriented people would. Americans will probably remain present-oriented. They will not sacrifice consumption today for more consumption later. But I do not expect Congress to balance the federal budget by cutting spending. I do not expect Congress to become the exemplar of future-orientation anytime soon.


Ludwig von Mises called this time preference. Some people are highly future-oriented. They are willing to sacrifice present consumption for even greater future consumption. Mises said they have low time preference. Other people are the reverse. So, at any given interest rate, some people will save more than others.

Mises did not pass judgment on people’s motivations. He did pass judgment against government policies that use coercion to restrict people’s peaceful pursuit of their own self-interest, as they see it.

There is a crucial economic chapter in the Book of Deuteronomy that recommends thrift. It is chapter 28. Here, we read of positive sanctions and negative sanctions relating to credit/debt.

The LORD shall open unto thee his good treasure, the heaven to give the rain unto thy land in his season, and to bless all the work of thine hand: and thou shalt lend unto many nations, and thou shalt not borrow (v. 12).

The stranger that is within thee shall get up above thee very high; and thou shalt come down very low. He shall lend to thee, and thou shalt not lend to him: he shall be the head, and thou shalt be the tail (vv. 43-44).

These passages indicate that it is better to be a creditor than a debtor. But this is another way of saying that it is better to be future-oriented than present-oriented. Low time preference is better than high time preference. Leadership is better than followership. “The rich ruleth over the poor, and the borrower is servant to the lender” (Proverbs 22:7).

These are ethical issues. They are not technical issues. There is great debate over whether a specific debt is a good idea or a bad idea. The old answer is correct: it depends mainly on whether the debt is for a tool or consumption. Even here, it is not always clear. A consumption debt – water in a drought, food in a famine – may be a good idea. The issue is (1) goal and (2) future-orientation. What is the purpose of the goal? If it is accumulation of assets, then the question arises: Accumulation for what?

The future-oriented person prefers greater capital in the future to present capital. He may be a miser. He may be a philanthropist with a vision. In either case, his desire for greater wealth in the future is reflected in his low time preference. He will save at a lower rate of return than a high time preference person will.

When this outlook is widespread in a society, it will be marked by reduced debt and increased credit. The old Jewish gag is this, “Why are there gentiles?” Answer: “Someone has to pay retail.” (This is qualified by an observation made by my Jewish roommate regarding Fresno, California in the 1940s: “When the Armenians moved in, the Jews moved out.”) But the gag has a corollary: “Somebody has to borrow.” To sell more, you must lend more. Low time preference people lend to high time preference people. It’s win-win, given the time perspective of both groups. But it may be win-lose if either side is incorrect about what lies ahead.

If a nation has the power to inflate its currency, the high time preference person may be a winner. The low time preference person lends in a currency that is worth a lot. After the inflation, the high time preference person pays off the loan by selling an egg. This happened in the German inflation of 1922-23. Farmers won. Urban people lost.

Is the American shopper stupid for buying cheap imports that have been subsidized by some Asian central bank’s domestic inflation and its willingness to buy bonds from the U.S. government? Not necessarily. When the FED inflates, as it will, the Asian central banks will find out how short-sighted their monetary policies were. They will discover that mercantilism fails.


The twin deficits – trade and federal – are linked. They are linked by (1) the mercantilistic central bank policy of inflating the domestic currency in order to buy IOUs from the U. S. Government, and (2) the Keynesian policy of increasing U. S. Government spending by borrowing. We have two fiat money governments specializing in what each does best. The Asians specialize in lending fiat money to buy fiat promises. Congress takes advantage of this blindness of Asians. Both sides say: “Let’s party!”

The winners are American consumers – for as long as the party continues.

December 8, 2011

Gary North [send him mail] is the author of Mises on Money. Visit He is also the author of a free 20-volume series, An Economic Commentary on the Bible.

Copyright © 2011 Gary North