Dean Baker on the causes of the current federal deficit

Dean Baker in President Obama Doesn't Understand the Origins of the Deficit FDL 07/26/2011 catches the President misstating the recent history of the federal deficit:

The Congressional Budget Office's projections from January of 2008, the last ones made before it recognized the housing bubble and the implications of its collapse, showed a deficit of just $198 billion for 2009, the year President Obama took office. In other words, the deficit was absolutely not "on track to top $1 trillion."

This is what is known as a "gaffe" of enormous proportions. It indicates that President Obama does not have the most basic understanding of the nature of the budget problems the country faces. He apparently believes that there was a huge deficit on an ongoing basis as a result of the policies in place prior to the downturn. In fact, the deficits were relatively modest. The huge deficits came about entirely as a result of the economic downturn brought about by the collapse of the housing bubble. This misunderstanding of the origins of the budget deficit could explain President Obama's willingness to make large cuts to core social welfare programs, like Social Security, Medicare, and Medicaid. [my emphasis]

There is another aspect to this, too, to which I'm not quite economics-literate enough to explain the connection to the factors Dean Baker identifies. Because the dollar is the world's reserve currency, other nations can be expected to hold dollars for their foreign-exchange reserves as long as the dollar maintains that role. That means that the trade balance will be continually in deficit, as it has been for many years. There is an accounting identity between domestic and trade deficits; combined public and private deficits equal the trade deficit. Since most states are required to balance their budgets, the federal government and private savers make up the domestic side of the equation. If private savers spend more than their income in a given year (a net private deficit), the federal government will run a surplus. If private savers earn more than they spend, which has been very much the case in the current Lesser Depression, the federal government will run a deficit.

I do know enough to say that this factor is consistent with what Baker observes, which is that the current "huge deficits came about entirely as a result of the economic downturn."

Tags: dean baker, us economy