Surplus to America's economic requirements

Debt made the US. So Alan Greenspan's doubts about unbalanced budgets should surprise no one, least of all Democrats.

This week the Congressional Budget Office is set to forecast US federal surpluses even fatter than anyone had imagined. But the big public finance splash of the season came from Alan Greenspan, who delivered the lowdown on the federal surplus:

It is an evil, was the logic of what he had to say.

This revelation appeared to shock and offend America's political and financial actors, many of whom have argued that the focus of public finance must always be the systematic elimination of the federal debt. Over the course of the 1990s, this school of thought has become so ingrained that to diverge from it is considered heresy. Many Democrats are now accusing Mr Greenspan of selling out in order to win the affection of the tax-cutting, deficit-generating, Bush administration.

But the devil surplus as conjured by the Fed chairman is not a new one, not even to the chairman himself. When, in his testimony last week, he expressed surprise, it was not surprise at his own tax-cut-rather-than-surplus position. That he had laid out any number of times, including years ago, when the need to cuddle up to Mr Bush had not yet materialised on the political horizon. If he was selectively read at the time, that is not entirely his fault. No, the chairman's surprise was at the size of the surplus, and that it had accumulated so quickly.

In fact, the abhorrence of surplus and the appreciation of debt have deep roots in the Anglo-American tradition. Most obviously, there is John Maynard Keynes's argument that a surplus may lead to inadequate demand - too much taxation and too little government spending can slow down the economy. But there are at least three other important anti-surplus arguments.

The first is that great powers need to be debtors. Only then will they issue bonds that perform their necessary function of providing liquidity in financial markets. Mr Greenspan worried that, without its bonds, a debt-free Washington would be forced to invest in private sector bonds. This would lead to a lively debate over who got to sell bonds to the government - or, as he put it, make it "exceptionally difficult to insulate the government's investment decisions from political pressures".

In Hamilton's Blessing, his history of American debt,John Steele Gordon goes further, positing that debt may be a necessary concomitant to prosperity. Mr Gordon notes that Alexander Hamilton, the great consolidator of the young America's debt, helped turn a debtor collection of colonies whose credit was "not worth a Continental [dollar]" into a sovereign magnet for global capital. Hamilton's America was so admired that in 1794 it had the highest credit rating in Europe; the French diplomat Charles Maurice de Talleyrand called US bonds "safe and free from reverses".

Hamilton was influenced by the experience of 18th-century Britain, which used debt to expand. The key to the debtor empire's success, as Mr Gordon notes, was that the debt was properly structured and funded, with a portfolio offering a range of maturities. (Americans already feeling nostalgic about the demise of their long bond will find Mr Gordon's account of Consols, callable bonds of indefinite maturity, particularly interesting.)

The second argument against a surplus is that the cash could be put to better use elsewhere. This argument - similar to Keynes's concern - is that Adam Smith was wrong when he said: "What is prudence in the conduct of every private family can scarce be folly in that of a great kingdom." In fact, a government is more like a business than a family. And a business that spends too much money paying off debt forgoes the opportunity to invest in new ventures. Or, as Mr Greenspan put it, surpluses and their consequences "lower the potential growth of the economy".

The third argument against a surplus - and, in America's case, for tax cuts - is that it concentrates financial power in the hands of the government. A government will always spend a surplus and such extra spending in the public sector is dangerous. In more religious periods, other American leaders routinely couched this view in the language of the Church. In 1889, for example, the new president, the Presbyterian Benjamin Harrison, used his inaugural address to warn that "while a Treasury surplus is not the greatest evil, it is a serious evil". It led to wastefulness, he said, and "wastefulness, profligacy or favouritism in public expenditures is criminal". Mr Greenspan seems to share something of this view.

But if Mr Greenspan's anti-surplus position is so much grounded in tradition, why the controversy? The answer lies in politics. Democrats are angry not because they have always opposed deficit spending. They have not, at least not in periods such as the Great Society. They are angry because they feel Mr Greenspan has betrayed them. For close to a decade, his anti-deficit line provided economic and moral cover for their dual agenda: to make Republicans who want to cut taxes look like foolish big spenders; and eventually to expand the government. Anyone who doubts this need only recall Vice-President Gore's favourite 1996 campaign line - that Republicans would "blow a hole in the deficit" - and his 2000 Los Angeles convention speech, in which he promised government expansion costlier than any Bush tax cut proposal.

Now, by shining a spotlight on the anti-surplus component of his thinking, Mr Greenspan has permitted Republicans to snatch the mantle of respectability. Suddenly the previously spurned tax cuts have become healthy surplus blasters - and promoters of faster growth.

This is as it should be. No economic theory can suit all periods. The deficit fighters of the 1990s cast themselves as moral heroes. Now the enemies of surpluses have just as much right to claim the high ground.

© Copyright 2001 Financial Times

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