Barack Obama has now come clean about his thinking on why his administration has decided to focus first on reducing the deficit and next on jobs. He fears a double-dip recession will occur if foreigners lose confidence in the U.S. dollar, causing interest rates to spike.
This is nonsense and it demonstrates how much at odds Obama's economic thinking is with reality. In fact, by focusing on deficit reduction, he has increased the chances of a double dip instead of decreasing them. This is the clearest indication that the Obama Administration doesn't understand how modern money works.
What Obama actually said
At issue is whether the federal government's enormous debt burden in the U.S. could cause investors to lose confidence in the U.S. government and shun its debt.
In an interview on Fox News today, the President said the following:
I think it is important though to recognize that. If we keep on adding to the — Even in the midst of this recovery that at some point. People could lose confidence in the US economy in a way that could actually lead to a double dip recession.
Is this really true though?
How deficits really work
Think of an economy this way: the people in any economy buy goods and services from one another and from the outside. In any given time period, one person, one company or one group/sector might use credit in order to buy more goods and services than it makes in income. It's like spending future income by using credit. This puts that individual, company or group/sector in deficit i.e. they have spent more money than they have earned. Now obviously, if one sector is in deficit in a given period (i.e. they have spent more capital than they have earned), then another sector is in surplus (i.e. they have received more cash than they have earned).
Let's give these groups/sectors of the economy names: the private sector, the public sector and the foreign sector. Giving the groups names makes it plain that if the public sector is in deficit, the combined foreign and private sectors must be in surplus. Simply put, if you look at all of the households and businesses that make up the private sector and aggregate them together, you can determine if the private sector has a net surplus or a net deficit in any individual time period. And if the private sector has a net surplus, the combined foreign sector and public sector must have a deficit for that time period. The sector financial balances move in concert.
What this means for today is that a government which reduces its deficit in a given time period is forcing an equal reduction in surplus in the private and foreign sectors.
