Budget Deficit needs to get Bigger to get Better

This year, government spending is set to annihilate previous U.S. budget deficit records. Even so, the government may be under pressure to spend more, not less.

In the 1986 comedy film Armed and Dangerous, attorney Norman Kane declares, "I sincerely feel that the facts are completely irrelevant in this case." The statement may be geared for laughs, but it might also contain a hint of advice for the decision makers who are working to stabilize the U.S. economy.

Expect a record-breaking year

The U.S. government's fiscal year 2009 began on October 1. After just one month, government spending outpaced tax revenues by more than $237 billion. This compares to a shortfall of $56.8 billion last October. Clearly, fiscal year 2009 is on pace to shatter previous U.S. budget deficit records. Some estimates indicate that the difference between tax revenues and federal spending for the year could be in excess of $1 trillion. That's almost 10 percent of the existing federal debt.

The annual interest burden of the federal debt is already well in excess of amounts spent on education, NASA, and transportation, combined. Deficit spending will lead to more borrowing, which will squeeze the budget and leave less room for spending on other programs.

Yet, despite the dangers of burdening taxpayers with excessive debt, massive deficit spending may be exactly what this economy needs.

Lending makes the world go 'round

The U.S. economy is facing its worst economic downturn since the Great Depression. This economic cycle is different from other slowdowns, because it's been largely prompted by a shutdown of the credit markets. Banks have become increasingly unwilling to lend, even to each other. And this trend has caused a logjam in our economy; banks are collecting debt repayments and deposits, but they aren't putting that cash back into the money supply by lending.

A shrinking money supply can give rise to deflation, which is potentially one of the most devastating economic circumstances. Severe deflationary trends usually spark extended economic depressions, marked by very high unemployment. The last time the U.S. did battle with extreme deflation was during the Great Depression.

If banks won't lend, it's time to spend

To overcome the economic crisis that we're currently facing, the Fed would typically attempt to expand the money supply by lowering interest rates to stimulate borrowing. Unfortunately, interest rates are already pretty low; with the fed funds rate at a meager 1 percent, there's little room for dramatic cuts. If lenders won't lend, the U.S. Treasury can force an expansion of the money supply by borrowing and spending. Long-term, this strategy will do some damage to the financial health of the government-but that may be preferable to watching the country slide into another Great Depression.

As counter intuitive as it sounds, wild federal spending may, for once, be a good thing. Or, as Norman Kane might say, fiscal responsibility has no bearing on this economic situation.