Practical analysis for investment professionals
06 November 2012

The Case for a Balanced Budget Amendment

Posted In: Economics

Lacy Hunt, executive director at Hoisington Investment Management, believes the debt problem in the United States and the other major economies is far worse than most realize, and he thinks an amendment to the constitution mandating a balanced Federal budget may be the only thing that can save us from a disastrous outcome.

“The ‘Keynesian Endgame’ that is increasingly part of the lexicon refers to a government becoming so excessively indebted that it loses access to credit,” he said at the Fixed-Income Management 2012 conference in San Francisco.

While historically low yields on US Treasury debt would seem to indicate that losing access to credit markets is not an imminent prospect for the United States, Hunt warned that debt accumulation trends in the United States are having increasingly negative economic effects that could take a long time to reverse.

Worse, interest rates won’t provide the early warning system many expect, a consequence of financially repressive Fed policies. By the time rates signal a problem, it may be too late to do anything about it, according to Hunt, who previously served as the chief economist for HSBC and a senior economist for the Federal Reserve Bank of Dallas.

Hunt traced the roots of the US debt problems to the election of 1960, when both major political parties favored greater government involvement in the economy, a policy advocated at the time by Yale economist James Tobin. But contrary to what many believe, deficit spending has not improved the economic outcome.

“Physical investment must equal savings and income over the long term,” Hunt said, citing two studies that suggest that debt accumulation beyond certain thresholds negatively impacts economic growth. In a 2011 study published in the Journal of Economic Surveys, Andreas Bergh of Lund University and Magnus Henrekson of the Research Institute of Industrial Economics found “an increase in government size by 10 percentage points is associated with a 0.5% to 1% lower annual growth rate.” This reinforced the findings of a study commissioned by the ECB, which concluded that the “negative growth rate effect of high debt may start from levels of around 70–80% of GDP.”

US aggregate public and private debt is now upwards of 350% of GDP (not including unfunded liabilities, which would bring debt-to-GDP to 750%), and Hunt noted that much of this is what he called “unproductive debt,” taken on to fuel consumption rather than generate lasting economic benefit.

“We’re in way over our head, and the mix is wrong,” he said, referring to the amount of US debt. According to Hunt, consumptive debt crowds out productive investment and weakens the overall economy over time, as the velocity of money falls despite increasing government spending. This is happening now.

“The business cycle is no longer really operating, and GDP growth is being misinterpreted. GDP measures spending, not prosperity,” Hunt said. “While GDP has gone up, real incomes have declined,” and the symptoms of economic dysfunction in the United States are becoming all too apparent:

The way out of this mess? The solution, according to Hunt, is a sustained increase in savings, sometimes referred to as “austerity.”

“The way you reverse over-indebtedness is by living within your means,” he said, suggesting that economist David Hume was correct when he wrote in 1752 that “the normal course of government activity should be to run a surplus.”

As Hunt sees it, the only way to achieve a balanced Federal budget is by enacting a Constitutional amendment, as advocated by economist Milton Friedman almost 30 years ago.

Japan, meanwhile, presents an example of what not to do, according to Hunt. “Japan has reduced the savings rate, trying to reduce indebtedness,” and over two decades has failed to generate sustainable economic growth, he said. The United States is “now on that path.”

Please note that the content of this site should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute.

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About the Author(s)
Charlie Henneman, CFA

Charlie Henneman, CFA, is head of educational events and programs at CFA Institute. Previously, he was the director of structuring and operations at Indosuez Capital, the CDO (collateralized debt obligation) management group of Credit Agricole Indosuez. Henneman previously held several positions in credit and structured finance, including managing director at advisory boutique AGS Financial, senior vice president and chief credit officer in the new products and ventures group at Enhance Financial Services Group, Inc., and director in the new assets group on Standard & Poor's structured finance ratings team. He holds a BA in political science from the University of Rochester and an MBA in finance from the New York University Stern School of Business.

6 thoughts on “The Case for a Balanced Budget Amendment”

  1. Frank Ashe says:

    How can a government such as the US lose access to credit? Anybody who follows the cash flows (no theory, just basic plumbing) shows that in a fiat money system this is impossible for a sovereign state.

    Note, the Eurozone problem is a problem because the states aren’t sovereign.

  2. oblivia says:

    Hard to believe that the answers to our problems are to be found in the works of an 18th century economist who was writing about an economy in which money creation was limited by the gold standard.

  3. David Merkel says:

    Which says that we will go through a Depression before this mess is cleared up, unless the Fed actually creates inflation on a large scale which would also be impoverishing.

    The illusions of wealth and the middle class in the US will be unwound, and lesser skilled labor in the US will earn what their counterparts do globally.

  4. mahilena says:

    Federal Budget is not like a household budget…also the US is a Monetarily Sovereign country it can run a successful deficit..and it can spend to balance the risky cycles of the markets in addition, Gov must be always ready to finance a war…BALANCE BUDGET AMENDMENT is thinking as if we were living under the GOLD STANDARD we are not subject to a limited supply of money …our monetary system is an electronic dash board and nothing more even without printing money we can take care of paying what we need to pay for..CONSERVATIVES must understand that the World changes and we are not living in the era before Nixon

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