Hans F. Sennholz, “Deficits Do Matter” (2003)

Sennholz’s essay argues that federal deficits are not harmless accounting entries but claims on real resources, capital markets, money holders, and foreign dollar creditors. Written in the context of the Bush administration’s post-September 11 spending, projected deficits, and proposed tax cuts, it treats fiscal policy and monetary policy as parts of one system.

In their election oratory, politicians usually stress their love of fiscal discipline and balanced budgets.

The opening contrast is between campaign promises and governing incentives. Politicians praise balanced budgets before elections, then find emergencies, wars, programs, and constituencies that justify more spending. Sennholz presents George W. Bush’s shift from fiscal restraint to large deficits and tax reduction as a revealing instance of this broader pattern.

The prospect of soaring deficits and simultaneous tax reductions alarms a few economists.

The essay’s central concern is that deficits must be financed somewhere. If voluntary saving is insufficient, government borrowing competes for capital; if the strain becomes too great, the Federal Reserve can create credit that enables continued federal spending. Sennholz therefore links deficit finance to inflationary monetary policy, arguing that central-bank accommodation transfers the burden from explicit taxation to depreciation of money and financial claims.

He also connects federal deficits to state fiscal pressure. Because state governments must balance budgets, they tend to raise taxes, fees, or exactions or cut spending when revenues fall. Federal tax reductions may therefore coexist with state-level fiscal tightening, complicating the political image of general tax relief.

The essay’s deeper framework is international monetary history. Sennholz traces the dollar’s role from Bretton Woods, when it was linked to gold, through Nixon’s suspension of gold convertibility and the emergence of a floating fiat dollar standard.

It is a fiat standard, unbacked and irredeemable, which can be inflated and depreciated at will.

This monetary order, in his view, gives the United States unusual latitude. Other countries that inflate aggressively face balance-of-payments pressure and currency weakness, while the United States can finance deficits by issuing dollar liabilities widely held abroad. Reserve-currency privilege thus delays adjustment but increases systemic danger.

Sennholz reads recent history as evidence of cumulative imbalance: the inflation of the 1970s, the debt expansion of the 1980s, the stock-market boom of the 1990s, the Asian crises, and the recession after 2001. These episodes show, for him, how credit expansion can mask weakness before producing sharper instability.

The floating system based on the U.S. dollar has been a precarious structure ever since its inception.

The conclusion warns that foreign confidence is crucial. By the early 2000s, foreign investors held large quantities of U.S. assets, and dollar depreciation had already imposed losses on them. If they began liquidating dollar claims, the United States could face a renewed currency crisis resembling the late 1970s.

Both point towards monetary upheavals and deep global recession straight ahead, and both cast a shadow on the future of the dollar standard.

Sennholz’s final claim is therefore stark: deficits matter because they depend on either real saving, higher taxation, or monetary expansion. When political authorities choose persistent borrowing supported by central-bank credit, they weaken the dollar standard and expose the global economy to financial upheaval.