If Budget Deficits Are Bad, Are Budget Surpluses Good?

In 1835, the U.S. government paid off all of its debt. So, why did that year mark the onset of the nation's first deflationary depression? There's an explanation. And, now, another country is wallowing in optimism about its budget.

Why would the financial surplus of a nation be a possible cause for worry?

After all, budget deficits and debt are bad things and surpluses are good -- a no-brainer. That's true, yet there is one nuance.

Consider a time in U.S. history when the government's debt had been erased (Conquer the Crash, 2002):

[I]n 1835, after over two decades of economic boom, U.S. government debt became essentially fully paid off for the first (and only) time. Conventional economists would cite such an achievement as a bullish "fundamental" condition. In actuality, that degree of government solvency occurred the very year of the onset of a 7-year bear market that produced two back-to-back depressions.

Government surpluses generated by something other than a permanent policy of thrift are the product of exceptionally high tax receipts during boom times and therefore signal major tops. They're not bullish; they're bearish and ironically portend huge deficits directly around the corner.

With that in mind, let's focus on the current financial optimism in Britain, where the FTSE 100 has been trending higher.

Britain's treasury just announced its largest January budget surplus since 2001. EWI's March European Financial Forecast adds:

In fact, under the previous calculation method, which accounted for corporate tax receipts differently, Britain's £9.4 billion January surplus was the country's largest since 1997!

In another sign of growing optimism, Chancellor of the Exchequer Philip Hammond has promised to cut the deficit below 2% by 2021 and eliminate it by 2025.

But, governments rarely fulfill their budget promises. And this chart and commentary from the March European Financial Forecast show you why Britain's deficit will probably get worse -- not better:

Budgets Getting Harder to Balance

Britain's national income has exceeded expenses as a percentage of GDP over just two relatively brief spans since 1985: the first following the stock market's surge in the mid-1980s, and the second occurring as the FTSE 100 blew off in the final leg of its late-1990s bull market.

In both cases, stocks peaked soon thereafter, and the resulting recessions quickly turned the budget surpluses into massive deficits.

The chart [shows that] the UK's overall financial condition has been worsening for decades.

Government spending in most advanced economies has been out of control for years. We see a new age of austerity just around the corner.

The time to be most cautious is when optimism is running extremely high, just like it was in the U.S. in 1835.

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