Megan McArdle is upset over the deficit numbers. Naturally, I’m thrilled. This is exactly what I intended when I suggested, as early as 2008, that the government slash the payroll tax and allow immediate depreciation on capital expenditures.

Since I wasn’t calling for huge cuts in government expenditure but I was calling for huge cuts in government revenue the natural result was a huge deficit. Its only mechanical.

However, that’s a good thing. We are moving liabilities off the household and business balance sheets – which are credit constrained and in some cases overloaded. We are putting those same liabilities on the government balance sheet which has no constraints on its credit what so ever.

How do I know?

5-years auctioned off yesterday with a super strong bid-cover of just under 3. That means 3 times as many people submitted bids to buy Treasuries as there were Treasuries for sale.

There is a clear reason for this. If the government takes out a loan and then gives that proceeds of that loan to taxpayers, the balance sheet of the US as a whole has not deteriorated. The government owes more, the people owe less.

So increasing the supply of US debt in and of itself doesn’t hurt the US’s asset position. It does, however, arbitrage the difference between private borrowing costs and public borrowing costs.

Performing this type of credit arbitrage is one the main functions of a financial system, however, ours is still working its kinks out and building back up its capital base. Thus, its helpful for the Feds to step in and do the arbitrage for us.