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One of the
problems with the debate over the "national debt" is that there's no
generally agreed upon definition of that term. Is it what the federal
government owes, or what it owes foreigners, or what the whole country,
private and public sector together, owes? Does it include off-balance-sheet
items and contingent liabilities?
There's a
hundred-trillion dollar gap between lowest and highest on this spectrum,
which allows each commentator to confuse the rest of us by picking the
measure that best suits their point of view. New York Times columnist Paul
Krugman, for instance, uses "net
debt" -- the amount that the US owes foreigners -- to argue that since
this number is relatively small and slow-growing, we're actually fine.
Analysts using broader definitions of debt come to the opposite, more
apocalyptic conclusion. Consider this from today's Wall Street Journal, on
the impact of off-balance-sheet obligations:
Smoke,
Mirrors and Public Deficits
By Richard Barley
Are public
debt and deficit numbers illusory? Perhaps, judging by the ruses employed by
governments and identified by the International Monetary Fund's Timothy Irwin
in a recent staff note. Deficit crises in developed countries may only
increase the allure of such devices, although they may do little to help in
the long run.
European
countries got creative as they strove to hit targets to join the single
currency during the 1990s. In 2005, Organization for Economic Cooperation and
Development researchers cataloged 192 cases of one-time measures and
accounting maneuvers across Europe--50 in Greece alone--with effects ranging
from negligible to 2% of GDP. In 1997, for instance, France took on the
pension liabilities of France Télécom
in exchange for a payment of €5.7 billion ($7.6 billion), or 0.5% of
GDP.
But Europe
wasn't alone in playing games. In 2003, the U.S. proposed buying 100
refueling planes via operating leases, which would have kept the cost from
being recognized upfront. The Congressional Budget Office said that was
federal borrowing in disguise and would prove more expensive than a normal
purchase.
The euro-zone
debt crisis has put these techniques front and center. Portugal hit its 2011
target only via a transfer of bank pension assets that shaved 3.5 percentage
points off its deficit.
Likewise, the
U.K. is taking on the Royal Mail's pension plan to pave the way for
privatization. The plan brings with it £28 billion ($44.8 billion) of
assets, thereby reducing the country's 2012-13 deficit. But the U.K. is also
taking on long-term liabilities on behalf of the company with a present value
of £37.5 billion--which aren't recognized immediately. So accounting
transforms the Royal Mail's pension deficit into a short-term gain for the
U.K. budget but at a long-term cost.
Keeping
long-term liabilities out of the picture is a common tactic: In the U.S.,
debt was 62% of GDP in 2010, but including civil-service pension and other
liabilities raises the total to 113%, Mr. Irwin notes. Public-private plans
for infrastructure have also shifted upfront investment costs off-budget but
have raised long-term debt risks--often through government guarantees.
The crisis
has narrowed governments' options. One way to flatter the statistics is via
optimistic growth assumptions, although skeptical markets and the rise of
independent fiscal watchdogs such as the U.K. Office for Budget
Responsibility make this difficult. Another way is to shift cash flows
forward, as Germany, Greece, Portugal and Belgium did in the past via
securitizations of future government revenue. This, too, may now prove a
tricky sell.
Investors
trying to keep track of governments should remember Goodhart's
law: As soon as an indicator becomes a target for conducting policy, it loses
its informational value. It also becomes a target for manipulation. That is a
sobering thought given the euro zone's obsession with deficit targets. They
might just conceal problems building up elsewhere.
Then there
are the "unfunded liabilities" of entitlements like Social Security
and Medicare, which dwarf the official national debt. From a recent Zero
Hedge article:
Massive
$17 Trillion Hole Found In Obamacare
Two years ago, when introducing then promptly enacting Obamacare,
the president stated that healthcare law reform would not cost a penny over
$1 trillion ($900 billion to be precise), and that it would not add 'one
dime' to the debt. It appears that this estimate may have been slightly
optimistic... by a factor of 1700%. Because coincident with the recent
Supreme Court debacle, in which a constitutional law president may be about
to find that his magnum opus law is, in fact, unconstitutional, someone
actually read the whole thing cover to cover, instead of merely relying on
the CBO's, pardon Morgan Stanley and Goldman Sachs', funding estimates. That
someone is Republican Jeff Sessions who after actually running the numbers
has uncovered that the true long-term funding gap is a mind-boggling $17
trillion, just a tad more than the original sub $1 trillion forecast.
This latest
revelation means that total underfunded US welfare liabilities: Medicare,
Medicaid and social security now amount to $99 trillion! Add to this total US
debt which in 2 months will be $16 trillion, and one can see why Japan, which
is about to breach 1 quadrillion in total debt (yen, but who's counting), may
want to start looking in the rearview mirror for up and comer competitors.
And while Obama may have been taking creative license with a number that is
greater than total US GDP, he was most certainly correct when saying that Obamacare would not add a penny to US debt. Because the
second the US government comes to market to fund a true total debt/GDP ratio
of 750%, it is game over, and the Fed will have its hands full selling
Treasury puts every waking nanosecond to have any time left for the daily 3pm
stock market ramp.
Here's a
chart illustrating the impact of adding unfunded liabilities to the national
debt (can't recall where I got it; my apologies to its creators for the lack
of citation):
There are two
reasons that debt and unfunded liabilities are treated as separate things:
- The practice allows government
to hide its true obligations in the same way that Enron did -- right up
to the day it evaporated. In other words, it's is a legally sanctioned
lie.
- Debt and unfunded liabilities
are, at first glance, different in some ways. Debt is a legal obligation
that gives the lender recourse, i.e. some way of getting back some of
their money. In the private sector a lender who's not getting paid can
seize the borrower's assets or force the latter into bankruptcy court
where a judge decides who gets what. With sovereign debt, the creditor
(who lent money by buying bonds) can sell those bonds and use the
proceeds to buy up the borrower's assets.
Unfunded
liabilities, in contrast, are simply promises that don't carry a legal
obligation. In theory, Medicare could be cancelled tomorrow by Congress. Just
like that, the program and its associated unfunded liabilities would
disappear.
So the
question becomes, how real -- and therefore how dangerous -- are US unfunded
liabilities? The answer is that because they represent a promise to tens of
millions of retired baby boomers who expect to get free money and health care
for the last 30 or so years of life, they're effectively more real an
obligation than a Treasury bond.
A politician
who messes with the Most Selfish Generation's free health care will find
himself back in the harsh private sector world of actual expected results
before the polls close in the next election. Compare this with the probable repercussions
of stiffing China or Saudi Arabia on bond interest -- some contentious
headlines and a bit of turmoil in the foreign exchange markets that most
voters would hardly notice -- and it's clear that unfunded liabilities have,
if anything, a more solid claim on future economic activity in the US than does interest on Treasury bonds.
So our true
national debt is government debt plus private sector debt plus
off-balance-sheet obligations plus unfunded liabilities, which comes to
somewhere around half a million dollars per man, woman and child, or two
million per family of four.
We can't pay
this of course, so the story of the next few years will be the search for the
least painful way of breaking our promises. And history is pretty clear on
this: a country with a printing press will always use it before exploring the
harder options of actual default, whether through non-payment of interest or
cancellation of benefits.
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