INSIGHTS: FEDERAL DEFICITS ARE WORSE THAN YOU THINK
By Guest Columnist Mark Brandly:
Professor of economics at Ferris State University and an Associated Scholar of the Mises Institute. Reprinted with permission.
Voters tend to be rationally ignorant. Since a single vote does not matter, for most potential voters the cost of being politically well-informed is greater than the benefit of being knowledgeable about political affairs. Therefore it’s rational for most voters to be ignorant regarding political issues.
A main reason for the high cost of being well-informed is that government officials may not want the public to be well-informed. They purposefully conceal their schemes to reduce the opposition to their policies. A well-informed body politic would be a threat to the welfare and warfare state.
This obscurantism is on full display regarding the government budget.
Let’s start with the annual deficit. You may have noticed that the stated annual deficit is less than the increase in government debt. In order to explain this, consider a small scale example. Assume that you were $20,000 in debt at the beginning of 2017 and you earned $3,000 and spent $4,000 during the year. You borrowed $1,000 to cover this spending so your total debt increased to $21,000. A sensible reading of this situation would be that you had a $1,000 deficit in 2017 (multiply these numbers by a billion dollars to roughly approximate what is generally asserted to be the federal budget).
However, if you followed the federal government’s method, you would claim a deficit of, say, $600. According to the feds, the official deficit is less than the increase in total debt. How do they do this? Well, some of the borrowed money is simply not included in the deficit. For example, in fiscal year 2016, they claimed a deficit of $587 billion even though the total debt increased $1,422 billion and the debt held by the public (the total debt less the intragovernmental debt) increased $1,049 billion. They hide some of the deficit by simply declaring that some of the increased debt is not part of the deficit.
But this deception is of little consequence compared to the government’s claims about its spending habits.
According to the “Economic Report of the President,” government spending (outlays) over the twenty year period from Fiscal Year 1998 to FY 2017 more than doubled from $1,652.5 billion to $3,981.6 billion. In real terms, using the implicit price deflator as our measure of inflation, this was a 67% increase in spending.
Let’s take into account the economic growth during this period. Again, according to the Economic Report of the President, real GDP increased 54% in this twenty year period. So spending as a percentage of GDP only increased from 18.9% of GDP to 20.5% of GDP. It’s important to note that this does not include the substantial amount of spending at the state and local levels of government.
But the “Economic Report of the President” does not give us the full story of the government’s budget.
Return to the previous example. Assume that you were $20,000 in debt at the beginning of the year. But in addition to your $4,000 of other spending you were required to make $8,000 of payments on this debt in 2017. Your income was only $3,000. So you borrowed $9,000 to cover your deficit plus principle payments (again multiply these numbers by a billion dollars to approximate actual federal spending).
This example is roughly the situation for the federal government.
The Treasury Department with their Daily Treasury Statements (DTS) gives us an accounting of all deposits into and withdrawals from federal government accounts. The DTS shows that withdrawals more than tripled from $4,036 billion in FY 1998 to $12,995 billion in FY 2017. This is all outlays of federal spending, including government purchases, transfer payments, interest payments, principal payments on their debt, and all other withdrawals.
Adjusting for inflation, again using the implicit price deflator, this is a 124% increase in spending over twenty years. And DTS withdrawals as a percentage of GDP increased from 46% to 67% of GDP in this time period.
Let me say this again. If we define spending as total withdrawals from government accounts, then FY 2017 spending was $12,995 billion and government spending is 67% of GDP.
So, is federal spending, in 2017, 20.5% of GDP or 67% of GDP? What is the discrepancy between these estimates? The main issue here is the government’s debt service payments. Federal debt held by the public increased from $3.8 trillion at the start of FY 1998 to $14.7 trillion at the end of FY 2017. That’s 287% in twenty years. This has led to an increase in debt payments (called Public Debt Cash Redemptions) from $2.18 trillion to $8.43 trillion over this same time period. That’s right. The federal government paid $8.43 trillion in debt redemption payments in FY 2017. That’s ten times the Social Security Benefits paid out ($842 billion). Not counting these payments when reporting government spending is the chief reason that federal spending is reported to be 20.5% of GDP.
In order to cover the 2017 payments servicing the debt, federal government borrowing (called Public Debt Cash Issues), again this information comes from the DTS, was $8.89 trillion. This was the borrowing necessary to cover the $8.43 trillion in debt payments and the deficit resulting from the remaining parts of the budget.
Should this be a concern? On one hand, borrowing to pay for previous borrowing does not substantially change the government’s balance sheet. $8.4 trillion of liabilities is still $8.4 trillion of liabilities. In that sense, we should not be concerned about this matter. We should instead focus on changes in the total debt (the true deficit) and interest payments on the debt of $240 billion in FY 2017.
However we must recognize that debt payments are a form of government spending and the fact that the feds must finance this spending. Due to the principal payments on the debt, 77% of federal spending is financed by borrowing. As the overall debt rises, the risk of default grows and lenders will demand higher interest rates on government securities to account for this risk. Borrowing to make the interest payments will compound the size of the debt. This exponential growth of the debt increases the risk associated with lending to our government and intensifies the problem.
Federal government spending is much higher and their budget position is more precarious than is typically reported. Including the federal debt payments as reported by the Daily Treasury Statements provides us with a more accurate picture of the federal budget and a better understanding of a possible upcoming budget crisis.
ON THE ECONOMY: SUMMERTIME BLUES
By John Dunham:
Managing Partner, John Dunham & Associates
Well I’m a gonna raise a fuss, I’m gonna raise a holler about workin’ all summer just to try an’ earn a dollar. Oh Lord, I call my baby, to try to get a date. Sometimes I wonder what I’m gonna do. ‘Cause there ain’t no cure for the summertime blues. Ok, what on earth does the 1958 song by Eddie Cochran and his manager Jerry Capehart have to do with metal? Well, the 1968 version, recorded by the American rock band Blue Cheer and released on their album Vincebus Eruptum, is considered by many to be the first heavy metal song.
I am currently at the Metals Service Center Institute’s annual economic summit so it seemed as if writing about the metals sector of the economy would be appropriate. We at John Dunham & Associates are fortunate in that we have the opportunity to work with clients in both the major metals producing trade associations, as well as major consuming industry associations. As such, we can often find ourselves on both sides of certain issues (for example tariffs), so we really need to make sure that our research on these topics is as unbiased and accurate as possible.
In this article, I’m going to present a summary of what I am hearing at the conference. This is a really important segment of the economy, and metals serve as an input to virtually every sector, so as metals go so does the economy.
From what I am hearing here, the metals industry is booming right now, but not because of the tariffs. Rather, the changes in the tax code, as well as a world economy that seems to finally be firing on all cylinders has pushed up demand and prices. The American economy, in particular, is very strong. Consumer demand is up as are business investments, which are up by 7 or 8 percent over last year. The problems in the economy are those that come from success – inflation is starting to rise and job growth will likely begin to fall, simply because there are no more people to hire.
In general, it appears as if the economy will continue to be strong at least until the second half of 2019, but there are some storm clouds on the horizon that could bring the party tumbling down. The most concerning issue is trade. Right now, the balance of trade deficit is in line with post gold-standard averages, with large merchandise trade deficits offset in part by services surpluses. But trade frictions are starting to impact trading partners including Turkey, China, Brazil and Germany. A collapse in one of these economies could ricochet through the world economic system. But according to those presenting here, the Administration’s combative push on trade is probably necessary.
The President campaigned on reducing the trade deficit, and has taken a range of actions against both friend and foe. This is part of his objective to regain economic sovereignty by moving American trade policy away from world organizations to more bi-lateral deals. The Administration believes that there are true national security issues in industries like steel and aluminum and is using the big stick of trade actions to move toward more of a managed trade system with partners in Europe, Asia and the Americas.
The real trade issues are with China, and the current mercantilist system espoused by that country are unsustainable. It is likely that the Administration will use actions to force trade concessions on the Middle Kingdom, but China will likely react by either trying to get around tariffs (i.e. by exporting more parts and less raw steel and aluminum) or by using its geopolitical clout and influence with countries like North Korea, Iran and Pakistan to punch back.
Overall, the Administration sees this as a longterm game, and a battle that the country cannot lose. Trade issues will be one of the big exogenous factors playing on the economy over the next few quarters.
The take away from this heavy metals meeting is that the world and American economy is peaking about now. There is not a lot of potential upside, and there are a range of factors – mainly trade related – that could likely lead to the next recession.
Hopefully, we can manage these risks, and won’t be faced with the summertime blues by next August.
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