Month: September 2008

How Large is the Real Federal Deficit?

Politicians have a habit of trying to obfuscate facts that don’t paint a positive picture.  Thus when uncomfortable discussions on the federal deficit cannot be avoided, attempts are made to conceal its true size.  For instance, the Iraq war has been funded through emergency supplemental spending, leaving it outside the official federal budget and deficit numbers, though the spending is quite real.

A simple technique can be used to reveal the true* size of the annual Federal deficit. Since all federal revenue shortfalls (deficits) are paid for through increases in the total US debt, the increase in debt each year exactly equals that year’s real federal deficit.

Here is the amount of US Federal debt outstanding from 1997-2008, for Sept. 30th of each year:

Year US Debt ($ Billions)
2008 10,024
2007 9,007
2006 8,506
2005 7,932
2004 7,379
2003 6,783
2002 6,228
2001 5,807
2000 5,674
1999 5,656
1998 5,526
1997 5,413

Using this data, we can calculate the true Federal deficit for each year, and compare it to the publicly announced deficit for that year:

Year Official US Surplus / Deficit ($Billions) Actual US Deficit
($Billions, based on actual borrowing)		 % Larger than Official
2008 -410 -1017 115%
2007 -162 -501 209%
2006 -248 -574 131%
2005 -318 -553 74%
2004 -412 -596 45%
2003 -377 -555 47%
2002 -158 -421 166%
2001 128 -133 204%
2000 236 -18 108%
1999 125 -130 204%
1998 69 -113 263%

The Federal government’s need to borrow has been consistently understated in official deficits for the past decade, and has been as large as triple the official number! These numbers also show that the US government never actually ran a surplus at any time in the last decade. It appears that the first step to dealing with our government’s revenue shortfalls is to get our government to admit how large they are!

* Under US GAAP, federal deficits would be even larger, because they would take into account future Social Security and Medicare shortfalls. These programs are likely to be modified in the future, however, and so I believe that the method used above provides an accurate measure of the government’s cash deficit each year. This is a number most Americans would recognize – how much do you have to borrow to pay the bills each year?

** The argument might be made that during the “surplus” years of the late 90s, debt was increased simply to provide liquidity in treasury bond markets. This doesn’t make sense, however – if it had a cash surplus, the Treasury could easily have issued new debt while retiring old debt, leaving net debt unchanged. Economists generally take the view that government debt crowds out private sector borrowing, so why would the Treasury borrow if it didn’t need the funds?

Posted on by praveenghanta 8

We Need a Good Recession

“I believe if the credit markets are not functioning, that jobs will be lost, that our credit rate will rise, more houses will be foreclosed upon, GDP will contract, that the economy will just not be able to recover in a normal, healthy way.” – Ben Bernanke, Fed Chairman, Sept. 23rd, 2008

“that our American economy’s arteries, our financial system, is clogged and if we don’t act the patient will surely suffer a heart attack — maybe next week, maybe in six months, but it will happen.” – Hank Paulson, Secretary of the Treasury, Sept. 23rd, 2008

Even before testimony concluded yesterday on Capitol Hill, reports with headlines like “Bernanke: Recession Certain in Absence of Bailout” and “Bush Administration Tells Congress to Act Quickly or Risk Recession” hit the wire services. Both Ben Bernanke and Hank Paulson stated clearly that a recession would occur if the proposed $700 Billion dollar bailout plan were not enacted. Similar threats of recession were used earlier this year when President Bush and Congress enacted a tax rebate stimulus program.

Let me ask a simple question: why is everyone so afraid of a recession? Recessions and boom times are both natural parts of the business cycle in market economies, and the United States experienced twenty recessions (including the Great Depression) in the 20th century alone. Economic downturns, with the associated bankruptcies and layoffs, help trim inefficient investments made at the peak of economic cycles, thus paving the way for the next round of economic growth.

The alternative to business cycles can be found in state-controlled economies, where inability to reallocate capital to new enterprises slows overall economic growth dramatically. Governments presiding over market economies also attempt to tamper with business cycles, and while intervention may soften the landing in a recession, it may also delay the recovery. Japan’s “lost decade” of the 90’s, where poor economic growth was the norm, resulted after Japan’s incredible economic boom of the 80’s. The extraordinary length of Japan’s recovery stemmed partly from the Japanese government’s inability to allow corporate and bank bankruptcies progress at the rate needed to clear out bad loans and start a new economic cycle.

The US would do well to heed Japan’s allegory. Ideally, any intervention in the financial markets should enable orderly collapse and restructuring of businesses overridden with bad debt. No one gains in a financial panic, but an unwinding of the excesses of the US housing bubble is inevitable. Creative Destruction is at the heart of the business cycle, it’s at the heart of the American economy, and it will be necessary in this cycle as well. Let’s not make it take longer than necessary.

Posted on by praveenghanta 4