The Beverley Hillbillies and the Fiscal Cliff-Part 2

My recent post The Beverley Hillbillies and the Fiscal Cliff sparked considerable debate amongst some of my regular readers. With this in mind I wanted to write a detailed response, specifically to the interesting points raised by Algernon Percy on the current fiscal position of the US.

Algernon Percy said:
Remember that this imaginary household ('back of the envelope' figures) – 1) Lives in, and owns a house worth $563,000 (total value of tangible assets in America) 2) Has total wealth of approximately $750,000 (a capital base which is growing all the time) 3) Is able to print / devalue the currency The household is therefore approximately 15% geared, but interest cover is 40 x (GDP/ interest cost), the household is in work (becoming more busy by the day) and its income and asset base is growing all the time. Also, new joiners are joining the household (immigration). Conclusion – It’s certainly not the way I’d run my household, but as an outside observer, I’m not too concerned that they are going to hit the rocks.

I think Mr Percy is making a fundamental mistake: my original blog post took the state of US government finances and turned them into a household budget of the sort Jed Clampett might have understood. Mr Percy suggests that I am wrong to worry about the US financial position on this basis because of the private sector’s assets. But if we bring in the private sectors assets, we will also have to bring in their debts, and I also have some doubts about the assets.

The debt figure I quoted is just Federal debt. The total debt is far higher. On top of the $11,279bn of Federal debt, we must add:

▪   State and local government debt ($3,008bn)
▪   Private debt ($41,071bn)

Then there’s quasi-debt and off balance sheet debt:

▪   Federal debt owned by the welfare agencies ($4,711bn) ▪   Pensions owed to Federal employees ($5,792bn) ▪   Forward welfare commitments, in excess of assets, owed by Social Security (“OASDI”) and Medicare. I’ve reduced this from the official (75-year) number to a shorter (30-year) period, but still come to $36,472bn. (Others, such as Laurence Kotlikoff, put the quasi-debt number very much higher than this).

So total debt, for the all the Clampetts (now defined as America-private and government) averages $553,579, rising to $1,023,329 if we include quasi-debt:

	$	Clampetts	$bn
Private	$41,071,400,000,000	$410,714	$41,071
Government debt:
Federal debt	$11,278,900,000,000	$112,789	$11,279
State & local debt	$3,007,600,000,000	$30,076	$3,008
Total government debt	$14,286,500,000,000	$142,865	$14,287
Total debt	$55,357,900,000,000	$553,579	$55,358
Intra-agency	$4,711,000,000,000	$47,110	$4,711
Pensions	$5,792,000,000,000	$57,920	$5,792
Medicare and OASDI	$36,472,000,000,000	$364,720	$36,472
Quasi-debt	$46,975,000,000,000	$469,750	$46,975
Government debt & quasi-debt	$61,261,500,000,000	$612,615	$61,262
Grand total	$102,332,900,000,000	$1,023,329	$102,333

Turning to the assets, according to the Fed, household assets, at the end of 3Q 2012, were $78,204bn, pretty close to Mr Percy’s total. But the validity of the asset figures for this purpose (debt service) is highly debateable.

Real estate is worth what it can be sold for. You cannot sell a country’s entire housing stock, so any real estate value for this purpose is is notional. (This where the household analogy breaks down-you might choose to live beyond your means and realise your property assets but a whole nation can’t). They can only sell homes to other Americans - so they are worth what their fellow citizens can afford to pay you, a zero-sum figure. The boomer generation, who will need to monetise these assets, will have to sell them to a younger generation, who are fewer in number, and poorer.

Stocks-Again, you cannot monetise the whole lot, so the capital value is largely notional en masse.  

So very little of the assets are actually cash-equivalent and available to service the debts. That needs to be done from the income of $23,480pa. So I think that America is closer to those rocks than Mr Percy thinks.

 

Comments

[dezzie]

More than 50% of Fundsmith's money (£800M) is directly invested in the USA. Are the chosen companies as resilent to the present situation as they have been to other crises over the past 100 years? We investors all hope they are.

[Terry Smith]

Dezzie: We are less interested in where a company is headquartered or listed than in where it does business. Almost all of the companies that Fundsmith is invested in operate internationally if not globally. As for resilience, on average they were founded in 1902 so they survived two world wars and the Great Depression so we hope and expect they will survive the present difficulties.

[Andrew]

I think we can debate "quasi" debt vs actual debt until we're blue in the face (I think there's a good argument to class inter-agency debt as actual debt...but PV'ing future expenditures is much more dubious). I'd also caution against using a "household" as an analog for the "government".
Firstly: households owe money to someone else outside the household but U.S. debt is largely owed to Americans themselves.
Secondly: households have to pay off their debt; governments do not.

In any event, I think there's an easier way to look at this problem: the objective is not suddenly to start running a budget surplus but rather to ensure that government debt as a share of GDP is going down rather than up. (I'll qualify that by saying one shouldn't expect to achieve that goal during a recession).

When looked at from this perspective, the gap you have to fill is considerably less than the USD 1 trillion that's being bandied about.

[Terry Smith]

Andrew: We don’t need to argue about quasi debt-America is in a precarious enough situation based upon its actual debt-but the idea that social security and healthcare liabilities are not part of the financial burden is a novel idea which will never catch on in the corporate sector which has to undertake accrual accounting. The analogy with households is good in my view. Traditionally individuals could not run core debt which was not repaid unlike government and corporations because they died and the governments and companies did not-they carried on indefinitely. But in the modern age it seems to have been accepted by banks and society that individuals can similarly run some core debt which is never repaid-that is exactly what an interest only mortgage is. As for who owns US government debt-there is a large and growing sum owned by the Federal Reserve which presumably you are counting as part of the American owned portion and I will count as financial legerdemain. If we exclude that a much larger portion is owned by foreign government entities. But overall if we can’t agree that America has a massive debt problem, we’ll just have to differ.