Wednesday, July 30, 2008

The Trouble with Balance Sheet Analysis

In my never ending quest to alert the American people to the avalanche of debt about to befall them (and sell a few books at the same time), I sometimes stumble across otherwise rational looking and sounding people who claim that the national debt is no big deal. Such folks sloughed off this week's increase in the debt ceiling (to over $10 TRILLION) and the announcement of a $.5 TRILLION annual federal deficit, the largest in nominal terms in U.S. history. Their main line of counterattack is that while we OWE a lot we also OWN a lot so the debt is no big deal. Our assets exceed our liabilities (at least they claim) so the country is basically sound.

That sounds a lot like Bear Stearns and Fannie Mae thinking. The trouble with balance sheet analysis of the national debt is that the value of assets can change, and usually much more quickly than the value of liabilities. If interest rates were to spike, due to some shock and/or high levels of inflation, the value of most assets would drop (yet more) but the government would still owe $9.5 TRILLION (and growing). And of course most government assets are not liquid.

Cash flow issues loom large as well. Say we borrowed another $10 TRILLION to fix our aging bridge and highway infrastructure. For the balance sheet types, there is no problem here because our nation's assets will increase by the same amount of the debt. (Implausibly assuming, of course, that the public gets $10 TRILLION worth of construction for its money. See for a counter view.) But the interest due on the debt would double. To pay that additional interest the government could always print more money, but that would further fuel inflation, which is already getting to scary levels. It could also increase tax revenues but that seems unlikely, at least this election cycle.

I'm increasingly convinced we need major changes to the way our government gets and spends our money. Unfortunately, we'll probably have to suffer through a major crisis to get reforms passed and then they will be rushed and grossly suboptimal.

Monday, July 07, 2008

Walking the Walk: Can McCain Do It?

I caught a bit of a John McCain speech today. He is certainly "talking the talk" regarding fiscal responsibility. But can he really walk the walk? A message I received today from a government budget bureaucrat in response to my op-ed in the Free Lance-Star suggests not.

My correspondent, who I shall call Shallow Throat, says that our budgeting system is broken because at the unit level it builds in automatic yearly increases and fails to create incentives to cut back spending. If McCain wants my vote, he should address this important issue in a concrete way.

I suggested to Shallow Throat that what we need to do is to build in the expectation of annual budget decreases, at least in real (inflation-adjusted) terms. That way, front line government managers will have incentives to cut fat because the money that pays for it will disappear soon, and automatically.