Steve Wynn, chairman and CEO of Wynn Resorts Ltd., repeated a common argument to a CNBC reporter today — that the U.S. government, like any individual, could not continue to spend more money than it makes. While this is how most of us learn to think about consumer and other household debt, it’s worth a closer look.
First, a quick accounting primer. Assets, liabilities, and net worth (the balance sheet) are distinct from revenues and expenditures (the income statement). When expenditures exceed revenues over some period of time, a business (or a government or a household) runs a deficit. Deficits can be absorbed by assets such as savings (net assets are assets minus liabilities). If liabilities exceed an entity’s assets, then it is leveraged, or said to be in a ’negative asset position’. While this sounds bad, it simply means that if a sufficient number of the entity’s creditors demanded repayment of its obligations, it would be wiped out (this is essentially what happens in a bank run). If that were to happen, then the entity must either raise capital or fold. It can raise capital by finding new lenders to loan it additional funds (creditors who are willing to assume the risk that future debt service will occur), or by finding investors who are willing to provide capital in exchange for an ownership stake (equity owners who are willing to put capital at risk in exchange for a claim on future profits). However, if creditors do not suddenly demand repayment in full, and the entity is able to service its debts from its operations, then it can survive and even do quite well.
How does this apply to public finances? First, it tells us that public deficits are a pressing concern only if they threaten a society’s overall net wealth (net wealth being the assets left over if all debt were suddenly repaid). To determine that, we have to compare the level of debt to the level of assets. Estimating the underlying assets that a government has access to is difficult, but as a quick and dirty rule of thumb, we can multiply the government’s share of GDP by the net underlying assets in the economy. This gives us a rough idea of the level of discounted future output over which the U.S. Government has some (indirect) control. Unfortunately, as John Rutledge has pointed out, this is not an easy number to estimate, because federal economic statistics tend to focus on flows (like GDP) rather than assets. However, using recent Federal Reserve Flow of Funds data, we can conservatively estimate that the net asset position of the U.S. is somewhere north of $71 trillion (we’ve left out the net assets of governments, farms, and retirement funds).
Assuming that the federal government’s share of GDP is 20% and that this corresponds to its degree of control over economic assets, the U.S. government has access to roughly $14.2 trillion in assets. At 30% of GDP (a level which we believe could unfold in the coming decade), that number increases to $21.3 trillion. At an estimated $12.9 trillion in 2009, the gross U.S. national debt stands at 61% to 91% of net assets. And again, those asset figures are conservative. If they were more accurate, the debt percentage would almost certainly be lower.
Contrast this to the company that Wynn heads. It has a net asset position, ex-intangible and other assets and deferred charges, of roughly $1.37 billion, and long term debt of $4.29 billion. Its debt is over 300% of net assets, which is some three to five times more levered than the federal government, according to our back of the envelope numbers (though both pale in comparison to the leverage ratios taken on by the financial industry in this decade). There are other important contrasts as well. Wynn Resorts will never have a cost of capital as low as the U.S. Treasury; it has to compete intensely for revenues, and its profitability is subject to many factors that are well beyond its control. The U.S. government has few if any competitors, and its revenues come about via legally enforceable obligations imposed upon the private sector.
I don’t mean to put forth the argument that the U.S. government should lever up to the level of a corporation like Wynn, or that it couldn’t quickly push itself into a more precarious financial position***. To be sure, like any other entity, it needs to service its debt from cash flows rather than assets whenever possible. And long term entitlement commitments are indeed an eight hundred pound gorilla. I’m simply pointing out that as things stand today, gross U.S. debt is hardly at an unmanageable level. Thus, widely agreeable public investments and expenditures should not be held hostage to hyperbole or anxiety over government deficits. This should be kept in mind when thinking about what Treasury Secretary Geithner has called the “central economic choice of our time”.
***OMB forecasts gross public debt of $18.35 trillion by 2018, a compound annual growth rate of almost 7.5%. This will surely surpass normalized annual GDP growth over the same period. But note that it’s well below the growth rate of household and some other types of debt in the 2004-2008 period, and still represents a reasonable proportion of today’s net economic assets.
IMPORTANT DISCLOSURES and DISCLAIMER: Symmetry Capital Management, LLC is a state registered investment advisor. Neither the firm, its principals, its employees, or its clients own securities of any companies mentioned. The foregoing information is for educational and entertainment purposes only. It does not constitute an offer to buy or sell any securities, or a recommendation of any investment strategy.