What determines geopolitical strength, and ultimately survivability, for a nation? At or near the top of the list is solvency — a nation’s ability to meet its obligations. Since 2003 David M. Walker, Comptroller General of the United States (now retired) has warned us of the precarious and deteriorating finances of the US Federal and State governments.
Three times per year the the General Accountability Office (GAO) publishes an update on the “Nation’s Long-Term Fiscal Outlook.” Here is their April 2008 Update; it is not pretty. I doubt anything published recently by the Department of Defense or Homeland Security Department has such ominous implications for America.
One aspect of the problem is that the US government keeps its books on a cash basis. Hence those annual deficit numbers reported in the newspapers do not include the increase each year in the government’s future obligations. The government does report the real numbers each year, calculated on a accrual basis: “Understanding Similarities and Differences between Accrual and Cash Deficits.” Here is the Update for Fiscal Year 2007.
Taking it one step further, corporations report annual balance sheets, including the value of all assets and liabilities. Computing the value of the government’s assets is difficult. For example, what is the value of its land? Its liabilities, however, can be calculated — and that is what matters, unless we plan to sell off our inheritance. The GAO reports each year on the increase in the government’s — our — liabilities: here is their current report (December 2007). Terrifying numbers.
Usually the media ignores those, preferring the numbers spoon-fed them by the government. The rare exceptions deserve our attention. Such as “Taxpayers’ bill leaps by trillions“, USA Today (18 May 2008) — Excerpt:
The federal government’s long-term financial obligations grew by $2.5 trillion last year, a reflection of the mushrooming cost of Medicare and Social Security benefits as more baby boomers reach retirement.
That’s double the red ink of a year earlier.
Taxpayers are on the hook for a record $57.3 trillion in federal liabilities to cover the lifetime benefits of everyone eligible for Medicare, Social Security and other government programs, a USA TODAY analysis found. That’s nearly $500,000 per household.
When obligations of state and local governments are added, the total rises to $61.7 trillion, or $531,472 per household. That is more than four times what Americans owe in personal debt such as mortgages.
The $2.5 trillion in federal liabilities dwarfs the $162 billion the government officially announced as last year’s deficit, down from $248 billion a year earlier.
Please share your comments by posting below (brief and relevant, please), or email me at fabmaximus at hotmail dot com (note the spam-protected spelling).
For more information about this subject
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A brief note on the US Dollar. Is this like August 1914? (8 November 2007) — How the current situation is as unstable financially as was Europe geopolitically in early 1914.
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The post-WWII geopolitical regime is dying. Chapter One (21 November 2007) — Why the current geopolitical order is unstable, describing the policy choices that brought us here.
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We have been warned. Death of the post-WWII geopolitical regime, Chapter II (28 November 2007) — A long list of the warnings we have ignored, from individual experts and major financial institutions (links included).
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Death of the post-WWII geopolitical regime, III – death by debt (8 January 2008) – Origins of the long economic expansion from 1982 to 2006; why the down cycle will be so severe.
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Geopolitical implications of the current economic downturn (24 January 2008) – How will this recession end? With re-balancing of the global economy, so that the US goods and services are again competitive. No more trade deficit, and we can pay out debts.
- A happy ending to the current economic recession (12 February 2008) – The political actions which might end this downturn, and their long-term implications.
- What will America look like after this recession? (18 March 208) — More forecasts. The recession might change so many things, from the distribution of wealth within the US to the ranking of global powers.
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The most important story in this week’s newspapers (22 May 2008) — How solvent is the US government? They report the facts to us every year.
To see the all posts on this subject, go to the archive for The End of the Post-WWII Geopolitical Regime.
Could well be the most important story of the generation because our ability to influence events (favorably) in the future rests on an economic foundation — remember the Soviet Union?
Fortunately the Sec. of Defense has concluded that neither Russia, China, nor Iran represent a near term-strategic threat, so we can probably save a few bucks there. But this post shows that we’re talking chump change. Even if we chopped the DoD budget back to pre-Bush II levels (easily doable without a major conventional threat), we save maybe $400 BN = 0.4 trillion per year. Not too impressive when we need to come up with sums in the 50-60 trillion range.
Time to crank up the printing presses at the Mint?
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Fabius Maximus replies: (1) We have generations to deal with the almsot $60 trillion debt. Balancing the budget (the real budget, on an accrual basis) is the first step on this journey.
(2) Inflation does not help. No only are its benefits an illusion, but it damages our economy.
Deficit or not is a minor issue about these liabilities – the long-term real growth rate is the interesting variable.
A perfectly balanced or positive budget isn’t really necessary – a deficit budget is acceptable as long as the percentage of debt in comparison to GDP doesn’t raise.
The claim of “chopping” the Bush II defense budget and “saving” $400 billion is an example of how the anti-Bush rhetoric is based upon pure fantasy. Bush increased defense spending from 3.0% of GDP to 4.0% of GDP. Even this level of spending is extremely low compared to historical levels, and even if we reduced defense spending to the low levels of the CLinton administration we would only save $100 billion. But, what is clear, is that the defense spending throughout the later parts of the Clinton Administration were much too low and left the military to small to even deal with a minor threat like Iraq. Those anti-Bush critics who claim that we did not send in enough troops can look at those numbers and find the answer why.
Fab — you’re assuming that we stop accumulating new debt. Assuming that USA Today’s numbers are correct, the DoD budget wouldn’t pay the interest on this liability.
You’re probably right on inflation. But aren’t we damaging our economy anyway?
Mark — I wasn’t talking about percentage of GDP, which is purely an internal measure and therefore irrelevant when discussing requirements for the Department of Defense.
As for Iraq, Bush himself decided the numbers of troops to be sent, overriding virtually everyone who could find the Middle East on a map. Sorry – you can’t blame that one on Clinton, or anybody else, for that matter.
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Fabius Maximus replies: No, I recommended that we balance the budget, so that we can stop accumulating new debt. It does not solve the problem, but follows rule #1: first stop digging!
I do not know what you mean about damaging our economy. How?
Mark, two points that you ignored:
1) A country that spends more on military affairs than all other countries of the world IN SUM cannot have “extremely low” levels of military spending.
2) You seem to look at the normal “defence” budgets, not the real costs. You need to consider a lot of DHS and other budget, especially the supplementals as well. Saving 400 billion USD would in fact be quite close to a return to Clinton’s levels.
3) Even Clinton’s “defence” spending was questionably high in light of the downfall of the Soviet Union and the extremely favourable alliance situation.
4) The Iraq invasion & occupation had no connection to national security necessities whatsoever – to prepare for such a shitty and needless adventure is not necessary or advisable. A real, offensive threat would face not only the active U.S. forces, but likely more than a million if not millions of allied troops as well.
In re inflation: While this might wipe out our publicly-held debt, it obviously has other deleterious consequences. And it does nothing towards our social security / Medicare obligations since these would rise in cost as well. They are obligations of real wealth, not paper dollars.
Mark on the defense budget: This is a bit of a dead horse, but it seems apparent to many that a good portion of the tax money dumped into the Pentagon pads the pockets of contractors, congressmen and lobbyists with weapons programs that are marginally effective, if at all, in fighting the asymmetrical wars of the modern era. “Dollar-delivery platforms.” Slashing this pork would save quite a bit. As would adopting a defensive grand strategic posture as suggested by Lind (i.e. let the Department of Defense live up to its name). We spend nearly as much (depending on the year, sometimes more) than the rest of the world combined on our armed forces. For defense, surely a fraction of this would suffice. For remaking the world according to our wishes, perhaps no amount of money is sufficient.
Sry, that became more than the originally planned “two points”…
Computing the value of the government’s assets is difficult.
The difference between an “asset” and and “expenditure” is that an asset is an outlay of money that is expected to generate money over future years and hence must be compared to future revenues while an “expenditure” can only be compared to current revenues.
If, for example, through brutal tactics, we were formally to colonize Iraq and expropriate its oil revenues, then we could capitalize our Iraq outlays and determine our Return on Investment.
On the other hand, should we bribe the Saudis to double their oil output this year, we would have to expense this bribe money so that we could match it against increased tax revenues resulting from lower oil costs in the economy.
I don’t see how this helps us with Social Security.
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Fabius Maximus replies: While I agree with the general notion you express, your explanation does not match general accounting principles.
An asset can be defined in many ways. The common element is that it is a “static” thing, hence included on the balance sheet. An expenditure is a “dynamic” thing, representing a movement or change — hence on the income statement. An asset can be created in many ways, one of which is by an expenditure.
More important, you touch upon something of great importance for our future. Eventually a reckoning will come for our debts. Our debts to ourselves (e.g., social security, Medicare, government and military pensions) and to our creditors (domestic and foreign). We can pay, at great cost to ourselves. We can default (there are several ways to do so, including inflation).
There is another alternative. We have the most powerful military on this planet, by a large margin. It could be used to obtain funds from the many nations that lack nukes (i.e., trusting fools).
What option will we choose?
There is another alternative. We have the most powerful military on this planet, by a large margin. It could be used to obtain funds from the many nations that lack nukes (i.e., trusting fools).
Levying tribute from your vassal states. The final step for turning into a true empire. Scary.
Here is the Wikepedia article on assets:
Probably the most accepted accounting definition of asset is the one used by the International Accounting Standards Board [1]. The following is a quotation from the IFRS Framework: “An asset is a resource controlled by the enterprise as a result of past events and from which future economic benefits are expected to flow to the enterprise.” [2]
Applying this definition, by far the most important intangible asset the federal government has is its moral authority to levy taxes.
Economists tend to presume that governments have this authority;. However, both Charles I of England and Louis XVI of France discovered that governments, to their detriment, can loose this authority. Both found this loss to be a pain in the neck.
Current “No New Taxes!” type rhetoric suggests that the federal government’s moral authority to raise taxes is constrained.
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Fabius Maximus replies: Yes, that matches (more technically) what I said assets were. I agree, the power to tax is the government’s major resource.
To what “no new taxes” rhetoric do you refer? The Democratic Party is forcast to sweep up Congress, probably with a veto-proof majority. Few of them are running on a “no new tax” platform.
By developed nation standards, American’s are lightly taxed. I suspect that by 2012 we will be more heavily taxed.
Dear Fabius Maximus:
Thank you for such a thought-provoking website. I especially approve of your focus on the non-military aspects of American geopolitical strength/weakness.
Your entry, “The most important story in this week’s newspapers” (22 May 08), raises a number of questions and comments, such as:
Fabius Maximus replies: Due to the length and complexity of Pete’s questions, I will insert answers into his post.
1. If – as you note – the government largely spoon-feeds cooked economic data to the media, where are concerned voters to get accurate, politically-impartial information about the state of the economy? Are business dailies such as The Wall Street Journal or Investor’s Business Daily et al. reliable, or are these also “poisoned wells”?
Fabius Maximus: Yes, the major papers have written about all these problems. Not as major stories, but as coverage of minority views (which they are).
2. It is bad enough that the government, many of our businesses, and consumers (i.e., citizens, as they used to be known) are deeply in debt and hooked on deficit spending, and that we are being slowly crushed by unfunded entitlements. There is an even more fundamental problem: As the Enron, Global Crossing, and World Com scandals should have taught us but did not, accounting practices in our appear to be serious damaged if not broken. I am certainly not an expert, but it appears that the number-crunchers have – to some extent anyway – abandoned their fiduciary responsibilities in favor of collusion with their clients, whose profligate spending they seek to hide or excuse. Isn’t the first step in fixing any problem an accurate diagnosis? What are accountants doing aiding and abetting financial misconduct? Am I missing something here?
** See Duncan Kinder’s reply below.
3. Thanks to your column, we have a better idea of our financial liabilities, but what about our assets? Let me use a simple example: Many commentators on national security call the U.S. generally, especially our armed services, “the world’s policeman.” Leaving aside whether that is a desirable state of affairs or not, let’s assume the statement is factual – we are the ‘cops world-wide. My response is, “OK, who is paying us?” Consider a typical municipality, whose residents need police and fire protection. How are these services supported? By taxes, fees and duties collected from the public being served by those agencies. Why should it be any different on the world stage? Ideally, every other nation should shoulder the burden of its defense itself, and not rely upon the U.S.; absent that – if we are in fact to serve as “world cops,” then we ought to be paid for rendering the service, and paid well. That is not currently the case, as far as I am aware.
*** This is a powerful insight. The most likely answer is that they do not see us as providing them with a valuable service. For example, against whom does our fleet of attack subs defend? This is even more reasonable a view if you believe that 4GW threats have become the most serious.
4. What are our national leaders doing about collecting outstanding debt from our years of defense of Western Europe during the Cold War, to name one example? Knowing our political class, they have already forgiven this debt – which is inexcusable. Europe has subsidized its generous welfare state under the umbrella of our armed forces while we have drained our treasury.
*** What debts? Did the nations of Europe sign contracts with us? Can I bill your for subscription services after you read my blog?
5. You do not support the current war in Iraq and regard it as a strategic mistake, if I recall correctly. However, we are there and should strive to make the best of the situation. The current administration, on the defensive over the causes of the invasion, has pledged repeatedly that the war is not about oil and that the Iraqi people own it. Well, who says so? To my way of thinking, we own that oil until we say otherwise. We paid for it in the oldest known currency – the blood of our soldiers, not to mention trillions from our treasury. Call it realpolitik if you like; I call it being pragmatic. That nation’s oil is the best way to salvage our mission there, short of a miraculous and unlikely political transformation.
** I do not understand the basis of this claim by America on Iraq’s oil. I thought the UN charter specifically forbid claims on the basis of invasion and conquest. Such a claim would undo what is one of the greatest accomplishments of WWII and the subsequent generations of American statecraft: making war illegitmate. It still happens, like adultry.
I haven’t run the numbers on whether or not Iraqi oil could even begin to pay down the enormous costs we’ve incurred by being in Iraq, but getting some of it certainly would help, wouldn’t it? We are fools if we leave without getting paid for our troubles. At the minimum, we ought to secure a percentage of Iraqi oil pumped in the coming decades.
*** In an age of 4GW, few foreign occupiers have successfully held and exploited their conquests. China/Tibet is one of the few exceptions. How much American blood do you plan to spend attempting to hold Iraq? How much is its oil worth to you?
6. Perhaps it is cruel of me, but another simple idea occurs to me, and I know I am not the only one: Why haven’t the food-producers of the world, the net exporters, formed a cartel to oppose OPEC? The Saudis and their kind may control much the world’s oil – but they can’t eat it. Shouldn’t we in the west improve our negotiation position by marshalling our assets, and deploying them accordingly?
We could do something very similar with technology and manufacturing, given that many of the oil-producing nations in the OPEC cartel are comparatively backward in these areas, and dependent on the developed world. The sheiks may have the oil, but they cannot build a decent wrist watch last I saw. Why aren’t we exploiting this advantage?
*** Cartels seldom work. OPEC never really worked, except from 1973 – 1983. There is a large literature in economics on the reasons for this.
I’ve made my point. I’d like to see a reply on your blog if you think it is appropriate. I hope you sense my frustration with the conventional thinking coming from so many of our leaders and institutions. I am not claiming I am more competent than our senior leadership; I am not at all sure that is the case. Rather, I deplore the lack of imagination being displayed by our leaders in coping with our most difficult problems.
*** Times change, and people’s thinking only slowly adapts. Consider how rapidly and extnesively the world has changed since WWII. These things take time.
Thanks again for an interesting and informative site.
I’m sorry, you’ll have to explain:
I hadn’t realized that the economy was in such good shape. Perhaps I should have read today’s Wall St. J. more carefully.
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Fabius Maximus replies: Exactly so. The consensus opinion among economists is that the US economy is fine, that we have entered a normal cyclical slowdown, and this will likely end late this year.
Recessions are just one phase of the business cycle, and do not show that we “are damaging our economy” any more than winter shows that we are damaging our climate. After 25 years with only two slight recessions, even a severe recession would be normal. The post-1982 US economy is extraordinary: 100 quarters with only 5 quarters of falling GDP, vs. the post WWII average of 20%!
A small minority believe that this extraordinary run resulted from excessive debt accumulation, which has damaged our economy. This is just a theory, one explained at length in these posts.
Good points pretty much all round.
For background information traditional accounting mechanisms, designed for private companies do struggle with Returns On Investment (ROI) for Govt infrastructure investment.
What is the value of public schools? Or roads or railways? Public health systems? What does fundamantal research really deliver? What about clear air? Or environmental protection?
These are all things that everyone struggles with when talking about Govt investment, both on the Left and on the Right.
There is an even more fundamental problem: As the Enron, Global Crossing, and World Com scandals should have taught us but did not, accounting practices in our appear to be serious damaged if not broken.
Pete:
With respect to the Worldcom scandal, essentially they capitalized ( i.e., treated as assets ) financial outlays that they should have expensed. When a company thereby fails to expense outlays, its “income” ( i.e., revenues minus “expenses” ) apparently but falsely increases. This is one of the oldest scams around.
It also, analytically, relates to my first post on this thread about capitalizing vs. expensing various items.
The Enron scandal is more complex, involving some recently developed razzle dazzle. I doubt if anybody, including Ken Lay, has ever understood it.
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Fabius Maximus replies: Nicely said. Accounting fraud is probably as old as counting. The same methods get updated and re-used with each new generation. We will have perfect accounting when we have perfect people, no sooner. Here is a list of books about accounting frauds.
There is no need for the Government to account for future obligations, as they may simply be repudiated by any Congress with the courage to do so. As a sovereign, the Government can’t be sued for broken promises – even those supposedly “paid for.”
Of course, how that hypothetical future Congress will deal with the resulting geezer revolution remains to be seen. The younger generations, from gen X forward, will support the default of course, since they will not want to sacrifice all their income for a bunch of greedy old people.
By developed nation standards, American’s are lightly taxed. I suspect that by 2012 we will be more heavily taxed
I will leave it to others to thresh out whether this, or some other projection concerning future tax revenues is correct. However, let us suppose that we could, according to some recognized, credible, objectively sound, fully disclosed procedure, thresh out some set of figures for future tax revenues for the foreseeable future. Given this set of figures, we could thereupon compute its net present value.
One means of valuing an asset is the net present value of its projected future cash flows.
QED: We would have a reasonable basis to assert the value of the federal government’s moral authority to levy taxes.
We also, by analogous procedure, could compute the net present value of future entitlement outputs. Add this to our official debt and we have our actual total liabilities.
Subtract total liabilities from assets and we have equity (if any )
We can leave it to academics to thresh out how to characterize bridges to nowhere, continuing Pentagon expenditures on Third Generation Warfare, and other such items.
But the big meat and potatoes would have been dealt with.
CAVEAT: While arguably there could be a number of different methods of computing these net present values, it would be vital that, once having chosen a given procedure, that we be consistent in applying it in all instances.
Fabius Maximus replies: This has, of course, been done several times. In fact, that was the point of this post. The USA Today report was based on GAO calculations using this methodology. Each year the GAO calculates the tax policy changes necessary to meet our liabilities.
The first to do so: “Fiscal and Generational Imbalances: New Budget Measures for New Budget Priorities“, Jagadeesh Gokhale and Kent Smetters (July 2003). There is an interesting story behind this, described in this article: “The $44 Trillion Abyss“, Fortune (10 November 2003) — “The baby-boomers are about to retire, and it’s going to cost us — big. Here’s what the government doesn’t want you to know.” Opening:
“Last fall Paul O’Neill, then Secretary of the Treasury, wanted a simple answer to a thorny question: How prepared was the nation today to pay all its future bills? Two government experts worked for months to calculate the answer. Their findings, which shocked even them, were never published—the Bush administration made sure of that. The reason for the silence was that by the time the two researchers had completed their study, O’Neill had been thrown out of the Treasury and replaced by the more politically astute John Snow.”
This article is still one of the best descriptions of our situation. Since then the Gokhale-Smetters analysis has been replicatd by others, such as the IMF, and is now a part of the annual GAO report.
The comptroller general (head of GAO) has been on this theme for some of the time. In some of the live presentations (some number on CSPAN) one of the comments has been that nobody in congress for at least fifty years has been capable of middle school arithmetic. Post from 13Apr2006 mentioning catching the comptroller general (head of GAO) on CSPAN giving the presentation
http://www.garlic.com/~lynn/2006f.html#41
So another facet … is the upcoming baby boomer retirements. Various studies have focused on the loss of that expertise (institutional knowledge that only really exists in their heads). However, this study can be interpreted within the context of funding retirement benefits:
The Workplace War for Age and Talent
http://www.newswise.com/articles/view/538892/
Indicates that the following generation (replacing the baby boomers) is only a little over half as large. The baby boomers retirement explode the number of retirees by something like a factor of four. The net result is the numbers of retirees needing benefits increases by a factor of four while the workers that are taxed to provide those benefits is cut in half. Compared to the current situation the ratio of workers (taxed to provide the benefits) to the number of retirees (requiring befits) declines by a factor of eight times (each worker will need to pay eight times in taxes to support the current level of retiree benefits).
The effects of globalization may also result in declining aggregate worker income base … resulting in the ratio of the aggregate worker income base to number of retirees declining by an overall factor of 16 times … aka ratio of aggregate worker income base per number of retirees may only be 1/16th the current level.
note that with regard to audits … GAO has done a number of reports and is accumulating a database of SEC financial “restatements” (because of audit/financial reporting problems), the number/percentage has been increasing even since Enron, SOX, etc.
Part of this is attributed to the current audit paradigm where the entity getting the rating/audit, pays for the rating/audit (can compromise impartiality). This has also been implicated in the recent credit crisis. CDOs were used by Milken two decades ago in the S&L crisis to obfuscate the underlying values (I’ve used the analogy to undermining the “observe” in OODA-loop). However, in the current scenario there has been comments about “CDO rating shopping” … the mortgage originators going around to the different rating services until they find one that will give their CDO the rating they want.
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Fabius Maximus replies: Please stay on topic. This blog is about geopolitics; this discussion concerns the solvency of the US government.
There has been a lot about the effect of globalization and outsourcing … companies getting cheaper labor elsewhere. However, OECD studies also show that the US education system is ranking at or near the bottom of industrial nations. In addition to globalization, there is also the trends about transition from industrial economy to knowledge economy … where education competitiveness is playing larger and larger factor in national economies.
“Study Finds Sharp Math, Science Skills Help Expand Economy“, Wall Street Journal (3 march 2008) — Excerpt:
“Nearly two decades ago, the National Governors Association called for U.S. students to sharply improve in math and science by 2000. If the U.S. had managed to achieve the goal, and joined world leaders like Finland, Hong Kong and South Korea, GDP would be two percentage points higher today and 4.5 points higher in 2015, the study calculated.
“… The generation after the baby boomers is only a little over half as large … and apparently much less competitive in the global economy (and current outsourcing trends may well accelerate not just because of availability of lower-paid workers).”
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Fabius Maximus replies: Interesting comment, but still not on on topic. This post discusses the government’s solvency. This is a related subject, but then there are a thousand related subjects. Last warning.
I once suggested, to you, that borrowing (as in paying for Iraq and entitlements) was a way of losing one’s sovereignty (we become an asset of a foreign country). In that sense, sovereignty and solvency has a direct relationship.
While you rejected this notion (of losing sovereignty), the thought of not being solvent does make a person wonder who in the end is going to “own” this debt we are collecting.
Also, I have been wondering at the “and apparently much less competitive in the global economy” of the generation after the baby boomers. Perhaps you see some generational “skip” by the newer generation?
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Fabius Maximus replies: Where was this exchange? I do not see it here.
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As for the effect of poor education in the US, I find it disturbing but have no idea of its magnitude or efffects. Our educational system is like DoD:
(1) its output has little relation to the money we pump in, and
(2) its bureaucracy has so far proved impossible to reform.