AS THE ECONOMY TURNS

GET OUT OF JAIL FREE, SO FAR

Dr. William Shingleton

October 22, 2005

 

Last week the Treasury announced the good news about the federal budget.  In a joint statement from JOHN W. SNOW, Secretary Of The Treasury, and Joshua B. Bolten, Director Of The Office Of Management And Budget, in the “Budget Results For Fiscal Year 2005”, they said that “the actual budget totals for the fiscal year that ended September 30, 2005” were:  TOTAL RECEIPTS of $2.15 billion; TOTAL OUTLAYS of $2.47 billion; and a BUDGET DEFICIT of $319 billion [SOURCE: October 14, 2005 http://www.treas.gov/press/releases/js2973.htm js-2973].  The total receipts are mostly taxes and fees paid to the federal government; the total outlays represent all of the federal spending on all of its  many projects, programs, and boondoggles; and the budget deficit is supposed to tell us how much the federal government had to borrow last year (on a net basis) so that its checks didn’t bounce.  There is so much fun in these numbers it’s hard to know where to start.

 

For instance, if you cut the baloney and do a legitimate report on the deficit, the numbers are quite different.  Consider what a BUDGET DEFICIT is supposed to represent.  It is money that you spent that you did not take in as income and had to borrow instead.  The definition doesn’t change whether we are talking about an individual consumer or about the federal government.  When you borrow money in order to spend it you add to your DEBT, which is the total amount of money you are obligated to pay back some day.  [NOTE: The federal government is not obligated to pay any of it back; all they have to do is keep rolling it over, as we’ll see in another report.]  For example, if I have no savings and owe $60,000 on my house and then this year I decide, without paying anything off or actually saving any money, to borrow $25,000 for a new car my total debt goes from $60,000 to $85,000 and my deficit is $25,000.  If you don’t know me, or if you doubt my ability to provide accurate numbers about my income or my spending, one way for you to find out how much of a budget deficit I have actually run is to compare the amount of money I owed last year ($60,000) with the amount that I owe this year ($85,000).  The difference, the $25,000, is what I borrowed this year, my true deficit.  Since my numbers are accurate, we get the same $25,000 in both cases.

 

But what happens when we apply this approach to the federal government?  According to the BUREAU OF THE PUBLIC DEBT, at the end of September 2004 our government owed $7.379 trillion and at the end of September 2005 it owed $7.933 trillion [NOTE: The federal government starts its FISCAL YEAR on the first of October. You don’t want to know why. SOURCE: http://www.publicdebt.treas.gov/opd/opdhisms.htm]. If we apply the same accounting rules we used a moment ago we find that the government actually had a deficit of $553.7 billion rather than the $319 billion they officially reported.  Of course, if a corporation reported that they had borrowed $319 billion when they had actually borrowed $553.7 billion the top officers would be on their way to federal prison.  But this is the federal government we are talking about, so these guys will probably get on the David Letterman show instead.  Especially if he notices that they are now advertising a new program “to teach students how to budget, use credit cards and build a positive payment history.” [SOURCE: http://www.treas.gov/press/releases/js2978.htm>]  The kids would probably be better off sticking to their piggy banks.

 

So how did they come up with the $553.7 billion to spend that was not covered by their income?  Some of our older readers may not want to see this, but they got about one third of it ($171.7 billion) by using the money that we paid into SOCIAL SECURITY and its related programs [NOTE: $1.4 billion from Supplemental Medicaid, $9.3 billion from Hospital Insurance, $10.0 billion from Disability Insurance, and $151.0 billion from Old Age and Survivors benefits. (As you are no doubt aware, the rest of the money that we paid into these programs was used to pay out benefits to current recipients.)  SOURCE: Historical Tables, Table 13.1, http://www.treas.gov/press/releases/js2978.htm>]

 

In an unusual series of transactions (The appropriate adjective would be “illegal” if you tried it in your business.); the government collected a little more than a trillion dollars in taxes for these programs. (The taxes are officially called “contributions”.)  That money they rake in doesn’t technically belong to the federal government; it belongs to the various social security trust funds.  Unfortunately for the “contributors” like us, the trust fund is run by the federal government.  In addition, in a remarkable and fiscally convenient restriction, the social security trust funds are only allowed to purchase U.S. government obligations.  Therefore this extra $171.7 billion that was collected last year had to be “invested” in the federal debt.  When the trust funds use your money to “buy” U.S. government obligations, then your money belongs to the Treasury and your trust funds get a bunch of I.O.U.’s that will be paid off by future taxpayers.  [NOTE: If it’s any consolation, almost all of the other federal trust funds are required to play the same game. As of September 30th, the total amount of INTRAGOVERNMENT DEBT is $3.4 trillion.]

 

They come up with a few other dollars in strange ways also.  For instance, a not insignificant $37.1 was indirectly purchased by the FEDERAL RESERVE during the same period.  [SOURCES: http://www.federalreserve.gov/releases/h41/20050929/ and 200440930.]  The people who wrote the FEDERAL RESERVE ACT OF 1913 were worried about this kind of action when they wrote the original legislation, so they set up a rule that stops the FEDERAL RESERVE from buying anything directly from the Treasury.  It wasn’t that they didn’t want it to end up with a bunch of worthless paper like social security but rather they believed that if the Treasury could sell its debt to the Federal Reserve then the Treasury would feel free to run its deficits up into the millions of dollars.  (That’s millions with an “m” not the billions with a “b” that we have been talking about.)

 

Somebody got the bright idea that the Federal Reserve could obey the law and buy government debt simply by buying in the SECONDARY MARKET.  So what happens is that when the Treasury needs money they sell Bills, Notes, and Bonds in periodic auctions.  The Federal Reserve does not participate in them.  Instead, corporations like CITICORP buy the new stuff and then turn around and sell it to the Federal Reserve in what is called an OPEN MARKET PURCHASE.  Since the Federal Reserve does not participate in the auction they don’t violate the law.  And since they can buy anything CITICORP has a couple of seconds later if they want to, then the Federal Reserve gets to pay CITICORP before CITICORP pays the Treasury.  The accounts for the individual member banks are not settled until the close of the business day.

 

And where does the Federal Reserve come up with the money to buy the securities?  That’s the beauty of it.  Their payments are made in terms of FEDERAL RESERVE CREDITS, basically green lights on a computer screen somewhere.  No paper, no cash, no anything.  The Federal Reserve posts a credit for the member institution on the account the member institution is required to keep with the Federal Reserve.   The money eventually received by the Treasury is created out of thin air.

 

Another $172.4 billion toward the deficit represents the increase in “Marketable securities held in custody for foreign official and international accounts”.  These are U.S. government securities held for foreign governments and foreign central banks.  [NOTE: At the close of 2005 the total holding was $1.46 billion.]  Basically, this is money that was given to the United States by these foreign institutions in exchange for more I.O.U.’s.  And where did that money come from?

 

The United States buys all kinds of things from other countries; much more than they buy from us, to the tune of $700 billion.  While a good deal of the $700 billion comes back as foreign investment, the $172.4 billion represents some of the U.S. Dollars that these foreign institutions have bought with their own currencies.   Once they buy them, they want to get a return on their investments, so they use these dollars to buy U.S. government securities and then let the Federal Reserve act as custodian for them.  In short, because we buy so much from other countries, they have the excess dollars available to lend to our government to finance its deficit.

 

There are others, but if we just consider what we have here, we have $381.2 billion out of the $553.7 billion deficit covered without ever going directly to the U.S. capital markets. [It would be completely covered if the deficit had been the $319 billion reported by the administration.]  That leaves $172.5 billion that the government actually had to borrow from the capital markets.  While $172.5 is not a small number, it isn’t quite as bad as the $537.7 billion we started with.  If our concern is that the federal government is CROWDING OUT all of the other investment in the marketplace we may not quite be there just yet.

 

On the other hand, the INTRAGOVERNMENT DEBT is $3.4 trillion, and that doesn’t even count the shortfall in the Pension Guarantee Fund.  Some day we are going to need that missing $3.4 trillion and the doubt has to be whether or not future taxpayers are going to be willing and able to honor our obligations.  We may be in a position that is quite similar to the workers who foolishly chose the DEFINED BENEFIT model for their pensions.  When it came time for the benefits to be paid the money was not there.

 

Final notes:  If you would like to be removed from the distribution list just send a reply on email.  Back issues are available on my website <http://www.oocities.org/wsirius30/2cents.html>. The opinions expressed in these newsletters are those of the author.  Comments, including suggestions for future newsletters, are always welcome.