Unexpectedly, the Federal deficit is now
shrinking with the surge of tax receipts received in April. The
Treasury Department reported a couple of weeks ago that there was a $77
billion swing from projected deficit to surplus in the April-to-June
quarter (shrinking to $350 billion this year from a projected $427
billion). They think the deficit crested with the highest level ever
reached last year. Even so, the press would have you believe that a
Federal deficit is a bad thing. But is that true?
Kenneth Fisher made an excellent case
supporting the large U.S. deficit in his column in the April 18, 2005
issue of Forbes. "Here's another reason to be bullish: Everyone
is worried sick that America is over-indebted, but it's not. This
country could profitably take on more loans from abroad and invest money
in productive assets. We're under-indebted." Those that worry about
the debt come from the school of thought that thinks all debt is bad.
They just don't like to see the U.S. funding their debt with foreign
dollars. It's just too risky to allow others the option of unloading
their U.S. Treasury holdings and equity positions on the open market.
If it happened, it would depress both our markets and the value of the
dollar, i.e., it would devalue the asset that they are trying to
unload. Unlikely that this would happen on any large scale.
Foreigners like to invest in the U.S.
because it's the soundest major economy in the world, offering the
highest returns (and growing higher), the most liquid & transparent
markets, the clearest rules, the fairest laws and the fastest growth.
Fisher's case is that the U.S. could stand
to have an even greater debt load. Since its borrowing costs are
smaller than its return on equity, it could borrow even more to increase
its yield. That is, if one can borrow at 6 percent interest to build
factories yielding a 12 percent return, one should borrow. In fact,
economic models relating profit levels to debt, would never be optimized
with a zero debt load for the company.
The Federal government can fund its deficit
by raising taxes (unpopular and economically stifling), printing money
(inflationary), or selling bonds (in the U.S. or abroad). The method or
combination that they choose can have very different consequences to the
economy and to the market. By far the best approach is a vibrant
economy is the last.
Let's look at the Federal Reserve's Flow of
Funds report to create a national balance sheet for the U.S. and answer
the question: Is the federal deficit too large?
|
Aggregate Hard Asset Balance Sheet of the United States |
|
Assets |
|
($ billions) |
|
Liabilities |
|
|
($ billions) |
|
Cash & Equivalents |
$9,408 |
|
Home Mortgages |
|
$7,261 |
|
Public Stock Equities |
14,712 |
|
Credit Card & Auto Loans |
|
2,125 |
|
Other Corporate Stock |
6,184 |
|
Non-Corporate Business Debt |
2,578 |
|
Non-Corporate Business |
8,558 |
|
Non-Financial Corporate Debt |
5,094 |
|
Fixed Income Vehicles |
29,588 |
|
Financial Sector Debt |
|
11,674 |
|
Total Financial Assets |
68,449 |
|
Savings/Checking Accounts |
9,987 |
|
|
|
|
|
Federal Government Debt |
|
4,317 |
|
Residential Real Estate |
16,583 |
|
State and Local Government Debt |
1,670 |
|
Other Real Estate |
12,541 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Assets |
$97,573 |
|
Total Debt |
|
|
$44,706 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net Worth |
|
|
$52,868 |
|
|
|
|
|
Total Debt to Net Worth (%) |
84.60% |
|
Source: Standard & Poors and Federal Reserve Flow of Funds
Accounts (Third Quarter) |
|
The U.S. has a net worth of $52.868
trillion and a debt ratio of 84.6 percent. The national income (GDP)
at $12 trillion represents a 22.7 percent return on equity. In essence,
the U.S. borrows dollars at 4.5 percent, dollars that accumulate abroad
form our negative trade balance. That funding is then used to generate
a 22.7 percent return. Budget deficits while increasing national debt,
also bring the nation closer to its optimal debt level. Conversely,
running surpluses creates a non-optimal debt level. In Fisher's words,
"Stop worrying; instead, buy stocks."