Government Borrowing

One naïve idea concerning government borrowing is that the amount being borrowed by the government in a given year is approximately equal to its budget deficit for that year. However, those who commit to such an idea are ignoring an important part of the equation.

Typically, past debts incurred by the government through borrowing become payable each year.

For example, consider the 10-year Treasury note issued August 15, 2000, which corresponds to CUSIP 9128276J6. On this particular note, interest is payable (to the owner of the note) every February 15 and August 15; therefore, interest is first paid on February 15, 2001, and interest is last paid on August 15, 2010 (where the latter date coincides with the expiration date of the note). Once the note expires, the outstanding balance (in this case, 22.438 billion) is due in its entirety to the owner of the note.

Thus, several hypothetical situations arise. The three most important are:

  1. The government has a budget and outstanding balance, that when combined, is less than its revenue. For example,
    • Suppose the government budget is $100, its oustanding balance is $50, and its revenue is $200. The revenue is greater than the budget and outstanding balance combined (i.e., $150); therefore, the government has the option to pay its debt completely. If it does so, it will have $50 left over.
  2. The government has a budget and oustanding balance, that when combined, is greater than its revenue. For example,
    • Suppose the government budget is $100, its outstanding balance is $50, and its revenue is $125. The revenue is less than the budget and outstanding balance combined (i.e., $150); therefore, the government does not have the option to pay its outstanding balance completely. However, the government is operating at a surplus because it does not have to take on any additional debt to fund its operations.
  3. The government has a budget which alone is greater than its revenue. For example,
    • Suppose the government budget is $100, its payable debt is $50, and its revenue is $75. By itself, the revenue is less than the budget. Consequently, it is less than the budget and outstanding balance combined (i.e., $150); therefore the government does not have the option to pay any of its outstanding balance. The government is operating at a deficit because it must take on additional debt to fund its operations.

I hope you noticed #3 was a special case of #2. After all, the underlying assumptions regarding the budget, outstanding balance, and revenue for #2 and #3 are the same. The only difference is that the government is operating at a surplus and deficit for #2 and #3, respectively.

Clearly, the United States is operating in the territory of #3 (i.e., a special case of #2).

As an aside, the government is not truly operating at a surplus for #2 (although people will say it is). Although the revenue is greater than the budget, it is not greater than the budget and outstanding balance combined; therefore, the outstanding balance must be rolled over. Rolling the outstanding balance over means additional interest will be incurred in later years, and consequently, the total amount owed by the government will increase.

But, what does rolling the outstanding balance over mean? Basically, when the government does not have enough money to pay its debt in the present, it rolls the outstanding balance over by auctioning additional Treasury securities. These additional securities are not included in the budget deficit, but they are included in the public debt!

As a result, the budget deficit is not always indicative of the amount the government is borrowing for a given timeframe.

For example, consider the year 2009, when the government auctioned off nearly $8.5t in Treasury securities. To be fair, a little over $6t of this was concentrated in Treasury bills, which have a maturity date (i.e., the date when the outstanding balance is due) ranging from a few days to one year in the future. However, the fact remains that since the government is incapable of paying any of its outstanding balances off, these short-term securities  have continued to accumulate.

The remaining $2.2t represented long-term securities, which have a maturity date ranging from two years to thirty years. The federal deficit for 2009 was approximately $1.4t. Thus, we see that the dollar amount of long-term securities auctioned was greater than the federal deficit.

But, what does this mean? The government is borrowing more money for a given timeframe than is realized.

In the coming years, a massive amount of debt will need to be rolled over. In the table below, the projected federal deficit corresponds to the CBO’s baseline.

table2

If one were to use the CBO’s estimate of the President’s Budget, the projected federal deficits would be $1341b, $915b, $747b, and $724b for 2011 through 2014, in chronological order. These projections were gathered from a report published by the Congressional Budget Office. The Treasury will need to auction securities in addition to those required to finance the deficit.

The end result is that the increased amount of Treasury securities being auctioned will reduce investment in private enterprises as more capital is diverted to the government. This can only go on for so long.

The U.S. Treasury market is in much more trouble than it currently appears. Exploding deficits, coupled with a massive amount of Treasury debt that needs to be rolled over, will cause trouble for the market.

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