US Public Debt Reporting Out of Balance

Recent headlines report that the US public debt is approaching the congressionally mandated ceiling of $14.29b and that unless the debt ceiling is increased, the US will default on its debts and the government will be forced to shutdown. Unlike corporate America which reports its financial health using net debt, government accounts are reported in terms of gross debt. Perhaps this approach is preferred due to the fact that a firm where liabilities exceeded assets would be technically bankrupt. According to Economy Watch, US public net debt at the end of 2010 was $9.5t and is forecast to be $11.03t at the end of 2011 based on the current federal budget which is significantly less than the $14.3t public debt reported in the headlines. Net debt is defined as gross debt minus financial assets which include gold, foreign currency reserves, securities and other holdings but does not include non financial assets such as buildings and roads. Although the annual budget deficits contributed significantly to an increase in US public debt, a large percentage of the US public debt increase since 2008 was used to purchase financial assets of distressed US financial institutions through TARP and to purchase US Treasury securities as part of the quantitative easing programs. As of 6/15/2011, the Federal Reserve held $1.58t of US Treasury securities which is an increase of $793b from one year earlier. US public debt can be reduced by selling financial assets on the balance sheet without any change in the annual budget deficit. In the year to 6/15/2011, US public debt declined by $204b at the Federal Reserve from what it would otherwise have been through the sale of mortgage backed securities. Although an orderly sale of US financial assets over time would be required in order to avoid tanking the asset prices, the US government can finance operations for an extended period of time through the sale of financial assets without an increase in the debt ceiling. Although there may be good reasons not to sell assets in the short term such as the desire to maintain high levels of liquidity in financial markets and to avoid depressing equity prices, slightly depressed equity prices and lower levels of liquidity would be preferable to a US government default. Although the cookie jar is far from full, there are still more cookies left than the headlines suggest.