How much would the U.S. government be value if we valued it like several other company using a reduced money flow (DCF) model? A brand new article by Zhengyang Jiang, Hanno Lustig, Stijn Van Nieuwerburgh and Mindy Z. Xiaolan addresses exactly this query.
The exercise is easy and easy. Every U.S. citizen and taxpayer owns, in a way, a stake within the U.S. government. The U.S. government generates revenue through taxes and in return provides goods and services to its stakeholders. Meanwhile, the U.S. government is taking over debt that it’ll should repay in some unspecified time in the future in the longer term. It can tackle debt to cover losses, but it surely just isn’t easy to lift equity.
The Congressional Budget Office (CBO) publishes long-term forecasts for presidency tax revenues, government spending, and debt through 2051, which might be used to estimate future money flows.
But what concerning the discount rate? The authors rightly assume that the discount rate of future money flows have to be higher than the secure rate of interest or Treasury yield for the corresponding term. Why? Because tax revenues are volatile and highly correlated with GDP growth. When the country goes into recession, tax revenues often plummet. Therefore, the authors apply a reduction rate that assumes there may be a risk premium of roughly 2.6% above government bond yields. (Read the paper to learn more about how the danger premium was derived.)
Putting these numbers into motion, the authors conclude that the web present value of future government primary surpluses – government revenues minus government spending – is negative and amounts to $21.6 trillion. That’s a whole lot of money the federal government needs to lift to cover deficits from now until 2051.
But the federal government can tackle debt, and the web present value of debt on its balance sheet is about $31.7 trillion. Thus, the whole net present value of the U.S. government is greater than $10 trillion. However, the whole value of outstanding debt today is $23.5 trillion, which is about $13.5 trillion greater than the federal government is value.
If the US government were a standard company, it might have filed for bankruptcy way back.
But the US government just isn’t a standard corporation. It has two key benefits. First, it may well print money and generate revenue through the privilege of seigniorage. This seigniorage premium is estimated to extend GDP by roughly 0.6% every year through international demand for U.S. Treasury securities, because the United States is the world’s largest economy and the U.S. dollar is the world’s dominant currency.
But even this seigniorage premium will only increase the web present value of the U.S. government by about $3.7 trillion, leaving a large gap of greater than $10 trillion.
This brings us to the second advantage. The US government can raise taxes and force its residents to pay. Of course, the federal government will most certainly not increase taxes until the economy falters and it becomes tougher to repay existing debts and interest on those debts. This implies that the federal government will are likely to increase taxes on the worst possible time – when GDP growth is low or negative, not when it is robust.
So if taxes should cover national debt defaults, fiscal policy could have to grow to be procyclical and taxpayers will essentially be the insurance that covers the bankruptcy of the US government. In financial parlance, it’s as if US taxpayers sold credit default swaps (CDS) to the US government.
And here’s one other scary thought: Not only have U.S. residents involuntarily insured the federal government against default, but the danger of default increases as rates of interest rise. Because the U.S. Congress, in its everlasting wisdom, has decided to spend now and defer additional revenue into the longer term, the duration of the spending is far shorter than the duration of the revenue stream. Thus, as rates of interest rise, increasing discount rates lead to a faster decline in the web present value of future revenues than the web present value of future costs.
That means the federal government needs to chop spending and increase revenue faster and more aggressively. The more rates of interest rise, the more likely it’s that the insurance contract can be concluded and residents could have to pay.
And government spending cuts won’t be enough to wash up this mess. They will result in a decline in GDP growth and subsequently a decline in tax revenues. Meanwhile, the danger premium on government money flows will rise. This, in turn, makes the situation worse because future revenues can be value even less today and the capital value of the U.S. government will decline.
This is the quagmire the US government finds itself in today. In my opinion there is barely a method out: to maintain rates of interest as little as possible for so long as possible. And that implies that in the long run there’ll probably be negative real rates of interest, which could even worsen over time.
The faster rates of interest rise today, the more financial repression can be essential in the approaching many years and the more the United States will resemble Japan. I see no other way out of the present situation. All other paths result in a default by the U.S. government and thus a world economic collapse that makes the collapse of the COVID-19 pandemic and the Great Depression appear to be child’s play.
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