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A Business Perspective on the Federal Debt

Wednesday, February 13, 2013

A proper analysis of the debt burden tells a much different story than the debt level by itself.

Until recently, Republicans were perceived as the business-savvy party. But in the time since Reagan left office, the party’s business veterans, whose wealth-creation expertise had been a major force driving both the party’s agenda and the nation’s economic growth, have gradually lost their mantle of agenda leadership. What happened? Did they all retire before passing the baton to the next generation? Did they forget to train their replacements? More than ever, our sluggish economy needs a large, sustained injection of wealth-creation expertise to help balance the dominant wealth-redistribution agenda. In any case, the relative silence of the business-savvy group within the GOP has been deafening, and it’s high time the next generation started speaking up.

Take the party’s stance on the federal debt, for example. Everybody who’s paying attention knows that total federal debt is $16.4 trillion, and that the public holds $11 trillion or so of that debt. Both of those numbers are incomprehensibly large. But, as incomprehensible as they are, today’s squeaky-wheel Republicans just keep repeating that single number, $16.4 trillion, without doing what a responsible business manager would do: place it into some kind of context, to help us decide whether the debt (or its trend) is out of control, tame, or somewhere in between.

Fortunately, there is a way to place the federal debt into better context. It’s a simple way to shed light on the debt burden of any given corporation, and to help people gain a better understanding of the federal debt.

The Debt Burden: Not the Same as the Debt Level

McDonald’s has been utilizing long-term debt to help fund its operations, and so has IBM. Both companies are among the 30 that comprise the Dow Jones Industrial Average, and their financial statements are easily accessible through the EDGAR website of the Securities and Exchange Commission. Those financials provide two convenient examples of how we might better understand our federal debt.

The charts below show the wrong way versus a much better way to judge not only the debt burden of McDonald’s and IBM, but also how those burdens have changed in the 20-year timeframe shown.

caps conover1

Source: Securities and Exchange Commission.

The wrong way is to look at the raw debt level in isolation (see Figures 1a and 2a); both McDonald’s and IBM have significantly increased their long-term debt. But just look at how they improved their ability to handle their debt! (See Figures 1b and 2b.) In both cases, the growing cash flow generated by their respective operations grew enough over 20 years to make it much easier to pay the interest on the debt.

In short, both companies increased their long-term debt, yet decreased the burden of that debt. How? Through growth. Their ability to handle debt grew faster than the debt itself.

caps conover2

Source: Securities and Exchange Commission.

What about the federal debt? The same analysis is easy to apply, because the numbers are readily available from the U.S. Treasury. They are shown in Figures 3a and 3b below.

The result is similar to those for McDonald’s and IBM: the debt has increased (not a surprise), but the burden of that debt has decreased (perhaps a big surprise). It’s easier today to pay the interest on the federal debt using federal tax receipts than it was 20 years ago. Who knew?

(For an explanation of why the interest on the debt, not the principal, is the key variable in the debt burden calculation, see "How to Reduce the Debt Burden for Future Generations.")

The Debt Burden: Yesterday, Today, and Tomorrow

Business-savvy individuals know that it’s difficult or impossible to manage anything we can’t comprehend — and that includes the huge level of our federal debt. But they also know there’s a way to put debt into a context that is more comprehensible. The analysis above employs one measure of what it takes to “handle” our debt: the so-called interest bite, i.e., the portion of tax receipts it takes to cover the interest. That measure tells us that the federal debt is similar to the debt of McDonald’s and IBM: over the period of 20 years, the debt increased, but the debt burden decreased.

conover212final

Source: U.S. Treasury.

That analysis helps to straighten out the past and the present. It also begs the questions about what will happen in the future, and it’s the same set of questions for McDonald’s, IBM, and the federal government: How fast should debt grow? How much will interest rates rise? How much can we grow our ability to handle the effects of rising interest rates and growing debt — or, flipping that around, how much more growth could we get by funding extra investments with low-cost debt financing? These questions deserve more discussion (and I addressed them briefly here).

For now, however, we can see that proper analysis of the debt burden tells a much different story than the debt level by itself. Business-savvy Republicans should speak up more loudly about this; after all, it’s time for some (relatively) good news regarding the federal debt.

Steve Conover retired recently from a 35-year career in corporate America. He has a BS in engineering, an MBA in finance, and a PhD in political economy.

FURTHER READING: Conover also writes “A Winning Strategy on the Debt Ceiling (Courtesy of Warren Buffett),” “How to Reduce the Debt Burden for Future Generations,” and “The Tea Party and the Debt Ceiling vs. Economic Growth.” Ramesh Ponnuru explains “Why a Debt-Ceiling Fight Is Good for the Country.” Daniel Hanson says “Debt Burdens Choke Growth.”

Image by Dianna Ingram / Bergman Group

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