By Scott Krisiloff
Scott Krisiloff runs Avondale Asset Management in Los Angeles, California. You can find much more of his ginsu sharp commentary at avondaleam.com.
If Congress doesn’t adjust the debt ceiling by October 17th, many have (rightly) noted that a debt default is not a necessity. That’s because depending on how Treasury prioritizes cash flows, there should still be more than enough money coming into the Federal Government to service interest payments on existing debt.
In order to visualize the expenditure waterfall in a way that is a little more intuitive for a financial analyst, below is a mock income statement put together using the President’s 2014 budget proposal.
On $3 Trillion in revenue, the US Government spends $2.3 T on mandatory programs as defined by the Budget Enforcement Act. The majority of these are social welfare programs including Social Security, Medicare and Medicaid.
That leaves $725 B for interest expense, which works out to an interest coverage ratio of 3.2x. After $222 B in net interest expense, there is then $502 B left over to cover $1.2 T in discretionary spending, which includes defense spending.
The numbers below imply that the government could operate up through 80% of the defense budget on current tax receipts alone. Past that point, the government effectively borrows every dollar that it spends, so it theoretically couldn’t fund those programs if it couldn’t accumulate new debt. Those “discretionary” categories include some important functions, but hopefully this data helps contextualize the argument that hitting the debt ceiling could just be equivalent to a larger scale government shutdown.
Side Note: It’s amazing to me that I actually had to put this together and that there’s not a simple consolidated statement of income or balance sheet for the Federal Government using something equivalent to GAAP or IFRS. If we had an official consolidated income statement and balance sheet, it would be much easier to analyze the state of the US Government’s finances.
In actuality, Sovereign Debt repayment ability isn’t constrained by GDP as much as it’s constrained by cash flows. On that basis, the interest coverage ratio isn’t awful, but the Debt to EBID ratio (Surplus before interest and defense spend) leaves something to be desired. The government is levered 23x with $16 T in debt. That would be well into junk territory if the government was a company. Throw in unfunded pension liabilities like Social Security, and that leverage becomes even worse.
In Uncle Sam’s defense though, it does have a superior business model. It generates tax revenue on demand and all incremental revenue can fall straight to the bottom line. And if all else fails, it might be able to force the Fed to print the money to fund whatever it desires. Still, if the gears of operations are grinding to a halt, none of that matters.