True National Debt Nowhere Near $14.3 Trillion

I am about as big a small government guy as anyone, and I sure hope the House Republicans demand massive spending cuts in exchange for raising the debt ceiling; but the fact is our true national debt is nowhere near the $14.3 trillion debt ceiling.

Sure, the nominal debt - thanks to the Obama-era spending explosion - is fast approaching the $14.3 trillion debt ceiling and will soon surpass 100 percent of GDP. As a result, the dollar is falling as China and other foreign governments sell dollar-denominated investments, and credit rating agencies are getting jittery: Standard and Poor's recently revised their outlook on US debt from "stable" to "negative."

Open any newspaper and you're likely to conclude the S and P outlook downgrade is tied to the possibility that House Republicans will block any effort to raise the debt ceiling. But the credit rater says "in two years" it may have to downgrade the Government's coveted triple A credit rating while the debt limit will be reached in less than a month. Like other credit raters, S and P bases its outlook on where it projects US national debt will be as a percentage of GDP over the next several years - and according to S and P, by 2013 it will be where Greece's was in 2007, over 105 percent.

Our national debt comes in two flavors: $9.65 trillion is held by the public - individuals, corporations, and state, local and foreign governments; and $4.64 trillion are intragovernmental holdings - "special issue bonds" Treasury gave the federal trust funds when it "borrowed" their money.

That is, for decades the party in power has raided every federal trust fund: $2.6 trillion from the Social Security Trust Fund, $750 billion from the Civil Service Retirement and Disability Fund and $300 billion from the Military Retirement Fund, to name three examples. Washington politicians gave away most of that money, and used the rest to run the Government.

In his 2011 budget, President Obama admitted: "The trust fund balances are assets of the trust fund[s] ... and liabilities of the Treasury, netting to zero for the Government as a whole. ... The existence of large trust fund balances, therefore, does not, by itself, increase the Government's ability to pay benefits."

Though there was a time the trust funds held marketable Treasury debt, now they only hold SIBs that can never be sold. Because the Government controls both lender and borrower, Treasury needn't (and doesn't) pay the SIBs as they mature; instead they roll them over, by issuing replacement SIBs with later maturities, unless (and to the extent) the trust funds suffer actual cash shortfalls.

To keep things looking kosher, the SIBs are backed by the "full faith and credit" of the US, and Treasury has kept up with the interest - about half the annual interest Washington pays goes to the trust funds - as well as principal redemptions needed to fund cash shortfalls the trusts incur from time to time.

But every time a trust fund, in order to meet a cash shortfall, redeems a dollar of SIBs or gets paid a dollar of interest, Treasury (because it's always operating at a deficit) must issue a dollar's worth of new public treasury bonds to raise the needed cash.

That means the SIBs are mere bookkeeping entries - the real debt only arises when Treasury issues new public debt to redeem SIBs (or pays interest on them). But, because the SIBs have been on Washington's books since the trust funds were raided, the national debt prematurely (by many years) reflects trillions in not-yet-borrowed funds.

Take Social Security: Its administrators anticipate redeeming $45 billion worth of SIBs in 2011 to meet cash shortfalls as the first wave of baby boomers start to retire. Treasury will issue $45 billion of new public debt to do pay for the redemptions, but the national debt will not rise a penny as a result.

Look at this way: If Congress passed a law tomorrow requiring Treasury to replace the $4.64 trillion of trust funds it took, Treasury would issue $4.64 trillion in new public debt, the $4.64 million cash Treasury borrows would be paid to the trusts, and all $4.64 trillion in SIBs would be cancelled. Those transactions would not result in the national debt going up a dime, and could even be carried out without raising the legal debt ceiling if the lawyers and bankers could get it all done simultaneously.

The SIBs really represent unfunded pension liabilities, not true third party debts. Specifically, they represent the portion of the (now) unfunded federal pension liabilities that were previously funded. That's a "political" liability to be sure, but not the kind of currently enforceable debt that should affect the Governments' credit rating in the same way that true third party debt does.

In contrast, state pension plans have racked up $1.26 to $3.8 trillion in unfunded pension liabilities, depending on what investment performance assumptions are made, yet that massive liability does not appear on their balance sheets as third party debt. And estimates of the unfunded Social Security and Medicare liabilities reach as high as $100 trillion, but no one counts those massive unfunded liabilities as part of the national debt.

That is, to perpetuate the fiction that Washington's raiding $4.64 trillion in trust funds didn't really happen, politicians have created fictional intragovernmental debts ostensibly backed by the full faith and credit of the US, and due to that backing- sheer optics for the voters - the SIBs are being counted as if they were real debts in assessing US creditworthiness. In reality, there is no more reason to count them then the remainder of unfunded federal pension and health care liabilities.

It's possible the SIBs could be restructured as intragovernmental "markers" - allowing the trust funds to compel Treasury to issue new public (re-funding) bonds to raise the money needed to replace the funds it previously "borrowed," as and when there are cash shortfalls in the trusts.

That would instantly bring the national debt down to two-thirds of GDP. But that will likely never happen because it would require our leaders in Washington to confess their crime - that they raided $4.64 trillion in trust funds - and a recent (IBD/IPP) poll shows that just 28 percent of Americans understand that the Social Security Trust Fund only has Government IOU's in it.

Don't get me wrong. We should be panicked about Washington's spending addiction; as we should about the unfunded Social Security and Medicare liabilities and the pressing need for entitlement reform.

While the national debt has gone up 33 percent under Obama, the real debt - the public debt - has gone up a stunning 77 percent since TARP began, going from $5.4 trillion in August, 2008 to $9.65 trillion today (even though most of the TARP funds have been repaid).

Nevertheless, a downgrading of the Washington's coveted AAA credit rating, which would have a devastating impact on the cost of US borrowings, should be based on our real national debt and the refusal of our leaders to make real spending cuts. It should never happen because politicians insist on continuing a decades-long political cover-up, the effect of which is to record $4.64 trillion of fictional debt on the US balance sheet.