No Such Thing As An Opinion!

August 10, 2011

To banking analyst Dick Bove: Remember, the US government is not a company...

On Tuesday, CNBC reported:

"The US credit rating would be even worse than its recent downgrade from Standard & Poor's if the nation was judged as a private company, banking analyst Dick Bove told CNBC Tuesday.

Speaking amid the hotly contested debate over whether the US should have lost its coveted triple-A rating in favor of the new Double-A plus, Bove said the US balance sheet and the burdensome national debt tell a clear story.

'You've got a company which is losing about $1.4 trillion this year, probably will lose somewhere around a trillion dollars over the next couple of years. It owes $14.4 trillion (and) over the next five years that will get up to $20 trillion,' the Rochdale Securities analyst said. 

'So there's no likelihood whatsoever that this particular company is able to pay down from its own resources the amount of debt that it has, nor is there any likelihood that it's going to get rid of its deficit,' he added. 'If that was a real company, of course, that would be a junk bond.'"

Dick Bove is a prominent analyst.

Before I critique his argument, let me be clear:

Regarding the above comments, I'm very happy to see someone finally taking a look at the debt issue from a fresh perspective.  I do think that the government should be run more like a company!

And I do think that the US government is in horrible financial shape.  But I don't make that claim simply, or even primarily, because the US government has so much debt.  I make the claim because the US effectively invests the borrowed money at a negative interest rate!

Why Dick Bove's Comparison Is Incorrect

Nevertheless, I think it's say to safe that Dick's comparison is way off.

Here's why.

1) He claims:

"You've got a company which is losing about $1.4 trillion this year..." 

He's referring to the budget deficit.

Since he claims that the government will lose about $1.4 trillion this year, he's claiming that the government's revenue less its expenses will come to about -$1.4 trillion this year.

But that's not correct!

The US government will not lose $1.4 trillion this year!

The $1.4 trillion gap between the government's tax revenue and spending expenses is not lost wealth!  

After all, the US borrowed the $1.4 trillion in cash needed to fill that gap, in exchange for owing the amount to its lenders.

So, the $1.4 trillion is simply a transfer of assets.  That's it.  It's not a loss in wealth at all!  

With a $1.4 trillion budget deficit, the overall equity of the USA remains the same:  Although their debt increases by $1.4 trillion, their cash also increases by $1.4 trillion!

By comparison, when a company loses $1.4 trillion, their equity, the company's worth, does fall by $1.4 trillion. 

If you have any doubt, picture this:

Let's say a company has $100 in cash and $50 in debt.  The value of the company is then $50 ($100 - $50).  

Let's say it costs the company a total of $50 to manufacture and sell a toy.  

Let's say that nobody wants to buy it for $50, so they reduce their price and get only $35 for it.

Overall, their revenue is $35 and their costs are $50.

After the sale, their cash balance becomes $85 ($100 starting balance + $35 revenue - $50 of costs).  Their debt of $50 remains unchanged, since no money was borrowed.

The value of the company has just decreased by $15, and the total value of the company becomes $35 ($85 cash balance - $50 of debt).

That $15 loss is a real loss.

A budget deficit of $1.4 trillion is not a loss.  At all!


I can understand how an intelligent person, even a very intelligent person, could come to the conclusion Dick did.  I can see how someone might have the perception that the budget deficit is actually a loss.

But that perception is dead wrong.

Dick Bove is undoubtedly incorrect.

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