13 March 2013

The Ongoing Net Debt Fallacy #nlpoli

In a post that starts out about Muskrat Falls, the Telegram’s James McLeod does a fine job of laying out some basic information about debt, deficit, current account, capital account and other bits of the provincial budget.

Read it.  Unless you have been living this sort of stuff up close for years, you will learn something.  If nothing else, you’ll get some insight into how some local politicians have been buggering up this sort of stuff because frankly it is complicated and they don’t understand it.

Regular readers of these scribbles will know that SRBP includes Kathy Dunderdale and Tom Marshall among the people who get confused.  You can add others from all parties.

There’s one part where McLeod misses a crucial point.  No fault there.  Lots of people miss it.  It’s also harder to see because provincial politicians like to talk it up.  We are talking about net debt.
“Net debt is your total outstanding liabilities, minus assets. So say you've issued $12 billion worth of bonds over the years, and you'll have to pay those people back. But you've got $4 billion cash sitting in the bank. …So your total debt is $12 billion, but because you're sitting on the $4 billion cash in the bank, your net debt is $8 billion.” 
“The same principle is being applied to Muskrat Falls. It won't increase the net debt even though we're going to borrow a bunch of money to build it. In the case of Muskrat Falls, say we borrow $5 billion to build the thing. But now we've built a dam worth $5 billion, which we're counting as an asset on our books. So while we've taken out some big loans to build it, the whole thing doesn't contribute to the net debt.”
All true.

To get a complete understanding of this point, though, you have to tally up all the ways Muskrat Falls will affect annual government spending and public debt.  Net debt doesn’t really mean much. 

You see, if the provincial government borrows $5.0 billion to fund Muskrat Falls, it will have to pay back some part of that $5.0 billion every year.  They will either pay interest alone or some combination of interest and principle. If they already owed $10 billion, they’ll be paying back some part of $15 billion. 

These are not James’ numbers.  We are using numbers that are a bit easier to see.  What you have done is increased the gross public debt – all the stuff you are liable to pay for – by 50%. 

The government owes that money to someone:  could be banks, teachers’ pension funds, and so on.  Those people don’t figure out the size of the government’s debt payments based on net debt.  If you have a $100,000 mortgage and $100,000 in assets, you don’t have an mortgage payment of zero.

So in rough numbers, if you have $10 billion in public debt and it costs you $100 million a year in totally made-up numbers - to pay down annually, then you will wind up having to find $150 million to cover the costs annually of that $15 billion you owe with the new Muskrat falls debt in on top.

Here’s where it gets more curious, but still interesting.  Nalcor is owned entirely by the provincial government.  What Nalcor owes shows up on the provincial government’s books as an indirect debt. The government doesn’t necessarily pay money on the debt every year but they still have to carry around the debt as part of their list of things they are or might be liable to pay. 

Taxpayers are potentially liable since they own the company.  If it goes under, the government will likely have to cover all its debts one way, or another.  So if Nalcor borrows another $5 billion for its share of Muskrat Falls, the total (gross) public debt will show as $20 billion.

Anyway,  government’s argument is that Nalcor will get cash to cover all the cost of the project, including government’s borrowing.  That appears to be true.  If the government demands it, Nalcor will fork over the cash to pay for the borrowing and then the provincial finance department will send the cash on to the lenders.  The only source of cash Nalcor has identified for Muskrat Falls is the taxpayers of this province.  They aren’t counting on any cash from anywhere else.

So in the end, Muskrat Falls increases the public debt and taxpayers will have to fork over money to pay for all the borrowing either through their own taxes or through their electricity rates. If government doesn’t ask Nalcor for the cash for some reason, then servicing the direct public debt in Muskrat falls will affect the annual amount government will spend to service the debt.  After all, they’d have 50% more money to cover.

Net debt doesn’t matter here.

Let’s go a step beyond.  Any money transferred to Nalcor either from cash holdings or as a result of borrowing during the construction will show up in the budget documents in one way or another since it involves spending public money.

When Kathy Dunderdale says that Muskrat Falls will not add to the deficit, she is right but only in the sense that any one amount of money in the annual budget doesn’t add to the deficit all by itself.

What Dunderdale is doing is playing with words.  An annual deficit means that the total of what government spends is more than its income. In any year that happens, the whole list of spending contributes to the deficit.  The fact that the deficit this year is going to be $725 million and the planned transfer to Nalcor was $664 mission is just coincidental.

If federation of labour boss Lana Payne or anyone else makes the claim that the Nalcor transfer is the largest part of the deficit, they are just wrong.  Likewise, when, as James puts it, “Tory MHA Steve Kent says Muskrat Falls has nothing to do with the deficit. (He's correct.)”, both Kent and McLeod are wrong.  Some part of every dollar spent added to the deficit.

Now be fair to everyone, this stuff is complex.  It took McLeod three thousand words to explain all that hedoes explain and frankly he does an admirable job.

What we just went through is a refined discussion of some details.  The toad of truth lurks down there in that swamp of fine bits.  Once you get into that swamp, though, you can start to see just what is going on in the current public discussion.  Read McLeod’s piece.  You will learn something, even if it is only which politicians understand all this stuff and which of them – government and opposition, in cabinet or out – are just hopelessly mired in the muck.