Debt Scare - Lessons from Billy Beane

 

The national debt as of March 2012 is $15.5 trillion

This article represents independent research and has not been peer-reviewed in any way. Many simplifications have been assumed to present a more understandable forumla to the reader. Where they have been recognized in the article by the author, they have been described.

 Fifteen trillion is an unfathomably large number. Try to count to it at a tick every second and it would take you nearly 500,000 years; our species has existed for about 100,000. In miles, the number represents over half of the distance to our nearest neighboring star, Alpha Centauri. In cubic miles, the number represents 50,000 times the volume of all of the Earth's oceans. So folks are understandably concerned when that number represents the number of dollars our country is indebted. But is their concern legitimate? I worry that we are not looking at the right number, and I believe the great American pastime of baseball can give us clues on how to find it.

For those of you that don't follow baseball, the game is a treasure trove of statistics. Any one player is tracked by dozens of metrics, all used to analyze their productivity on the field. With such an overwhelming wealth of information, it becomes difficult to find a single number that represents a player's ability, and as a result managers, scouts, and fantasy owners developed their own non-scientific methods to do so. But this all changed in 2002 when Billy Beane, immortalized in the book and recent film Moneyball, crunched the numbers down to one statistic that he used to evaluate each of his players: on-base-percentage. This number best represented a player's likelihood to score runs, which Beane correctly identified as the most important area of productivity for a baseball player. Beane's success in analyzing players changed the game of baseball and revitalized the field of sabermetrics (applied statistics) in sports. But how does this apply to the debt problem?

When looking at the debt of a nation, there are many figures that get thrown around, with total debt (shown above) and the deficit (the difference between a country's taxes and its public expenditures) as the two most popular. But these numbers do not tell the whole story. Is $15 trillion too much for a nation with a GDP of $10 trillion? How about for a GPD of $100 trillion? Is it an acceptable level of debt if it grows by $500 billion a year? What about $3 trillion a year? These questions cannot be answered just by looking at the debt level of a nation and the level with which the debt grows, even if the GDP of that nation is known.

To truly answer the question of whether our debt is growing to high, we need to understand what the debt accomplishes for our nation and what it costs to incur that debt. If a nation takes on new debt to pay for things other than servicing old debt, then that new debt is an investment. If that investment yields positive returns, then those returns can be measured as a net-positive effect on the nation's GDP. However, debt comes at a cost: the principle of the debt, plus any interest demanded by creditors, must be paid back at some time in the future. These payments - assuming, for the purposes of simplification, that all creditors are foreign - can be measured as a net-negative effect on the nation's GDP.  Therefore, the real measure of the health of a nation's debt level, measured in terms of GDP, becomes:

Deficit - Cost of debt

GDP

By using this measure, it becomes more clear whether a country's level of debt is healthy for its economy. In the example of the United States, let us further simplify our model and assume the country is currently not paying any principle on its debt. We will also skip the step of dividing by the GDP to lessen the required calculations. Interest payments for US debt was nearly $500 billion in FY 2011. Government contribution to the GDP in that year was $3 trillion (after transfers are accounted for), with $1.2 financed through additional debt. That gives $1.2 - 0.5 = $700 billion net-positive effect of debt on the US economy for FY 2011. This would imply that debt has spurred economic activity to the tune of $700 billion. But what if the interest payments were higher? An interest payment of $1.5 trillion would yield a net-negative effect of $300 billion, which would imply that $300 billion in taxes had been used to finance debt.

Does this mean that the US doesn't really have a debt problem? Well, no. This calculation does not have the accuracy to tell for sure, but it provides a valid blueprint for those with the right information (looking at you, Federal Reserve!) to get the answer. But for those out there that look at the debt clock and worry, my advice to you is this: don't complain that our debt and deficits are too high. Instead, do what Billy Beane did. Get it down to the one number. Once we all start to look at the effect of debt in this manner, we can begin to make more appropriate decisions concerning borrowing in the future.