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By: Frank Restly

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“Frank, If you are talking about the ratio of federal spending to GDP, it doesn’t matter whether you are using nominal or real as long as both numerator and denominator are both real or are both nominal. Sorry, but I can’t make sense of your graph, because I don’t know what’s being measured.”

Okay, here is nominal expenditures versus nominal GDP:

http://research.stlouisfed.org/fred2/graph/fredgraph.pdf?&chart_type=line&graph_id=&category_id=&recession_bars=On&width=630&height=378&bgcolor=%23b3cde7&graph_bgcolor=%23ffffff&txtcolor=%23000000&ts=8&preserve_ratio=true&fo=ve&id=FGEXPND_GDP&transformation=lin_lin&scale=Left&range=Custom&cosd=1960-01-01&coed=2012-04-01&line_color=%230000ff&link_values=&mark_type=NONE&mw=4&line_style=Solid&lw=1&vintage_date=2012-09-23_2012-09-23&revision_date=2012-09-23_2012-09-23&mma=0&nd=_&ost=&oet=&fml=a%2Fb&fq=Quarterly&fam=avg&fgst=lin

As an FYI, the Bureau of Economic analysis maintains both real and nominal measures of GDP (real being nominal adjusted by the GDP deflator). The BEA maintains nominal government expenditures only. There is no such thing as a government expenditure deflator. And so the whole concept of Real government expenditures is vague at best.

“As a historical question, can you cite any cases in which governments have financed their deficits by selling equity? And can you explain what kind of equity instruments were used in those cases?”

Let us define the difference between debt and equity first. Debt (as far as sovereign governments go) is a contract between borrower (government) and lender (individual, group, or company) that offers a fixed rate of return over a fixed / variable time frame. That rate of return is guaranteed by a legal protection. In the case of U. S. Treasuries – re-payment is guaranteed by the 14th amendment to the Constitution.

Equity, on the other hand, is a contract between seller (government) and buyer (individual, group, or company) that offers a non-guaranteed rate of return.

In essence equity claims (being non-guaranteed) are subordinate to bond holder claims (being guaranteed).

Are there historical examples of governments selling non-guaranteed contracts? Certainly. Social Security , Medicare, Medicaid, etc. are all non-guaranteed in the sense that certain conditions must be reached for the owner of the claim to receive re-payment. For Social Security it is retirement age and maintaining a steady job during your life. If you work your entire life, contributing to Social Security all along, but fail to reach retirement age, you will not get your return on investment.

You might argue that Social Security is an insurance policy (not equity), but on a fundamental basis, Social Security is simply a non-guaranteed claim on future tax revenue.

Equity in the corporate realm, is an ownership claim on the profitability of a company. As such, it is a junior claim on a company’s revenue stream (bonds being senior claims). Because the federal government does not operate to turn a profit, its equity claims are not claims on profitability. It’s equity claims are instead junior claims on its revenue stream (taxes).

You might even argue that Social Security is protected by a trust fund which would be incorrect. The Social Security trust fund is holdings of U. S. Treasuries by the Social Security Administration. The trust fund is legally protected by the Constitution through its holdings of Treasuries.

In essence, Social Security is an equity claim on future tax revenue. The federal government sells those equity claims and uses the tax revenue to loan itself money, in the process creating additional bonds.


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