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Federal Asset Privatization, Not a Higher Debt Ceiling (SPR a good place to begin)

As the battle rages over the federal debt ceiling, more pundits and even some politicians are taking a serious look at a solution that any private organization would have considered from the beginning: selling off assets to satisfy creditors.

Contrary to the doomsday rhetoric of Treasury Secretary Geithner, it is simply not true that the Congress needs to raise the federal debt ceiling, lest Uncle Sam default on existing obligations. On the contrary, large (but feasible) spending cuts, coupled with aggressive privatization of federal assets, would balance the books. There is no need to raise taxes or the debt ceiling.

The bonus to privatization is also market entrepreneurship in place of bureaucratic management. So the asset transfer would be good for both taxpayers and the private sector writ large.

I’ll outline the numbers, then focus on the possible objection to privatizing the Strategic Petroleum Reserve, a topic that should be of the most interest to readers of Master Resource.

The Scope of the Problem

When analysts ran the numbers about a month ago, the federal government was projected to spend about $750 billion more in the remainder of Fiscal Year 2011 (which ends on September 30) than it would collect in revenues. Therefore, in order to avoid raising the debt ceiling without defaulting on interest payments on existing debt, the feds would need to cut spending and/or increase revenues by that amount, just over the next four months.

In a political culture where agreements shaving a few hundred million dollars are touted as radical measures, the prospect of slashing $750 billion seems inconceivable. Indeed, this is why Brad DeLong and other leftist commentators think it is obvious that the “adult” thing to do is raise the debt ceiling already, since they can see no other alternative.

There are two problems with this analysis. First, part of the reason the deficit is so high, is that federal spending has mushroomed in recent years. If the government merely went back to its 2003 spending levels, then the problem would be solved. In other words, cutting the equivalent of $1.5 trillion per year in spending sounds like draconian cuts, but only if you think the federal government was small in 2003.

Second, the shortfall doesn’t have to be filled by immediate budget cuts. By selling off assets, the federal government can buy itself time and phase in deep cuts more slowly.

Slated for the Auction Block

Here are just some of the potential items that could be privatized, with the proceeds from auction being used to cover expenses in lieu of borrowing more:

* Sell the gold in Fort Knox. The Heritage Foundation’s Ron Utt has recently proposed this, and Congressman Ron Paul endorsed the idea. The government says it holds 261.5 million ounces of gold, which would fetch about $403 billion at the current gold price of around $1,540 (as of this writing).

* Sell the oil in the Strategic Petroleum Reserve. As of late November, the SPR held 726.5 million barrels of crude. At this writing’s price of about $100 per barrel, this works out to another $73 billion in highly liquid assets held by the government. Discount the inventory by 25 percent for its in-ground status and taxpayers are still north of $50 billion.

* Sell the rights to ANWR and offshore resource extraction. According to the government’s own estimates, ANWR has some 10.4 billion barrels of recoverable crude, while the Outer Continental Shelf (OCS) has some 86 billion barrels. Although a barrel of crude in the hand is obviously worth far more than a hypothetical one buried under the sea, clearly the federal government could raise many billions of dollars if it sold the rights to develop these resources–especially if the current sale included all future royalty streams and other payments normally going to the government.

* Sell student loans and remaining TARP holdings. According to the WSJ, the federal government owns about $400 billion in student loans and $142 billion in claims on companies it rescued during the financial crisis.

We can stop at this point, as we have already documented well over $1 trillion in assets that the federal government could sell. We have not even mentioned the government’s vast holdings of real estate. Clearly there is no need to raise taxes or the debt ceiling, in order to get through the current budget crunch.

A Private SPR?

The broader point behind a sweeping privatization is that resources should be returned to the private sector, anyway. In other words, it’s not that we “have no choice” but to do something drastic like selling off student loans; what the heck is the federal government doing in the student loan business in the first place?

For readers interested in energy issues, the case of the SPR is instructive. The free market is perfectly capable of handling the functions ostensibly served by the strategic reserve.

For example, suppose tensions heat up with Iran. Speculators anticipate that in the event of war, exports from the Middle East will be interrupted, and the spot price of oil (at that future time) might jump to, say, $200 per barrel. If the prevailing price for a futures contract on oil 3 months out is only, say, $110, then as hostilities escalated speculators would buy futures contracts, thinking they were underpriced. Suppose they would continue to do so until the new futures price settles at $150, fully pricing in the likelihood of a new war in the Middle East.

It is precisely this type of behavior that President Obama and others have condemned (whether or not speculation is actually responsible for the upswing in oil prices over the last two years). But in the hypothetical scenario just described, speculators are doing what we want. That is their role in a market economy, to adjust price discrepancies and actually reduce volatility. If war breaks out and oil really does jump to $200 overnight, the jump will not be so jarring because of the prior acts of the speculators.

In particular, when the current spot price is (say) $100 while the 3-month futures price is $150, the oil market would be in severe contango. Someone could earn a relatively sure return by buying physical oil in the current spot market (at $100 per barrel), selling futures contracts for that many barrels (at $150 each), and then simply storing the oil for three months in order to deliver the product as specified. This would be a sure 50% return (over three months) less the cost of storing and insuring the oil.

Such a lucrative investment opportunity would not persist for very long. So long as speculators kept the 3-month futures price propped up at $150, investors would continue to stockpile crude in the present, in order to sell it three months later. But as more and more of current output were diverted into inventory accumulation, rather than refineries for current use, the spot price of oil would go up as well. Equilibrium would be restored when oil prices in the present had risen close enough to $150 to make it unprofitable to accumulate more physical oil inventory.

What we have just sketched (with our exaggerated numbers) is the mechanism by which speculators, who anticipate future price increases, can induce current price increases by diverting production out of current use and into inventory build-ups. Although the idea of speculators driving prices up while “withholding oil from the market” seems to be the epitome of evil in some quarters, I repeat that this is the market working properly. If the diplomatic situation deteriorates such that the chance of war in the Middle East suddenly jumps, then the “right thing to do” is for people around the world to economize on their oil consumption, while producers need to ramp up production as much as they can, in preparation for the possible catastrophe. The (nearly) $150 spot price gives the right incentives to both consumers and producers.

Finally, notice that the mechanism I’ve sketched shows that the government doesn’t need to maintain a strategic petroleum reserve. Private investors could do it far more efficiently, guided by market prices. When it looks like imports will be interrupted, the intertemporal prices in commodity markets would give the incentive to build up the private-sector “reserve.” When the danger passed, and speculators anticipated falling spot prices over time, the holders of inventory would sell down their reserves. This is exactly what the government managers of the SPR are supposed to do.

Conclusion

One caveat: In the real world, speculators and investors would not be able to earn high returns from correctly anticipating swings in oil prices, as we assumed in our example above. In reality, they would be hauled before Congress,  charged with all manner of “manipulation,” and slapped with windfall profits taxes. Therefore the market’s ability to handle a private-sector SPR would be muted. Even so, it’s worth pointing out that the fault would lie with government intervention, not with the nature of the product or industry.

Most people understand the folly of letting the federal government design personal computers or create pop music. But Uncle Sam likewise has no business lending money to college students or maintaining stockpiles of oil. All of these legitimate functions could be handled much more efficiently in the private sector, and returning them would also help solve the current budget crisis.

10 comments

1 Ed Reid { 06.02.11 at 7:41 am }

The list above hardly scratches the surface regarding the current extra-constitutional activities of the US fe(de)ral government. There are several Executive Branch departments and agencies which are clearly extra-constitutional, as well as detrimental to the liberties and freedoms of US citizens.

It should be relatively simple to compile a current list of the constitutional functions of the federal government, since the basic list is enumerated in the US Constitution. All of the current functions not on that list are functions of a feral government; and, are properly either functions of the states, or not government functions at all.

It would appear, at first blush, that the Department of Defense, the Department of State and the Department of the Treasury are safe, though there are likely programs of those departments which are extra-constitutional. On the other hand, also at first blush, it would appear that the Department of Education and the Department of Housing and Urban Development, among others, could be dispensed with in total, though there might possibly be constitutional programs within those departments.

Germain to the focus of this site, there should be a serious and detailed review of the current functions of the US Department of Energy and FERC, as well as the Nuclear Regulatory Commission. (Every time I think about the NRC, I think about a sign which was posted in a “while you wait” shoe repair shop in Worthington, Ohio several years ago: “It takes 10 minutes to repair your shoes – now, or two weeks from now.” I wonder how long it should take to review and approve the plans for a new nuclear generation plant.)

I am sure that such a review of the functions of the fe(der)al government would be accompanied by much “wailing and gnashing of teeth”, since it would be likely that “many are called, but few are chosen”.

2 rbradley { 06.02.11 at 8:37 am }

It is important to get the government out of the crude oil business by selling the SPR rather than having this ‘club in the closet’. One fear is that having 3.5 mm barrels per day of withdrawal capacity at its disposal encourages reckless behavior such as the very thought of implementing wellhead price controls.

3 Energy and Environment News { 06.02.11 at 9:35 am }

[...] Federal Asset Privatization, Not a Higher Debt Ceiling (SPR a good place to begin) Robert Murphy, Master Resource, 2 June 2011 [...]

4 Paddy { 06.02.11 at 2:10 pm }

Terminology used in this post and comments plays into the hands of the tax and spend crowd in the White House and Congress who are usually Democrats. They use “invest” to describe spending to govern, regulate and build. Government investing is good.

Conversely, those who have financial interests in the extraction and production of and marketing of fossil fuels “speculate.” To speculate is evil.

However, speculate and invest are synonyms:

“speculate |?speky??l?t|
verb [ intrans. ]
1 form a theory or conjecture about a subject without firm evidence : my colleagues speculate about my private life | [with clause ] observers speculated that the authorities wished to improve their image.
2 invest in stocks, property, or other ventures in the hope of gain but with the risk of loss : he didn’t look as though he had the money to speculate in stocks.”

Democrats seem to control the narrative. Their wasteful spending to expand government and suck wealth out of the economy is not investing. But, those who speculate on energy production sale are investors in the true sense of the term.

It is time regain control of the narrative by using invest and speculate interchangeably. Governments don’t invest, they spend other peoples money and destroy wealth. Speculators are the real investors who create wealth by assuming risks and profiting in free market economies.

Words are extremely important in the battle for the hearts and minds of voters. It is essential to prevent definitions from being high jacked in political propaganda.

5 Andrew { 06.02.11 at 7:27 pm }

I always thought SPR was in case we are invaded or something, not a sudden destabilization of Iran. But either way, I definitely agree that it performs a function that the market is more than capable of doing.

Paddy-The definition of “investment” claimed to be done in this situation is not the financial definition but the economic definition “building physical capital” (not that the government really does that either). But why “speculation” carries a negative connotation at all is the real problem with the control of the “narrative”. Speculation really isn’t just any kind of financial “investment” but rather amounts to nothing but people putting their money behind their beliefs about the future status of something. It is a kind of financial investment (but not necessarily economic investment) but not the only kind. It isn’t then entirely interchangeable in every situation. Instead we should reclaim the word “speculation” from it’s demonizers, because it isn’t even a bad thing.

6 Kermit { 06.03.11 at 8:07 am }

Doesn’t the London Metal Exchange have warehouse stockpiles of several non-ferrous metals which perform could perform such a function as the SPR does with oil?

7 Kermit { 06.03.11 at 8:51 am }

If the Feds want to stockpile such items needed for the military, due some type of major military action, would it not be better to stockpile at least raw fuels and base lubricating oils? It FINALLY liquidated the mountains of alumina ore (bauxite is but one) locally sometime during the last 10 years which were stockpiled decades ago.

8 No Debt Increase #4: We Don’t Have to Reinvent the Wheel « History of Our Future { 07.08.11 at 12:20 am }

[...] Federal Government holds more than $1 trillion in highly liquid assets that should be sold to the private sector, and doing this now would allow the cuts to be phased in [...]

9 We Are Being Sold a bill of goods on the debt ceiling | North shore Tea Party { 07.09.11 at 11:26 am }

[...] Federal Government holds more than $1 trillion in highly liquid assets that should be sold to the private sector, and doing this now would allow the cuts to be phased in [...]

10 fred { 07.15.11 at 3:00 pm }

The big picture seems rather clear when it comes to caring for our fiscal responsibilities. Sell off these assets and then in a statesmanlike manner begin to make the necessary cuts to government programs. The problem is finding enough statesmen, men and women, to carry out the plan. When are we as a nation going to grow up and face our challenges as serious thinking adults? Why does it always have to turn into a Republican/Democrat issue.
In the typical American family if our expenses exceed our income we make choices or at least we should be making choices to spend less. We cannot simply print more money. We can create more spending power by increasing our debt load with credit cards and the like. We have seen the results of that kind of action. Why is the issue of our federal government cutting back any different than what private citizens are asked to do? I am open to thoughts on this issue.

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