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May 16,1986

Selling Government Assets
In the market for a dam? How about Grand
Coulee dam - the world's second largest concrete dam? Prefer an airport? Would you be
interested in Dulles International Airport outside
Washington, D.C.? Too far out of town? Well,
Washington's National Airport is also available.
For more information, contact the Reagan
The Bonneville Power Admi~istration, which
operates Grand Coulee dam, and Dulles and
National Airports are just some of the federal
government assets listed for sale in the 1987 fiscal year budget that President Reagan recently
sent to Congress. National Weather Service satellites, Naval Petroleum Reserves, Small Business Administration loans and some housing
loans are also on the list.
"Privatization" is the term recently coined to
describe the transfer of federal government
assets and agencies to the private sector.
Whether a particular activity should be carried
out by the private sector or the public sector
depends on the relative efficiency of the two
sectors and the presence or absence of market
failures - situations in which market forces are
not well suited to producing efficient allocations
of goods and services. Supporters of privatization believe that the federal government currently engages in a wide variety of activities for
which the private sector is better suited.
This Letter focuses not on the general merits or
demerits of "privatization", but on the narrower
issue of whether selling government assets can
contribute to reducing the deficit problem, as
some proponents claim. Reported federal deficits would be reduced by asset sales, but the disposal of those assets will in no way ameliorate
the deleterious effects of government expenditures that exceed tax revenues. Examining why
this is the case also helps illustrate how unreliable the reported deficit is as an indicator of the
impact of the federal budget on the economy.

Federal budget deficits
It is easy to see why the federal government is
searching for innovative ways to reduce its budget deficit. Historically high recent budget deficits have led to a huge increase in the
outstanding stock of government debt. At the
end of fiscal year 1980, the total outstanding
debt of the federal government held by the public (excluding, that is, holdings by the Federal
Reserve System) was just under $600 billion. By
the end of fiscal year 1986, that figure had
doubled. Moreover, the Congressional Budget
Office's most recent projection shows that large
increases in the accumulated government debt
most likely will continue for the rest of the
decade. The fiscal year deficit is projected to
drop in future years from the $208 billion level it
reached in 1986, but projections show it will
still exceed $100 billion in 1990.
Federal budget deficits can be reduced either by
cutting spending or by increasing revenue.
Given the political difficulties of the former, and
the President's opposition to tax increases, the
sale of government assets seems to provide a
happy solution. These assets constitute an enormous source of wealth, and their liquidation
could generate large amounts of revenue.

The value of federal assets
Some recent attempts have been made to estimate the value of the assets held by the federal
government. The federal government owns both
tangible (structures, equipment, inventories and
land) and financial (gold, currency, deposits,
mortgages and other loans) assets. As of the end
of 1980, the Bureau of Economic Analysis of the
Department of Commerce estimated that the
replacement value of government structures,
equipment and inventories totaled $608 billion.
The value of land owned by the federal government in 1981 was $175 billion, not including
the total value of oil and gas mineral rights on
that same land. Recent work by Michael Boskin,

Marc Robinson, Terrence O'Reilly, and Praveen
Kumar pegged the value of these mineral rights
at about $820 billion 1981. Since the estimated
value of federal land may include some of the
capitalized value of these mineral rights, adding
the value of land to the value of the mineral
rights would involve some double counting.
Nevertheless, these estimates suggest that the
total value of the government's tangible assets is
in the neighborhood of $1.5 trillion.
The financial assets of the federal government
totaled $707 billion at the end of 1980. This
included $152billion in gold, $126 billion in
mortgages and $200 billion in other loans.
Added together, these estimates of tangible and
financial asset holdings yield a value of over $2
trillion. By comparison, the total real market
value of the federal government's debt at the end
of 1980 was $1.15 trillion. By selling its assets,
the federal government could more than retire
its debt. But would this be good for the
economy? Not necessarily. Focusing only on the
debt of the federal government - the liabilities
side of the balance sheet ~ can give a misleading impression of the government's financial

Crowding out
To understand the effect a sale of government
assets will have on the problems caused by
federal budget deficits,a distinction must be
made between the effect of such a sale on the
economic problems normally attributed to deficits and the effect such a sale has on the
reported budget deficit.
When the government borrows, it adds to the
total demand for credit in the economy. Normqlly, an increasein the d~mand for credit,
whether it originates from the government or
from households or corporations, would tend to
lead to increased interest rates. The rise in
interest rates works to keep credit markets in
equilibrium in two ways. First, by making saving
more attractive, it increases the total supply of
credit. Second, by raising the cost of borrowing,
it reduces the demand for credit.
Since the government tends to borrow what it
needs regardless of the level of interest rates, it is
the private sector whose borrowing is reduced
by a rise in interest rates. Government bor-

rowing, by raising interest rates, therefore
crowds out some private borrowing. As a result,
households and firms reduce their investment in
tangible productive assets.
It is possible, however, for deficits not to crowd
out private borrowing. If savings rose, they may
generate enough new credit to supply the government's borrowing needs without a rise in
interest rates or a fall in investments. Savings
may rise if households recognize that current
deficits imply higher future taxes. That is, if the
trend in government expenditures remains
unchanged, a cut in taxes implies that, some
time in the future, there must also be a rise in
taxes. Households might increase their current
saving to pay for the higher expected future
But except for the special case in which private
saving increases enough to meet the government's borrowing needs, federal deficits do
impose a real cost on the economy by affecting
the aggregate demand for credit. The major cost
of government deficits over the long-run arises
from the effect of higher real interest rates and
lower private investment on the economy's
capital stock. Because financing government
deficits reduces private investment, the economy
will have a smaller private stock of capital in the
future. This, in turn, means that the economy's
productive capacity will be smaller and incomes
in the future will be lower. The real cost of government deficits therefore is lower real income
in the future.
When government borrowing tends to raise
domestic interest rates, investment funds will be
attracted from abroad. Since this capital inflow
represents an increase in the supply of credit
available to finance government borrowing,
there will be less crowding outof domestic
investment than would occur in a closed
At first glance, foreign capital inflows mean that
there will be a higher capital stock in the future,
and thus higher levels.of real production.
Foreign investors, however,own claims on this
higher income. Because foreign lenders must be
paid back, the domestic economy receives
lower income in the future as a result of past
government borrowing.

Offsetting effects
The effects of a sale of government assets on the
economic problems due to the federal government's deficits will depend on how such a sale
affects the economy's total demand for credit.
The proceeds from the sale of an asset would
directly reduce the amount of borrowing the
federal government would need to undertake,
and thereby reduce the aggregate demand for
credit. For every sale, however, there must be a
buyer. And the buyer of the asset must raise the
purchase price by borrowing. The buyer therefore increases the demand for credit by an
amount exactly equal to the fall in the government's demand, offsetting its effect on the total
demand for credit.
Selling the assets of the federal government is
likely then to have no net effect on the total
demand for credit in the economy. Such a sale
cannot, in any way, reduce the detrimental
effects of government borrowing. However,
because the federal government operates on a
cash budget basis, the entire proceeds from the
sale of an asset would be reported as income at
the time of the sale, thereby reducing the
reported deficit. If, as do corporations, the
federal government kept separate capital and
current budgets, it would be clear that the sale
of an asset owned by the government has no
effect on the balance between its current expenditures and revenues. The reported federal deficit therefore can be a very poor guide to the true
effect of government expenditures and taxes on
the economy.
Some opponents of the sale of federal government assets have argued that liquidation sales
are undesirable because they would actually
make future deficits worse if assets that generate
revenue for the government are sold. An example of a revenue-generating asset is the Grand
Coulee dam, which produces hydroelectric
power. But this reasoning fails to consider that
the price at which a government asset can be
sold will equal the currentvalue of the future
income a private operator could earn from
owning that asset. In other words, the value of
the Grand Coulee dam's future revenues would
be reflected in its sale price.
Moreover, if the private sector is able to operate
more efficiently than the government, the price
it would be willing to pay for, say, the Grand

Coulee dam, would exceed the value of the
dam's future revenues under continued government operation. Conversely, if the government is
the more efficient operator, the price a private
investor would be willing to pay would fall short
of the value of future income the government
could earn by maintaining operation. Simply
changing the ownership of an existing economic
asset therefore has no effect unless the new
owner's efficiency in operating the asset differs
from that of the original owner.

Borrowing differently
While the federal government may reduce its
current reported deficit by selling an asset, it will
have set the stage for a rise in future reported
deficits by foregoing the future revenues produced by the asset. In essence, the government
will have converted future revenue into current
revenue. This is just like borrowing directly,
whereby the government converts future tax.
revenues into current revenue by issuing debf
that must be paid off in the future.
An imbalance between spending and income,
and its economic effects, cannot be corrected by
liquidating some of the federal government's
assets. Receipts from such sales are not income
since they simply represent the exchange of one
asset, such as an airport, for another asset, such
as money. If the receipts are used tofinance current expenditures, the government has reduced
its wealth ~ it has "dis-saved" - by exactly the
same amount as it would if it had borrowed
directly to finance its expenditures. In both
cases, the dis-saving of the government must be
financed by the saving of other sectors of the
economy. And this leaves less saving available
to finance private investment.
This Letter has only examined the impact of
asset sales on the economic effects of the deficit.
The more fundamental issue of whether deficits
are too large or too small depends on how the
government uses the funds it borrows, whether
public capital (schools, dams; roads) is more
productive than alternative privc3te investment
projects, and the relative efficiency of public
versus private provision of services. Reported
deficits therefore cannot always accurately
measure the impact of government on the private economy.

Carl E. Walsh

Opinions expressed in this newsletter do not necessarily reflect the views of the management of the Federal Reserve Bank of San
. ' . .
Francisco, or of the Board of Governors of the Federal Reserve System.
Editorial comments may be addressed to the editor (Gregory Tong) or to the author .... Free copies of Federal Reserve pubhca~lOns
can be obtained from the Public Information Department, Federal Reserve Bank of San Francisco, P.O. Box 7702, San FranCISco
94120. Phone (415) 974-2246.




!!omoH O!UJO}!I0)






aAJaSa~ IOJapa::J

~uaw~Jodaa lpJOaSa~
(Dollar amounts in millions)

Selected Assets and Liabilities
Large Commercial Banks
Loans, Leases and Investments 1 2
Loans and Leases 1 6
Commercial and Industrial
Real estate
Loans to Individuals
U.S. Treasury and Agency Securities 2
Other Securities 2
Total Deposits
Demand Deposits
Demand Deposits Adjusted 3
Other Transaction Balances4
TotalNon-Transaction Balances 6
Money Market Deposit
Time Deposits in Amounts of
$100,000 or more
Other Liabilities for Borrowed MoneyS

Two Week Averages
of Daily Figures



Change from 4/24/85


- 837
- 411



11 ,714



Perrod ended


- 5.2

Perrod ended




Reserve Position, All Reporting Banks
Excess Reserves (+ )jDeficiency (-)
Net free reserves (+ )jNet borrowed( -)



1 Includes loss reserves,unearned income, excludes interbank loans



Excludes trading account securities

3 Excludes U.S. government and depository institution deposits and cash items
4 ATS, NOW, Super NOW and savings accounts with telephone transfers

S Includes borrowing via FRB, TT&L notes, Fed Funds, RPs and other sources
6 Includes items not shown separately
7 Annualized percent change