[quote=davelj][quote=dumbrenter][quote=davelj]
Yes, debt has been growing at a much faster rate than GDP, so we know that it has had a positive impact on GDP (in the past). Now we’re at the point where debt is so large that it has a negative impact on GDP (too much to service). We have too much debt – there’s no question about that. But… you’re dramatically overstating your case when you suggest that there hasn’t been ANY economic growth ex-debt over the last 30 years; this is empirically incorrect. In fact, there’s been a bit of research done on this subject and most of it concludes that about 50-100 bps of annual GDP growth over the last 30 years has been the result of incremental debt.[/quote]
Would it be correct to say that the debt service payments will be a short-term liability (i.e. in current portion of liability) while the same debt used productively will be having a positive effect on the revenue portion of the income statement?[/quote]
This is an interesting issue and it’s complicated by politics and the fact that our economy isn’t a corporation, although they share certain similarities. A traditional view of corporate finance suggests that you issue debt and invest in projects so long as the new projects’ expected rate of return is greater than the weighted-average cost of capital (weighting both debt and equity). As debt increases, the individual costs of both equity and debt increase (as the whole enterprise becomes more risky), but the weighted-average cost declines (because debt is cheaper than equity) UP TO A POINT. At a point – and this varies by company – the overall cost of capital starts to increase with each unit of additional debt – this is, in theory, where the “optimal capital structure” lies. To use extreme examples, the optimal debt-to-capital ratio for a tech start-up is zero (as it’s a very risky enterprise). Conversely, the optimal debt-to-capital ratio for a utility is fairly high, as its cash flows are highly predictable.
Which brings us to the US. Aggregate debt, in and of itself, is not a bad thing. And the US doesn’t have a “true” cost of capital because it’s not a corporation (the Federal Reserve can print money, after all). Arguably, however, at the point at which $1 of incremental debt no longer produces $1 of incremental GDP… well, you need to start asking some hard questions. Perhaps that $1 of debt will pay off in the longer term. For example, a corporation doesn’t issue $1 of debt assuming it’s going to generate a like $1 of earnings in year 1 – that’s absurd. But over time… it needs to generate something positive. The problem that we face now, of course, is that $1 of new debt generates about $0.15 of incremental GDP. While I don’t know what the optimal capital structure is for the US (I’d have to really think about that), it’s not what we have currently – we’re over-leveraged. The only reason we can service our debt right now (and for the foreseeable future) is that Mr. Bernanke has fixed interest rates at a very low level.
So, in a corporate context, it’s much easier to determine whether or not an enterprise is over-leveraged. It’s much more difficult when you look at an economy. But I think when you look at the mountain of debt we have today relative to GDP it’s pretty clear we have a problem. The debate is whether it’s a painful, albeit surmountable, problem over the long term or completely insurmountable. The jury’s still out on that question.[/quote]
Thanks.
So going to back to what I am trying to figure out:
A debt issued by government is very different from that of a corporation.
Additionally, while the interest rate on a bond issued by a corporation is dependent on market, the US government at this time can choose the interest it wants to pay on its debt.
To make things even interesting, the US can not only choose the interest rate, but the debt is denominated in paper that the US can print at will.
So where exactly is the problem? How can we be over-leveraged when we get to control the rate AND the denomination in which the debt is serviced?
We can keep issuing debt till there is no buyer at which point we cannot issue debt anymore which means there is no more debt problem.
OR we will reach a point of exchange rates / devaluation / inflation where it will become cheaper to make things here instead of making them overseas and shipping them here. Which means more jobs here and a vibrant economy.
Looks like folks holding dollar or dollar denominated assets will win in either case. Or so it seems to this dumb renter.
