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Productive Debt, Productive Capital

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Government needs to make our money work for us.

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One of the common themes on Minyanville has been the notion that our problem is simple: Too much debt and not enough income. It's hard to argue with that scenario when we see evidence of it every day.

But there's more going on here. Debt isn't necessarily a bad thing. We all understand the implications of having too much leverage on a personal level: While our incomes may fluctuate, our indebtedness does not. When this crisis eventually ends (and it will end), a whole generation of Americans may refuse to take on debt.

Having said that, debt can be extremely productive, provided 2 conditions are met:

1. That there is enough income to service the debt; and

2. That the capital acquired by utilizing leverage is deployed productively. It is this second point that merits discussion.

Our government appears hell-bent on spending us out of the current fiscal crisis. And yet our country is already hugely over-leveraged, as are many of its citizens and institutions. So for this strategy to have any merit, the spending proposed by the government must be productive. But productivity can be easily redefined by our public servants for their own ends. A new bridge can be considered productive, as can a swimming pool: These things may be helpful, or necessary, but that hardly makes them productive.

Think of any basic manufacturing corporation. Odds are that it borrows money for a variety of purposes. If a new plant costs $20 million, and the corporation seeks to borrow the money, the math on the project is simple. If the debt bears an interest rate of, say, 8%, it would cost the company $1.6 million annually to service that debt (assuming no amortization).

If the income associated with the new plant could reasonably be expected to exceed $1.6 million, then the project would begin to make sense. If the income associated with the plant was less than the cost of capital required to service it, then the investment wouldn't have merit. For the purposes of this conversation, the first investment would be considered productive, while the second investment would not.

Now, I have read the stimulus bill proposed by President Obama: Unfortunately, it includes very few productive spending items. In fact, most of what's proposed will be counter-productive, because it will add to the size of the government (permanently, I fear), hence adding significant costs to the normal course of operations. The government isn't spending make-believe money; they're spending our money. And ultimately, they're reducing possible productive spending at the expense of non-productive spending.

I'm certain the spending proposed for infrastructure (roads and bridges, the grid) make sense. For everything else, I suggest we all ask our local elected officials exactly how the taxpayer will earn a return on that money. We understand the cost of this debt: It's the current rate at which our government borrows money. Amazingly, this rate is extremely low.

So we should be asking ourselves and our elected officials: Do these things have merit as an investment? Does it actually make sense to spend money we don't have to create a bad bank we don't necessarily need? What are the expected returns, and how productive can this spending be, considering various purchase prices for the toxic assets in question? These are the type of discussions we should be having as a country, as opposed to having officials directing funds to the most politically expedient causes.
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The information on this website solely reflects the analysis of or opinion about the performance of securities and financial markets by the writers whose articles appear on the site. The views expressed by the writers are not necessarily the views of Minyanville Media, Inc. or members of its management. Nothing contained on the website is intended to constitute a recommendation or advice addressed to an individual investor or category of investors to purchase, sell or hold any security, or to take any action with respect to the prospective movement of the securities markets or to solicit the purchase or sale of any security. Any investment decisions must be made by the reader either individually or in consultation with his or her investment professional. Minyanville writers and staff may trade or hold positions in securities that are discussed in articles appearing on the website. Writers of articles are required to disclose whether they have a position in any stock or fund discussed in an article, but are not permitted to disclose the size or direction of the position. Nothing on this website is intended to solicit business of any kind for a writer's business or fund. Minyanville management and staff as well as contributing writers will not respond to emails or other communications requesting investment advice.

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