Debt and equity

January 23, 2013

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A couple of weeks ago, my esteemed fellow blogger and close watcher of all things economic, Eric Lundin, wrote a post entitled “We’ve all fallen off the fiscal cliff.” Commenting on the last-minute deal Congress approved to avoid sending the U.S. economy off the fiscal cliff, Lundin said, “Yes, superficially, the new legislation prevented the U.S. economy from becoming the equivalent of a high-speed train wreck. However, it didn’t deal with the broad, deep, fundamental problems that are weakening the foundation of the U.S. economy. We have the same problems we had before this legislation passed, and the U.S. economy will eventually go off the rails. It won’t be sudden. It will play out like a painfully slow train wreck. Rather than a couple dozen freight cars piling up in a matter of seconds, it will take a decade or two, but it will happen nonetheless.”

This blog post became the lead story in January’s “Tube Talk” e-newsletter, and we asked readers to share their thoughts about the pending train wreck. Here’s what some of them had to say (the caps are all theirs):

The owner of a New York-based company that’s been making tooling for five decades said, “As a business owner I totally AGREE with Eric Lundin. We are a POORLY RUN COUNTRY. But we cannot prevent this TRAIN WRECK with the CONDUCTORS we have now.”

The president of a Michigan-based company that supplies equipment to tube and pipe mills said, “CUT SPENDING NOW!!!!!!!! It is an easy problem to solve; too bad our fearless leaders just don’t get it. I would pay more in taxes for a period of time if I knew spending would be cut and we actually ran the country like a business. Only the strong survive, and we are becoming weaker with the debt burden we carry.”

The general manager of a company in Washington State took issue with Lundin’s analogy of just where the country is economically explained in terms of an individual’s financial state. Lundin wrote, “To put [the state of affairs] into perspective, imagine you’re an average wage-earner in an average household: Your household income is about $50,000. Now let’s imagine you ran up debt on a credit card to the tune of 6.6 [current debt to revenue ratio] times your household’s annual earnings. Your debt would be $330,000. Of course, the government is facing the growing burden associated with mass retirements as the baby boomer generation approaches retirement age. If we were to continue the household analogy, imagine you have to deal with $330,000 in debt as your children approach the college age. Let’s throw in a crisis, such as Hurricane Sandy (your house needs a new roof), and a tenacious problem that has to be dealt with sooner or later, such as Iran’s nuclear ambitions (your car needs a new transmission), and it starts to look like your finances are a train wreck in slow motion.”

Regarding this, the general manager said, “People often speak of the ‘debt’ and never speak of the assets.

“In this analogy, the debt is ‘credit card debt.’ The question really needs to be asked ‘What was PURCHASED with that debt?’

“In other words, if I purchase $330K of entertainment that is gone, I’m in trouble. But if I purchase a house that has equity, or if I purchased a machine that helps me make money (and has equity), I’m not
necessarily in a ‘slow train wreck.’

“There are always two sides to the balance sheet. Debt and equity. Our debt to GDP ratio was near all-time highs right after WWII, and it was the start of the longest industrial expansion in U.S. history.  That’s because a lot of the debt was invested in things that ‘produce things.’  This is exactly what an ROI analysis is supposed to determine (you won’t find many people doing ROI analysis on a vacation, but they may on a house rental purchase).

“I’m not saying we don’t have significant challenges, but this article falls into the same trap many others fall into when they do not speak of the things that the (debt purchased).”

I forwarded this response to Lundin, and he replied to the GM.  I don’t know if his reply generated
an ongoing dialogue or not. That’s for Lundin to cover, if he is so inclined.

I also responded to the GM, and while I am not an economic whiz, I do have an opinion about our debt and what it’s purchased. My brief reply also was slightly analogous: “Thanks for your feedback, GM. You raised a good point. However, I fear that our national debt is a little light on the equity. I could be wrong. And some things that you hope will build equity don’t always pan out. I’m sitting in one of them now as I work from my home office.”

OK … that’s a very simplistic response (Lundin’s was far more intelligent and informative; I hope he shares it), but that’s my perspective. Take one initiative, for example, the American Recovery and Reinvestment Act. As reported by recovery.gov and noted in a Chicago Tribune article about  infrastructure spending in Illinois, most of the $840 billion in federal stimulus was spent in three major areas: $241.2 billion paid into entitlements such as unemployment insurance and Medicaid grants to the state; $290.7 billion to cover tax benefits such as those for first-time homeowners, and income tax credits; $248.2 billion for contracts, grants and loans to pay for specific projects, ranging from infrastructure development to funding to help stabilize state education budgets. Just how do we measure this ROI? Perhaps someone out there can answer this question for me.

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