The myth that debt is always bad

The dudes over at Indonesia Anonymous have come up with an interesting post comparing Indonesia and the US. Both countries are alike in many ways they say. But while the article certainly makes a good read, it is also a very good example of how to play on the reader’s prejudices, using fallacious arguments and hyperbole to reinforce myths.

This is not to say that I like Bush. I don’t. But not liking Bush doesn't mean debt is out of control.

I’ll focus on one myth in the article; that is that the US has an unsustainably large amount of public debt and that debt in itself is bad.

Indonesia Anonymous link to a ticker which shows - horror of all horrors - that US public debt stands at US$8 trillion. (Public debt, by the way, is money owed by the US government.)

A lot of money sure. But does that mean it’s a disaster for the US? Not at all. The mistake made here – which is often made by non-financially minded people – is that they are only looking at one piece of the puzzle.

Sure the public debt might amount to US$30,000 for each American on average. But that is a gross figure! You are not taking into account all the assets that America owns to offset these debts! This is a bit like analyzing a company’s balance sheet and saying it is in trouble because it has some loans. But what about the assets the company has? And in the case of the US government it has a lot of assets of course: it’s called America and would be valued at many many times the value of the current US debts!!!

Debts, in fact, help a country to expand (ie they increase its GDP or economic growth). Thus, even if public debts are maintained at a certain level, if the economy grows, then the proportion of debt to the economy will decline.

This is a very very crucial thing to understand and explains why Indonesia has drastically cut its public debt in recent years from 158 percent of GDP to just 60 percent now – even though it has actually issued more government debts!!!! This is because the Indonesian economy has grown hugely in both nominal and real terms.

People who don’t understand finance also often have the commonly misheld perception that foreign investment in the form of equity or FDI is much better than taking on loans or debt. Again not true. In fact, debt is much much cheaper. For Indonesia to borrow money to fund a project it may pay say 6 percent interest on the loan.

Allow a foreign company to come in and what is the cost of capital? The answer: probably in the 15-20 percent range. Much much more expensive. This is because an investor wants a higher return commensurate with the risks he has undertaken. This return on profit is eventually returned to the shareholders – probably in America - in the form of dividends.

Yep folks – it ain’t only one way traffic. Where do you think all the profits from all those US companies set up in China are heading? Back to the US for the most part. But that’s largely forgotten by most economic pundits and they just reiterate the same old tosh about the size of the US govt public deficit!!

And if you are still under the illusion that Bush has pushed up debt to unprecedented highs, take a look at the chart below.

Tells a totally different story huh? Actually quite stable since 1995.

And as the US economy grows – at much faster rates than in lethargic Europe – US debt is perfectly sustainable.

Oh and by the way: US corporate earnings were at their highest levels ever in history in the third quarter of 2006, unemployment is at low levels, and Wall Street is at record highs.

What more could you possibly want?


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