A Contrarian Idea About Deficits

By Kevin Muir of the Macro Tourist

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Imagine you are running a small business. Although sales are slowly growing, competition is driving down your margins.

Your employees are getting squeezed by rising living expenses. Not only that, they are worried about the fact they are living longer and have not saved enough for retirement.

To stay competitive you desperately need to invest in new technology, retrain your workers, and adapt to the new landscape. But you are scared because you don’t have the capital.

So what are your choices?

Well, you could try the status quo route. Borrow a little from the bank to fund short term cash flow issues. To keep your employees happy, promise an increased retirement package – after all, that need not be paid for today. Tighten your belt, put off large maintenance expenditures, and hope somehow your business improves.

Or you could do the opposite. Tell your employees that promising future benefits without a strong underlying business strategy is irresponsible, but you have a plan to make your company more competitive. You head to the bank and get a long term loan (at a stupidly low rate). With the money, you invest in the much needed capital improvements to make your business more competitive. You set about making a better company for everyone involved.

Now imagine instead of running a company, you are running a country. Why do so few see the similarities between the two situations?

Pundits constantly shout about the dangers of governments borrowing too much. They make all sorts of scary charts, and, uniformly, put all borrowing in the same pile. Debt is bad. It will be our downfall. Stop borrowing immediately. Yadadada.

Yes, borrowing to fund some entitlement promise the country cannot afford is asinine. Citizens everywhere should be up in arms about the irresponsibility of governments in making commitments they don’t have a hope in hell in keeping. Often these are just vote buying exercises, but the problem is, the naive public doesn’t realize governments are in no position to make such promises. Just like our small business owner, the writing is on the wall.

Yet sticking our heads in the sand and claiming all borrowing is bad is equally stupid. Investing in infrastructure is how we will continue to grow our economy. Without it, other societies will leap ahead, leaving us trying to produce a product with antiquated infrastructure. Sure, for a while we will be able to compete, but eventually, the lack of investment will become apparent. Like the small business owner, we are just delaying the inevitable.

I was going to include some charts in this note, maybe develop the idea with real world examples. Yet I have decided to leave it with just this simple concept.

Not all government borrowing is bad. At the same time, not all government borrowing is good. Differentiating between good and bad spending (investing) will be the key to deciding which countries’ deficits you should worry about.

In this day and age of challenged government balance sheets, there is bound to be lots of discussion about the unsustainability of government deficits. My message is to not tar them with the same brush.

And if you want to take a truly contrarian approach, you could argue the government with the courage to invest while everyone else is busy retreating, will be greatly rewarded in the coming decades. After all, bond markets are practically giving it away. Long term money has never been so cheap, yet never before have so few governments been willing to spend it. The hurdle to produce positive returns from investment is laughably low. I think even governments might be able to beat it.

 

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