13 ms·

How companies became addicted to debt

123 points by bertdc 6y ago

daniel-s 6y ago
That period in the 70s also corresponds with the moment that US dollars lost any ties to gold. There is a natural rate of interest in an economy. When the central bank artificially lowers interest rates you get malinvestments. This is only possible with fiat currencies because you can't print gold. None of this would be possible if interest rates were at (say) 5% which is about the historic average, or at early 90s (double digit) levels. This ends dramatically. I'm guessing with a less dramatic version of Zimbabwe or the Weimar republic.
- friendly_chap 6y ago
  I'm not sure why you are being downvoted. All we see is bubbles, inflation, inequality, record low interest rates and stagnant wages, but apparently printing trillions and and not having a gold standard has nothing to do with it. Sure.
  - newhotelowner 6y ago
    > apparently printing trillions and and not having a gold standard has nothing to do with it Printed trillions because of Covid-19. It would have been grim situation without the stimulus. 12-14% unemployement, no stimulus would have closed thousands of business, and would have increase unemployement. People who has money (Silicon valley engineers) is not going to invest in rural Ohio. Wages are stagnated because of policies and misinformation. Federal minimum wages should be raised at least $12 and tied to inflation with universal health care. Inflation is record low. Not sure what you talking about. Its time to be robin hood. Tax high income, tax stock buy backs, higher capital gain taxes etc. Its pathetic that people making $500k/year pays less than $75k in Federal income tax (14%).
    - deleted 6y ago
      [deleted]
    - votepaunchy 6y ago
      > Its pathetic that people making $500k/year pays less than $75k in Federal income tax (14%). The 32% bracket begins at $160k and at $500k AGI you’re paying $150k in taxes (30%).
      - take_a_breath 6y ago
        If taxes were that easy, we wouldn’t need so many accountants in the US. In reality, there are a bunch of ways a person makes $500k and pays less than $150k in taxes. - For example, if it’s paid as carried interest, they only pay a 20% tax rate. - They could itemize deductions. - A farmer could buy a brand new truck and call it a business investment. - If you’re a pass-through entity you only pay a 20% rate
        newhotelowner 6y ago
        > A farmer could buy a brand new truck and call it a business investment. That is a business expense. 500k is after all the business (Non-personal) expenses, depreciation and deductions .
        take_a_breath 6y ago
        $500k is the income. The entire point is that business and personal expenses overlap considerably for farmers so they have wide range for tax purposes. It’s an inefficiency in the tax code which allows a person to have income of $500k and pay less than 31% in taxes.
        WalterBright 6y ago
        > They could itemize deductions. The AMT (Alternative Minimum Tax) phases out itemized deductions for higher incomes.
      - newhotelowner 6y ago
- chii 6y ago
  > This is only possible with fiat currencies because you can't print gold. on the other hand, if the world was still on a gold standard, then the gov't couldn't have printed stimulus packages, and it would lead to more poverty and misery in the short to medium term (even if that would've been better in the long term, which is a debatable outcome). Fiat is only as good as the gov't handling it. It can indeed be abused more than gold can. But it's also more powerful than gold. A tool, in the hands of the capable, can do wonders. So the debate around monetary policy should be how to achieve the best results.
  - roenxi 6y ago
    > if the world was still on a gold standard, then the gov't couldn't have printed stimulus packages Sure they could, borrowing is still allowed. And the government can just declare "property rights are lovely but we're suspending them in this emergency, here are some IOU for after we raise taxes to cover this". Which would have a largely equivalent effect in real terms to money printing but much easier to understand. > Fiat is only as good as the gov't handling it. The government is consistently made up of financial incompetents. Most governments struggle to deliver a balanced budget when they try. All the people who know how to make good financial decisions are in private industry making them.
    - AshamedCaptain 6y ago
      > And the government can just declare "property rights are lovely but we're suspending them in this emergency, here are some IOU for after we raise taxes to cover this". Which would have a largely equivalent effect in real terms to money In no way this has the same effect. The uber wealthy have an even easier time of hiding their property in this case, and the mid wealthy react much worse (violently) to private property forfeits than to the usage of printing press (which as you say most of us don't even understand). > Most governments struggle to deliver a balanced budget when they try. All the people who know how to make good financial decisions are in private industry making them. This is very old bullshit, and thinking like this leads to parties trying to be cool by hiring people from industry with the consequent terrible results ( this trope is so old its even parodied on yes minister).
- _qulr 6y ago
  If we're "wise" enough to constrain our currency to gold, then we're also wise enough not to manipulate our currency in self-defeating ways. But if we're not wise enough, nothing can save us. Some lumps of gold won't save us from ourselves.
- alexmingoia 6y ago
  A gold standard doesn't prevent manipulation of interest rates. The Federal Reserve manipulated interest rates while on a gold standard. One of the reasons they would increase or decrease interest rates was to manage the desired gold stock. The reason the US abandoned the gold standard was the (inevitable) failure of centralized fractional-reserve banking. By 1971 the U.S. was effectively insolvent in its ability to cover foreign holdings, and feared a run on the dollar. U.S. gold reserves couldn't keep pace with the expanding money supply and increasing demands by foreign holders for redemption of their dollars.
- mtgp1000 6y ago
  A growing number of netizens are starting to believe that we are already living in an American Weimar Republic. And it's hard not to see the many social and political parallels - I'm not familiar with the economic side of Weimar Germany.
- 082349872349872 6y ago
  Two things mentioned in the article (a) US tax advantaging of a debt-laden structure and (b) LBOs actively punishing firms for not carrying an "efficient" level of debt are probably more important. Note that LBOs were invented in a period of double digit interest rates. (there is an argument that USD interest rates are "too low" due to market reasons, because USD is the global reserve currency. I suspect leveraging global reserve status to apply strategic sanctions is, at least over the short term, far worth more the US than any resulting malinvestment. If not, we'd all be using Bancor for exchange.)
- pjc50 6y ago
  I don't understand how people can look at the near-zero price and wage inflation and then claim America is suddenly going to become Zimbabwe without going through an intermediate phase of "slightly higher inflation", like 5 or 10%. Besides, the use of gold has no bearing on "M2", which is quite important in the modern economy. And all the classic hyperinflation cases were forex-driven: either the country's exports fell below their ability to import necessities like food and oil, or (in the case of Weimar) they were forced at gunpoint to hand over gold. So long as the US continues to produce enough food and oil domestically, it's very well insulated against hyperinflation.
  - zzleeper 6y ago
    You make some really interesting points. Allow me to reply with a bit of speculation: 1) Peruvian, Bolivian, Argentinan hyperinflation were purely printing-press inflations, without forex being the culprit. 2) Inflation is strongly affected by expectations. If everyone think prices will go up 5%, then we all increase salaries/prices by that and we self fulfill the prophecy. 3) 5-10% inflation is actually quite high for modern standards. We are not in the 70s anymore. 4) Lastly, the main point: onxe you get there, there is a high chance that the dollar will lose its place as the world's currency. Then, inflation accelerates and you enter a spiral.
    - jcranmer 6y ago
      The good counterpoint here is Japan, which has insanely high public debt (about 200% of GDP), invented quantitative easing, and has struggled to hit 2% inflation for several decades now. If Japan hasn't been able to hit a hyperinflationary spiral based on its debt-fueled trajectory, then the US (which is far less along that path) isn't going to be hitting it anytime soon.
      - Nasrudith 6y ago
        As nuts as it sounds I suspect high levels of debt may be a hint that there isn't enough money printed into the economy and the debt is a symptom. That more supply doesn't drop the demand significantly seems like a hint. I would love to hear counterarguments because this seems odd even to me.
- neilwilson 6y ago
  "There is a natural rate of interest in an economy." Yes, and the base rate is zero. Since reserves are costless to produce and banks can't get rid of them in aggregate the base rate should always be zero. It is rates above zero that are unnatural since by definition they are a market intervention that reduces the price of all other assets and drives up yields artificially. The state shouldn't be paying a Basic Income to banks in the form of interest on reserves. Banks should earn their crust by lending productively. Beyond that the rate of interest is the one estimated by the lender to be sufficient to cover the risk of discounting your collateral into the state's liquidity. Banks are really just pawnbrokers with shinier suits and better PR.
  - 6510 6y ago
    How would banks lend productively? (just curious)
    - voisin 6y ago
      Borrow from depositors at one rate, lend to borrowers at a higher rate with losses to bad loans amounting to less than the spread.
  - AbrahamParangi 6y ago
    The base rate is non-zero because capital has non-zero cost. Interest is just the limit of the cost of capital. If you don’t have a fed, or if the fed does nothing then interest rates will converge on their own to a positive value.
    - neilwilson 6y ago
      Banks have a capital cost. The central bank does not. I was talking about base rates. Banks mark up on base rate to cover the risk to their capital
  - alexmingoia 6y ago
    The natural interest rate refers to the interest rate in a free market of banking. In a free market interest rates would not be zero otherwise the bank can’t make any money...
- nknealk 6y ago
  Actually, the last time we had high inflation, the fed kicked interest rates up[1]. So I don’t know if we end up like Zimbabwe. The fed would likely step in well before something bad happened. https://www.stlouisfed.org/publications/regional-economist/january-2005/volckers-handling-of-the-great-inflation-taught-us-much https://www.stlouisfed.org/publications/regional-economist/j...
- Nasrudith 6y ago
  That isn't true for gold - historically it has destabilized economies several times by having both too little and too much gold relative to the true size. The gold standard has caused many wars and travesties as conquest was started for the sake of raising their economic cap above deflation, let alone debasement of currency. A "natural rate" of interest doesn't seem like a meaningful concept to me, to be pedantic. There is nothing natural about it, it is all tautological based upon what "works". Closest concept to it I see is the currency vs productivity mapping for what causes real inflation. Given that universal value is a mere mentally convenient myth everything is fuzzy anyway.
- jariel 6y ago
  Limiting the money supply on the basis of quantity of some arbitrary metal is in no way creating a 'natural' interest rate in the economy. Gold acts as an 'independent, non-political' arbiter, but it's nowhere near 'natural'. How does the discovery of a lot of Gold, somewhere on the planet, related to the 'natural' productivity and growth of a nation? There's no such thing a 'natural' interest rates - we have to decide how much currency we want in circulation, and we try to use 'objective rules' to do that, and try to keep that system as far away from the Political System as possible. But since 2008, we are definitely playing with fire in terms of the funny business and 'breaking of our own rules' we are doing at the Fed, i.e. by accepting crap mortgages as collateral etc..
simonCGN 6y ago
No, not companies. Investors who rather get dividends or share buybacks than having the company pay down debt
_qulr 6y ago
"Pension funds and insurance companies bought the debt in bulk" Is it fair to say that pension funds are largely to blame for this? Corporations can't acquire debt if nobody offers them money. Insurance companies too, of course, but pension funds in particular are at least theoretically supposed to be protecting the workers. Hard to see how debt-funded corporations (I'll mention Uber as an egregious example) are in alignment with the interest of the workers.
- em500 6y ago
  > Is it fair to say that pension funds are largely to blame for this? Corporations can't acquire debt if nobody offers them money. About as fair as it is to say that people who wish to receive some income after retirement are to "blame" for this. Nobody can save without some other party (households, companies or the state) acquiring debt.
  - amelius 6y ago
    > Nobody can save without some other party (households, companies or the state) acquiring debt. If this is true, then perhaps something is wrong with the system? In the old days I could just save some nuggets of gold I earned, and spend them after retirement.
    - dageshi 6y ago
      I think in the old days you had as many kids as you could and expected them to look after you in your old age.
  - _qulr 6y ago
    Junk bonds are hardly the only form of investment, and certainly not the safest, if your goal is to ensure someone's retirement. Moreover, corporate debt is at high risk of mass default in a market downturn such as the current one.
    - _qulr 6y ago
      Pension funds spend $trillions on investments. They have a lot of power to incentivize corporate behavior, in either a responsible or irresponsible direction. It seems to me that pension funds have been enablers of irresponsible corporate debt stockpiling. Pension funds had a choice, and I'm not sure they chose wisely.
dsukhin 6y ago
Perhaps an unorthodox way of looking at things, but it's very intersting take a step back to consider what 0 to low interest rates might accomplish for society: - Low interest rates mean it makes no sense to simply keep cash, it's better to invest in something productive. For companies that's new projects/ideas which create jobs, for individuals that might be spending on goods to stimulate the economy or buying a house. - High interest rates are a considered a way to reduce "risky" investments. But in reality, interest is rent seeking on capital which benefits (1) lenders/banks (2) capital holders. Cheap capital enables more projects with positive ROI (above cost of capital) to be persued. And this is good for society as it drives innovation and allocates capital to innovators instead of locking it under stagnant rent seeking. Lest you worry, this doesn't hurt capital holders, as they can instead proactively invest in companies and make the same or larger returns, but now capital is allocated by merit of the project being invested in instead of by simply who can afford it because it meets some threshold. This unlocks the "long tail" of innovation. This is what is referenced in the article: 1970s Hertz took a risky bet using debt which paid off to record profits. - Higher interest really means higher long run inflation. If you can just let money sit in a bank, doing nothing directly productive for society, and there is suddenly more of it, prices will adjust accordingly. With low interest rates, money supply will adjust with GDP growth from innovation and prices might even be reduced by higher competition and discovery of efficiencies. As long as innovation (enabled by access to capital) stays on pace with money supply, inflation stays low. This is of course a very optimistic way of looking at things which doesn't consider the effect of things like wage growth which has all but stopped. One could argue in a non-inflationary environment that might be ok, but this is a larger topic having to do with social mobility goals rather than just the economics.
- pjc50 6y ago
  > Higher interest really means higher long run inflation. In orthodox macro, higher interest rates -> reduced investment -> reduced demand -> reduced inflation. This is pretty much empirically proven by how central banks have been able to control inflation in the West. The way I see it is the "search for safety", especially where negative interest rates are concerned. There are two huge concentrations of safety-seeking money in the modern economy: pension funds and oligarchs. The pension funds more or less have to buy government bonds in a certain ratio, regardless of the price. Whereas the oligarchs have hundreds of billions they need to keep anonymously in a stable economy - ie dollars, pounds, and euros. Things like the Apple "cash" pile of $245bn represent a lot of floating wealth too. Ultimately, if we don't get real wealth taxes, interest rates will be forced negative simply by the market and the huge volume of safety-seeking money.
pixelmonkey 6y ago
Something I have never seen a good answer to or explanation of: what is an "appropriate" debt or leverage ratio for a healthy company? Obviously, a private company with hundreds of millions in stable recurring revenue shouldn't operate debt-free -- debt can be a useful tool, even if only as a rainy-day tool for situations such as the recent pandemic. In other words, corporate debt -- and especially low-interest and covenant-free debt that is secured using recurring revenue -- seems like a capital allocation (corporate finance) tool with a set of trade-offs relative to cash and venture investment. But, how much debt is "too much"? I feel like those of us who work in software can sometimes forget that for most industries, venture capital isn't even an option, which means debt can be one of your only growth financing sources of capital -- and even for those in software, some companies are not venture-fundable but might still be debt-fundable. It's clear that the PE firms that load up billion dollar companies with billions in debt are just playing a speculative finance and asset strip-mining game. But, it would be a shame if we invested all of this time, money, and regulation into a robust "financial capital banking sector", and we can't even rely on it for capital that businesses can use to create jobs, service customers, and smooth the rough patches in the economy.
- ihodes 6y ago
  There's a fair amount of thought behind what the ideal debt ratio should be for a company, but basically the goal is to minimize the cost of capital while maximizing market value.^[1] [1]: https://www.investopedia.com/terms/o/optimal-capital-structure.asp https://www.investopedia.com/terms/o/optimal-capital-structu...
  - pixelmonkey 6y ago
    Thank you for this. I did not know the term "Optimal Capital Structure" but it seems like a good jumping-off point for researching the topic.
- ciconia 6y ago
  > Obviously, a private company with hundreds of millions in stable recurring revenue shouldn't operate debt-free -- debt can be a useful tool, even if only as a rainy-day tool for situations such as the recent pandemic. Why obviously? Seems to me when a crisis hits the last thing you want to have is debt you need to pay back. For example, should Apple, with their huge mountain of cash, have debt? Do they need debt? I guess one can also ask the same about countries. Do they really have to maintain some level of debt in order to have a healthy economy? Why not just have a big bunch of cash put aside for a rainy day? How is this "obvious"?
dwighttk 6y ago
is it different from governments or individuals?
- neilwilson 6y ago
  Depends which sort of government: sovereign or otherwise (US state, Scotland, Eurozone member). Sovereign government don't really have debt in the sense you would recognise as debt.
  - dwighttk 6y ago
    sure, but they get addicted to something we call debt
    - neilwilson 6y ago
      Only if the private sector gets addicted to something called "wealth". One can't exist without the other. A Treasury or a Gilt is a safe private asset that is much in demand.
  - smabie 6y ago
    Government debt denominated in foreign currency looks pretty much identical to corporate or individual debt.
    - neilwilson 6y ago
      Indeed. That's part of the "otherwise" - the reason why a Eurozone country struggles. They denominate in a currency issued by a foreign entity they don't control.
cs702 6y ago
> …has drawn attention to the relentless build-up in corporate debt in the US, where companies now owe a record $10tn — equivalent to 49 per cent of economic output. When other forms of business debt are added in, including to partnerships and small businesses, that already extraordinary figure increases to $17tn [83% of GDP, the highest ever]. > Even before the pandemic, the level of corporate leverage was beginning to cause alarm. At the end of last year, the IMF issued a striking warning: as much as $19tn of business debt in eight countries led by the US — or 40 per cent of the total — could be vulnerable if there were a “material slowdown” in the economy, a scenario that, if anything, now seems tame. I like to think of it this way: At present, a business that is barely-investment-grade (say, BBB-/Baa3) can borrow for a decade at just over 3%/year. A risky business that is rated as junk (i.e., below BBB-/Baa3) can borrow for a decade for as little as 6% to 7%/year. The interest payments are tax deductible, so the effective annual cost to borrow is around 2.5% for barely-investment-grade and around 5% for junk, give or take. As long as the executives think they can earn more than 2.5% to 5% per year on any money they borrow, why not borrow it? And if they can justify using borrowed money to buy back shares, keeping their stock options in-the-money, why not do it? Many US companies in mature industries (think energy, hospitality, travel, transportation, etc.) have been doing exactly that, to the point that corporate debt is now the highest ever in relation to US GDP. And it has worked beautifully... that is, until a global pandemic suddenly cut their revenues by 10% to 20% or even more, instantly flipping those expected earnings into losses. People are no longer traveling as much, or going to restaurants as much, or going to the office as much, etc. All of a sudden, all those businesses are losing money on all that borrowed money -- they are losing so much, in fact, that many have had to borrow even more during the pandemic to be able to continue paying interest on prior borrowing and avoid going into bankruptcy.
- supercanuck 6y ago
  >As long as the executives think they can earn more than 2.5% to 5% per year on any money they borrow, why not borrow it? Back in the day, people were responsible for their Choices. So if some unforeseen happened, a savings was considered a good thing. Today, a CEO can just shrug and say “meh, pandemic” and the government is suppose to be the lender of last resort. This is the moral hazard that we were all afraid would happen after 2008.
neonate 6y ago
https://archive.is/r1js6 https://archive.is/r1js6
woodandsteel 6y ago
From what I understand, the basic problem is this. The way things are supposed to work is corporations take their profits and divide them up in two ways. Part goes to paying the owners, like dividends to stockholders. Part goes in investing in the future, like research and building factories. The problem is that for a long time a large proportion of companies have been paying out an increasing portion of their profits to pay off massive and ever increasing debts. They still keep paying profits to the owners, and so they have ever less left for investing in improving the company. That in turn means poor growth and being less competitive in world markets. And even worse when the economy goes through a bad period, many thousands of companies can no longer pay their huge debts and go bankrupt, with great damage to the economy.
woodandsteel 6y ago
This is a very informative article, but it has one major deficiency. I have a general rule that when we are looking at something going bad in our country, one of the things to do is look at how the issue is handled in other countries, like are they doing it better or worse, and what can we learn from that that might help us decide what to do here. With that in mind, the article should have covered how this whole corporate debt issue is handled in other countries. Are they doing better or worse? Perhaps someone who has some knowledge here could make a comment.
- smabie 6y ago
  Well, Japanese companies used to have a lot of debt in the 80s and when the crash came, a lot of them got hurt. Now, they're mortally afraid of debt and cant for the life of them ever expand their revenue. Japan is a cautionary tale of what happens when people save too much money, are too risk-adverse, and are unwilling to borrow. The BOJ has been trying to get inflation up for decades with some of the lowest rates around and it hasn't worked. The country has been in a recession for a good 30 years and no amount of monetary policy manages to make things any better. Debt is a really powerful force, both positive and negative. I think for some businesses, like real estate, it makes sense to have a lot of debt, and others, like brick and mortar retailers, where debt can very easily destroy your entire business.
  - woodandsteel 6y ago
    Thank you, that's a very interesting comment.
davidjnelson 6y ago
The economy has been based on credit for a loooong time. I learned about how it works from Ray Dalio’s excellent video on how the economic machine works https://m.youtube.com/watch?v=PHe0bXAIuk0 https://m.youtube.com/watch?v=PHe0bXAIuk0
jariel 6y ago
The 'Elephant in the Room' here is the chart they did not show, and it's interest rates, which have been steadily declining. You can't fight the impetus for the system to want to give you free money because in the race to equilibrium, your competitor will do it, which leaves you with little choice. Imagine that some industries are 'thin margin' and naturally going to be competitive, and a little prone to failing if there is a hiccup. What 'low interest rates' do is exacerbate that quite a lot - so that only a little hiccup is needed to blow you up. There is a really, really interesting national parallel between the fall of Spain in the 2008 crisis and this story. The 'accepted narrative' is that when the Euro came along, Spain acted 'irresponsibly' and borrowed too much. But a more careful analysis (from an FT interview no less!) showed that they actually acted rationally given the very cheap money flowing in from 'Rich Europe' at the time. So the overarching issue is real: there's a lot of corporate debt. But it's a financing instrument like any other, it might actually make sense for companies to be leveraged to some extent. Credit runs the economy, this is a form of credit. I think a much bigger 'meta' look at this from the FT Economists would be warranted - instead of looking at this as more of a 'corporate activity' kind of thing, look at it from an economic equilibrium perspective in terms of defining 'how much debt' is actually good, or bad, and why.
shitgoose 6y ago
Instead of free market finding the proper risk-adjusted yield for a bond, we are swinging between over-regulated squeeze (shut down non-blue chips companies from access to capital) and free-for-all central bank buying bonanza (carpet-buying of corp bonds). It is either very hard for business to get access to capital, or CB makes it excessively easy. Somehow FT makes is look like it is some "financial engineering" fault that companies are "addicted to debt". How about letting willing debt buyers get into transaction with willing debt sellers? That simple.
tomerbd 6y ago
Just print the money

123 points by bertdc 6y ago

That period in the 70s also corresponds with the moment that US dollars lost any ties to gold. There is a natural rate of interest in an economy. When the central bank artificially lowers interest rates you get malinvestments. This is only possible with fiat currencies because you can't print gold. None of this would be possible if interest rates were at (say) 5% which is about the historic average, or at early 90s (double digit) levels. This ends dramatically. I'm guessing with a less dramatic version of Zimbabwe or the Weimar republic.

friendly_chap 6y ago
I'm not sure why you are being downvoted. All we see is bubbles, inflation, inequality, record low interest rates and stagnant wages, but apparently printing trillions and and not having a gold standard has nothing to do with it. Sure.
- newhotelowner 6y ago
  > apparently printing trillions and and not having a gold standard has nothing to do with it Printed trillions because of Covid-19. It would have been grim situation without the stimulus. 12-14% unemployement, no stimulus would have closed thousands of business, and would have increase unemployement. People who has money (Silicon valley engineers) is not going to invest in rural Ohio. Wages are stagnated because of policies and misinformation. Federal minimum wages should be raised at least $12 and tied to inflation with universal health care. Inflation is record low. Not sure what you talking about. Its time to be robin hood. Tax high income, tax stock buy backs, higher capital gain taxes etc. Its pathetic that people making $500k/year pays less than $75k in Federal income tax (14%).
  - deleted 6y ago
    [deleted]
  - votepaunchy 6y ago
    > Its pathetic that people making $500k/year pays less than $75k in Federal income tax (14%). The 32% bracket begins at $160k and at $500k AGI you’re paying $150k in taxes (30%).
    - take_a_breath 6y ago
      If taxes were that easy, we wouldn’t need so many accountants in the US. In reality, there are a bunch of ways a person makes $500k and pays less than $150k in taxes. - For example, if it’s paid as carried interest, they only pay a 20% tax rate. - They could itemize deductions. - A farmer could buy a brand new truck and call it a business investment. - If you’re a pass-through entity you only pay a 20% rate
      - newhotelowner 6y ago
        > A farmer could buy a brand new truck and call it a business investment. That is a business expense. 500k is after all the business (Non-personal) expenses, depreciation and deductions .
        take_a_breath 6y ago
        $500k is the income. The entire point is that business and personal expenses overlap considerably for farmers so they have wide range for tax purposes. It’s an inefficiency in the tax code which allows a person to have income of $500k and pay less than 31% in taxes.
      - WalterBright 6y ago
        > They could itemize deductions. The AMT (Alternative Minimum Tax) phases out itemized deductions for higher incomes.
    - newhotelowner 6y ago
chii 6y ago
> This is only possible with fiat currencies because you can't print gold. on the other hand, if the world was still on a gold standard, then the gov't couldn't have printed stimulus packages, and it would lead to more poverty and misery in the short to medium term (even if that would've been better in the long term, which is a debatable outcome). Fiat is only as good as the gov't handling it. It can indeed be abused more than gold can. But it's also more powerful than gold. A tool, in the hands of the capable, can do wonders. So the debate around monetary policy should be how to achieve the best results.
- roenxi 6y ago
  > if the world was still on a gold standard, then the gov't couldn't have printed stimulus packages Sure they could, borrowing is still allowed. And the government can just declare "property rights are lovely but we're suspending them in this emergency, here are some IOU for after we raise taxes to cover this". Which would have a largely equivalent effect in real terms to money printing but much easier to understand. > Fiat is only as good as the gov't handling it. The government is consistently made up of financial incompetents. Most governments struggle to deliver a balanced budget when they try. All the people who know how to make good financial decisions are in private industry making them.
  - AshamedCaptain 6y ago
    > And the government can just declare "property rights are lovely but we're suspending them in this emergency, here are some IOU for after we raise taxes to cover this". Which would have a largely equivalent effect in real terms to money In no way this has the same effect. The uber wealthy have an even easier time of hiding their property in this case, and the mid wealthy react much worse (violently) to private property forfeits than to the usage of printing press (which as you say most of us don't even understand). > Most governments struggle to deliver a balanced budget when they try. All the people who know how to make good financial decisions are in private industry making them. This is very old bullshit, and thinking like this leads to parties trying to be cool by hiring people from industry with the consequent terrible results ( this trope is so old its even parodied on yes minister).
_qulr 6y ago
If we're "wise" enough to constrain our currency to gold, then we're also wise enough not to manipulate our currency in self-defeating ways. But if we're not wise enough, nothing can save us. Some lumps of gold won't save us from ourselves.
alexmingoia 6y ago
A gold standard doesn't prevent manipulation of interest rates. The Federal Reserve manipulated interest rates while on a gold standard. One of the reasons they would increase or decrease interest rates was to manage the desired gold stock. The reason the US abandoned the gold standard was the (inevitable) failure of centralized fractional-reserve banking. By 1971 the U.S. was effectively insolvent in its ability to cover foreign holdings, and feared a run on the dollar. U.S. gold reserves couldn't keep pace with the expanding money supply and increasing demands by foreign holders for redemption of their dollars.
mtgp1000 6y ago
A growing number of netizens are starting to believe that we are already living in an American Weimar Republic. And it's hard not to see the many social and political parallels - I'm not familiar with the economic side of Weimar Germany.
082349872349872 6y ago
Two things mentioned in the article (a) US tax advantaging of a debt-laden structure and (b) LBOs actively punishing firms for not carrying an "efficient" level of debt are probably more important. Note that LBOs were invented in a period of double digit interest rates. (there is an argument that USD interest rates are "too low" due to market reasons, because USD is the global reserve currency. I suspect leveraging global reserve status to apply strategic sanctions is, at least over the short term, far worth more the US than any resulting malinvestment. If not, we'd all be using Bancor for exchange.)
pjc50 6y ago
I don't understand how people can look at the near-zero price and wage inflation and then claim America is suddenly going to become Zimbabwe without going through an intermediate phase of "slightly higher inflation", like 5 or 10%. Besides, the use of gold has no bearing on "M2", which is quite important in the modern economy. And all the classic hyperinflation cases were forex-driven: either the country's exports fell below their ability to import necessities like food and oil, or (in the case of Weimar) they were forced at gunpoint to hand over gold. So long as the US continues to produce enough food and oil domestically, it's very well insulated against hyperinflation.
- zzleeper 6y ago
  You make some really interesting points. Allow me to reply with a bit of speculation: 1) Peruvian, Bolivian, Argentinan hyperinflation were purely printing-press inflations, without forex being the culprit. 2) Inflation is strongly affected by expectations. If everyone think prices will go up 5%, then we all increase salaries/prices by that and we self fulfill the prophecy. 3) 5-10% inflation is actually quite high for modern standards. We are not in the 70s anymore. 4) Lastly, the main point: onxe you get there, there is a high chance that the dollar will lose its place as the world's currency. Then, inflation accelerates and you enter a spiral.
  - jcranmer 6y ago
    The good counterpoint here is Japan, which has insanely high public debt (about 200% of GDP), invented quantitative easing, and has struggled to hit 2% inflation for several decades now. If Japan hasn't been able to hit a hyperinflationary spiral based on its debt-fueled trajectory, then the US (which is far less along that path) isn't going to be hitting it anytime soon.
    - Nasrudith 6y ago
      As nuts as it sounds I suspect high levels of debt may be a hint that there isn't enough money printed into the economy and the debt is a symptom. That more supply doesn't drop the demand significantly seems like a hint. I would love to hear counterarguments because this seems odd even to me.
neilwilson 6y ago
"There is a natural rate of interest in an economy." Yes, and the base rate is zero. Since reserves are costless to produce and banks can't get rid of them in aggregate the base rate should always be zero. It is rates above zero that are unnatural since by definition they are a market intervention that reduces the price of all other assets and drives up yields artificially. The state shouldn't be paying a Basic Income to banks in the form of interest on reserves. Banks should earn their crust by lending productively. Beyond that the rate of interest is the one estimated by the lender to be sufficient to cover the risk of discounting your collateral into the state's liquidity. Banks are really just pawnbrokers with shinier suits and better PR.
- 6510 6y ago
  How would banks lend productively? (just curious)
  - voisin 6y ago
    Borrow from depositors at one rate, lend to borrowers at a higher rate with losses to bad loans amounting to less than the spread.
- AbrahamParangi 6y ago
  The base rate is non-zero because capital has non-zero cost. Interest is just the limit of the cost of capital. If you don’t have a fed, or if the fed does nothing then interest rates will converge on their own to a positive value.
  - neilwilson 6y ago
    Banks have a capital cost. The central bank does not. I was talking about base rates. Banks mark up on base rate to cover the risk to their capital
- alexmingoia 6y ago
  The natural interest rate refers to the interest rate in a free market of banking. In a free market interest rates would not be zero otherwise the bank can’t make any money...
nknealk 6y ago
Actually, the last time we had high inflation, the fed kicked interest rates up[1]. So I don’t know if we end up like Zimbabwe. The fed would likely step in well before something bad happened. https://www.stlouisfed.org/publications/regional-economist/january-2005/volckers-handling-of-the-great-inflation-taught-us-much https://www.stlouisfed.org/publications/regional-economist/j...
Nasrudith 6y ago
That isn't true for gold - historically it has destabilized economies several times by having both too little and too much gold relative to the true size. The gold standard has caused many wars and travesties as conquest was started for the sake of raising their economic cap above deflation, let alone debasement of currency. A "natural rate" of interest doesn't seem like a meaningful concept to me, to be pedantic. There is nothing natural about it, it is all tautological based upon what "works". Closest concept to it I see is the currency vs productivity mapping for what causes real inflation. Given that universal value is a mere mentally convenient myth everything is fuzzy anyway.
jariel 6y ago
Limiting the money supply on the basis of quantity of some arbitrary metal is in no way creating a 'natural' interest rate in the economy. Gold acts as an 'independent, non-political' arbiter, but it's nowhere near 'natural'. How does the discovery of a lot of Gold, somewhere on the planet, related to the 'natural' productivity and growth of a nation? There's no such thing a 'natural' interest rates - we have to decide how much currency we want in circulation, and we try to use 'objective rules' to do that, and try to keep that system as far away from the Political System as possible. But since 2008, we are definitely playing with fire in terms of the funny business and 'breaking of our own rules' we are doing at the Fed, i.e. by accepting crap mortgages as collateral etc..

simonCGN 6y ago

No, not companies. Investors who rather get dividends or share buybacks than having the company pay down debt

_qulr 6y ago

"Pension funds and insurance companies bought the debt in bulk" Is it fair to say that pension funds are largely to blame for this? Corporations can't acquire debt if nobody offers them money. Insurance companies too, of course, but pension funds in particular are at least theoretically supposed to be protecting the workers. Hard to see how debt-funded corporations (I'll mention Uber as an egregious example) are in alignment with the interest of the workers.

em500 6y ago
> Is it fair to say that pension funds are largely to blame for this? Corporations can't acquire debt if nobody offers them money. About as fair as it is to say that people who wish to receive some income after retirement are to "blame" for this. Nobody can save without some other party (households, companies or the state) acquiring debt.
- amelius 6y ago
  > Nobody can save without some other party (households, companies or the state) acquiring debt. If this is true, then perhaps something is wrong with the system? In the old days I could just save some nuggets of gold I earned, and spend them after retirement.
  - dageshi 6y ago
    I think in the old days you had as many kids as you could and expected them to look after you in your old age.
- _qulr 6y ago
  Junk bonds are hardly the only form of investment, and certainly not the safest, if your goal is to ensure someone's retirement. Moreover, corporate debt is at high risk of mass default in a market downturn such as the current one.
  - _qulr 6y ago
    Pension funds spend $trillions on investments. They have a lot of power to incentivize corporate behavior, in either a responsible or irresponsible direction. It seems to me that pension funds have been enablers of irresponsible corporate debt stockpiling. Pension funds had a choice, and I'm not sure they chose wisely.

dsukhin 6y ago

Perhaps an unorthodox way of looking at things, but it's very intersting take a step back to consider what 0 to low interest rates might accomplish for society: - Low interest rates mean it makes no sense to simply keep cash, it's better to invest in something productive. For companies that's new projects/ideas which create jobs, for individuals that might be spending on goods to stimulate the economy or buying a house. - High interest rates are a considered a way to reduce "risky" investments. But in reality, interest is rent seeking on capital which benefits (1) lenders/banks (2) capital holders. Cheap capital enables more projects with positive ROI (above cost of capital) to be persued. And this is good for society as it drives innovation and allocates capital to innovators instead of locking it under stagnant rent seeking. Lest you worry, this doesn't hurt capital holders, as they can instead proactively invest in companies and make the same or larger returns, but now capital is allocated by merit of the project being invested in instead of by simply who can afford it because it meets some threshold. This unlocks the "long tail" of innovation. This is what is referenced in the article: 1970s Hertz took a risky bet using debt which paid off to record profits. - Higher interest really means higher long run inflation. If you can just let money sit in a bank, doing nothing directly productive for society, and there is suddenly more of it, prices will adjust accordingly. With low interest rates, money supply will adjust with GDP growth from innovation and prices might even be reduced by higher competition and discovery of efficiencies. As long as innovation (enabled by access to capital) stays on pace with money supply, inflation stays low. This is of course a very optimistic way of looking at things which doesn't consider the effect of things like wage growth which has all but stopped. One could argue in a non-inflationary environment that might be ok, but this is a larger topic having to do with social mobility goals rather than just the economics.

pjc50 6y ago
> Higher interest really means higher long run inflation. In orthodox macro, higher interest rates -> reduced investment -> reduced demand -> reduced inflation. This is pretty much empirically proven by how central banks have been able to control inflation in the West. The way I see it is the "search for safety", especially where negative interest rates are concerned. There are two huge concentrations of safety-seeking money in the modern economy: pension funds and oligarchs. The pension funds more or less have to buy government bonds in a certain ratio, regardless of the price. Whereas the oligarchs have hundreds of billions they need to keep anonymously in a stable economy - ie dollars, pounds, and euros. Things like the Apple "cash" pile of $245bn represent a lot of floating wealth too. Ultimately, if we don't get real wealth taxes, interest rates will be forced negative simply by the market and the huge volume of safety-seeking money.

pixelmonkey 6y ago

Something I have never seen a good answer to or explanation of: what is an "appropriate" debt or leverage ratio for a healthy company? Obviously, a private company with hundreds of millions in stable recurring revenue shouldn't operate debt-free -- debt can be a useful tool, even if only as a rainy-day tool for situations such as the recent pandemic. In other words, corporate debt -- and especially low-interest and covenant-free debt that is secured using recurring revenue -- seems like a capital allocation (corporate finance) tool with a set of trade-offs relative to cash and venture investment. But, how much debt is "too much"? I feel like those of us who work in software can sometimes forget that for most industries, venture capital isn't even an option, which means debt can be one of your only growth financing sources of capital -- and even for those in software, some companies are not venture-fundable but might still be debt-fundable. It's clear that the PE firms that load up billion dollar companies with billions in debt are just playing a speculative finance and asset strip-mining game. But, it would be a shame if we invested all of this time, money, and regulation into a robust "financial capital banking sector", and we can't even rely on it for capital that businesses can use to create jobs, service customers, and smooth the rough patches in the economy.

ihodes 6y ago
There's a fair amount of thought behind what the ideal debt ratio should be for a company, but basically the goal is to minimize the cost of capital while maximizing market value.^[1] [1]: https://www.investopedia.com/terms/o/optimal-capital-structure.asp https://www.investopedia.com/terms/o/optimal-capital-structu...
- pixelmonkey 6y ago
  Thank you for this. I did not know the term "Optimal Capital Structure" but it seems like a good jumping-off point for researching the topic.
ciconia 6y ago
> Obviously, a private company with hundreds of millions in stable recurring revenue shouldn't operate debt-free -- debt can be a useful tool, even if only as a rainy-day tool for situations such as the recent pandemic. Why obviously? Seems to me when a crisis hits the last thing you want to have is debt you need to pay back. For example, should Apple, with their huge mountain of cash, have debt? Do they need debt? I guess one can also ask the same about countries. Do they really have to maintain some level of debt in order to have a healthy economy? Why not just have a big bunch of cash put aside for a rainy day? How is this "obvious"?

dwighttk 6y ago

is it different from governments or individuals?

neilwilson 6y ago
Depends which sort of government: sovereign or otherwise (US state, Scotland, Eurozone member). Sovereign government don't really have debt in the sense you would recognise as debt.
- dwighttk 6y ago
  sure, but they get addicted to something we call debt
  - neilwilson 6y ago
    Only if the private sector gets addicted to something called "wealth". One can't exist without the other. A Treasury or a Gilt is a safe private asset that is much in demand.
- smabie 6y ago
  Government debt denominated in foreign currency looks pretty much identical to corporate or individual debt.
  - neilwilson 6y ago
    Indeed. That's part of the "otherwise" - the reason why a Eurozone country struggles. They denominate in a currency issued by a foreign entity they don't control.

cs702 6y ago

> …has drawn attention to the relentless build-up in corporate debt in the US, where companies now owe a record $10tn — equivalent to 49 per cent of economic output. When other forms of business debt are added in, including to partnerships and small businesses, that already extraordinary figure increases to $17tn [83% of GDP, the highest ever]. > Even before the pandemic, the level of corporate leverage was beginning to cause alarm. At the end of last year, the IMF issued a striking warning: as much as $19tn of business debt in eight countries led by the US — or 40 per cent of the total — could be vulnerable if there were a “material slowdown” in the economy, a scenario that, if anything, now seems tame. I like to think of it this way: At present, a business that is barely-investment-grade (say, BBB-/Baa3) can borrow for a decade at just over 3%/year. A risky business that is rated as junk (i.e., below BBB-/Baa3) can borrow for a decade for as little as 6% to 7%/year. The interest payments are tax deductible, so the effective annual cost to borrow is around 2.5% for barely-investment-grade and around 5% for junk, give or take. As long as the executives think they can earn more than 2.5% to 5% per year on any money they borrow, why not borrow it? And if they can justify using borrowed money to buy back shares, keeping their stock options in-the-money, why not do it? Many US companies in mature industries (think energy, hospitality, travel, transportation, etc.) have been doing exactly that, to the point that corporate debt is now the highest ever in relation to US GDP. And it has worked beautifully... that is, until a global pandemic suddenly cut their revenues by 10% to 20% or even more, instantly flipping those expected earnings into losses. People are no longer traveling as much, or going to restaurants as much, or going to the office as much, etc. All of a sudden, all those businesses are losing money on all that borrowed money -- they are losing so much, in fact, that many have had to borrow even more during the pandemic to be able to continue paying interest on prior borrowing and avoid going into bankruptcy.

supercanuck 6y ago
>As long as the executives think they can earn more than 2.5% to 5% per year on any money they borrow, why not borrow it? Back in the day, people were responsible for their Choices. So if some unforeseen happened, a savings was considered a good thing. Today, a CEO can just shrug and say “meh, pandemic” and the government is suppose to be the lender of last resort. This is the moral hazard that we were all afraid would happen after 2008.

neonate 6y ago

https://archive.is/r1js6 https://archive.is/r1js6

woodandsteel 6y ago

From what I understand, the basic problem is this. The way things are supposed to work is corporations take their profits and divide them up in two ways. Part goes to paying the owners, like dividends to stockholders. Part goes in investing in the future, like research and building factories. The problem is that for a long time a large proportion of companies have been paying out an increasing portion of their profits to pay off massive and ever increasing debts. They still keep paying profits to the owners, and so they have ever less left for investing in improving the company. That in turn means poor growth and being less competitive in world markets. And even worse when the economy goes through a bad period, many thousands of companies can no longer pay their huge debts and go bankrupt, with great damage to the economy.

woodandsteel 6y ago

This is a very informative article, but it has one major deficiency. I have a general rule that when we are looking at something going bad in our country, one of the things to do is look at how the issue is handled in other countries, like are they doing it better or worse, and what can we learn from that that might help us decide what to do here. With that in mind, the article should have covered how this whole corporate debt issue is handled in other countries. Are they doing better or worse? Perhaps someone who has some knowledge here could make a comment.

smabie 6y ago
Well, Japanese companies used to have a lot of debt in the 80s and when the crash came, a lot of them got hurt. Now, they're mortally afraid of debt and cant for the life of them ever expand their revenue. Japan is a cautionary tale of what happens when people save too much money, are too risk-adverse, and are unwilling to borrow. The BOJ has been trying to get inflation up for decades with some of the lowest rates around and it hasn't worked. The country has been in a recession for a good 30 years and no amount of monetary policy manages to make things any better. Debt is a really powerful force, both positive and negative. I think for some businesses, like real estate, it makes sense to have a lot of debt, and others, like brick and mortar retailers, where debt can very easily destroy your entire business.
- woodandsteel 6y ago
  Thank you, that's a very interesting comment.

davidjnelson 6y ago

The economy has been based on credit for a loooong time. I learned about how it works from Ray Dalio’s excellent video on how the economic machine works https://m.youtube.com/watch?v=PHe0bXAIuk0 https://m.youtube.com/watch?v=PHe0bXAIuk0

jariel 6y ago

The 'Elephant in the Room' here is the chart they did not show, and it's interest rates, which have been steadily declining. You can't fight the impetus for the system to want to give you free money because in the race to equilibrium, your competitor will do it, which leaves you with little choice. Imagine that some industries are 'thin margin' and naturally going to be competitive, and a little prone to failing if there is a hiccup. What 'low interest rates' do is exacerbate that quite a lot - so that only a little hiccup is needed to blow you up. There is a really, really interesting national parallel between the fall of Spain in the 2008 crisis and this story. The 'accepted narrative' is that when the Euro came along, Spain acted 'irresponsibly' and borrowed too much. But a more careful analysis (from an FT interview no less!) showed that they actually acted rationally given the very cheap money flowing in from 'Rich Europe' at the time. So the overarching issue is real: there's a lot of corporate debt. But it's a financing instrument like any other, it might actually make sense for companies to be leveraged to some extent. Credit runs the economy, this is a form of credit. I think a much bigger 'meta' look at this from the FT Economists would be warranted - instead of looking at this as more of a 'corporate activity' kind of thing, look at it from an economic equilibrium perspective in terms of defining 'how much debt' is actually good, or bad, and why.

shitgoose 6y ago

Instead of free market finding the proper risk-adjusted yield for a bond, we are swinging between over-regulated squeeze (shut down non-blue chips companies from access to capital) and free-for-all central bank buying bonanza (carpet-buying of corp bonds). It is either very hard for business to get access to capital, or CB makes it excessively easy. Somehow FT makes is look like it is some "financial engineering" fault that companies are "addicted to debt". How about letting willing debt buyers get into transaction with willing debt sellers? That simple.

tomerbd 6y ago

Just print the money