Balancing act

Kerry Knudsen

Kerry Knudsen

The U.S. real gross domestic product grew at an annual rate of 3 percent in the fourth quarter, according to the second estimate released by the U.S. Bureau of Economic Analysis. This, of course, starts the definitions. What is “real” GDP? How do they measure the increase in the fourth quarter – against last year or the last quarter? If this is the second estimate, what was the first and how many are there? It’s no wonder economists don’t get invited to other people’s cottages.

Another economic fact: last month Apple reached $500 billion in equity, proving two dozen Apples is worth the entire U.S. debt, more-or-less. For definition purposes, the debt of the U.S. is calculated as “the face value or principal amount of marketable and non-marketable securities outstanding.” It does not include interest.

Since most readers of these notes are entrepreneurs, you know why it does not include interest. Interest is an expense and goes on the P&L. Debt is a liability and goes on the balance sheet. You measure liabilities against assets and you measure expenses against revenue. You would never measure liabilities against income unless you were thinking about changing your profession to journalism.

Journalists like nothing better than to throw wet blankets. Nobody will read a newspaper if everything is fine and nice. The apocalypse must be near for journalists to feel needed, so they are absolutely fascinated to report the debt as a function of GDP – that is, liabilities as a function of revenue. For example, right now the debt of the U.S. is $15.4 trillion, and the GDP is $15.0 trillion, so the gross debt to GDP ratio is 102.4 percent.

Sounds scary, eh? It is, too, until you learn the last time the U.S. GDP-to-debt ratio was this high was right after WWII, and even with that ratio the taxpayers of the U.S. and Canada took it on their own backs to rebuild Europe and Asia, best known under the U.S.’s Marshall Plan, to which Canada contributed and also had an aid program of its own.

The result of the U.S. adding $13 billion of aid to its already burdensome debt of $258 billion (1948 dollars) was the strongest economic engine the world has ever seen.

How can that be? This is not difficult. They took resources (not income) and made those resources generate revenues. Hoodathunkit? From this simple lesson, it appears if you unleash an entrepreneurial spirit with sufficient resources on creating wealth, wealth is created.

If you wanted to come up with a name for this phenomenon, you could call it “business,” and you could define it as the selling of goods and services. That would create a GDP, and it would prove that assets are better for creating revenues than they are for paying off debt. The idea is that you pay off debt with revenues, instead of assets, and have some left over.

Of course, once assets are present, the phenomenon of “need” shows up. Need is not easily defined in polite terms. For example, the owners of the assets (U.S. and Canada) after WWII decided there was a need, so they gave Europe and Asia money, training, goods and services out of the goodness of their hearts. Since then, some of the beneficiaries have decided to define “need” to fit their own situation and have become limpets on the economic structure of the European Union.

Let’s forget about GDP for a minute, since the flow of goods and services is being restricted by politics, and look, instead, at assets. How much would the American sell me Manhattan for? Can I buy Vancouver Island? What is Canada worth?

Let’s take a river. The Churchill River in Labrador was once was famous for its Churchill Falls, one of the world’s wonders. I wish I had seen it. However, it was sold for progress as a hydro dam. Somehow, Quebec Hydro got hold of the rights.

The Churchill project finally went on-line (no more falls) in late 1971. Its peak capacity is 8,400 mW/hr. The cost necessary to recover production costs is called the levelized (American spelling) cost, which, for American hydro in 2010, was $86.40 per mWh. That means the Churchill dam, in 40 years of peak production, would produce $10.5 billion in billable revenues. Granted, that is not much when you consider Ottawa can generate that much in revenues in 10 minutes, but it’s an idea of how assets can be converted to revenues, and Ottawa uses slave labour: you. Fail to pay Ottawa, and there is a guy with a gun at the end of the process.

Canada’s mineral industries have produced about $500 billion over the past 20 years, and estimates for Alberta’s oil sands put the value at $1.7 trillion per year from 2015 on. Also, compared to the U.S. our national debt is projected next year to be about $600 billion. Our asset:liability picture is not bad. Many bona fide businessmen actually don’t understand that if you take $50,000 of assets and pay off $50,000 of debt, your net worth does not change one nickel. We and the Americans have the assets: we are “good for it.”

For the most part, taxes are a function of income, not net worth. (Except inheritance, property, etc. You will never get away.) But generally, taxing the GDP will not increase the GDP, while increasing the GDP will, necessarily, increase tax revenues. Like banks, the government lives on percentages. That way, they can’t lose. Likewise, you can’t win.

I have been jumping back-and-forth, here, because I am not trying to provide an economic report, exactly, but to draw a picture. We have traditionally relied upon the American economy on every level. We sell to them, we buy from them and we even buy homes and marry there. They have been through, and have taken the world through, a mess. They are in an interminable election cycle, and their politics are dominating the economic news on both sides of the border. They should stop.

We really need to ignore the Americans and the journalists. They are worth it. The Americans can cover any debt they write out of their back pockets. So, for that matter, can we. The real question is whether you have a viable market, whether you can generate sales, and whether you can fill the orders.

Based on the current political model of using cash flow versus debt to define economic health, the non-entrepreneurial side thinks taxing more of the producers of wealth is the answer. If so, then your best bet to pay down debt is to cut the salaries of your staff. Try that, and let me know how your output improves. My guess is that quality will go down, lead times will lengthen and labour and compliance costs will go up.

Anyway, disposable income went up in the U.S. in January by $14.1 billion. Canadian building permits were worth $6.8 billion in December, up 11.1 percent from November, and the highest level since June 2007. In addition, housing starts increased in December, returning to an annual rate of 200,200 units. Starts for single-family dwellings rose for the fourth consecutive month to their second highest level of the year, and the number of multiple units recovered two-thirds of November’s decline. Existing home sales increased 1.8 percent in December following a 0.5 percent gain in November. Sales were higher in the West and lower in the Eastern provinces in December, the reverse of the sales in November. Ontario posted increases in both months.

Finally, after a fit of negativity about “Canadian homes sales pull back in January,” from the Canadian Real Estate Association, we are told, “Actual (not seasonally adjusted) national sales activity was up four per cent from year-ago levels in January.” More importantly, Canadian home sales met or beat both the five-year and 10-year averages in September, November, December and January, and nearly matched those averages for sales in October. That means home sales in Canada are equalling or passing the sales rates from before the U.S. crisis.

Is life a bed of roses? Not exactly. However, there is much to support an attitude of optimism.

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