Capacity Growth: A Wiser Use of Borrowed Money

It nearly slipped through the cracks this week as mediastocracy marveled at the apparent lack of inflation as the PPI and CPI reports hit the wires. However, just beneath the surface, the financial and economic metamorphosis continues unabated. I am talking about Qatar and its very successful bond sale.

This tiny emirate nation-state is 164th in total landmass, 159th in population, and 123rd in population density. Oddly enough, Qatar is 65th globally in terms of GDP, but is number two in per capita GDP (on a purchasing power parity basis) at over $86,000 per annum. They are second only to Lichtenstein.

This past week, this small country, known primarily for its exporting of natural gas, managed to garner $28 billion in orders for a $7 billion bond auction. Given the still partially fractured state of global credit markets, this level of interest borders on remarkable. The $28 billion bond sale is the largest by an emerging market player to date.

What is not so remarkable, however, is why this level of interest was present in this bond auction. The small nation state listed among its purposes for proceeds from the auction infrastructure projects, international oil and gas investment, and the purchase of stakes in companies such as Volkswagen (VLKAY.PK). Perhaps we in the Unites States should take notice as the seats at our own bond auctions continue to empty and we edge further down the dangerous path of overt monetization.

This situation shines a good deal of light on the proven economic principle that capital formation comes from the foregoing of consumption and the resulting investment. Even though credit has gotten a bad name recently, it plays a vital role in any healthy economic system. Borrowing money to build productive capacity and to make strategic acquisitions that will produce cash streams to pay for themselves is a wise use of credit. This is where the US has departed from the tenets of economic common sense and descended into the depths of absurdity.

What makes a place like Qatar such an obvious choice for foreign direct investment is the fact that the government has 8 consecutive years of budget surpluses. The citizens are extremely productive in terms of per capita GDP. There is no income tax, which results in lower societal debt burdens. Qatar’s external debt obligations are $55.79 billion as of 12/08, which translates to 55% of GDP. While 55% is rather high, compare it to the over 90% here in the US. Furthermore, Qatar is unencumbered by unfunded future liabilities.

Strategically, Qatar is in an excellent position as the vast majority of its national wealth comes from its natural gas reserves. The country also has approximately 15 billion barrels of crude oil in reserve according to the IEA. Perhaps more importantly, Qatar is positioning itself for the inevitable time when its income from energy exports dwindles. These are clearly carefully calculated long-term moves. The debt growth is disturbing, but at least for now, the borrowings are being put to productive uses. Time will tell if Qatar maintains fiscal discipline or opts for the same path as many Western nations.

The borrowing news from the Middle East is not all productive however. Dubai, decimated by the simultaneous bursting of multiple asset bubbles along with the crash in energy prices in 2008 was able to raise nearly $2 billion. The Dubai Tourism Development & Investment Co. was able to raise $1 billion. Given that its primary focus is the development of hotels, it would indicate that there is still a good deal of foolish money out there searching for a place to live.

Still, adapting the old saying, a lousy hotel investment is still better than a good US Government debt obligation, apparently. If these recent developments don’t demonstrate the ongoing metamorphosis of the global financial structure, then nothing will. Maintaining reckless fiscal behavior here at home will continue to have a deleterious affect on our currency, our ability to finance future activities legitimately and ultimately our standard of living.

The lesson in this week’s news is a simple one: use credit wisely and for productive purposes and there will be demand at your bond auctions. Behave foolishly and you’re going to have empty seats and the need to monetize.

Comments

[bob adamson]

Mr. Sutton, what you say is valid in the long term. The immediate challenge for the US now, however, is to stabilize its recovery, undertake serious reform of its industries and institutions that let the US down and created the basis for the October of 2008 meltdown and ensuing deepening recession and generally to emerge out of the current malaise sound. Then the US needs to move on to the agenda you describe.

To imply, as your article does, that the fiscal and monetary stimulus of the past year or more was misdirected and should, instead, have focused on promoting capital formation misses the important points that:
1. For the ten or more months after September of 2008 there was no demand for capital formation and none could have been induced by tax changes etc. given the lack of confidence and falling markets for output then existing.
2. The crying need at that time was to prevent the collapse of consumption and credit and promoting capital formation would do little to address that need.
3. Even if points 1 and 2 are overstated, capital formation has a multi-year timeline and any efforts to promote such capital formation would only start to benefit the general economy years in the future.

The situation is evolving and the time for your agenda is approaching but it has not yet arrived. The tiny emirate nation-state of Qatar is in a very different economic situation from that of the US and it is not useful to suggest that actions it is now taking are actions that the US should also be taking now.

2009 Nov 22 12:05 AM

[professorpinch]

Well done. If we don't get our fiscal house in order and get back to the business of building out capital in this country there will be dire consequences.

We need to do this sooner rather than later. Because we don't want to be looking back, 20 years later, with an aging population of pensioners and declining birth rates wondering how we got there with only a debt-to-GDP ratio of 250% to show for it.

The first part of that path has already laid - the creation of zombie-like financial institutions with their debt guarantees, central bank loans, and capital injections.

2009 Nov 23 02:02 AM

[surfgeezer]

Well I'm glad you agree with Obama when he called for infrastructure spending on the stimulus debt. To bad Congress disagreed and opted for quicker acting tax cuts and social support. I do disagree that a falling dollar will be bad. I would argue that the strong dollar/cheap credit has in fact just encouraged over consumerism and discouraged exports, that your graphs show are indeed critical.

2009 Nov 23 09:53 PM