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Tom Au, CFA
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In the early 1990s, during the middle of a secular bull market, I began work on "A Modern Approach To Graham and Dodd Investing," that was not particularly suited for the decade of the 1990s, but was ideally suited for the following "Lost Decade" of the 2000s.
My book:
A Modern Approach to Graham and Dodd Investing
  • Is the U.S. Economy Too Built on Growth? 8 comments
    Apr 5, 2010 10:44 AM
    In general, economies grow at some times, and not others. More often than not, there have been speed bumps along the way. These aren't bad things if they end of being the "pause that refreshes." More to the point, they allow for mid-course corrections.

    Unfortunately, a lot of America's economic institutions have been built on the theory of relentless, never-ending growth. Housing was one example. Prices in this key sector grew at double digit rates for the better part of the decade around the turn of the century. This was cheered, because price growth was supposed to be the cure for defaults. If prices continually kept rising, there would be no incentive to default; at worst, a non-paying situation could be "worked out."

    The dependence on growth was illustrated by one salient fact. If price growth merely reverted to historical levels (mid single digits) default rates would double. If it went to zero, or worse, reverse, losses would skyrocket. Yet practically no one connected with the industry around 2005-2006 could imagine such a scenario, even though it was part of the historical record.

    Hoping for good growth is one thing. DEPENDING on it is quite another.  The latter makes it like a drug. And when it ends, the "withdrawal pains" are likely to be quite painful



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  • John Lounsbury
    , contributor
    Comments (3988) | Send Message
    Although it looks like this post is still being worked on, I will make a comment anyway.


    The entire rationalization of debt is based on growth. Who would borrow if the capital obtained would not produce enough growth to pay the interest and repay the principal? Of course, the borrower would also like some further growth to pay him something for his time and trouble. Who wants to borrow money, only to make enough with that capital to repay principal and interest? No one. A borrower also expects to make enough to provide himself a wage for his work. To borrow when one does not expect to create enough growth to repay principal, pay all interest and compensate the borrower for "wages" is idiotic.


    Oops!!! How do I explain consumer loans? Clue: The answer contains the word "idiots".
    5 Apr 2010, 01:17 PM Reply Like
  • Tom Au, CFA
    , contributor
    Comments (6780) | Send Message
    Author’s reply » I wouldn't call growth the rationale for debt (although I concede that debt often leads to growth).


    To me, taking on (or lending on) debt is a net present value calculation: Will the discounted cash flows be sufficient to pay back debt and a fair rate of interest, (hopefully with a margin of safety that leads to a positive net present value, or NPV). The larger the NPV, the larger the growth.


    Many commentators have observed that it has recently required increasing amounts of debt to generate a given amount of GDP growth. What is means is the NPVs for projects have gotten progressively smaller for given amounts of debt.


    NPVs are now approaching zero in a dangerous fashion. If and when they actually become negative, more debt will lead to a CONTRACTION in the economy.
    5 Apr 2010, 01:47 PM Reply Like
  • John Lounsbury
    , contributor
    Comments (3988) | Send Message
    G&D - - -


    I believe I made the first presentation on Seeking Alpha (about a year ago) of the curve you refer to


    In that article I suggested that there was a possible non-zero resolution to the projection of the historical data. That suggestion has not received any support that I know of. Perhaps it is wrong.


    None the less, I am continuing to consider the curvilinear non-zero projection to have as much analytical crediblility as the linear projection to and through zero.
    5 Apr 2010, 02:17 PM Reply Like
  • John Lounsbury
    , contributor
    Comments (3988) | Send Message
    G&D - - -


    I'm not making this comment in way of argument, but to clarify what I was thinking.


    If debt is assumed and no growth results, then the interest payments must be paid from existing assets. Thus assets will decline. In aggregate, declining assets equal negative growth.


    That is what I was thinking when I made the statement that debt which does not produce growth is taken on only by idiots. The assets they have associated with the debt will decline.
    5 Apr 2010, 02:22 PM Reply Like
  • Tom Au, CFA
    , contributor
    Comments (6780) | Send Message
    Author’s reply » Dear John,


    I'm using the following tautology:


    NPV of (related) cash flows > debt, growth results.


    NPV of cash flows= debt, stagnation.


    NPV of cash flows < debt, contraction.


    Investment (usually) leads to positive NPVs. Borrowing for consumption, to negative NPVs, at the personal level, although this is offset by "profits" at the corporate level. Netting them all out gives us the growth factor.


    One reason we're growing is because we have artificially low interest rates, which in turn stems from the dollar as the world reserve currency. Low rates are very useful for positive NPVs.


    If we had to pay a "true" interest rate based on our trade balance, like the mid-teens Treasury rates of Mexico in 1994 ( I spent that year there), our project NPVs would plummet, and might lead to negative growth when balanced against debt.
    5 Apr 2010, 02:36 PM Reply Like
  • John Lounsbury
    , contributor
    Comments (3988) | Send Message
    G&D - - -


    I think we agree. I may be criticized for not specifically mentioning NPV.
    5 Apr 2010, 02:39 PM Reply Like
  • Clive Corcoran
    , contributor
    Comments (1207) | Send Message
    I've preferred to think of economic growth more in qualitative than quantitative terms - increases in general welfare, better infrastructure and quality of life for average citizens.
    The problem with having too much of a quantitative focus is the anomaly of non-affordability. It was great for existing home-owners to see the price of their homes going up strongly every year - but the increases were far in excess of the growth of real incomes for the average worker who eventually got priced out of the market.


    In essence I would argue that economic growth is quite a different thing to rising asset prices considered in isolation from income levels.
    5 Apr 2010, 01:25 PM Reply Like
  • Tom Au, CFA
    , contributor
    Comments (6780) | Send Message
    Author’s reply » "Good" quality growth is BALANCED growth; assets, productivity, and income, moving up more or less in tandem, in a mutually self-reinforcing cycle.


    "Bad" growth of the kind that you and I deplore, is unbalanced growth of one of these factors, out of line with the others; something like a teenager with say, a thyroid problem, whose trunk is all out of proportion to the legs, etc. That's the kind of growth that is likely to topple over.
    5 Apr 2010, 01:51 PM Reply Like
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