Resource World Magazine

Government debt and the resource sector by A.J. Deus Europe showed negative growth of -0.5% in the fourth quarter of 2012, more than expected. Even France and Germany, bastions of strength, are experiencing a slump, and North America continues to perform unsatisfactorily. The consensus about the cause of the persistent, half decade long economic slowdown focuses on the excessive debt load across the industrialized world, leading to a prescription of deep cuts in spending. However, do entrepreneurs in capital intensive resource industries agree that debt matters so much to merit the crippling of economies? Why should debt and deficits take precedent over unemployment hovering around 8%, or 45 million in poverty in America alone? Businesses in resource industries typically balance their financing needs between leveraging and capital with the goal of capital efficiency and profit return. Governments could learn from them that reducing debt is not important; it is cost, expected return, and refinancing that matter most. For private and public institutions alike, sustained deficits lead to bankruptcy when the debt ceiling is reached and the capital is consumed. Western governments are far from that breaking point and seem to have lost their way by talking themselves into a self-fulfilling and deepening vicious-cycle that keeps prices for resources squeezed. Certainly, governments keep on spending beyond their means, and this needs addressing while avoiding choking economies. To put the refinancing problem into numbers, as a measure of GDP the American debt , load today is lower than during the postwar years, and while refinancing President Jimmy Carter's $1 trillion debt would have cost $190 billion in interest, Barak Obama could refinance his $16.5 trillion burden (it APRIL 2013 doubled in four years to now 74% of GDP) at less than $42 billion a year at 0.25%. In addition, the Fed could set interest rates almost arbitrarily. With such ramifications, no business in the resource industries would be worried about either debt load or refinancing cost. Instead, they would seek for ways to hedge cost, improve productivity, and maybe, at ridiculously low rates, even leverage more. The situation in Europe seems markedly more difficult with GDP/debt ratios double that of the Americans, with up to 30 times greater interest rates, and with astronomical recurring social cost. Regardless, Europe could set its interest rate lower and refinance its struggling members cheaply in order to open up options for a fundamental economic restructuring. As an opportunity, America or China could extinguish the old continent's crisis in a heartbeat by offering smart deals that include deeper economic partnerships in exchange for cheap money. Not fixing the issue will extend the paralysis and keep resource markets depressed. However, for such a step, a number of conditions should be met, particularly in respect to related speculative financial instruments that need to be isolated. Still, the ground rule of an acceptable GDP/debt ratio remains quite simply a function of expected growth. This is where the cat chases its tail. Entrepreneurs in resource industries tend to focus on outlook, strategy, competition, and profitability. As long as there is strong growth (outlook), deficits or debt do not matter all that much. The ability to zero in on a problem and make tough choices in a strategic context is what separates successful businesses from those that fail. That governments' core responsibilities and intentions are not clearly detectable exposes the biggest shortcoming of democracies: the inability to identify, choose, and separate a critical path from wish-lists that perpetuate systemic deficits and boastful teleprompter speeches to fix the negative numbers. President Obama has made a proposal that could trigger a chain of unintended consequences that are important for businesses in resource industries: raising the minimum wage from US $7.25 to $9 an hour. Obama's idea is that increasing payroll would bolster the middle class. Instead, the effect would cascade through union contracts and general salaries. This would trigger not only inflationary pressure but also higher interest rates (while deflating fixed-rate debt). Hence, raising wages needs to be balanced with a freeze in interest rates in order to make refinancing costs predictable and less speculative. Otherwise, Obama's operation, if approved, ends up in a domestic zerosum game, leaving America exposed to even higher competition from abroad. In order to put a stop-gap on this, the American resource industry needs to demand that imported goods will be submitted to the importing country's safety, labour, and environmental standards. Regulations that are subverted by imports ultimately render domestic production unable to compete with suppliers that are free from those rules. Thus, with a smart strategy, a raise in wages could indeed lead to increased domestic production, a stronger middle class, a more manageable debt burden, and more reasonable domestic prices for resources. It could even help lift labour standards in the developing world, leading to expanding middle class markets and new opportunities there. Companies in the resource industry should do the unexpected and embrace an increase in the minimum wage but insist on a deal that includes a fixed rate regime and a change in trade rules for equal safety, labour, and environmental standards. Resource businesses should carefully hedge their floating interest debt with financial institutions that are so large that they are bound to be bailed out in a possible next shakeup. While the assumption of a perpetual stagnation is as faulty as the assumption of perpetual growth, the resource industry needs to embrace the prospect of inflation. n A.J. Deus lives in Vancouver, BC and is an author, film-maker, economist, and entrepreneur. You will find more columns by A.J. Deus at www.ajdeus.org. His contact information is ajdeus@yahoo.com. This material is taken from sources believed to be reliable and is provided for information only. Any investment decision should be made only after prior consultation with investment professionals. www.resourceworld.com 25

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