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I wanted to open a discussion to evaluate Soddy’s thought experiment used to show that capitalists are incentivised to repay interestbearing debt by raising prices.
Full article: https://capitalaspower.com/2021/09/fredericksoddysdebtdynamics/
In the thought experiment Soddy asks us to imagine that.
1. Alice is a wouldbe cattle farmer. She inherited some land and wants to use it to farm cattle. The problem is she has no money.
2. Alice goes to the bank and gets a $100,000 loan. With this money, Alice buys 100 cows.
3. Alice’s bank requires no regular payments. Instead, after t years, the bank demands full repayment (with interest).
4. If the bank calls in her loan after 10 years, she owes $163,000. That’s the equivalent of 163 cows
5. After 10 years, the bank calls in her loan at $163,000. If cow prices don’t change, Alice needs to sell 163 cows to pay her debt.
6. Alice could either: breed more cows so that she has 163 cows to sell or she could raise the price of cows.
7. So repaying interestbearing debt doesn’t necessarily require economic growth. It can also be financed with inflation.
This is supposedly analogous to mechanisms in the wider economy because “The economy must grow” or “Prices must grow”
My issue with this argument is that we have to pretend, in Soddy’s thought experiement, that cows have no ability to generate cash flows. We are told to imagine that no cow can produce beef worth more than $1630 nor produce more than $1630 worth of milk in its lifetime. So it seems Soddy has created a false economy in which assets are bought purely for their speculative value. This is therefore not a helpful thought experiment because I would imagine that the vast majority of investments are made into assets that generate cash flows which are worth more than the cost of the asset and the interest used to buy it. In the real world, Alice would have used a DCF model to ensure that the NPV of her purchasing 100 cows was positive, taking into account the projected future cash flows, the cost of the loan and interest payments.
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