Tuesday, June 5, 2012

The Awesomeness of Debt

Why have we become so comfortable with debt? Why don't we worry about taking on more debt, as a nation or as individuals.

David Brooks asks the question this morning by declaring that we are living in “an age of indebtedness.”

In his words:

In this country, the federal government has borrowed more than $6 trillion in the last four years alone, trying to counteract the effects of the last two bubbles. States struggle with pension promises that should never have been made. Europe is on the verge of collapse because governments there can’t figure out how to deal with their debts. Nations around the globe have debt-to-G.D.P. ratios at or approaching 90 percent — the point at which growth slows and prosperity stalls.

Why don’t we care about debt? Are we moral slugs, oblivious to our obligations to our creditors, our children or our grandchildren?

Perhaps we are happy to lard on the debt because we don't think that we will have to pay it off. We get to enjoy; they get to pay it off.

You win; they lose. What could be wrong with that?

The bank sends you a letter offering you free money, so to speak. It considers you creditworthy. Who are you to contradict a bank’s judgment?

Besides, when the bank offers you a credit card, it does not ask for collateral.

Remember that these same banks, under the aegis of the federal government were writing mortgages for more than the purchase price of the homes they were financing. 

In principle, when you take out a mortgage your home is the collateral for your loan. If the mortgage exceeds the value of the home, you have no equity and you have put up no collateral.

At that point, the word loses its meaning.

Anyway, there’s an easy answer to Brooks’s question. We live in inflationary times.

Rising prices encourage you to spend now. If you have to borrow the money, inflation will still be your friend.

It will help you to pay off your debt with cheaper dollars.

You are going to be thinking that the world is showering you with gifts and asking very little in return. Who are you to contradict the system?

In inflationary times debt is only a feeling. When it becomes less real, when you feel that you have no skin in the game, you start believing that it cannot hurt you.

The worst that can happen is: the bank takes your house. Since you didn’t really own it in the first place, you are not likely to feel that you have lost very much.

You can even feel like a good citizen, for making the wheels of commerce and banking run.

Like a lax parent, a bank indulges your appetite for excessive consumption and then only requires you to pay some of the money back.

In deflationary times debt is your mortal enemy. Deflation erodes your earning power while your debt remains the same. You have to work harder to pay back what you borrowed.

If you cannot pay it back, then your creditors will take the loss. Everyone knows that one of the Club Med countries is soon going to start defaulting on debt.

If you hold that debt, that is, if you loaned the country money, you are going to be out of luck. Unfortunately, the money the creditor banks will be losing is your money, your deposits.

Evidently this is a bad thing. Thus, central bankers hate deflation. They will do everything in their power to keep it at bay.

Prior generations have not been quite so insouciant about debt. The generation that lived through the massive deflation of the Great Depression learned to hate debt.

In deflationary times people tend to spend less. Why buy it for more today when you can buy it for less tomorrow.

More money goes to paying off debt, so less is available for consumption and investment.

In a severe deflation, people default on their debts. This ruins their credit rating and forces them to live within their means. The hit to their lifestyle becomes a hit to the economy.

If your employer has too much debt he might not be able to borrow the money to make payroll. He will then have to shut down the company or the project, and you might find yourself unemployed.

It’s impossible to know whether inflation corrupts human virtue or whether people who lack moral fiber are more likely to exploit the system.

If people got seduced into immoral behavior the market will impose a diet of deflation, thereby teaching them good conduct… the hard way.

Unfortunately, the markets do not feel your pain. They do not care about your pain. One way or another they will make you pay up. I know it's not fair. I know it offends everyone's sensibilities. 

Fortunately, you do have a choice.

If you do not like the marketplace solution, then you should start living within your means and start paying down debt now, before it’s too late.

It's not going to be fun, but it's better than letting the market work its black magic.


n.n said...
This comment has been removed by the author.
n.n said...

Human beings, whether as adults or children, are incapable of self-moderating behavior. This is the basis for justifying progressive totalitarianism.

People need to choose between liberty and submission with benefits. Only a select few can reasonably have both.