Friday, July 14, 2017

Debt is killing us

I've written often enough about the problem of debt in the past.  Now Charles Hugh Smith reminds us of the grim reality of this burden that overhangs each and every one of us as individuals, and our society as a whole.

We are now totally, completely dependent on expanding debt for the maintenance of our society and economy. Every sector of the economy--households, businesses and government--all borrow vast sums just to maintain the status quo for another year.

. . .

Borrowing more money from the future is easy, painless and requires no trade-offs, sacrifices or accountability--until the debt-addicted economy collapses under its own weight of debt service and insolvency. People keep repeating various versions of the story that "debt doesn't matter" because "future growth" will outgrow the skyrocketing debt, or inflation will make it all manageable, or that central banks will do whatever it takes to make sure everyone has enough money to service their debt burdens: negative interest rates, helicopter money, etc. etc. etc.

We want to believe in financial magic because we want things to remain easy.Borrowing from the future is easy, making sacrifices and being accountable is hard.

But eventually the cost of servicing even low interest-rate debt squeezes spending, eventually capital tires of chasing negative interest-rate bonds, eventually lenders realize that leverage has skyrocketed along with the debt and risk is piled up like dry tinder in a drought-weakened forest.

. . .

If you believe that going from a total debt burden (government and personal debt) per household being 79% of median household income to debt per household being 584% of median household income doesn't matter and will have no consequences, you believe in magic. Unfortunately, thinking something will be easy forever and have no consequences is not the same as the real world of skyrocketing debt and leverage having no consequences ... Believing that debt has no consequence, that the status quo is permanent, that all the promises based on soaring debt can be paid--it's all an appealing fantasy, magical thinking at its most enchanting. Believe these fantasies at your own risk.

There's more at the link.  Essential reading, IMHO, and highly recommended.

Debt is the single most important, and most critical, financial issue facing our nation at this time - and it's getting worse every day.  The so-called 'fiscally responsible' Republicans, who now control the House, the Senate and the Presidency, have ignored all their promises by jacking up government spending to a record $400 billion plus every month (much of it funded by new borrowing).  The tapped-out, debt-burdened US shopper is spending less and less, thereby imperiling our consumer-based economy.  New car sales, a key area of US industry, are dropping, and bank loans to finance vehicle purchases are doing likewise.  The signs are everywhere:  debt is crippling our ability to continue on our present path, as individuals, as states, as a nation, and as a society.

The problem is not limited to the USA.  The International Monetary Fund warned last year:

Global debt has hit a record high of $152 trillion, weighing down economic growth and adding to risks that recovery could turn into stagnation or even recession, the International Monetary Fund has warned.

. . .

“At 225pc of world GDP, the global debt... is currently at an all-time high. Two-thirds, amounting to about $100 trillion, consists of liabilities of the private sector which can carry great risks when they reach excessive levels,” the IMF said in its fiscal monitor.

“The sheer size of debt could set the stage for an unprecedented private deleveraging process that could thwart the fragile economic recovery.”

This debt burden is mounting at a time when slow growth means inflation and interest rates will remain low, making it hard for companies, individuals and governments to earn their way out of debt.

A combination of low growth, high debt and weak banks could push the world in a dangerous financial and political direction, the IMF said.

Again, more at the link.

Folks, I can't emphasize too strongly that each and every one of us needs to do the following:
  1. Pay off existing debt as soon as possible.
  2. Refuse to enter into new debt for short- to medium-term needs (e.g. vehicles, furniture, etc.)  Pay cash or do without, unless it's absolutely, critically necessary.
  3. Enter into debt for long-term needs (e.g. housing) only when absolutely necessary, and in such cases, buy within one's means - certainly less than the banks (who are looking after their own interests, not yours) will lend you.  I'd suggest an absolute maximum of 25% of your household's net income (i.e. after taxes and other deductions at source) should be allocated to such debt;  if you can get it below 20%, so much the better.
  4. Enter into debt for the shortest period you can afford (e.g. monthly payments on a 15-year housing note will be more expensive than a 30-year note, but you'll be debt-free much faster with the former than with the latter).
  5. Build up a reserve of at least six months expenditure, and if possible a year's worth.  It will be invaluable if hard times come around.

These are not just financially prudent measures;  they're security measures.  If our economy goes haywire, only those who have reserves, and are not over-burdened with debt, will likely keep their heads above water.



Anonymous said...

You cannot borrow money from the future, that would require a time machine to transport the money from there to here. You are not actually acquiring those future resources. What you are actually doing is consuming present resources, and promising to replace them in the future. The logistics of that is way different when repayment plans fall through. The debt is not going to be repaid. Don't be a lender.

Old NFO said...

Sad but true. This is a no win situation many are ignoring...

Anonymous said...

In the UK, the Building Societies (which, as the name suggests, were mutual savings societies that would only lend for the purchase of housing) had a limit on the amount y=they would lend you. It was 2 1/2 times your annual salary for a single person, 3 1/2 times the combined annual salary of a married couple.

Presumably, more than this would mean that you could not survive on the residue of your wages after paying the mortgage so it was a sensible rule.

I wonder how much I could borrow nowadays ...

Phil B

Suz said...

When I look at the economy and debt burden all I can think is that nothing goes up forever. Sooner or later, everything that goes up does comes down. I think now it is just a question of how hard...

CDH said...

More importantly, how do the fiscally responsible of us survive the crash with OUR assets intact? Physical assets are one way, if they don't get taxed out from under us, but liquid savings like 401k, IRA, CD's, etc. are severely at risk as well.

I can take stay in the black all I want, but if the debt craters the markets and economy, runaway inflation (for example) can quickly wipe out all my hard work.

Peter said...

@CDH: Several suggestions:

1. Use as much of your assets as necessary to pay off debts you owe. That will put you in a much more secure place.
2. Buy investments that you control and can sell at will, not those controlled by others that can be confiscated by legislative or executive whim. Examples: fixed property, gold, things that will always be in demand (particularly in a time of shortages - lubricating oil, alcoholic spirits, etc.).
3. Keep your cash reserve at home, in cash, in a safe place, rather than in a savings account. 6-12 months worth of money to pay all your bills comes to a substantial sum. (Invest in a good safe for it, including fire protection.)
4. Consider lending money to friends you trust, at commercial rates of interest. If you can be reasonably sure of them repaying you, you'll make a higher return from them than you will from banks or other financial instruments.
5. Beware of buying investments that "everybody" is buying. If everyone's buying them, then, in a crisis, everyone will be trying to sell them to regain liquidity. You'll be lost in the crowd.

Just a few thoughts. I hope they help. Right now, I'd stay as liquid as possible, and avoid the stock market entirely.

SQT said...

My husband sees this everyday as a financial consultant. It's amazing to me that no matter how much people make they still manage to spend themselves into oblivion. We're about 2 years away from paying off our house and our accountant says to my husband, almost rolling his eyes, "oh you finanace guys, always obsessed with paying off your houses..." It's like people live in some alternate reality and can't see common sense if it was waved in front of their face like a red flag. People think debt is normal

Anonymous said...

(e.g. monthly payments on a 15-year housing note will be more expensive than a 30-year note, but you'll be debt-free much faster with the former than with the latter).

If I may, a suggestion or two:
1) Pick the 30-year mortgage, not the 15. Then pay at the higher 10-year mortgage rate (or higher) for the first two years, dropping to the 15-year rate afterward.

If one looks at an amortization chart, the first year of payments, for either 30-year or 15-year, mortgages are almost all interest. Often, increasing the monthly payment by $20-$30 or so, dedicated to principal, obviates the next monthly payment. Adding a couple hundred moves you through the amortization table in huge jumps, often a year's worth at a time. When you can turn a 30-year mortgage into a 29-year mortgage with $200 that's something not to be missed. An extra grand or so in principal over the first 6 months can easily move you into year 5 or 6 of the mortgage, frequently further.

The goal is to advance into the amortization table as far, and as fast, as you can, because the further into the table you go the more of your payment is spent on principal rather than interest. The goal is to get the loan to Zero Principal as soon as possible.

2) Should an emergency develop, one that simply cannot be handled by any other rmeans, you can drop back to the 30-year payment level for a month.

Yes, a 30-year note will carry a slightly higher interest rate than a 15-year, but it offers lower payments. Which you should ignore as you make the higher 15-year payments instead. And, true, a 30-year loan paid at a 15-year rate will actually be something like a 17-year mortgage because of the interest rate difference, but front-loading principal payments during the first year can make it a 13-year mortgage instead.

In any event, front-load your payments - make lots of extra principal payments the first 6 months. Same trick works on car loans; finance for 60 months, pay off in 24-30.

If you don't have the financial discipline to do all of this you should not be taking out loans in the first place. Stick with cash.

Uncle Lar said...

For all that's holy, teach the young that plastic is their short path to enslavement.
Credit companies target college ages to get them hooked early as they are most likely to put instant gratification above fiscal responsibility. A pizza here, dinner out there, must have new electronics, and they're hooked for potentially the rest of their lives. And only much later do they realize just how much of their income has to be paid right back out to service the debt. Easy credit and student loans for worthless degrees are both crimes against the unsuspecting youth of our nation.
Now I have two credit cards and a credit/debit card with my credit union. In fifteen years I have never carried a charge past the monthly payment date. The card companies have a name for such as me, freeloaders. A title I wear with a good bit of pride.
I took out a 30 year mortgage on a modest home in 2002, made very aggressive over payments, and paid the house off free and clear by 2009. Of course should I ever fail to pay the taxes the government will be quick to take it away from me, but there are mechanisms in place to ensure that will not happen.