The Consequences of Debt
I want to have a look more closely at something I have been working through in some of my books.
I have been writing two non-fiction books over the past two years. They have been published on Amazon and I will give links to those books at the end of this blog.
Both the books discuss wealth and the relationship between debt and wealth, with one of the books homing in on government, and the appalling state of government in Europe at the moment.
One of the things that is screwing up life in the West is that no-one has been paying attention to the basic rules of money.
Money is precious, and it is there to be used. In my book about how to get rich I point out that the most important way to get rich is to use money as a servant to get you more money. That is not just true of personal wealth, but it is true with regard to government finances as well.
We talk a lot about the problem of debt, but very few people seem to appreciate just how damaging debt is.
Let me for a moment think in terms of government finances.
One of the chapters in my book sub-titled Reform or Ruin is about the British pension scheme. It is a disaster. It isn’t even a pension scheme, and it is predicated on a false premise.
In reality there is no pension scheme in the UK, and what there is, like so many things in this world, is constructed backwards.
Einstein claimed that the eighth wonder of the world was compound interest. Compounding interest is a wonderful way to finance ventures, but you have to have money to start with in order to compound it. If you spend money, you dont have it any more, and so cant compound it, that is why you need the money there in the background. If instead you have debt, the cost of that debt compounds, and you have exactly the opposite state of affairs; a road to rapid ruin.
If you have £100, and you spend it you have effectively done one of two things. You have either wasted that money and no longer have it, or you have converted it to something else which you may or may not be able to make work for you.
If you get rid of the money to buy a tractor and a few attachments, you can go out and plough the fields, and make yourself an income. If you spend it on a holiday, once the holiday is over, you have no more holiday and you also no longer have the money. In practical terms, if you spend money you are giving away one of your best servants.
I always maintain that the way to wealth is simply to harness money to work for you. Turn money into a servant.
The trouble with debt is that there is no possibility to do that. You give away what should be your servant. It now becomes your master.
A typical person leaves school and goes to university, which costs money. A school-leaver has no money, so has to borrow to get that education, and in three or four years time goes into the wide world with a massive debt. How is that person to make any wealth if he or she has to pay back a debt? Basically, it cant be done.
Let’s briefly go back to the public sector.
I’m sure that most of you have come across the concept of the measure of public debt. If government debt reaches a certain level it ceases to be productive, and quickly turns into a long term and often terminal liability.
Let’s analyse what is happening very simply by going back to the private sector and analysing a very simple proposition.
If you borrow £100 to buy yourself a fishing rod, you can now go fishing, and put fish on the table two or three times a week. That fishing rod is paying for itself.
If you go out and spend £20,000 on a car and use it to run a taxi service, that car is paying for itself.
It doesn’t matter what the deal is so long as the end product is positive. In other words you can create a productive equation. a-(b+c)= +Z, where Z is perhaps the value of the fish you can catch, and b is the cost of that rod, and c is the cost of the money spent on the rod. So long as the value of the fish is more than its eventual cost, you have a viable economic situation. The big problem comes when the figure to the right of that equals sign is negative.
Sorry to keep mucking you about, but let’s now go back to the government and its debt situation.
A government can get into debt to make something happen, but that something must be useful and cost effective. In other words it has to be profitable. It doesn’t matter what the deal is, look at that deal presented as an equation. Here’s the equation in simple language:
Borrow money to create a highway from one major town to another. What will the highway cost to get built, and what will the annual maintenance be? Now work out what the value is of the benefit of being able to get goods more cheaply from one town to the other.
Here’s the proposition presented as an algebraic equation:
Money saved by improving the transportation - (road cost + maintenance cost).
You now need to populate the language with numbers. If we say that a-(b+c)=20, we have an equation where the value created is a positive number. That’s good.
What happens if the value is negative?
It increases the size of the debt.
The general view when looking at government debt is that if the size of the debt compared with the value of the asset supporting that debt is more than 90% then that is bad and unsustainable.
Think about it. The underlying value of the country is for sake of argument $25 trillion, whereas the size of the government debt which is underwritten by the former figure is $34 trillion. The American debt of $34 trillion is way over that 90%. The USA is technically bankrupt, and every time they increase that debt the ability to repay it gets more and more difficult.
That’s obvious, but what people forget is that they now need to draw a conclusion from all this.
That conclusion is that if you borrow to make a profit then all is well. If you borrow and end up with a loss, then you shouldn’t have borrowed in the first place, and you are now in trouble.
We can take matters a little further. If your total borrowing is more than 90% of your underlying equity, any further borrowing is pointless, and indeed, very silly. What you are doing is borrowing to make yourself poorer. Where’s the sense in that?
Result, the USA, and most western governments are in the process of going bust, and they are making things progressively worse for themselves and their voters.
Let’s put that another way. Most western governments are operating an absurd economic model which will eventually collapse.
As a matter of comparison the debt ratio to underlying equity in Russia is 27%. Russia can afford to borrow to create more wealth whereas the USA, and west European governments are borrowing in order to lose money, and eventually go broke. Excuse me, but isn’t that utterly absurd?
What do you do if you live in such a country?
There really is only one answer to that question. Expect to either go broke or get a lot poorer.
Mind you, you could do something about it, but that needs concerted effort rather than anything individual. In other words it is up the electorate of a country to make sure there is change before they are engulfed in ruin.
I live in the EU. My first suggestion to my fellow compatriots would be to defund Brussels.
I live in hope.
Here are the links to the two books I have referred to above.
Being Rich is Easy:
USA https://www.amazon.com/dp/B0CLS37VX1
UK https://www.amazon.co.uk/dp/B0CLS37VX1
Governments Are Obsolete: