Oct 132015
 

Debt is Freedom

I once read in a book, “the borrower is slave to the lender” Proverb 22:7. But I don’t see it that way. I think debt is simply a loan between a borrower and a lender which usually involves a contract to pay back the loan over time. Nobody is a slave to anyone in this voluntary transaction. If I have a car loan and continue to make my payments on time, then the lender can’t tell me what to do with my life. It can even be said that I’m less of a slave now because I’ve gained more personal freedom by having a reliable vehicle, which wouldn’t have been possible without going into debt in the first place. 🙂 So hooray for convenient transportation. I’d like to give a big shout out to my car, for giving me the drive I needed to succeed. ?

Illusion of Debt

It’s often assumed that more debt is bad and leads to more financial risk. But debt is a funny concept. Japan has a debt to GDP ratio of 230%. This means Japan owes 2.3 times more than its annual economic output. Holy frankfurter! 😯 On the other hand, Canada’s debt to GDP ratio is a much more manageable 86%. Naturally we would expect Canada to be in a better financial position to take on additional debt. However, as of this post global lenders are demanding 5 times higher interest rate when Canada borrows money than when Japan does. (Sources: Japan gov’t 10Y Yield,  Canadian gov’t 10Y yield.)

Part of this disconnect between risk vs return is due to central bank manipulation. But debt itself is not always what it seems. Consider the following comic strip I found on the internet awhile ago.

The illusion of debt in Greece and Europe

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Jun 122012
 

Money and Banks

Spain will be getting a bailout package up to €100 billion from the Euro zone.  The idea of injecting this new money into the system is to help stabilize the banks and the economy. It sounds like a good idea on paper. Below is a funny comic I found showing the effects of lending money to an indebted economy.

source: via 9gag.com

But the reality of bailouts are more complicated and sometimes bring more bad news than good news. In the comic strip above the net debt everyone owes is zero. But in reality Greece, Ireland, Portugal, and now Spain all have a negative net worth. Instead of “he owes me and I owe her,” the situation in these countries is more like “we all owe the bank.” But the banks are sitting on mountains of debt as well from bad real estate loans, similar to what happened in the US.

Also, money is not free. So unlike the comic, when Spain takes on a bailout package it has to pay interest on it. Normally if a person was in a lot of debt, the best thing to do is cut discretionary spending, find ways to make more money, and save, not borrow even more money. But Spain is doing the opposite of that, taking on up to €100 billion ($125 billion) of more debt with no plans to cut its own spending. This is why stock markets have reacted negatively to this news. Bailouts are temporary solutions to a long-term problem. But to have a sustainable economy everyone has to pull their own weight.

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Random Useless Fact:

Men’s shirts have the buttons on the right side, while women’s shirts have them on the left.