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.
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.
Wow, that German traveler sure took his sweet time inspecting that hotel room. I wouldn’t be surprised if he secretly took a nap in there. Anyway, the moral of the story is that the stress of financial debt exists more in our imaginations than in reality. This illusion of debt prevents us from seeing what’s really important.
The little Greek village went from having loads of personal debt to a debt free status! even though no economic activities happened. That’s because one person’s debt is another person’s asset. And everyone has assets. Even human capital is an asset because it can produce income, lol. The average consumer needn’t worry about living on credit. Just like in the comic, most of us have more assets than debts. So getting out of debt doesn’t objectively improve our quality of life. But many people still think it does.
Another great point the comic demonstrates is how important liquidity is to an economy. All it took for everyone in the village to get out of debt was to infuse temporary cash into the the system. This is essentially how bail outs work. 🙂
Random Useless Fact:
Interesting commentary. Debt is inevitable for 99.9% of us if you are going to own a house, transportation, etc. The difference is being responsible or reckless. Also didn’t know that Canada had higher rates than Japan. Very surprising a reader from south of the border.
If we want to live in today’s society debt is pretty much a necessary evil. Oh well. I feel like it’s okay to borrow money, especially responsibly like you said, because everyone else seems to be doing it.
Debt allows for production to be pulled forward from the future.
It might take you 5 years to save money to pay for the car outright, but with debt you can assume that good today.
(One reason why QE may have slashed market returns for the next 10-20 years.)
The enslavement aspect of the debtor exists, but perhaps only to himself. If you want to keep that car then you have to keep paying/keep working. But what you are really paying for is the perceived new-found “personal freedom”. You’ll keep paying as long as your desire/pleasure to have that freedom exceeds the pain of parting with money.
Debt can also cause a lot of negative reactions. If there were no student loans or mortgages available, education and real estate prices would be nowhere near the outlandish levels they are today.
In the end, debt is merely a monetary device. It can be used constructively or wielded destructively (or not at all).
Next time I play Monopoly with my friends, when I land on an unclaimed property and I can’t afford it, I’ll try to buy it with debt. I wonder if anyone else would be willing to lend me the money lol. I agree that debt shifts the cost from today to the future. That’s exactly why I bought my car on credit 5 years ago. 🙂 I wanted to drive it right away because I just got a new job and didn’t want to take the bus around town anymore with the smelly passengers. Pushing the cost of the vehicle down the road for a couple of years was worth it.
Another interesting post Liquid,
If we scare for debts, then we wouldn’t have invested ourselves for better education and we wouldn’t have bought house. We will be saving money until get age 40 to get education and 60 to buy a home.
If you use your debts in a good way (as you do), you will be rewarded.
Yup, most people use debt in good ways. I think they just don’t want to admit it to themselves because going into debt for whatever reason isn’t seen as a positive thing to do.
I think the story raises a good point. However, debt tends to be negative given that debt is typically used to purchase assets that do not equal the value of the debt. Additionally, debt provides the illusion of wealth, causes those in debt to spend more than they would have had they used existing assets.
However, it is a good point. Debt is certainly not inherently bad, particularly when your debt service is manageable and the debt balance is more than offset by marketable assets.
An illusion of wealth can be really harmful. It’s too bad so many people fall into that trap. It’s better to be financially secure and appear average, than to live paycheck to paycheck while looking rich. XD
C’est epic!! (What’s epic in French anyway?) I love the story, It’s a consumption economy now. It will continue to be this way until resources run out.
I’m not sure what epic is French. I think your Francais is better than mine anyway. Resources are finite, but some people are pretending like they’re not. I hope I don’t get to see the day when the earth runs out of oil and gas.
I wouldn’t worry about that – as the whole fracking industry has shown, there is actually a massive amount of these resources, the issue is just how costly it is to get to them. We will not run out of oil or natural gas for a long time, just might end up paying more, and based on the world production right now, even that doesn’t seem to be an issue for a number of years. Other resources like food and lumber are renewable, so they don’t run out. Finally, there is always a new technology around the corner waiting to capture energy in some new way – nuclear, wind, solar, tide, biomass, geothermal – lots of forms of energy and we keep getting better at harvesting and holding. Don’t get me wrong, I hate waste and pollution as much as anyone, but to say the resources are finite – I don’t think that’s an issue for many generations.
There will be too many earth quakes and bad result from environmental changes before all the resources run out. I have to give it to the writer of the movie superman, who describes the world on krypton, they move from planet to planet after they’ve taken all the resources until the planet become unstable and imploded.
We are not too far from fiction movie. Probably, not in our lifetime though.
I would urge caution in “predicting” catastrophic environmental change, especially based on scenarios out of fiction.
It’s very naive to think that we humans, who’ve been on this planet for a mere blink of the existence of this planet, somehow can accurately project what our inputs into this very, very complex system will produce.
And like Chris said, we are not going to be running out of oil and gas. Perhaps “conventional, stick it like a straw in the ground and suck it up oil and gas” but not all oil and gas. There is so much unconventional forms locked away that we could possibly not use it all for a few generations.
It’s funny to read this now in May 2020 when the price of oil went negative(!) at one point because supply was exceeding demand by that much.
Interesting to think about. We know that for us, debt is definitely not freedom, but you make a going point on a macro scale. We no longer have any personal debt, and will have the house paid off by the time we retire in two years, which will mean we have to earn less income each year to cover the cost of the mortgage payments. Having to earn less makes us more free.
Congrats on being so close to pay off your mortgage. I still have around 27 more years on mine lol.
Yes, the debt was temporarily relieved of all the people, but the only person that had any money at the end was the German who left town. Once he left, everyone was left cashless again.
And so they all go back to using credit once again, lol.
Ray Dalio has a famous youtube video where he takes his crack at explaining how the economy works (https://www.youtube.com/watch?v=PHe0bXAIuk0). In it, he explains that there are two types of debt: production and consumption. The first type of debt is a net positive to our economy, and the second is where you bring future consumption into the present. When you enter into productive debt, such as school loans or debt for a manufacturing company to grow, that’s one of the drivers for our economy. Essentially you are entering into an agreement where we pay X and make X + Y. IMO, this is the type of debt that LQ uses in their investments. Even entering into debt to buy a car is a good decision if that car helps you be more productive and/or get to work. The second type of debt is consumption based. Think of when you want to purchase a brand new tv or coat and put it on your credit card without being able to afford it. Those types of debt tend to destroy value more than create it. These are the debts that people should limit, unless there is some special case (one could argue that… Read more »
“When you enter into productive debt, such as school loans…”
What exactly does a student loan produce?
The differential in human capital and subsequent economic output between the person as a graduate versus a non-grad.
Student loans (and mortgages) produce exactly zero output.
The price of a degree does not equate in any way, shape, or form to economic output.
If we’re debating the value of a university education & beyond, there are some signs that the costs are beginning to eat into the value of the education. However, the facts remain that the world’s wealthy have higher levels of education. This value is compounded by individuals who seek master’s and doctoral degrees. The same holds for house mortgages, since people are able to earn more than what they pay on the mortgage rate–especially in today’s ZIRP environment. I believe your last sentence is correct in the sense that the amount of money you spend on education does not equal or drive the value you’ll receive. Simply spending Harvard or Stanford tuition dollars will not mean that you gain more knowledge and skills compared to a graduate of Western or UofT. Tangentially, it’s apparent that some of our youth are overly focused on certifications and education because of the lack of opportunities in the workforce. Skills learned in textbooks have to be practiced in life in order for one to benefit from the alphabet soup after his or her name. Without a chance to practice what is taught in the classroom, it’s unlikely that these individuals will be able to… Read more »
Thanks for the video, HarperFanClub. Ray Dalio sounds like a smart man. I’ll have to watch the entire thing later this weekend. It makes sense that borrowing to invest is good for the economy, but borrowing to consume like buying the TV or coat in your example, will slow down economic growth. I wonder if that’s why China’s economy is slowing down. I’ve heard the Chinese central government has been pushing for a more consumer-driven economy rather than one based on traditional production and exports like the country was 20 years ago.
I didn’t know that back in the day loans were forgiven after 7 years. But I guess people lived shorter lives back then too so 7 years probably felt like 15 lol. But that’s an interesting piece of trivia about the Catholic church banning interest rates on loans. This would essentially mean there is no cost to money. No investors would lend to the poor farmers because they don’t want to risk their money for zero return since there is no upside. So for a society to expand properly interest rates have to exist.
Yea, I’ve read that one before. The problem of course is that none of these people were really in debt, as they were all owed exactly the same amount that they owed to someone else. All the transactions did was clear the books. That would be like me going to the bank and getting a loan for 1000, then adding that total to my net worth. I’m actually no richer or poorer than I was before, I just have 1000 more in my account and owe the bank 1000. The complication with real life of course is that both loans and assets have potential risks/rewards. Is the interest cost of the loan more or less than the return on the investment I purchase with it. What if the interest rate rises? What if the investment tanks? What if the investment doubles? What if I lose my job and can’t make the loan payments due to lack of cash flow? I am actually not against debt as long as it’s calculated – I still have a small mortgage and also have some investments purchases from the HELOC – but in both cases I’m well within my comfort zone so that job… Read more »
Right you are, Chris. The hammer analogy is bang on. 🙂 You can hurt yourself if you’re not careful. Borrowing within your comfort zone is key, and there are many ways to determine what the limit is. I like to use a stress test chart which I’ve wrote about before. Other investors might use a different what-if-scenario approach. In the end we should be fine as long as we don’t over-extend our borrowing.
Great post and terrific example of that small Greek village. Debt, money, etc. is all created and all an illusion. Your post reminds me of a quote from Wall Street – Gordon Gekko: It’s not a question of enough, pal. It’s a zero sum game, somebody wins, somebody loses. Money itself isn’t lost or made, it’s simply transferred from one perception to another. This post made me think 🙂
Great quote, dude. Finance can be quite philosophical if we put our minds to it. 🙂
I’d agree to a point it is an illusion. However, money is just the medium in which we exchange services amongst each other. At the core, all it’s fundamentally about is how much value you are giving to society.
If you create value and have a surplus – be it from excessive value creation or minimal consumption – you have stored up ‘claims cheques’ on society. These claims cheques are really just services that you are owed for exchanging services to someone else yourself.
Paper cash, gold coins, silver bars, seashells, bitcoins, whatever, are just the medium we use as a more efficient conduit to transfer services among ourselves. They in and of themselves have no intrinsic value – it’s just the faith we put in these mediums that prop them up.
Therefore, I don’t think it’s necessarily a zero sum game: if you can provide a service to others that is in demand, they will exchange their services for your services. And sometimes the rewards will be lopsided.
I agree. Money is a form of stored value that we can readily use to gain other resources or services that have actual utility. When an entrepreneur has an idea and turns it into a successful business then productivity and wealth is created in a place where there was no value before. It’s not always a zero sum game in the bigger picture, but from within a single business or stock exchange maybe it could be.
This story creates an illusion. Nobody in the story had debt, because they also had a “receivable” of the same amount. So their net was zero. Now i want to understand something below. .. because I believe debt is actually always “unpayable till the next crisis”, if you consider the big picture. The big pic would be the whole debt of a population. Here is the thing: =================== Let’s say all lenders lend a total of 1000 to everyone combined in a certain year. (lateryou can get that example and apply to the total world debt and population). I see no way for that money to be paid in full, simply because the new money/credit created was just 1000, therefore if they come up with over 1000 in total, that would be taken from savings. It would be a deficit. I’m saying this because the only way for that total 1000 to be invested and get a return over 1000 would be impossible unless the population itself consumes/buys over 1000. But they don’t have over 1000 (unless they use savings). That’s why the core foundation of capitalism is failed. There will be always bubbles of assets and increase of debt… Read more »
Damn, that’s scary. What should average people do then?
Not an easy question. (Avg people can’t do much, because the way to make money is also the way to break the big machine) Just as an example: the owner of this blog (which seems to be an avg person) is doing some of the most rewarding things financially speaking… which is using debt as leverage. The economy nowadays is rewarding who takes debt, not who saves money. But even though, I believe Freedom35 (as an example) has the 2 farms which are cashflow negative, and lots of stocks that pay dividends and increase over time .. and also some debt yields (MICS) and REITS… I mean, All of these will increase only if Debt increases (I mean the total debt of the population). Because If the total debt of population start to slowly get paid and decreases over time, I see no way the assets would increase in price. (we are still in an artificially made leverage stage of a debt cycle). Found this on Wikipedia under “deleveraging”: “Every major financial crisis has been followed by a period of deleveraging. But after the 2008 financial crisis, economists expected deleveraging to occur globally. Instead the total debt in all nations… Read more »
just a comment on that last post by Raf. This blog ‘freedom 35’ (liquid independence)seems to be doing quiet well on the journey to ‘freedom’. He also has a lot of non-registered investment debt of approx $300,000 (excluding the home he lives in) that is serviced and still nets a positive return.
On that basis, anyone that can borrow leverage high amounts (use Trump as an example) then lets say they can borrow $1,000,000 with a net return on that investment of just 3% or $30,000 after servicing that debt. Now that wouldn’t be too shabby or is it?. Many folks can pay towards or all their living expenses from $30,000 net.
Some folks will do a similar thing with real-estate investing in a ‘buy to lease’ and not worry to much about capital appreciation, just the cash flow, like Liquid is doing with his farm investment.