World Debt and Investment: risk and reality

“Everything we get, outside of the free gifts of nature, must in some way be paid for.” ~ Henry Hazelitt ‘One Lesson: The Shortest and Surest Way to Understand Basic Economics’

Debt is a complex issue – and depending on how it is controlled – can have either positive or negative effects. In its simplest form, debt could well look like this: if you owe more money than you earn, you are bankrupt, actually poor. Yet the world seems determined to ignore this reality and continues to spend beyond means and borrow beyond ability to repay. The effect is the same whether you’re an individual, a company, or a country.

The tatters of wealth

There is a lot of talk about ‘rich’ countries – but in reality, are they? When a country has borrowed beyond its means to pay back the loan, and is carrying an impossible repayment load of billions and trillions, would you call that country ‘rich’ merely because it displays a comfortable or even extravagant lifestyle? Before you judge any entity’s wealth status, you should look at what is owed against income – that way you might look at many ‘rich’ countries in a different light; the US, UK, France, Spain, Italy and several others might just surprise you.

Between the years 2000 and 2009, total global credit grew from $57 trillion to $109 trillion. The scary thing is that this reflects debt burgeoning at around double the growth in economic activity – in other words the debt is growing faster than money is being made to pay it off. The alarm bells are ringing. Why does this happen?

Like all debt traps, one is sucked in, thinking that eventually there will be enough money to pay off what is owed – but in the meantime one will have the comfort of material possessions and services one wants. Governments invest in debt because they believe that, while giving society the benefits they demand, the economic growth derived from the investment of this borrowing will provide grist to economic activity, which in turn will produce more than enough to pay back the loan.

A leap of faith

So debt can be useful. It helps to accelerate spending – thus generating economic activity, creating jobs, and meeting the public’s demands through the provision of cheap or free public services. Indeed, debt handled well can stimulate enough busyness to produce good returns and therefore not only the ability to pay back the loan, but also enough to pay the interest on that loan.

But here’s the rub: the build-up of debt over the last 25 years has been excessive, ballooning to numbers that countries can find no way of paying back. Indeed, sometimes they borrow more money to pay back loans that have reached payback date and which carry further substantial financial costs if not met. These governments scrabble to maintain their welfare systems and standards of living while finding themselves at the mercy of big lenders, rising interest rates, and financial penalties which obviously they cannot afford. Greece is a prime example of this.

So what can be done?

  • Reducing debt through debt forgiveness, defaults or inflation has serious knock-on effects. Savings designed to finance future needs, such as retirement, are lost. This means more people will be turning to the state to assist them, which results in greater state expenditure, which in turn takes money away from support for economic growth.
  • Raising taxes is the next option – although this never goes down well with an electorate who perceive their hard-earned tax money as being misused and abused by irresponsible politicians.
  • Those countries with high or rising sovereign debt may find themselves benefiting initially due to broadly accommodative monetary policies – however, this comfortable situation cannot be sustained when in reality what has been achieved is only an illusion of stability. It also tends to slow the implementation of the very necessary and difficult reforms, often in the form of austerity measures, that are vital to attaining fiscal balance and promoting future growth.
  • Investing in an environment of increasing debt can become high risk for everybody. When debt is simply increased to maintain consumption – whether as an individual, a company, or government – it creates an entirely unsustainable scenario.

Debt and investment – dangerous liaison or delicate harmony?

“In the solution to one economic crisis, lies the seeds of the next.” ~ Stuart Young, Executive Consultant, Director of Companies.

The seeds of the current situation predate the 2008 credit crunch which put the US economy under the greatest stress since the Depression of the 1930s. And the solution was ‘quantitative easing’ – simply printing more money that had no solid backing, effectively without real value. Simply printing more money might give the impression of a flush society, but in reality is merely a façade.

Debt offers the same illusion, allowing people to spend more of what they don’t actually have. Households and businesses borrow in order to finance consumption – and see this as an investment, believing that spending more today will increase their welfare in the future.

This ploy can work: if for instance, the money borrowed is used to train staff to greater productivity, thus increasing a company’s capacity and therefore opportunity for profits, the debt can propel a company forward. Borrowed money used well – with regular repayments to avoid censure – can help individuals to improve their lives, a company to develop positively, and a government to meet taxpayers’ expectations.

Debt can act as a fundamental anchor to economies, value lying more in amounts owed than ownership. Asset value lies in what is owed and the interest due on those loans. The right kind of debt should fuel growth, stability and confidence, bolstered by the belief that investments funded by debt should ultimately deliver financial returns greater than the debt.

Problems arise when one debt load is still outstanding, and an entity is forced to borrow again to maintain a lifestyle already built on credit. This begins a spiral that is soon out of control. Global debt is currently struggling to pay off the interest on their loans, let alone make any substantial inroad on reducing the debt itself. In this way, past and present sins may haunt us well into the future.

Foster Wealth – the safest path on a rocky journey

At Foster Wealth we’re aware of the tricky balance between global debt, stock markets and investment strategies. Market tensions are not within our control, but certainly an astute eye is vital to keeping one step ahead. Our track record is not only built on experience, but unrelenting focus, expertise and passion for our industry – complemented by highly professional, personal involvement in every client’s valued portfolio.

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