Tag Archives: consumer debt

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2011- The Battle of the Budget

It’s a New Year and a time for new beginnings… Each year we look back and see what we hoped to achieve and how far we have come—both personally and collectively.

2010 began with a painful economic recovery. We were told by official government sources that everything was getting better. Yet unemployment increased, banks closed, foreclosures continued, consumers defaulted and bankruptcies exploded. In the business world, millions of small, medium and big enterprises shut their doors. Credit was restricted and working America struggled to stay afloat.

Where are we now at the start of this new decade? Hopefully we are learning from our past mistakes so we can build a new future.

A look at the top headlines this week of a brewing partisan showdown in Congress indicates history might repeat itself. News reports warn of a “looming budget fight” over healthcare, financial reform and the growing deficit. Republicans declared they would fight to close the credit spigots and Democrats cautioned against “catastrophic consequences.”

White House economic adviser Austan Goolsbee issued dire forecasts if U.S. borrowing power were curtailed. “This is not a game…If we hit the debt ceiling, that’s … essentially defaulting on our obligations, which is totally unprecedented in American history. The impact on the economy would be catastrophic. I mean, that would be a worse financial economic crisis than anything we saw in 2008.”

Totally unprecedented in American history… Now that’s scary and I imagine the response from the other side will be equally scary. What’s not unprecedented is this argument that continues to rage for the two centuries of our history. To debt or not to debt—that is the question and has been the question since our nation began. So let’s take a look.

As always, both sides of the issue have merit and both sides are flawed. The balance lay somewhere in between. Right now, it’s true we have an out-of-control Federal Reserve. Ben Bernanke is playing God with our future. No doubt with the best of intentions. But giving the store away without conditions is never a good idea. Auditing the Fed is a must going forward and getting both sides of the economic debate at the table with equal say will help shore up the ship.

Is “debt,” as some in Congress would have us believe, a bad thing? In traditional middle class thinking, well yes. “A penny saved is a penny earned,” as our founding father Ben Franklin would say. If you are borrowing, you are not saving. But then there is another adage espousing the virtues of debt that we all know well, “It takes money to make money.”

So which is it? Expanding Debt and Credit? Or pulling up the bootstraps and cutting down on spending and consumption? Answer: Both.  Sorry to confuse you.

The thing is when we look at spending and debt – we must also consider income and revenue. There are always two sides to the balance sheet. If we are spending and not earning—then debt is not a good thing. If we are spending to earn—then debt is a key to our future.

Let me ‘splain…If you go out and shop and buy on credit those $1200 Prada boots you have your eyes on or that $90,000 Black Turbo you covet, you are simply adding to your debt load. If you have the income to sustain this, well bully for you—no worries. However, if you have no substantial income and are using your mortgage money to pay for non-performing consumer products like gold watches and Diesel Jeans, then you are in real hot water.

If you use your credit line, however, to invest $20,000 in a state-of-the-art website for your online tech biz, you would be using debt to expand revenues. Or if you buy that vacation property with a good down payment, low interest rate mortgage for a drastically reduced price, you might be building your retirement fund. So debt is not always debt – sometimes it’s investment.

Ask any parent if paying for his or her child’s college education is empty debt or an investment in the future? Depends on whom you ask, I guess.

One of the things missing from pundit and politician debates is this distinction. Is the budget item dead weight consumption – debt that simply drags us down with no way to repay it? Or is it debt that invested properly through job creation, business investment, training and education equals economic growth on the other side of the balance sheet?

We hear a lot from policymakers that we are saddling future generations with debt. It’s understandable to say this – after all outsized debt got us to this economic conundrum. We over-consumed and overleveraged. Which brings up two points. Over-consumption, the kind of shopaholic, buy now, pay later trap many of us individually and collectively fell for, is part of the dead weight debt we carry. Unless we make enough money to pay for these things, we struggle. For many people whose incomes shrank over the last couple of years, this is a painful burden of repayment. So granted as a nation we want to be cautious of this—however unavoidable it may be.

Yet when we claim we are adding to future generations’ debts – the question to ask is are we including improving infrastructure, decent education, expanding job markets, updating planet friendly policies, creating tax incentives for entrepreneurs and businesses that keep jobs home? Are we investing in new green energy initiatives and innovations that offer alternatives for soon-to-be obsolete jobs like off-shore drilling?  Are we then saddling new generations with debt or are we building their future?

Perhaps few Americans know that our nation began its life in debt. We borrowed from the French to pay for the fight with the British—and Great Britain was our main creditor! So much for biting the hand that feeds you. Our ancestors bit and the rest is history. The point of the story is that debt is how the world of commerce operates.

If we paid for everything with cash individually or as a nation, we would not be growing at the rate we are. How long would it take you to save up all cash for your home? Do we do away with mortgages and auto loans? Those are debts.

So the question of debt cannot be reduced to simplistic notions of burden without understanding that debt can also be investments to stimulate the economy. We need to ask is this “good debt or bad debt?” Necessary debt or unnecessary debt?

People ask me how Wall Street has profited again. I say simply: debt. Wall Street roared back from the abyss through what method? Debt and Credit. Corporations run on debt and credit. What’s a corporate bond? Debt. A company issues a bond which is akin to taking out a loan. Investment banks underwrite those loans for a fee. It cost money to borrow money. Bonds create more debt for a company who uses them to pay overhead, back debts, or to expand.

What are company shares? Credit. You are investing in that company and essentially offering them credit for expenses (necessary debt) and expansion (good debt). Your investment is not guaranteed and neither is their credit.

It’s true we got into this mess with too much lending and borrowing. Flawed debt instruments (subprime mortgage securities) started the downward spiral and continue to weigh us down. These “instruments” were not based on the genuine ability to repay, therefore they really weren’t debt – they were made of fluff and “air” under the false wrappings of debt. No one on the borrowing or the lending ends had any intention of repaying them. So bad debt  brought us here.

Yet what brings us out going forward is good debt and investment in our future. If we take a look at Europe we see a full array of debt and credit. Greece is in trouble because of dead weight debts—too much consumption and not enough earnings. Ireland is suffering from the same flawed mortgage debt and subsequent housing collapse as are we. Only they don’t have the access to credit that we have. The United Kingdom has established austerity measures to make up for their bad housing debt shortfalls. In 2009, the UK held a Treasury auction and no one showed up! A country’s worst fear is that they can’t borrow their way out of debt.

Germany is the most sound economy at the moment and they are paying for their reckless neighbors. But why is the German economy robust? Exports. They manufacture machinery, machine parts and basic non-luxury things like tools. They make more than they spend. Hey, that’s an idea. Maybe America could reinvest in their people and businesses and create something to export aside from jobs and bank deposits.

But Goolsbee might be onto something. If we don’t make good on U.S. debt, our treasury bonds will sink. No one might show up for our auctions and we could not pay our debts. Right now we pay these against future earnings with more debt.

So the question is do we believe that America can rebound and create abundance and prosperity again? Of course we do! Do we understand that American business is based on debt and credit and that Wall Street is the business of debt and credit? This is how the engine runs.

Someone should tell our politicians. Maybe we should require everyone in Congress to take a one year crash course in business school before they can vote on any budget issue. Ok, it’s a thought…

Right now we are staring in the face of another potential debt crisis at the state and local levels. Guaranteed the same senators who slam the ceiling on “debt” without knowing what they are doing will come crawling back for loans for their own constituents.

Cutting off credit and arbitrarily limiting debt in an economy based on these can be severely damaging and very painful. Just ask any small business that has lived through this over the past two years. That is if they are still around. As we hear the 2011 debate on debt and credit ensue, we should listen with new ears and ask whether they are talking about good debt or bad debt.

The answer makes a big difference.

© 2010 Good Business International, Inc.