A point on debt

Around the world there are a lot of complaints that there is too much debt, that debt will prevent a recovery, and that debt is the root of all problems – be it fiscal deficits, debt fueled consumption, or a debt powered housing market.

While there are undeniable issues to keep in mind, there are a few things to remember with these large debt levels – and one of the most important is that there are some people on the otherside of this debt.

Unknown to some is the fact that, as a planet, we are not actually in a net debt position with the rest of the galaxy (although the statistics say otherwise, I think there is an error – rather than us owing money to Martians).  As a result, for every person who has a liability owing there is another person or group who views that as an asset.  When we look at what the “issues” are with debt, we have to keep this point in mind.

Now this sounds like me stating the bleedingly obvious AGAIN … but lets think about some of the conclusions that come out of this:

1. If someone cannot pay back their debt, it is the person holding the “asset” that loses out – they will be the ones with a direct loss on the line.
2. If someone doesn’t pay back their debt, their loss is the ability to borrow in the future – and any “repossesion” in terms of what they secured said debt on.
3. In the case where there is “too much” debt it may be true that the borrower was borrowing beyond their means – but the lender was also willing to lend at either a low rate of interest, or accept a high level of risk, for what they are doing.  They are both at fault for the debt being “bad” (unless we believe there were information problems).
4. A high level of debt will slow future growth by limiting the willingness to lend/borrow for current lenders or borrowers – why this is the case, and how it can be reversed from either side is interesting. [Issues of trust, hold up, and risk all come into play here]
5. The large “stock” of debt would disappear if everyone defaulted – if it was really in everyones interest for the stock of debt to not be so large then everyone would want default!  However, this is not the case – and as a result, there must be some winners here.  [Note:  You could say there is a co-ordination issue, or prisoner’s dilemma, which would actually suggest we should force default – the opposite conclusion of what many believe]
6. The actual possibility of default does lower the asset value of the debt – which implies that the people holding debt are poorer then they thought.  In the current situation BOTH SIDES have discovered they are poorer than they thought!
7. IF INTEREST RATES FALL, people want to save less and people want to borrow more … given we need a saver and a borrower for lending to take place, if the world rate of interest is suddenly lower for an unspecified reason then we DO NOT KNOW whether savings/borrowing will be higher or lower (even ignoring the impact on global income/output) – we need to figure out what changed this first.

These are all simple logical points that fall out from admiting that there is a borrower and a lender in the market, not just a borrower.  Adding in the general economy and all other means of financial market goodness makes things more complicated, and more realistic – but by itself simply looking at the existence of supply and demand has given us a pretty good starting point for talking about what debt really is, and it has given us some facts we can use when we look over all the articles discussing the debt crisis 😉