Saturday, September 4, 2010

Debt - the good, bad and the ugly

Debt...Its an interesting tool that creates so much yet can be so destructive. The US has had debt flow through its veins for the past 20 years and looks like it will continue to do so for the foreseeable future. This debt has been the ultimate source of productivity and growth during this time. However, the problem starts when debt is either unpaid on time or forgiven (e.g. bankruptcy). Now, resources that were initially allocated for a product or service suddenly disappear into thin air. I call this resource erosion. It creates a vicious cycle of destruction. The more erosion, the more businesses fail, the greater the loss of productivity and hence fueling even more erosion. Just like a cliff that undergoes erosion and finally results in a massive landslide. This is what has and is occurring in the US economy. The US has already lost an immeasurable number of person years of productivity due to this. Our landslide will come unless we turn things around.

What causes it? The ineffective use of debt. Use of debt for intangible goods is probably the biggest culprit. Houses are a perfect example of an intangible good. The house itself has tangible value but the land is extremely hard to quantify. People who buy expensive houses in high priced locations - be very very careful !! Do so only if you can afford to pay off your debt appropriately.

Solutions? We need a serious change in the culture of spending. Debt must be used extremely carefully for only proven or at least very likely to be productive activities. Simplify your life. Instead of buying a house or buying a new car using debt, use the money to start a business, get an education or just be productive. Buy using cash you have or know that you will have.

This issue is pervasive and is highly co-dependent. I.e. Another person's debt is held together by many, many others. More than ever, each of us needs to help each other, encourage each other to be productive and reduce our dependency on debt. Let us hope that we do so sufficiently to avoid the landslide!

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