It occurs to me that debt is the act of moving future purchases into the present moment. In its purest form debt is an agreement between two parties that allows the borrower to take possession of a good or service today and pay the principal and interest back over time.
Both parties should win in this transaction because the borrower gets the use of a product or service he or she may not otherwise be able to afford and the lender has access to an income stream and can look forward to the retirement of that debt over time. Hopefully before the useful life of the product or service is finished.
What I would call "good debt" is a debt that actually produces something so that the debt would be retired by a productive enterprise that produces profits. Think of a small business loan.
A debt that I would call a "push debt" is a debt that would allow you to take possession of an asset and pay it off over time like a home mortgage. This is a debt that, while doesn't produce the profits to pay off the mortgage in and of itself, it is somewhat productive because at the end of the term you own an asset.
Non-productive debt is debt that is accrued and not only has no means of being paid off in and of itself but what is purchased is actually consumed. This type of debt is dangerous because it is actually spending for current consumption. This type of debt makes it imperative that new debt is created all of the time to pay off old debt that cannot be paid off and to continue with current consumption. Think of paying off a credit card with a credit card that has a higher balance.
This non-productive debt is what is issued when people pay for gas, food, medicine, etc. with a credit card because they can't pay with current income or assets. At the end of the day the product is consumed and the borrower is just left with more debt. Unless there is a substantial pay raise there is trouble in the near future as the debts keep piling up. At some point if this type of financial management continues it will likely end in bankruptcy.
Picture a person who has an income of $30,000.00 but has loans outstanding of $180,000.00 and no surplus to make payments. It won't be long until trouble arrives.
I gave you that illustration because we can understand those numbers. They are troubling and we all know why. That amount of income cannot carry that amount of debt for long.
These are the same numbers that the US Federal government is playing with right now-MINUS 8 zeros of course. In addition, if anyone were counting on Social Security, Medicare, prescription drug coverage, etc. the number in our hypothetical situation would go to an outstanding loan balance of 1.8 million dollars with a $30,000.00 income. OUCH!
Of course, our central bank has a printing press. We the people do not.
I believe we have long passed our ability to service the enormous amounts of debt and promises that we have made and are now reduced to "printing up" money to retire debt that is maturing and to pay interest on our current outstanding debt. This was illustrated when the treasury department issued a trillion dollars of new bonds in the first four weeks of the USA's fiscal 2015 year. The reason- to pay off maturing bonds. We issued an additional trillion dollars and have NOTHING to show for it - but the debt!
Another form of non-productive debt would be the issuance of debt to repurchase a company's stock. The debt is obtained to do some financial engineering and enrich the shareholders and the management team. Short term it is great. However, the debt remains long after the bonuses are paid out and that will be a drag on future earnings at some point. This doesn't even take into account what innovations and profits may have been earned if these assets were deployed in R&D or strategic acquisitions. Or how many jobs may have been created to retire the debt over time.
I am picking on the USA because we live here and I believe we will feel the greatest impact when this debt bubble, which dwarfs any other previous bubble of any kind, implodes under its own weight. (my opinion).
The problem is that this type of "debt-mageddon" is taking place in virtually all of the developed countries of the world. Think Greece (who, as far as I know, has the only government to officially declare, "We are bankrupt." We were bankrupt in 2010 and we took money to extend and pretend.
Think about Italy, Spain, Portugal, Ireland, France, even Russia and China have gone down the same path. And of course the leader on the way to the cliff has to be Japan. Their central bank obviously has no shame.
They are actively trying to devalue the Yen as they sell government bonds from government pensions to the central bank (which "prints" the money up as needed to buy them) and purchase stocks (foreign and domestic) and foreign bonds with the proceeds. (Conjuring up "money" with no effort and buying assets). Basically, they are making life more expensive for their citizens while exporting deflation to the rest of the world. They have admitted these actions officially. It is my opinion that most central banks are doing the same types of manipulations around the globe. That is why Ms. Yellen probably opposes the "audit the Fed" legislation.
Does anyone else see how absurd this is?
These are just a few of the shenanigans going on to keep the game going a little longer and make it someone else's problem. In my opinion, stocks, bonds and real estate are being artificially held higher by these games that enrich the few and other assets are being held down.
Just like when the Swiss allowed the Swiss Franc's artificial peg to the Euro to expire it increased the value of the Franc by 40% in 15 minutes. This is what happens when there is an artificial price and price discovery is allowed. The Franc was being held artificially low to protect the country's exporters.
I am expecting a lot more volatility as we move forward in 2015 because of the massive imbalances built up between economic reality and the underlying economy. This could be the year when many will realize that this debt (Over 200 Trillion dollars owed by governments - not including social spending) is not getting paid back in any traditional manner.
This debt underpins all of the financial assets. A lack of cheap money (higher rates) could implode the mortgage and stock markets in short order. Even drastic moves in currency markets could cause some serious price discovery in stock and bond markets.
Finally, as I woke up this morning I saw on CNBC that the government and the CFTC are investigating 10 major banks for manipulating the precious metals markets (gold, silver, platinum and palladium).
My guess is that a few mid-tier managers will be offered up as a sacrifice and we will move on. However, this game is almost up. I am surprised it went on this long but when there is true price discovery in these assets look out. These are the only assets that I am aware of that are not someone else's liability. This will be an extremely important point in the near future if greed turns to fear.
I cannot think of another asset other than gold and silver where the demand is high, supply is limited and the price is going down while trillions of currency units (what we would buy these assets with) are being conjured up by the tens to hundreds of trillions of dollars, yen, yuan, euro, etc.
This also appears to be the only market I have ever seen when major sellers make their largest trades when the market for trading is at its thinnest level. If you were trying to actually get a good price rather than knock the price down I would think that the more people trading would give you the best chance at a good price. This happens far too often to be a coincidence.
I believe that when this price discovery begins it will surprise virtually everyone in size and scope.
This is truly a time to hold all asset classes because this situation is highly unstable and practically any outcome is possible. In this environment it does not pay to be complacent but it very well could pay to BE PREPARED!