Crunch Time

Debt can be an awesome thing. Without it, few people would be able to buy a house,  a car or a higher education. It allows you to enjoy expensive and useful things now, and pay for them over time. Awesome. But… Debt can also be crushing. If you pile on too much debt and cannot find a way to pay it down, it can destroy you financially.

The key to debt is to ensure that it is being used for something useful, that the payments are manageable, and that you have a way to pay it off, even if interest rates go up.

This strategy applies to all debt. It should be useful, manageable and payable. And no debt escapes this logic, not even a country’s national debt. But this week there was a report that came out from the nonpartisan Congressional Budget Office that sent a shiver through GoldBean’s spine.

On the positive side the report forecast that the recent tax cuts will increase the size of the economy by 0.7% in the next 10 years. Which is good news. There will be a stimulus from the tax cuts.

But there is bad news. The CBO believes that the stimulus generated by the tax cuts will pale in comparison to the cost of the tax cut and the lost revenue caused by them. And this will cause the nation’s debt to balloon. The shortfall will be so big, the CBO has had to readjust their forecast and now see annual borrowing hitting $1 trillion by 2020.

Let’s put that into a personal perspective. Let’s say that over the years you’ve borrowed $21 trillion dollars (sweet!). About a quarter of that was used for something of value and is stashed away. Which is good news. You have something in reserve. But 75% of it, or about $16 trillion is gone, spent on some great things. But gone nonetheless.

And your spending doesn’t end. You’re still spending a lot, and having to borrow more money to pay for the stuff you’re buying. And it really starts to add up. In ten years you’ll have added an extra $13 trillion dollars to your debt, bringing the total of what is gone and spent to $29 trillion dollars of debt.

Interestingly, you’re not in this hole because you’re overspending. You aren’t actually spending a lot more year to year. Your spending has gone up, but only as much as the rest of the economy. The real reason you’re in this hole is because of your income. You’re just not making enough money.

Funny thing is, you did this to yourself. You actually decided to take a pay cut because you figured that if you took in less tax money, it would still come back to you. You figured that as the people around you got wealthier, some of that money would find a way back to you. The money you left out there would expand businesses, hire people, innovate, invent and grow its way back into your pocket.

Well, it doesn’t look like this is going to happen. At least not to the extent you thought it would. And in 10 years, your debt will be so big, it will be equal to the size of your annual paycheck. Not only that, but you’ve also broken the three rules of debt. The debt was not useful (it did not generate more income), it is not manageable, and there is no visible road to repayment.

And like personal debt, large national debts will have consequences. Interest payments will eat up your earnings, you’ll have to tighten your belt and spend less, you’ll have to hit up your friends for more money and the interest rate people charge you will go up (because as your recent track record shows, you’re horrible with money. Lenders charge higher interest to risky people like you).

But the one huge problem with national debt is that it affects everyone. If the US government hits a fiscal brick wall, everyone will pay the price. Investors will lose because the fiscal crisis will but the brakes on the economic growth. And regular humans will lose when the government tightens its belt by cutting services.

So where do things go from here? Obviously this can’t go on for ever. So in order to prevent a fiscal criss, one of two things need to happen. 1) Taxes will have to go up. 2) Government services will have to be reduced.

Neither of these options are politically easy. But if nether happens, there will be a financial reckoning some time in the future. And just like when you max out your credit card, the effects can be painful. But in this case, a trillion times more painful.

Team GoldBean

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