Debt, explained in detail

We've often spoken in these pages about the problem of debt in our modern economy.  Now, in his latest weekly 'Thoughts From The Frontline' newsletter (link is to an Adobe Acrobat document in .PDF format), John Mauldin goes into a great deal of detail about debt;  what it is, what's good about it, what's bad about it, and what it means for us as individuals and as a nation.  Here are some of the highlights.

Debt is at the center of every major macroeconomic issue facing the world today, not just in Europe and Japan but also in the US, China, and the emerging markets. Debt (which must include future entitlement promises) is a conundrum not just for governments; it is also significantly impacting corporations and individuals.

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Debt is future consumption brought forward ... It is hard for me to overemphasize how important that proposition is. If you borrow money to purchase something today, that money will have to be paid back over time and will not be available for other purchases. Debt moves future consumption into the present. Sometimes this is a good thing, and sometimes it is merely stealing from the future.

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Debt is future consumption brought forward into the present, but a corollary is that debt is also future consumption denied. If you will have to pay both principal and interest on debt in the future, then you are setting aside and spending money on debt service that is no longer available for current consumption.

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To put it in personal terms, if your real income drops 25%, then whatever debt service you’re carrying will be a correspondingly larger portion of your income.

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Too much debt will become an ever larger drag on the US economy, just as it already is in Japan and Europe.

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Debt, when used properly, can overcome obstacles to productivity and bring on a warm day of sunshine, fostering life and growth everywhere. But if debt increases too much, just like a massive dying star it can collapse upon itself, explode like a supernova, and become a black hole instead, sucking in all the life around it.

Without a massive increase in debt, present-day China would have been impossible. Clearly that debt has improved the life of its citizens. But in recent years China has used debt to maintain a strange new form of growth and is increasingly using debt to build and consume, heading toward an ever less productive outcome. As in many other places in the world, each new dollar of debt is producing less in terms of GDP growth.

There has been a massive explosion of global debt since the beginning of the Great Recession in 2007. Normally, after a banking and financial crisis, one would expect a period of deleveraging and a reduction of debt. This time is truly different.

There's much more at the link.  Essential reading if you want to understand the dangers of our current economic situation.

The discussion will continue next week in the next edition of 'Thoughts From The Frontline'.  I'll keep my eyes open for it, and bring you the highlights.

Peter