Business and Government Debt

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Last week I wrote about personal debt. This week I want to look at an overview of business and government debt.

Should a business get loans? Or should the business accumulate funds from its sales and then purchase items to expand the business?

Say, Bill Gates starts his business in his garage with $5,000. He becomes successful and makes some money. He hires a few programmers, buys a few computers and makes some more money. Meanwhile, his programmers come up with some innovations to improve the software program but they will need more programmers and more space, and more computers. Bill is successful, but does not make that kind of money to implement those innovations. Should he borrow money? If he doesn’t, it may take a few years yet before he can implement those innovations.

A cultural observation here is that America is in the forefront when it comes to confidence in the creation of new products. Marketing is an American phenomena in my opinion.  Americans believe when they have a brilliant idea, it should be developed. Of course this process exists in other cultures but not to the same degree.  Americans believe everyone should have an opportunity to show their ideas.

If Bill Gates borrows money to hire the extra programmers, get a bigger work space, buy the computers because he is confident it will raise the company to the next level, then the interest he pays on that borrowed money over 10-15 years is peanuts.  It is not only a matter of technical need but also of the timing as to how quickly the next level can be reached. It takes confidence and an (cultural) environment where this can happen. To incur debt in this scenario looks like a no-brainer. Here is a typical American way of thinking:

 It’s too late to change direction now. Is that really true? How many years of life do you think you have left? Now multiply that by 8,765, which is the number of hours in each year. Is that really too little time for you to change direction? Malcolm Gladwell’s book, “Outliers”, tells us you can be great at what you do with some ability and 10,000 hours of practice. Never put off a goal because it will take too long — the time will pass anyway. Might as well spend it working toward a goal that makes life fun.

Change the story: Instead of “It’s too late…”, replace with “If I start today, the journey of 1,000 miles starts with the first step.” 

Of course business uses other means to acquire funds such as selling stocks and bonds.

Government incurs debt by selling bonds to finance a project. We’ve all heard of cities going bankrupt like Stockton, California. So cities or states also have to remain within their budget, but used within limits debt can make things work out more smoothly.

There is one exception. How do you think the federal government can get by with a $17 trillion debt and is still not be bankrupt?

Debt, good or bad?

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In searching the web about national debt, I came across many articles as to how the current debt situation ought to be handled.  Many sites show different opinions as to what needs to be done, so my first question: is debt good or bad?

Looking closer to home, what about personal debt? If debt is bad then we should not mortgage a home because a mortgage is a debt of what we owe on our house. If debt is bad, then we should save up money first so we can pay for a home in cash. Doing so will take about 15-20 years assuming we can invest at a 8-12% interest rate. In the meantime we need to rent a place, which might not be too bad if we change jobs a few times at the beginning of our career. We have two streams of money going: one is a savings account to purchase a home in the future and the other is rent we have to pay for a current abode.

This can very efficiently be turned into one mortgage that we pay toward owning the house outright. Skip the renting. Borrowing costs money too, because the bank putting up the mortgage wants interest in return.  The house does not become ours until the mortgage is paid up in 30 years, or whatever time period is agreed upon.

It is not about debt or no debt but what are the parameters?  From the early ’50s to 2000 a mortgage represented 25-30% of the budget. We also need to budget for food, clothing, a car plus gas to run it and liability insurance, taxes, education of the children, health insurance, to name some of the big ticket items. What if we need to replace the water heater? All this assumes we have a job, which not everyone can say anymore. Especially the younger generation has trouble finding a job, unless they are satisfied with flipping burgers at McDonalds, or other part-time jobs.

Is debt good or bad? It depends, as far as personal debt is concerned. Next article will be debt for private companies and for government.