The Problem With Debt, or You don’t deserve what you want
By Eric Gemelli
I was at a party with the chair of a university economics department where we discussed the recipe for financial success and disaster. He explained America could continue to borrow to fund its social programs because we have an increasing gross national product and therefore increasing tax revenue to cover our debt payments. I asked him what would happen if we had those expenses built into our national budget and societal expectations but the economy turned down and we had less tax revenue. He calculated the results in his head for a moment; his face soured and declared the result would be disastrous.
Greece’s budget problems have been aired across the world lately. Bloomberg reports Greece’s debt is 115% of gross domestic product in 2009 and that they have a budget gap of almost 14%. Greek citizens took to the streets to strike and protest in response to wage freezes, bonus cuts, tax crackdowns and pension reforms proposed to address their budget shortfall.
Years ago Warren Buffet illuminated the risk of massive debt by giving an example of two imaginary island nations that went something like this: Nation A lived beyond its means for 40 years by borrowing 10% more than their income from Nation B, which was living on only 90% of its income. The end result was that Nation A borrowed 400% of one year’s revenue. Ask anyone with a 580 FICO score if they get preferred rates or have to borrow at higher rates that reflect the higher risk of default.
With the borrowing nation paying 10% interest on the 400% they borrowed, they owed 40% of their total revenue, leaving only 60% of their income to pay for necessities such as food and shelter. In a short period of time they became the slaves of the second, more frugal nation.
This example is simplistic and doesn’t account for growing GNP or the debtor nation having more or bigger guns than the nation that loaned the money, but the principle and results are eventually the same.
Both individuals and countries face the prospect of becoming financial slaves. Economists have long been concerned for America because we have been the debtor nation in the above scenario for too long. This video shows how much more we spend each year through borrowing: http://www.wimp.com/budgetcuts/ (it’s only a 1:38). The results of our binge borrowing should be clear: ultimately America will find itself in the same position as Greece. Or Rome.
In Bernardo Caprotti’s Trolley and Sickle he explains Rome’s first demise: “…..the Roman Empire, brought to its knees by a fiscal crisis, when the conquests and extortions of the wars were no longer sufficient to feed the mob of idlers in Rome” and its most recent weakening: “….Italy embarked on the squandering of its resources….The Italian “economic miracle” (of the 1960’s) had led unprepared politicians to believe that the resources were inexhaustible.”
Capital is a resource. We must not squander it.
Dr. K. Ryn Deitz, Certified Financial Stress Reduction ® Coach, says we need the “B-word” but warns “budget” doesn’t mean what you think. B.U.D.G.E.T. stands for Baby, You Deserve to Get Every Thing! With responsible planning and spending you can enjoy selective luxury.
“Budgeting isn’t so much figuring out the destination; it’s figuring out the roadmap TO the destination,” says Deitz. Budgets are painful if they reflect someone else’s priorities. “You reaffirm your own goals in the process of creating a budget – it is the process of choosing,” she said.
Deitz adds, “Budgets are like gardens. You can defer enjoyment by planting perennials and have years of flowers to come from that one effort, or may decide you want a splash of color now and plant annuals. Either way, someone has to tend to the garden.”
Fox News reports the State of California, the eighth largest economy in the world, has debt to GDP ratios that look similar to those of Greece’s. People regularly blame lawmakers for growing debt, but voters who demand ever increasing services are just as responsible.
Members of both political parties spend money; during the next election cycle we need to vote for the candidates that choose to make responsible priorities.
Author Eric Gemelli founded Cornerstone Financial Services LLC in 1997 and as the managing member has worked in mortgages, life and health insurance, raised venture capital, and trading commodities averaging 30% a month doing so. He offers market forecasting services, and is “sure enough of [his] ability that 80% of [his] fee is based on performance.”
Reader's Responses
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Eric, Great column, lets get together next week!
By John Benjamin on 2010 06 17
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Eric has brought me hope regarding my financial situation in the face of our current economy. Regarding his market forecasting business I’m up 49% this year so far and I’ve made erics fee back 5X in the past 2 months.
By Andre on 2010 06 18
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It should be known that at the beginning of a dynasty, taxation yields a large revenue from small assessments. At the end of the dynasty, taxation yields a small revenue from large assessments.
‘Abd-ar-Rah.mân Abû Zayd ibn Khaldûn, The Muqaddimah, An Introduction to History, Franz Rosenthal translation, abridged and edited by N.J. Dawood, Bollingen Series, Princeton University Press, 1967, p.230, quoted by Ronald Reagan [note].
By xqqume on 2010 06 20