In recent weeks, global markets were agitated by the mere mention of a word, debt. From the almost catastrophe of Evergrande Group in China, as it sat on a mountain of liabilities, to the United States government’s need to raise its debt ceiling. Debt has become one dirty word for investors for the time being. When it comes to debt, we all know there is a price to pay as there is no such thing as a free lunch.
For the US to ensure they do not default on their obligations, there is no doubt that they have constantly raised their debt ceiling over the years. According to the US Treasury website, Congress has acted 78 separate times to permanently raise, temporarily extend, or revise the definition of the nation’s debt limit, since 1960. For the US, a failure is never an option as it will cause a devastating chain reaction to the financial market as well as the economy as a whole.
According to the Institute of International Finance (IIF) in its Global Debt Monitor report published on Sept 14, 2021, global debt, which includes government, household and corporate, and bank debt increased by US$4.8 trillion to reach a new all-time high of US$296 trillion. Over the past six quarters, as the pandemic has caused significant damage to the global economy and unprecedented response from governments, total global debt has expanded by US$36 trillion or 13.6% from just about US$260 trillion as at end of 2019.
Debts raised due to the pandemic perhaps have become the norm globally as well, as the government has no choice but to raise the required funding to support the economy. While the Fed has expanded its balance sheet by more than 100% since the pandemic, the liquidity it has provided has caused significant gain not only in traditional asset classes but into everything else. Home prices are rising, commodities have boomed and markets are buoyant and cryptos have soared.
Individuals’ Debts
As for individuals, debts are rather straightforward. There are generally two types of debt – good debt and bad debt. Good debts are those that make you financially better such as a study loan, mortgage, and business loan. It serves a bigger purpose with equity or earnings potential in the future. However, bad debts generally make a person financially worse off.
In the middle of this pandemic with people losing their jobs and finding it difficult to make ends meet, bad debt is becoming increasingly inevitable for many in the middle-income class group. This is due to a lack of savings and poor financial management. Financial literacy is key to the accumulation of wealth and to avoid getting into a bad debt situation.
Getting into debt involves a series of gradual innocent money mistakes. One of the biggest mistakes that people make which leads them to debt is not knowing how much money they should commit to their lifestyle. Several factors cause people to take on more debt than they can manage.
One of the factor is the need for instant gratification, which the urge to own assets fast without really think through about the cost and repayments. The other factor is Societal pressure, especially during this era of social media wave when image and status become paramount. Besides, the desperation in wanting to obtain an asset by using more loans to cover existing loans is also a factor.
When taking on debts, the rule of the thumb is to take on what you can comfortably repay in monthly payments. The key is to have the awareness to avoid them.
When red flags arises, one should start taking action by adjusting expenses and lifestyle, or by consulting a licensed financial planner for the most holistic solutions. Bad debt is sacrificing your future day needs for your present-day desires.
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