Steve Keen's Debtwatch

Discussion (3) ¬

1. 
   Peter Hansen

   November 22, 2007 at 3:50 pm | #

   Hi Steve, I have noted your commentary re debt levels both on ABC & SBS recently. When you are raising concerns and quoting statistics about private debt levels, I am interested to understand whether this “debt” relates to what some commentators might refer to as “bad debt” (ie private home loans, credit cards, personal loans etc) only, or does it also include what the same commentators describe as tax deductible (& therefore termed) “good debt” on investment properties or shares? The reason I ask is that there has been a plethora of books issued this year on wealth creation via residential property investing whereby the authors (eg Chan & Naylor Accountants, Michael Yardney etc) are basically encouraging people to utilize a line of credit facility secured by the equity in their family home as the 20% deposit on a well located investment property & then borrow the other 80% from the bank, & then repeat the exercise as funds permit & rents increase, on the premise that the loan to value ratio decreases in the future as the property value increases…. you know the scenario. It appears very convincing especially when they present statistics showing median values doubling every 7-10 years. While it sounds great in theory, I am just concerned that family debt levels could easily increase into the millions with a handful of investment properties & the willingness of banks to lend. Would welcome your observations on this matter, especially given that one book titled “How to achieve wealth for life – through property investing” is by Chan & Naylor who are a high profile accountancy firm in Sydney & hence their opinion would influence a lot of people. They advocate that people should not be afraid of “good debt” as it is the basis of wealth creation.
2. 
   Steve Keen

   November 22, 2007 at 4:09 pm | #

   Hi Peter,

   What those books call “good debt” is precisely what I’d call “bad debt”. It is finance for leveraged speculation on house price appreciation. While it can work for the individual (and has done so for many for 40+ years), it does nothing for society: the increased debt isn’t matched by increased real assets but simply more expensive existing assets (unless the money is used to build a new property–something that now accounts for less than 8% of all “investor” borrowings).

   “Good debt” in my book is money borrowed to finance something that actually will generate a real income stream–whether that be new research, new product development, or even new housing. “Bad debt” is something that simply finances speculation on asset price appreciation.

   The latter is a game that can only be played for so long, because it can’t be the case that asset prices rise faster than commodity prices FOREVER (doubling every 7-10 years as you cite above, when commodity prices are doubling every 20 years at current inflation rates).

   The ultimate source of finance for debt is income from the sale of commodities–income from the sale of assets simply transfers who owns an asset from one person in society to another (and therefore only pays debt down at the national level if its a foreign purchase of a domestic asset). While asset price appreciation at a higher rate than consumer prices can be financed for some extended time by debt that rises even faster, ultimately that debt becomes unmanageable and there are no longer buyers willing to incur even more debt to enter the game.

   I think we’re close to the turning point on the personal profitability of asset price speculation, certainly as it relates to housing. When we do reach that turning point, then the final round of speculators are forced to endure depreciating assets, or selling their “investments” at a loss. They’re the people still on the inside when a Ponzi Scheme unravels, and they’re normally amongst the first to go bankrupt.

   In short, I don’t think the game that Chan & Naylor and the like are allegedly promoting is such a sure fire thing any more.
3. 
   Contrarian Investors' Journal

   November 23, 2007 at 11:41 am | #

   Yes, I agree with Steve Keen on the definition of ‘good’ and ‘bad’ debt. For those wealth ‘creation’ promoters, all of them have a common underlying assumption: monetary inflation, which allows for the existence of Ponzi scheme. Once the credit cycle turns into deflation, all these wealth ‘creation’ techniques will fail, resulting in losses for those ‘investors’.

   Examples of good debt, as I mentioned before in The myth of financial asset ‘investments’ as savings:

   For example, let’s say we save $100 in the bank. The bank then lends out $90 to an entrepreneur who uses it to set up a business enterprise that will produce goods that consumers want down the track. In this case, the $100 that we save is a sacrifice on our current consumption. Part of that $100 of ours is then put in good use to add value to the economy in the future. In return for my sacrifice, we are paid interest.

   In another example, let’s say a company decides to raise money in the stock market to fund its expansion plans. We invested $100 in that company’s IPO. That company then uses our $100 to build a new manufacturing plant that will produce consumer goods in the future. In this case, that $100 that we invest is considered savings since it involves us sacrificing current consumption worth $100. In return for our sacrifice, we are paid dividends from the company’s future earnings.

   Good debt makes a nation more wealthy because they ultimately add value to the economy.

   Ponzi schemes initially works because money is being ‘printed’ at an increasing rate to finance ‘asset’ price inflation. But the flip side of ‘printing’ money is that debt builds up. Since those debt are not used to add value to the economy, you will find bad debts and mal-investments accumulating, resulting in structural damage to the economy. The end result will be a bust (i.e. deflation) as those mal-invested capital has to be liquidated to make way for more sustainable investments (that really add value to the economy).