Thursday, June 25, 2015

The Chantrill Rule on Debt

Debt is a big deal these days, what with the National Debt, the Greek debt, the student debt.

And who can forget that the current sluggish Obama economy is a consequence of the Big One, the mortgage debt meltdown of 2007-09 and the Crash of 2008?

Today Victor Davis Hanson is writing at National Review about the current concept of debt, which is that you really don't have to pay if you are a little guy and the creditor is a big guy.

But I want to suggest a different understanding of debt. On my view, there are two kinds of debt: public-sector debt and private-sector debt.

Let us look at private-sector debt first.

In the private sector, people contract debt primarily to grease the wheels of commerce. A merchant borrows money in anticipation of selling those goods in a month or two. Or a homeowner borrows money to buy a house, using the house as collateral.

With this kind of private-sector debt, we are talking about a low risk proposition. The merchant or the homeowner cannot get a loan unless the lender is pretty certain that the borrower has the means to repay the loan. And the borrower shows that he has the means to repay, with the backup that the goods or the house in question is pledged as collateral in case of failure to repay. Nobody has any doubt that in the case of default the borrower must release the collateral to the lender and face a devastating loss.

But public-sector debt is different. Here the risk is piled on the lender.

Let us take the case of the National Debt of a sovereign nation. Typically, a nation state will borrow money to fight wars. The idea is that the extraordinary expenses of war will be paid back when the war is over, and then the nation state will run a surplus in its accounts to service the debt. Typically, the national debt is considered a low risk and the government enjoys the lowest interest rate as the most credit-worthy borrower.

But what happens if the nation state loses its war? Well, then the lenders, the bourgeoisie and the widows and orphans, are toast. In effect, the nation state has wagered the savings of the bourgeoisie on winning the war. If the state loses, well, too bad for the bourgeoisie.

In our modern post-WWII age, nations rack up the National Debt during financial crises as part of the Keynesian consensus. They bail out the banks and they keep the entitlements going and they even spend money on "stimulus" to revive the economy. Typically, the national debt is considered a low risk and the government enjoys the lowest interest rate as the most credit-worthy borrower.

But what happens if the nation state fails to revive its economy after all the borrowing? Well, then the lenders, the bourgeoisie and the widows and orphans, are toast. Vide Greece.

Do you see the difference between private-sector debt and public-sector debt? In private-sector debt it is the borrower that is making the big bet, and if the bet is a bust then the borrower, the little guy, is wiped out. But in public-sector debt it is the lender, the government, that is making the big bet. And if the bet is a bust then it is the lender, the little guy again, that is wiped out.

In private-sector debt it is the borrower, the little guy, that must pay the piper when things go wrong. In public-sector debt it is the lender, the little guy, that must pay the piper when things go wrong.

That is why I believe that widows and orphans should not put their money in banks and in municipal bonds and state toll authorities, let alone federal debt. Governments are all the same. When the going gets tough they default on their debt, all the time.

People should bet their savings on the economy, not on the government. And that means stocks.

That's because when it comes to debt, the little guy always loses.

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