If you’re broke, don’t try to fix it by borrowing
The real problem is the habit-forming nature of the debt drug, and the angst that it’ll give you
You won’t realise you’re poor until you find yourself among rich people. When you come from a place where everyone’s the same it’s easy, and peaceful. It’s inequality that causes the problem, and we have that in abundance.
You don’t have to leave your rural village any more to realise that there’s stuff you want that you can’t afford – your smartphone will show you what’s out there, and help you buy it now, pay for it later.
The thing about money is that its value is not measured by its abundance, but its absence. The marginal utility of money is reached sooner than you think. But if you’re short, even just a little bit short, it can spell disaster. So, if we’re short, we borrow. Big mistake.
People mostly get into debt to buy something they can’t afford. It is always defensible, but it never makes sense, even when the numbers stack up.
The Institute of International Finance estimates the total world debt at $244-trillion, which is more than three times global turnover. It is simply not possible to trade out of that. We’ll be in debt forever, and it’s going to get worse.
Eskom’s debt, at about R420bn, billion, is over twice its annual revenue for 2018 (R180bn) – it won’t be possible to trade out of that either. It will require capital from a source external to its ecosystem.
Corporations are different from individuals. Tax rules often drive the reason to incur debt, to leverage the equity capital, to maximise capital efficiency, return on assets, that sort of stuff.
These rules of businesses don’t hold for individuals. If you buy a flat to let it out and offset the interest cost against the rental income, that’s not personal, that’s business.
You shouldn’t borrow money to buy a house (to live in) or invest in shares or pay school fees, or eat – the financial yield on these assets is simply not enough to service the interest on the loan, let alone amortise the capital.
We all know this. We’re all hoping that the capital gain will more than compensate for the income shortfall. It often doesn’t happen. Debt doesn’t care.
So, what are we supposed to do? Ask the tortoise who beat the hare. (I didn’t, I just borrowed.) When it works, leverage is a fabulous thing, but for individuals it doesn’t work. Just take my word on this. I know. I’m not making this up.
Debt doesn’t sleep. Left to its own devices, at an interest cost of 12.25% (2% above prime – very few people can borrow at less) the outstanding balance of debt will double in less than six years and more than triple in ten. That’s compound interest for you.
The real cost of indebtedness however is neither the interest rate nor the increasing outstanding capital balance. These are measurable and constantly monitored by the loan providers. They’ll either step in to limit further advances or extract whatever is left when it all falls apart.
The real problem is the habit-forming nature of the debt drug, and the angst that it’ll give you. Every incremental dose of debt you take on will, weirdly enough, qualify you to take on even more. Once you’ve demonstrated creditworthiness, they’ll keep lending you more, until you reach your bankable, economic survival limit.
You can still get more, from various sources, when you least can afford it, at a higher price, or over a longer term, or some combination that the spreadsheet can swallow. The final upper limit of the system is determined by what the aggregate population can bear. It’s not personal.
Our challenge, the challenge of an economically polarised society, is that most people are not rich enough to get cheap credit. Poor people who can least afford to incur debt pay the most for it. The outcome of allowing this to happen to our citizens is that we have an anxious society, further angered by the obvious economic divide, that’ll eventually want to start a fight, or, perhaps worse still, succumb to corruption.
Ideally, individual credit should never have been legal. Imagine that? It is not that radical, but it’s too late for that now. Too many people are in the pool, and it’s not fair on the tortoises.
We need state intervention. We need the cost and availability of credit to be the enabler, not the destroyer of the poor that it is today. The state’s return, at least in part, will come from the creation of a tax base.
Mark Barnes is CEO of the Post Office.