Sound Money

Have you ever wondered why economic conditions are challenging for the man on the street, despite easy access to credit for cars, homes and shopping? In this first edition of the Sound Money Monthly we cover the most important macroeconomic trend, debt. (16 minute read)

TLDR: Economic opportunities for the masses and social mobility are declining, but the policy being offered by authorities, is the cause of the problem. We’ve overused debt, mortgaged our future and we’re wading through the consequences. Digesting the information allows constructive responses; judicious business strategies, strong relationships, value in non-monetary rewards and the chance to seize opportunities in new industries.

Something is rotten in the state of…

Long before the 2020 coronavirus, the world has been challenged by weak economic growth. Elevated unemployment, low social mobility, high youth unemployment, more part time workers relative to full-time, etc. In the US, unemployment numbers looked great until 2020 but other cracks emerged below the surface. US real GDP growth has steadily declined during each business cycle since the second world war, part-time work relative to full time work is elevated, there’s a uncomfortably large number of people on food stamps, an opioid crisis and rising. homelessness. Something is awry below the surface.

In Europe, youth unemployment is a disaster, and I don’t need to preach to South Africans about economic challenges. Each country is dealing with a slightly different variation, and each has its own scapegoat depending on your political affiliation.

I’m tired of petty political scapegoats. I’d like to draw your attention to the common theme – a deterioration in broader economic conditions, certainly for the average middle to lower class individual.

When the arsonist comes to fight the fire

Authorities argue that the answer to these challenges is economic stimulus. They want to lower interest rates, raise debt and implement bigger government programmes to directly target the challenges and support the afflicted groups. In truth, debt is the source of the problem. Authorities are exacerbating, rather than solving this problem. Let me explain.

Debt is a financial tool to smooth consumption

Before you think “Rob hates debt”, let’s start with the positive. Debt is a useful financial tool to smooth lifetime consumption. For example, I want a laptop when I’m 21 but I cannot afford it, so I promise to use my potential future income to pay for the laptop in the future. In return, the bank provides me with the $2,000 financing today. I’ve taken future Rob’s income and consumed it at 21. Waiting for the laptop is an inefficiency, which debt allows me to overcome. It’s a fair assumption that I’ll earn more income when I’m older, a laptop loan isn’t onerous and the laptop should enhance my productivity, making repayment of the loan effortless. This example is low-risk and shows the useful tool debt can serve in society.

Productivity matters

The logic of the debt arrangement declines, the larger the loan, the less productive the asset and if age becomes a constraint on future earning power. I’m not one to judge individual’s consumption patterns but obviously there’s a difference between the productivity, and the repayment implications, between a computer vs. a pair of designer shoes.

Let’s say I violate logic and I make the terrible decision to take a $10mn loan, at 60 years of age, for a property development that offers hot-desk services, two months before a coronavirus…

A terrible personal decision which damages my wealth prospects. But at least I’m only one individual. As the business goes belly-up, I can get support from family or friends. I may enter bankruptcy but at least there aren’t systemic risks. My employees will be out of work, but my failure won’t negatively impact society. In fact, there could be positive externalities. Maybe someone can purchase my office equipment and repurpose it into a profitable venture. Schumpeter’s creative destructive, the economic process of decay, repurposing and rebirth, can be powerful!

Isolated vs. Systemic Errors

If everyone in America is levered to the hilt with debt at the same time, systemic risks arise. Mistakes can’t be cushioned by successes elsewhere. Under these conditions, the whole of America has decided to take future income and consume it in the present. This could be a reasonable trade-off if we’re building something unequivocally productive for the coming years, perhaps a national transport network. But we’d expect to reap the returns from the investment in the coming 5 to 10 years and repay the debt, right? So, it should be a temporary increase in debt.

But what if debt levels continue to rise for an extended period, across all economies in the world? A similar principle applies, in this scenario the whole world has taken future income and consumed it already. The continuation of the trends implies that wherever we invested, wasn’t as productive as planned. If the investment was productive, we’d have earned better returns and paid down the debt, rather than seen debt levels rise.

This is exactly where the world finds itself today. Debt levels are at or near record highs across the globe.

The ratio of advanced economy government debt to Gross Domestic Product (GDP) is above 120%, at its highest levels since WW2. There’s more government debt than the size of these economies.

It’s not just a public sector story. US corporate debt as a percentage of GDP is at record highs.

Emerging Markets aren’t immune either. South African government debt to GDP is also at record highs.

Bad investments and the zombie apocalypse

It’s clear that society has made bad investment decisions because the investments aren’t providing the returns to pay down debt. Another simple way to view the number of bad investment decisions is the number of companies that are failing to return profits. Non-profitable companies are bad business decisions. These companies should be liquidated, but they aren’t, and the capital should be reallocated elsewhere, but it’s not. The jargon we use to refer to these companies is Zombie companies, because they’re walking dead! The number of US small cap zombies rises to a new record high during each recession.

Imagine we were able to measure government departments by the same method… Maybe we ARE living in the zombie apocalypse!?! At the extreme’s the inefficiencies are easy to identify but there are tones of businesses and individuals in the murky middle that aren’t even sure if they’re truly adding real value. Debt saturation hides the truth, even from us.

We’ve mortgaged our future

Record highs debt levels across the globe imply we’ve mortgaged the future to consume in the present. We’ve reached the future and we’re realising that it’s been mortgaged already. Many assess our massive debt levels as a problem for future generations that we’ll have to contend with in the years to come. As depressing as that is, it’s only half of the truth. We haven’t started to SOLVE this problem yet, but we are dealing with the CONSEQUENCES already. It’s like turning 21 and you’re already saddled with a major business bankruptcy. You’re climbing up Everest, but you’re starting with a 30KG/70LB backpack. You’re shouldering this debt burden, which constrains your ability to function freely today. Millennials certainly feel this weight, and there are real reasons for the frustration!

Macroeconomic growth expectations and social mobility prospects will remain weak until we reduce debt. Economic growth rates will almost certainly achieve a technical increase post the coronavirus shutdowns of Q2 2020. It’s not very difficult for real growth rates to increase from -10% towards 0%.  But the trend rate of economic growth continues to decline. As we’ve shown, the trend has been intact for the last few decades. Debt is a major contributor towards this downward trend in real growth. Economists, businesspeople and individuals who forecast a return to long-term average growth rates in the coming years are incorrect.

1. Building through adversity: Weak economic growth prospects imply challenging business conditions. This doesn’t imply that we must throw in the towel and stop trying because it’s going to be difficult. That’s senseless and defeatist. Opportunities exist in all economic environments. Successful people and businesses are made during tough conditions. General Motors was founded in 1908 during a 4-year recession, Hewlett Packard was founded in later years of the Great Depression, Electronic Arts during the energy crisis of the 1980s, Uber and AirBnb grew out of the 2008 Global Financial Crisis and Investec was founded during the tumultuous 1970s in South Africa. There will be sectors of strong economic performance despite broader weakness. There are constant changes in regulation, new technologies and government failure for entrepreneurs to solve.
2. Thinking differently and expecting errors: If business conditions are going to be challenging, it implies that we must be judicious with our business strategy, rather than merely follow the tried and tested strategy of the last 10 to 20 years. It’s not prudent to expect broad economic growth rates to reach their 20-year norms and for consumers to recover pre-2019 levels. Unless your producing necessities, low margin and high-volume business will likely face challenges. Real value-add and close relationships with clients are treasured during these times. Strong relationships create the possibility of charging good margins, maintaining business despite setbacks and receiving credit relief. Lastly, I expect to make errors. I expect the market to force me intro changing strategy. I need to remain very open-minded regarding the future possibilities and the fragility of my current strategies. 
3. Success isn’t purely characterised by financial gain. We all will put bread on the table despite record high debt levels and the negative impact on future economic conditions. Even in these challenging economic times opportunities emerge in non-monetary guises. Communities will grow, families will strengthen, relationships will persevere and meaning will be found despite challenges.

I’ll leave you with this picture I took on a trip to the Himalaya’s of the sun rising over the snow-capped mountains and a word I say everyday “shanti”, which is Sanskrit for “peace”, “shalom” in Hebrew and “salaam” in Arabic. Great that so many religions and cultures use peace as a greeting. I remember ritualistically saying “peace be with you” every Sunday at church as a boy. For years shanti/peace seemed trite and cheesy, but recently became meaningful when I started searching for peace within, rather than peace outside.

Peace, Rob Price

Subsequent articles:

• Edition 2: Die Slang in die Grass
• Edition 3: Debt’s unequal impact on wealth
• Edition 4: Trust and reality