Here’s some Personal Finance 101 for you.
What do you do when you get into too much debt?
You probably know where this is going.
The simple answer is that you try to pay it off. But you’ll probably do something else too. You’ll probably try to refinance the debt at a lower interest rate.
If you’ve done the latter, what should you do next? According to the International Monetary Fund (IMF), that’s a simple answer too — forget about paying it off, you need to go further into debt.
It sounds crazy, but that’s the message the IMF is giving the world’s governments…
Here’s how the Economist makes the argument on behalf of the IMF:
‘[The IMF’s economists] argue that the costs of raising taxes or cutting useful spending to reduce debt levels outweighs any benefits… They calculate that the expected costs of the higher taxation (for instance, from the disincentives to work created by increased tax rates) are likely to outweigh the expected benefits (from the lower risk of a default in the event of a crisis) by a factor of ten.’
So there you have it. If you’re spending too much, don’t stop…keep going. It’s the message every government wants to hear.
The trouble is, even by the IMF’s simplistic and childlike analysis, it doesn’t make sense. But, that hasn’t stopped them from sounding foolish before, and it won’t stop them doing it again.
‘Don’t worry about your debt’
We won’t go into the full reasoning behind the IMF’s analysis here. But, the short story is that countries that are a long way off from having troubling debt problems shouldn’t worry.
Countries the furthest away from having a debt problem are Norway, South Korea, New Zealand, and Australia. You can see various countries in differing levels of ‘debt stress’ in the chart below:
You’ll notice that the US is in the ‘green zone’. That means, according to this report, the US debt position is relatively safe — so what the heck have you been worrying about for the past seven years?
Even Britain, which is edging closer to the ‘yellow zone’ shouldn’t worry. As the Economist helpfully explains:
‘But for countries well into the green zone (of which America is a star performer and Britain is a somewhat marginal case), the IMF’s analysis has a clear message: don’t worry about your debt.’
We’re sure the French will be pleased to know that. Your editor will write to you from France and England for the next two weeks. Both countries are in a huge debt hole, seemingly with no way to get out of it.
So, we can only imagine how delighted both of their respective governments and central banks will be to hear the news that not only should they not worry, but they should keep doing what they’re doing.
Heading quickly towards the ‘red zone’
Now, if you’re a sane human being, you’re probably thinking to yourself, ‘If the countries in the ‘green zone’ go further into debt, won’t they one day fall into the ‘yellow zone’ and ‘red zone’ too?’
It’s clear that you’re way too smart to be an IMF economist. Besides, the IMF have that all sorted out. Again, this quote from the Economist lets you know just how smart the folks are at the IMF:
‘What should such countries do instead [of paying off debt]? The best thing, the paper says, is simply to let economic growth take its course. In the long run, if the economy grows more quickly than debt, the burden of it will fall as a percentage of GDP.’
There you have it. It’s so simple. Don’t worry about paying off debt, just let the economy grow. Easy.
Well, it is easy, providing the economy grows. What the clever folks at the IMF haven’t mentioned is what happens if economic growth stops?
The answer is that the economy heads quick smart into the ‘red zone’. From there, according to the numbers bods that the IMF has relied on for this data, it’s hard to turn back.
The interesting point here is that the number crunchers behind this data is ratings agency, Moody’s. You know them. They were one of the smart ratings agencies that rated subprime market debt as triple-A.
Now they expect investors to take their advice when it comes to sovereign debt.
Look, you don’t need to be a fancy economist working for the IMF or Moody’s to know that something isn’t right when folks in high places tell you that governments need to go further into debt.
The world’s economies remain at a key junction today. Governments and central bankers know the entire monetary system is on the verge of collapse. In response, they’re bankers are doing all they can to postpone the inevitable.
But when something is inevitable, there’s no way to stop it. So now they’re getting desperate. Rather than coming up with a genuine fix to the debt problem, they’re inventing solutions that just don’t make sense.
Government debts are growing worldwide. That includes in Australia, where the government’s debt is now $364 billion. The Aussie government seems to be taking the IMF’s advice. It’s got the green light to spend, spend, and spend.
That means the trouble you’re seeing in Europe and North America will soon happen here. There’s no getting away from it, all you can do is prepare for it…now.
For The Daily Reckoning, Australia
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