Surviving a Debt Euroclydon (Segment III)

Preface: You’re living the college student dream if you’re debt free.

Surviving a Debt Euroclydon  (Segment III)

Then the hypothetical debt Euroclydon came. The only man who sticks closer to you in adversity than a friend is a creditor – Author Unknown. Today, debt drives the economy from credit cards and real estate mortgages to personal and business lines of credit.

We can gain valuable and keystone business insights into the economic power of debt and the credit cycles from the book, The Big Debt Crisis; credit: author Ray Dalio.

If you understand the game of Monopoly®, you can pretty well understand how credit cycles work on the level of a whole economy…..Early in the game, “property is king” and later in the game, “cash is king.”

Now, let’s imagine how this Monopoly® game would work if we allowed the bank to make loans and take deposits. Players would be able to borrow money to buy property, and, rather than holding their cash idly, they would deposit it at the bank to earn interest, which in turn would provide the bank with more money to lend. Let’s also imagine that players in this game could buy and sell properties from each other on credit.

If Monopoly® were played this way, it would provide an almost perfect model for the way our economy operates. The amount of debt-financed spending on hotels would quickly grow to multiples of the amount of money in existence. Down the road, the debtors who hold those hotels will become short on the cash they need to pay their rents and service their debt. The bank will also get into trouble as their depositors’ rising need for cash will cause them to withdraw it, even as more and more debtors are falling behind on their payments. If nothing is done to intervene, both banks and debtors will go broke, and the economy will contract. Over time, as these cycles of expansion and contraction occur repeatedly, the conditions are created for a big, long-term debt crisis.

Today, central banker vocabulary doesn’t include the word “bankruptcy.” As of May 2019, the United States consumers in aggregate had $4.02 Trillion in consumer debt, says credit cards, and $1.50 trillion of student debt on educational loans, and $1.20 trillion of auto loans. In 2018, the average American household had too much debt, with an average of $135,000. The average US household had $47,500 of student loans, $27,500 of auto loans, $6,000 of credit card debt, and the remainder of the $135,000 of total debt is either a mortgage, line of credit, and home equity loans. With average wage earnings of $60,000 per household, approximately 8% to 10% of Americans think they will never be free of credit card debt in their life. The statistics are increasingly bleak for long-term economic vibrancy with the absence of continual injections of credit for new consumer spending highs.

Now, let’s ask a rhetorical question. Where will this average American likely receive the necessary future capital to acquire or pay for what your business will sell? Will it be from new credit cards, or say will it be a mortgage? Will it be a home equity line of credit? You hope it’s discretionary earning, right? Look at the statistics. Simply because someone earns more than $60,000 doesn’t say they save more capital or have a higher percentage of investable assets than someone who is earning less. Higher earnings permit more opportunity to accumulate debt with greater credit access. The economic gaps among the haves and have nots continue to widen creating expansions in the underlying tectonic pressures in the greater society.

A debt crisis is deflationary because the artificial price increases per the Monopoly game example above, simply cease to support inflated asset prices when the credit compressor stops. Deflation is a decline in asset prices. Hence real estate and business values decline in deflation. A Debt Euroclydon in terms of this article does not outline what happens in that scenario. The best answer may be that the actual economic playbook is almost impossible to design for most, but likely outlines bleak economic conditions that have not been seen in most generations in the business industry and entrepreneurship today.

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