Is Debt Friend or Foe?



The answer depends on what happens.Consider the following:


The majority of economists and investors like Warren Buffett believe that American ingenuity will bring the U.S. economy back to a sound growing position, and our current debt problems will ameliorate.I donít share that optimism.My principal reason is that itís not just the huge record debts that we have at all levels of the economy; itís the fact that we have so many people who have not saved enough.


The national savings statistics tell the story.During World War II we saved over 20% of disposable income.How?There was nothing to buy in the stores.Goods were rationed for civilians and were sent to our troops overseas.Added to that was the increased size of the workforce which included the employment of many women in the defense sector.So wages were coming in and not being spent.Hence, great savings.


After World War II, savings stabilized between 8% and 10% of disposable income until 1985.In 1985, the emergence of consumerism began to take its toll.Savings decreased about Ĺ% a year until 2005 when the national savings rate went to zero.Saving roughly 9% of disposable income before 1985 was sufficient to provide funds for emergencies and retirement for most of the older people today.


In addition to consumerism starting its vicious effects on savings in 1985, another thing started to happen in the years that followed.The emergence of 401(k) funds with matching employer money started the switch to defined contribution plans where the employees were expected to save for retirement on their own.This brought on the decline of pensions.†† Now, having both an employerís savings plan and a pension is unusual in private business.There was no comparable belt tightening in government service when 403(b) plans came on.Government employees retained both pensions and employer savings plans.


Anyway, the point of all this is that when employer savings plans substituted for pensions (in the private sector), the people were expected to save for their own retirement instead of their employer contributing to a pension trust.Savings rates should have gone much higher than 10%.


Only more savings didnít happen.For the most part, people not only chose to save less, they borrowed heavily.After all, the neighbors had a higher apparent standard of living on comparable incomes and never disclosed their debts.Developers started building much larger homes.High school students had to have cars and whatever was the latest technology electronics.Parents went on longer and more expensive vacations and often bought vacation homes or time-shares.Credit card bills went unpaid.


Some financial analysts were assigned (my word) the job of justifying the low national savings rate.When the stock market was booming, several articles said that we should not be worried.After all peopleís investments were growing so fast that no new savings were needed.†† After the stock market boom crashed, real estate values grew rapidly. More articles appeared justifying the growth in home value as a substitute for more cash savings, never mind that a home is not a liquid asset and is leveraged.We all know how the real estate boom ended and the leverage came back to destroy those who bought homes with little down, adjustable rate mortgages and option arms.††


We are now left with a large number of people about to retire without sufficient savings.In my book, Getting Starting in a Financially Secure Retirement (Wiley, 2007), I pointed out that it would take over twenty years and saving over 20% of disposable income, starting in 2007, to recoup those savings lost since 1985.This is clearly impossible.And that doesnít include the savings needed to replace pensions.You should ask yourself, ďWhy hasnít anyone else made this calculation?Ē The answer, of course, is that financial firms and the government donít want us to know the truth.†† It will nullify their own forecastsóand financial firmsí normally easy pickings.


Without sufficient savings, the elderly become more dependent on public programs and clamor for more social benefits.Many, many years ago, this would not have been a problem, because elderly parents would live with their working children.Today we donít have much of that, but we see ever increasing numbers of older working people having to both support both elderly parents and their own children at the same time.So the cry for more social benefits spreads beyond the elderly as people try to cling to a life style they really canít afford.


So now we have the cumulative effect of many years of little savings conflicting with the image the people have for their retirement.People are living longer, so they have to stretch those small savings further.The older people get, the more medical care they need.Medical costs compound because of the longer time needed for care, increased care and costly improvements in the technology helping to increase life spans.


Why isnít all of this recognized by the economists we see on television or their articles in publications? Financial firms cannot make money unless people trade and invest more.The prospect of a booming future encourages people to get active in the stock market.The prospect of a dismal future causes people to draw back, invest in less profitable and safer securities like money markets, treasuries, guaranteed income funds, bonds, certificates of deposits, immediate annuities, and so on.But not stocks, particularly the highly volatile speculative ventures.


So why wouldnít security firms be delighted with a drive to save more?After all, it would increase the volume of investments.The reason is security firms like market volatility and speculation.After all, stock trading is one of their most profitable markets.The reason is that savings reduces consumption which, in turn, reduces business growth.Stock speculation depends on business growth speculation.Boring markets brought on by consumer conservatism is deadly to financial firms.


That said, financial firms learned to make boring mortgage investments into something exciting by collecting groups of mortgages and selling them like stock in collateralized debt obligations.The boring insurance companies decided to offer insurance on these packages which brought about the even more speculative credit default swaps.The collapse of these securities almost brought down the whole economy.Now mortgages are almost back to boring again.


So instead of considering the fact that our national savings are totally insufficient to support the large number of people coming of retirement age, the economists look at data that may be only somewhere between a day and a year old to find an encouraging trend.Or they make comparisons with other countries which may be in worse shape, without giving consideration to the impact that a struggling foreign country is not any help to our own economy.


The fact is that people are going to have to save more and invest differently.This is NOT going to bring about historical growth patterns referenced over and over again by the financial community.People with little savings become risk adverseóas well they should.They also become more dependent on the government.Medicaid, for example, will have to expand exponentially.Taxes will have to go up both at the Federal and State levels.Tax rates will have to increase even faster because a smaller percentage of the population will be working to generate the larger taxes and less spending will reduce state revenues.


We are going to see lots of changes in consumer patterns.People will favor smaller homes to larger ones.It will be harder to sell the latest version of a computer, phone or television.Parents will clamp down on childrenís spending.Luxury restaurants will have far fewer patrons and restaurant chains will be hurt by more people bringing their own lunches to work.Weíll see a revival of picnics for large groups instead of catered events.


In the very long run, increased savings, and therefore increased investments, will make it easier for industry to get the capital it needs.This will offset some of the other effects we are talking about, but it will help only those industries that fit the new consumption patterns.And there is no guarantee that the additional investment by industry will stay in the U. S.


Reduced consumption will bring in less government revenue at a time when it is needed even more desperately.†† So what is left to solve the governmentís insolvency?The answer is INFLATION.Inflation will make it easier to pay some of the governmentís accumulated debt with ever cheaper dollars.Itís an enticing effect, but a lot of this will be thwarted by the governmentís entitlement programs which are inflation adjusted.Social Security, Medicare, Medicaid, and government wages increase with inflation.So do the huge government employee retirement benefits that far exceed anything in the private sector.So weíll see inflation, but it wonít have the power that itís had in the past when government and our entitlements were much smaller.


Inflation brings higher interest rates.No one is going to lend money at a low rate when they anticipate being paid back with cheaper dollars.Higher interest rates hurts anyone seeking a new loan.And it hurts the government because a good deal of our taxes go to pay interest on the national debt as debt must be rolled over or even increased if deficits continue.This too reduces the driving force inflation has on reducing the apparent value of old debt.


The other effect that of course will bring about increased interest rates is the need for the government to sell its debt securities abroad.For some strange reason, the federal government decided to reduce the amount of debt U. S. citizens can buy with savings bonds.Itís very strange when a nation would rather depend on foreigners than its own citizens.


Inflation of the price of U. S. goods may make it even more attractive to buy less expensive products from abroad where labor and material rates may be very much lower.This will exacerbate the already difficult employment situation.Reduced number s of U. S. workers further reduces consumption and adds to the welfare burden.


So, what does all of this have to do with personal debt being friend or foe?The answer lies in when we go from recession to inflation and the kind of debt we have.


Long-term debt at fixed low interest rates is fantastic during high inflationary periods for those whose income also goes up.Working people get to pay off the debt with cheap dollars, just as the government does for its long-term bonds.Itís not so fantastic for those retirees with fixed income or those who have short term debt dependent on prevailing interest rates or in a recession when the best investment is often to pay down debt.


Weíre going to have a political situation where the retired will be unhappy with inflation, and the working people will be unhappy with the large part of their income going to the government.Employers will struggle to keep costs competitive in spite of their high taxes and costs of employee entitlements.Employee unions will gain strength and exert their influence with strikes for higher wages or guaranteed jobs.Even the government will have to finally cut back its costs, and weíll see government unions strikingójust like in Greece now--or in our Seattle area where teachers went on strike last year.


So again, we ask when will we shift from recession or worse to inflation?The answer lies in when people recognize that they have to save more.Many who write me for financial help had their heads in the sand about retirement needs until they got close to age 60.Their only choice now is a bitter one for them because they recognize that even working till 70 will not give them the retirement they anticipated.I have people who have written to me who are in their late fifties making $200 to $300 thousand dollars a year who have saved nothing!†† One even told me not to tell him to start saving, because it wasnít in his makeup to save.


Itís a quandary, isnít it?When a large enough number ofpeople finally recognize that they should put some numbers for the financing of their future, the economy will go even more sour.Saving destroys consumption.Nevertheless, without savings people canít support what may be the last one-third of their life.Itís really a matter of how sharp the cliff is when this herd of buffalo awaken.Some will wise up quickly, work longer, put away a large part of their income, downsize their life style and maybe get some support from their children.Others will simply go into retirement living off welfare in subsidized housing.


I suppose itís fortunate that we canít see the future.Of course others have a different view, often without facts to support them but counting on some future as yet unknown invention to pull them out.They are encouraged by the fact that the market went up today or unemployment dropped a tad this month.But what about the onslaught of the baby boomers waking up financially or the generation Xs having to pay for our excesses?These are undeniable.Itís only a question of time.


Henry K. (Bud) Hebeler