Why Is Debt So Risky?

We Like It So…

If your goal is to achieve a high level of financial independence it is easy to understand why you would want to avoid debt. If you owe money, you immediately become dependent on your income, your job, your bank and a lot of other small things that can add up to a lot of hard, repetitive days ahead. Despite this slightly obvious outcome of cause and effect, millions and millions of people take on the arduous challenge of buying things today by using time and effort that they promise to forfeit in the future. Maybe these people don’t care so much about financial independence. Fine. But It’s not just about mastering your finances. In the end, having debt, will at some point or another force you to do something you would rather not do. Yet people still do it. They do so by coming up with a colorful variety of reasons to justify these decisions.  Now, examine these “arguments” closely; peel back all the fibers and thick layers of emotion poured onto them. The thing is now exposed, shivering and whimpering in the cruelly open air. It’s that little kid inside of us screaming out “I JUST CAN’T WAIT TO… [insert (g-rated) verb] THIS!”

We just can’t wait. Life is too short. Our friends are all doing it. We want it right now because we too work hard so we’re gonna get it today….and we do.

The Debt-Money Game

Now, I certainly understand that there are different varieties of debt out there. We like to divide the big pile into varying grades of this-and-that quality. We do so by examining the minutiae of each and every contract, saying “this is good debt because blah blah blah”. At this point, it is all too easy to lose sight of the big picture. If you have some kind of training in the financial arts or if you like to read books about our financial system or how it actually works you might know that it is a picture that looks something like this: There are 10 people playing musical chairs and there are only 9 chairs. Once the music stops someone will be left with out a chair and in real life you do not want this to happen to you or your family because it truly sucks.

It is actually a little more complex than a simple game of musical chairs. It’s more like musical chairs^10. There are more rules, more people playing, and lots more at stake. Think of it as 350,000,000 people playing and 315,000,000 chairs. You are allowed to sit down in a chair before the music stops and forgo the thrill of the game. While the game is going on, someone can add or take away some chairs. Also, around this ginormous ring of chairs everyone is dancing around, the music might stop in some sections but still be playing in others leading to stampeding lines in one area and playful dancing in another. The complexity goes on and on but the point is that there are many different pressure points to this system. These are the things that can lead to a sudden mad scramble for free chairs.

If you would like to become an expert in the rules of the game, go ahead and try. The manual is thick but crux is always the same: There are less chairs than there are people playing. Therein lies the risk. The end of the game involves eliminating the losers but in real life it hardly gets to that point. The more likely scenario is that, the stakes being what they are, people start to realize that chairs are running out and some would rather fight than be eliminated. That is another thing about musical chairs^10. People are not going to give up so easy. If you choose to play this game just know that the rules can and do change along the way. All that time you spent studying the old rules turns into proverbial dust. Thus, the inherent risk of the game gets amplified it to the moon…

On Feeling Safe

Maybe you feel slightly safer about your debt considering the assets you have under your belt. Sure you have a couple of outstanding loans, but if ever push comes to shove you can sell some stocks or move out of that over-sized house you bought. This line of thinking is what is commonly referred to as “confidence” in econo-parlance. It merely reflects that when people have more valuable stuff, they are more likely to do riskier things with their finances. The problems that come along with this line of thinking are many. They ripple out from a major flaw in the virtuous cycle environment that humans try so desperately to create and re-create. Once many people start to think and act on their so called confidence; borrowing more to buy more things of increasing value, they start to push the prices of the things that make them so confident higher. In other words, they are merely buying their own confidence by using borrowed money! No doubt this state can last for a while. Unfortunately, the longer this goes on, the higher your assets go and the more unshakable in your confidence you become.

What happens when debts start coming due; not just for one person but for many? The fire sales start and the last to the party will get the worst deal. Suddenly your home-equity has vanished along with your paper profits. Whats the rub? The number on your loan stays exactly the same. Relying on your assets to cover your debt is just not a good idea. This is simply because your asset values depend on your debt and that of everyone else too!

If, on the other hand, you have no debts to worry about, you will avoid the forced sales and maybe even have some chances to buy at a low price. In fact when the economy is in a sorry state, it will remain so until all the people who are truly safe – those who are out of debt – come to its rescue. These are the people who will not sell, simply because they don’t have to. There is no one knocking on their door. They can ignore the stock market and they probably don’t even know what their home is worth. They own what they have all the way and they are free to assign whatever worth they want to it in their minds. They live in a cocoon of psychic-benefits and need no other person to tell them the value of what they have. They are the ones who will assign the true values of things in the market and everyone one else flying high in the sky will all eventually adjust back to these. Sure it it a pretty steady state but you can also look for thrills elsewhere. When you are out of debt for a long time and take time to save up for things you become more appreciative of what you have and in the long run have access to more opportunities. It just takes a little time to get there.

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