For the more than three decades we have been involved in analysis of the economy, one nagging constant has been pessimistic prognostications over the U.S. debt. Now once again, debt is the news de jour. Consumer, business, and government debt are all at record highs, and, therefore, the theory goes, the economy is tempting fate.
We have some very basic problems with this theory. Debt has been rising for decades, as it usually has since the US was founded more than 200 years ago. But just like debt, assets, incomes and profits have hit record highs too. While it's true that debt is usually at a record high when a recession starts, debt itself doesn't cause recessions. And debt itself doesn't
Debt is a transfer of assets from someone who wants to spend less than they earn today, to someone who wants to spend more. When this debt fuels investment in entrepreneurial ventures that boost growth, then debt helps lift the economy. But if spendthrift consumers or governments borrow money for non-productive activities, then debt goes up while production stagnates. That's a problem, as there are no extra goods and services to offset the cost of larger debt payments as they come due.
The other thing about debt is that it can sometimes spur on more production. Imagine you wake up tomorrow and are $10,000 more in debt. Are you going to work more hours or fewer to pay that off?
In other words, investors should neither be "debtophobes" or "debtophiles." Instead, investors should be agnostic about debt, looking into the underlying reasons for the debt as well as its sustainability relative to asset levels and income.
Take, for example, the national debt of Japan, which is about 235% of GDP. That's a lot of debt! But Japan's interest rates have been hovering around 0% for years, which means the carrying cost of the enormous debt is minimal (for now).