"Economists are pessimists: they've predicted 8 of the last 3 depressions."
--Barry Asmus

The Required Disclosures

The information presented in this blog and its individual articles is provided for informational use only and should not be considered investment advice or an offer for a particular security. The contents reflect the views and opinions of the individual writer as of the date the article was written and do not necessarily represent the views of the individual writer on the current date. They also do not in any way, shape, or form represent the views of the Firm Never-To-Be-Named. Any such views are subject to change at any time based upon market or other conditions and The Great Redoubt and its individual writers disclaim any responsibility to update such views. These views should not be relied on as investment advice, and because investment decisions for any security are based on numerous factors, may not be relied on as an indication of trading intent on behalf of any contributor to The Great Redoubt. Neither The Great Redoubt nor any individual author can be held responsible for any direct or incidental loss incurred by applying any of the information offered. Please consult your tax or financial advisor for additional information concerning your specific situation.

Wednesday, December 1, 2010

“Debt is a prolific mother of folly and of crime”

Benjamin Disraeli said that. I have no idea how well he lived up to that as Prime Minister of Britain, but it doesn't actually impact the truth of the quote.

Recently, I've realized that my "dismal blog about this most dismal of sciences" has lacked any of the actual dismal science. So, let's rectify that with some basic concepts. We begin with definitions, courtesy of Investopedia:
Deficit: a situation in which liabilities exceed assets, expenditures exceed income, imports exceed exports, or losses exceed profits.

Debt: an amount of money borrowed by one party from another. Many corporations/individuals use debt as a method for making large purchases that they could not afford under normal circumstances. A debt arrangement gives the borrowing party permission to borrow money under the condition that it is to be paid back at a later date, usually with interest.
If you are facing a budget deficit - which is to say, you are spending more than you earn - you have three options:
  1. You can reduce the amount you spend.
  2. You can take on debt.
  3. You can attempt to generate more income.
In reality, these are not mutually exclusive. All three, or any of the three in any combination, can be used simultaneously in an effort to reduce the deficit. But, regardless of which option(s) you choose to take, there are some things to keep in mind:
  1. Spending less means actually reducing your total spending. It does not mean reducing the amount you spend on your current liabilities, and then taking the remainder and using it to take on more liabilities.
  2. Debt is a liability. If not utilized properly, and if not managed wisely, it will make your situation far worse.
  3. You may not actually succeed at generating more income. If you spend the income before you actually have it, and then you do not get it, you will make your situation worse.
If select option 1, and you fail to reduce your total spending, you increase your deficit. The fault, however, does not lie with the entity that encouraged you to take on the new liability.

If you select option 2, and you fail to manage your debt properly, you increase your deficit. The fault, however, does not lie with your lender.

If you select option 3, and you take on additional liabilities in anticipation of that income, and then you do not generate the anticipated income, you increase your deficit. The fault, however, does not lie with either the anticipated source of the anticipated income or the entity that encouraged you to take on the new liability.

The fault, in each case, lies with you. After all, you made the decision to take on the additional liability.

No comments:

Post a Comment