July 6, 2015

439 words 3 mins read

A Dangerous Misunderstanding of Debt

Debt is not a guarantee of future payments in full. Rather, it is a risk that creditors take, in hopes of maybe being paid tomorrow.

The key word there is “risk.”

If you’re willing to take the risk, you’ll get a premium — in the form of interest.

But the downside of that risk is that you lose your money. And Greece just called Germany’s bluff.

Jim Edwards nailed a major problem with modern finance. At some point, the financial world thinks that all debt must be guaranteed. That lenders must recover all of their principal and all their expected interest no matter what.

But lending is always a risk. If there is no risk, there is no interest. Normal people understand this. When we lend a circular saw to a neighbor, we might never see it again. Or the neighbor might break it. We take the risk in hopes of earning interest in the form of trust and loyalty from the neighbor.

When we lend money, we hope to get the money back, plus interest. But we understand we might never see the money again.

Every modern economy has some provision for bankruptcy because we expect some loans will go bad despite the best of intentions from all parties.

In 2008, the financial world decided it would no longer deal with bad debt. Instead, it would force debtors to take on even more debt, along with rules for living imposed by the lender. No businesses or big banks were allowed to fail even though many big businesses and banks had made years of bad decisions.

The Greek people have finally yelled “no more!” Now, it’s time for the rest of us to do the same. No more bailouts for Wall Street. No more bailouts for insolvent international corporations. No more forcing debt onto insolvent countries.

Let the risk-reward markets settle their own scores according the rules that were in place at the time the original loan was executed. Status quo ante.

Finally, here’s Jim Edwards’ close. He puts it much better than I tried to yesterday:

Greece is now likely an international pariah on the debt markets. It may have to start printing its own devalued drachma currency. It will have no access to credit. Sure, olive oil, feta and raki will suddenly become incredibly cheap commodities on the export markets. Tourism in Greece is about to become awesome. But mostly it will be awful. Unemployment will increase as Greece’s economy implodes.

But the awfulness will be Greece’s alone. Greece is now on its own path. It is deciding its own fate.

There is something admirable about that.