March 21, 2013 by Liberty
Many people underestimate the power of debt. They use their credit cards like it’s no big deal. The credit card companies are on the other end of that deal making millions of dollar with that power. Debt has the amazing power of controlling just about everything that happens in the world around us. Wars are being started with debt, financial breakdowns are being caused by debt, the dissolution of nations is being caused by debt, and just about everything else you can imagine is somehow being caused by this force. That’s no big surprise because debt is just another form of human interaction. It’s a promise to repay someone in the future (usually with a benefit for the person providing the money now.) The strangest part of our modern economy is that even the money that we use to pay the debt is nothing but a debt.
Money Is Debt
Every dollar that you carry in your in your pocket is just a promise that the government will provide you with a certain amount of value. The government used to back up this promise by holding gold in its vaults. Since the gold standard has been removed, this promise has become a lot more difficult to measure but the vast majority of people still appreciate the value (therefore, it has value.)
Money is just a debt that’s owed to you by the government. The government uses it to make sure we’re not all stuck trading real commodities like food for everything we need in life. It also affords the government to have a bit more control over the things that happen with the money supply. When you think about it, this debt controls virtually everything in the world.
Are You Owed More Than You Owe?
The goal for businesses and people when discussing finances is pretty simple. You want more money to be owed to you, than money that you owe to people. That means that you’re making money in life. That can be achieved through two major ways.
The first is to increase the money owed to you by other people. That can be through any of a million different ways from working hours, to selling products, to providing someone money at a long term cost. Rich people have a tendency to work this system in a much more efficient way than poor people. I’ll go over some of the important ways later.
The second way is to decrease the amount that you owe to other people. That is something that is very common among people without a lot of money. Middle class families are particularly good at cutting back the amount of money they spend and owe every year. While the statistics may be getting worse for the middle class every new year that passes, they still have a great reputation for spending and living with less money. Poor people tend to owe a lot of money compared to what they make. Many take up as much debt as possible. Rich people often have a similar strategy to poor people but they have a very clever strategy for managing it (or they go broke eventually.) That’s something else we’ll go over.
Money Is Trust
Debt, being a promise, is something that’s unbelievably powerful to use in life. The amount of debt you’re allowed to take out is kind of like the amount of trust people have in you. Just imagine the difficulty of doing anything in life with someone that doesn’t trust you very much.
Perhaps you’re going out on a date with a lovely young woman (unless you would date a man with a purse.) You’re going out to eat dinner with her in a restaurant. You hold the door for her. She reaches her hand out to make sure you’re not going to close it on her. You pull out her chair (you’re quite the gentleman.) She refuses to try and sit until you take your hands off the chair. She heads to the restroom and leaves her purse behind. She comes back and counts the money in it. When her food comes, she insists that you take a bite of her mashed potatoes first to make sure they’re not poisoned by someone you know in the kitchen.
A date would never do that because there is a certain amount of trust that comes from every human interaction.
Debt is just a form of that trust. For example:
A bank lends $1000 to a person and the bank is planning to receive $1,100 back in one year for it.
If they gave that deal to 10 people they’d ideally get $11,000 back instead of their $10,000 they started with. ($1000 profit)
If 1 of them fails to pay any money back then they only make the $10,000 back.
The bank wouldn’t have made any money off any of the 10 deals.
That means that the bank needs to be more than 90% sure that someone will pay them back to make a profit of that loan. (Naturally, quantifying trust is impossible but banks try never-the-less.) Just like the bank is 90% sure that you will pay back the debt, your dates are usually more than 90% sure you’re not going to poison them.
Trust Can Be Used
Debt can be used in a similar way to trust.
If John told Mary that Ken was a class act then, assuming Mary trusts John, she would believe that Ken is a class act. Even if Ken walked into meet her with a face tattoo and a creepy look in his eyes, Mary would still have some faith in John’s opinion. If Ken ends up stealing Mary’s keys then John will get a mouthful and lose some trust from Mary.
Good debt is the passing of trust.
When an investor buys a home with a mortgage and rents it out, they’re doing a similar transaction. The investor is going to the mortgage company and saying that he or she is going to pay the mortgage with a renter. The mortgage company trusts the investor enough to assume the renter is going to pay the mortgage or pay in some way.
That puts the investor is a very good position if the renter he selects is a good tenant. That means that he’ll be making a relatively passive income. That’s one of the greatest positives of the power of debt.
There are millions of different ways to use debt in a similar transaction. In fact, most of the richest people in the world have ridiculously high levels of debt. The difference between the poor and rich is that the rich use their debt to make them more money. The rich are often the ones with good reputations (lots of money) saying that they’ll vouch for a third party and take a risk.
That method of the creation of wealth is completely scalable. There are no limits to how rich someone can become if they develop enough debt for themselves and extend trust. That makes it an attractive goal for any intelligent investor. The more money they make, the more money they can make. It builds on itself to turn kind of rich into filthy rich.
But it’s not all positives…
The Dangers of Debt
Passing trust onto other people does not always pay off completely. A large percentage of the richest people in the world have been bankrupt at some point in their life. When they put trust in someone else, they need to be right a large percentage of the time. Often, a few mistakes could end a persons financial well-being for decades to come.
There is no way that a great investor can be right every single time. That makes it essential that they understand the power of debt in the positive and negative respects. Just like a rich person can stack on their wealth quickly with debt, they can also lose they’re money just as fast. Debt is a form of leverage that doesn’t always work in the investors favor.
It can be as simple as one mistake with debt that can make sure financial freedom is ruined in an instant.
The Precarious Balance
The more risks that you take, the more that you can make. That means that the goal should be to take as many risks as you can without ever having to suffer the consequences. You don’t have to be right all the time but, ideally, you want to be dead before you’re wrong. That process of balancing the power of debt can be difficult.
In an ideal situation, a person would not carry any debt that they’re not making money off of. That kind of debt you should avoid can be for anything from education to their home. This kind of debt just doesn’t provide any benefits. It only offers risks. You’re required to pay it whether your situation gets worse or not (and your situation won’t get better in exchange.) Having little of this kind of debt (that doesn’t provide you money) helps ensure that you’re prepared to handle any catastrophes that happen.
If you’re comfortable taking major risks then taking out as much debt as possible, to make money off of the power of debt, may be the best way to go but for most of the population, the best option is limiting good debt to similar levels as you would limit your bad debt. That means that you’re 100% safe from any catastrophes.
The balance is ultimately a personal decision. Every person is going to have to search for their own best option.
Government debt is a whole different story.
There are a number of problems with government debt but there is one thing that’s absolutely disgusting.
Just like rich people today choose to take risks that may end up leaving them dead with millions of dollars in debt, the government can take that same risk. Politicians can take out as much risk as they like because they’re not the ones bearing the responsibility of paying it back. The children of their constituents are going to be responsible.
That is just another form of taxation without representation and, as far as I can tell, the fetal voting movement is not going to be the solution. That means that the unborn will never get the chance to say no to our debts. It’s sending risk onto children. Honestly, there is a good chance that our generation won’t have to pay the consequences but is it really the risk we want to pass onto our children? The positives of the power of debt get left with us while our children receive the negative consequences.