Why the going is good, until it isn’t.
Benjamin Franklin once said that it is better to go to bed without dinner than to rise in debt. The reason being that when we don’t pay back what is owed, bad things happen. We can have our goods seized, we can lose our house, or we may even be forced to declare bankruptcy. Not surprisingly, financial stress is one of the top causes of anxiety and reasons for divorce. So why borrow?
Clearly, most of us would rather avoid jumping off a cliff unless we absolutely had to, and we borrow money because we must. The average annual wage in the UK is £31,285. That money will go a lot further in Yorkshire than in London, but after taxes, utilities, transportation and the minor subtleties of life, that’s still not much to go on. It is why the average household credit card debt in the UK is £2,033 with representative interest rates of 21%, but that’s another discussion.
Apart from supporting our lifestyle, we also borrow to speculate. Money is cheap for those that have assets. It’s called margin debt and it is there to be had for less than 1%. Imagine how much money we could have made last year if we had bought 10,000 Tesla shares and borrowed the money from someone else. Banks don’t like to lose money, so typically we would have to put up about 20% on margin. In other words, if we had invested $190,880, our gains would have been $7,091,192 and all it would have cost us, is about ten thousand Dollars.
Great, why doesn’t everyone do this? They do, and margin debt is at an all-time high. The problem is if it goes the other way. Were Tesla to fall by more than what we put up on margin, the bank would close our account and sell the position in the market. Remember Archegos? By the time the banks got done liquidating the massive positions in Chinese internet stocks they had “inherited” from a former master of the universe, the losses were enormous. Many paid the price and the fall out is far from over.
Fortunately, most of us don’t have to worry about things going wrong for those that can afford to lose a few billion amongst friends. However, that does not mean we are not at risk. The world currently owes more than $300 trillion in some form of government, corporate or household debt. There is a reason why central bankers are calling inflation “transient”. If interest rates ever were to go up significantly, you really have to wonder how we are going to pay for it all. Bitcoin anyone?