Oct/Nov 2011 – The Real Effects of Debt

The Real Effects of Debt

The Bank of International Settlements (BIS) released a working paper this past month entitled; The real effects of debt. Although it proves to be an interesting read (along with some alarming statistics on the role of debt in the economy) their conclusions simply validate most of the beliefs that the prudent business owner already governs themselves by.

Debt truly is a double edged sword. Used wisely and within reason it can clearly improve progress by smoothing out consumption and investment along with enhancing growth. But, when used recklessly or in excess the outcome will always prove disastrous.

The BIS study concluded that debt, beyond a certain level is bad for growth citing a workable ceiling for government, corporate and household debt as a percentage of GDP between 85% – 90%. As the trend in the graph below illustrates Canada (although in a much more enviable position than the rest of its G8 partners) still places itself in the unenviable position of impairing its future economic growth potential with excessive levels of debt.

Canadian Sector Debt as a percentage of GDP

Focusing on raising the cost of credit and making funding less readily available to would-be borrowers, while at the same time increasing our overall savings rate, is the only way out short of inflating the problem away which ultimately is a mugs game that magically lulls us into believing we are somehow wealthier today than we were yesterday while in real terms, actually eroding away the purchasing power of our savings.

From Victor Borge (1909-2000) Danish comedian, conductor and pianist:

"I don't mind going back to daylight saving time. With inflation, the hour will be the only thing I've saved all year."