Wednesday, 7 December 2016

Living Within Our Means

It always amazes me that the idea that both we and our Governments should live within our means is controversial. But I was reminded recently that it is, that many people find it very difficult to separate what is, from what could be or even what should be. So what do I mean by "living within our means"?

I mean that debt is bad, that sometimes we have no choice but to go into debt but that when we do have a choice we should choose not to be in debt. Because in many cases we do have a choice. Let me give you an example. You like camping but you've decided you want to do it in abit more comfort so you start looking at caravans. You find the perfect caravan for your needs and it costs $16,000. Now for some that is way too much money, it might be perfect but it is out of reach. But lets assume that you do decide to purchase this caravan, do you save for it or do you use credit to pay for it?

If you decided it was too much and did not buy the caravan you are living within your means.

If you decide to save up and only purchase it when you have saved the money, you are also living within your means.

If you decide to use credit to buy the caravan you have put yourself into debt. It would be very hard to pay back anything less than 10% of the purchase price. Right there is $1,600 that you could have used on anything you like, but instead it goes to a finance company. You are living beyond your means.  

A caravan might be a nice thing to own but it is really a necessity. But lets assume that you have lost your home in a natural disaster. You need somewhere to live and urgently. That same $16,000 caravan bought on credit is now a need not a want. You need it to live in and that comes back to what I wrote above, sometimes we have no choice but to go into debt. It is important to make a difference between need and want.

Now when I say debt is bad people always bring up houses, I'm not a fan of the real estate market but it is true that is how most people buy their home. But houses are different to nearly every other thing that you can buy, most things are less than your yearly income but a house will rarely fit into that category. So buying a house is something that most people will need to go into debt to buy and there is really no way around that. But a house does fall into the need category so in most cases that debt is acceptable. However if you buy a house that you can only afford because interest rates are low or for some other artificial reason then the really is that this is beyond your means, it is bad debt.

The Government should operate much the same, it should live within it's means. Now there is a genuine reason for Governments to borrow money. It has expenses that need to be paid regularly but it's income does not arrive with the same regularity. So to cover the gap it borrows  money to cover this cost. However in most cases there is very little that is too expensive for a Government to buy. If it needs new dams or airports, if it needs to repair bridges or a railway fleet. These things are expensive but they are not so much that Governments really need to borrow money to pay for them. It is however how those things are paid for now and in the past. But when you think about it it becomes a very expensive way of doing business. Lets say a Government wants to build a dam and it will cost $16,000,000, if it saved up and paid for it there would be little addition cost. If it decides to borrow the money as they so often do then we end up paying interest on that money. Money paid on interest should instead be spend on other things but instead it goes towards paying for something we already have. That bridge will end up costing alot more than $16,000,000 in the end, thats alot of dead money.

Government can and should save to buy things, they should rarely be in debt. War is one of the rare things that normal Government revenue cannot pay for. In that case or in other extreme emergencies then of course Governments should go into debt. But in normal years Governments should have money in the bank, they should not be borrowing money. And the same goes for you and I. Debt is bad, we should all try to live within our means!

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  1. My father always had a horror of being in debt and it's something that has stayed with me. People do have an extraordinary ability to persuade themselves that they need things that really they don't actually need at all.

  2. Be not a creditor or a debtor be!

    Being in debt is not necessarily so bad but only as long as you can pay the debt back without having a lessening of your lifestyle.

    Government debt is often bad as it tends to accumulate even more so beyond means and the solution is normally to print more money and devalue what already is in circulation.