Debt, Strategy, and Sleeping Well at Night
Debt is evil.
Debt is good.
It all depends ….
I think about debt the following way and I feel like it helps me harness the goodness of debt while mitigating its evilness.
What is debt?
Debt is money borrowed from a party who does not have a better alternative use for it in the near or (often) long term. It is money the lender has earmarked for later consumption (otherwise it would be spent now), and so to derive value from the forgone consumption, the person who has the money “sells it” to party who wants to “consume or use” cash now, but does not have it. The “cost” of that money is to give it back in the future along with interest to compensate the lender for her forgone consumption and the risk she took that she might not get it back when she lent it.
So debt is what is created when a person who has money, but a later consumption preference, gives that money to someone who doesn’t have money, but has an immediate consumption preference.
But what happens to the borrower over time? The borrower must earmarks future monies earned to pay back the debt (i.e. they will forgo future consumption in order to pay back funds to the person they borrowed from).
Are you following? This is the key point.
DEBT PULLS CONSUMPTION FROM THE FUTURE INTO THE PRESENT.
As a borrower, whatever you consume today is consumption you’ll forgo in the future.
When a whole bunch of people borrow money at once, a whole bunch of future consumption is brought into the present.
One reason that group debt binges are so bad (when everyone pulls their consumption into the present by borrowing), is that in the future they’ll all have to forgo consumption together as they pay the debt back. If everyone consumes at the same time (pulling future consumption into the NOW), one, they drive up prices of commodities and assets and labor today, and, two, in the future they will all NOT be consuming at the same time and drive down prices of commodities, assets and labor. As labor demand drops in the future, and as the price of assets drop in the future, it makes it harder to pay back the debt from all the previous consumption, and leads to bankruptcy.
This is often called a boom/bust cycle. And they are destructive to society.
We don’t want debt spikes. We want smooth debt patterns that aren’t lumpy, where not too much consumption is pulled into the present.
Knowing that, I get VERY CAUTIOUS when there’s a lot of people borrowing money at the same time because I know that a lot of the business the binge is generating now will result in a bust later. I don’t want to commit to business that is ephemeral.
On the flip side, if I don’t get into debt when everyone else is, but instead live within my means and save, then when the bust occurs and labor, assets, and commodities get cheap, I load up.
I’m not perfect and I make debt-related mistakes, but by keeping in mind what debt is and how it affects present and future consumption patterns we have kept our company out of trouble first during the tech boom/bust and later during the housing boom/bust because we were cautious when everyone else was reckless. After the busts, we were aggressive in expansion when others were hunkering down.
I don’t want to see boom/bust cycles in our economy, but so long as there’s a central bank manipulating interest rates, I have to live with them and plan accordingly. I hope you will choose to “run against the herd” so that instead of going over the cliff during debt-binge booms, you sleep well at night.
In fact, at our company when we discuss investing in expansion we have a “sleep at night” test. If any expansion move would cause any of us to lose sleep at night, we just don’t do it. That means we don’t do things just because everyone else does.