Last week, European leaders announced that they had the solution to their financial woes they came up with the idea of increasing their debt. Initially, markets responded positively to this idea. But less than a week later, markets are back to where they were before the announcement.
It seemed to me to be a bit silly to think you can fix your debt problem by adding more debt, but according to my mortgage expert, Rod Burriss from PHH Home loans, it sometimes can work.
His points were as follows:
1. Imagine you personally have several credit card debts with various interest rates, some high, some low.
2. You re-finance your home at a low rate and use the money to pay off all your high-interest credit card debt.
3. You then pay down the new debt systematically over time.
4. Key to making this work don’t charge up more debt until you’ve paid down your old debt!
We all know that this concept can work well for a household, and it works well for a country also; except when you factor in point number 4.
For some reason, countries have a real problem with not charging up more debt. Some people in the US are turning their noses up a bit watching Europe flounder, but aren’t we just a step behind them?
Europe might be close to collapse (see http://www.cnbc.com/id/48094098 for details) because of their inability to stop spending money they don’t have. Meanwhile, here in the US we are running $1 trillion+ deficits each year with no end in sight. Does our government even try to spend less?
Europe’s spending and debt problems could cause substantial negative effects on our stock market before too long, which would begin a downward spiral of problems for our country due to our own spending and debt problems.
The challenge we have is that we may not have seen the downside to this cycle yet. The ‘80s and ‘90s were the “up” portion of the economic cycle. And, we went way up.
We are now seeing the “down” portion of the cycle. But have we seen that significant drop to clean up all the junk? I believe that 2008 was just a preview.
We’ve seen this before. It’s called Japan. At the end of the 1980s, Japan’s stock market was an uptick away from 40,000. Twenty-two years later, it’s at 9,000. There’s a good argument out there that we (and Europe) are following Japan’s footsteps.
How will you personally fare if the stock market goes down 75 percent and stays there for the next 22 years? It can happen, and you are just fooling yourself if you think it can’t.
Today, a wise investor is someone who can partner with a professional advisor to work on lowering their investment risks without sacrificing potential returns.