Debt and credit are talked about extensively in news channels and economic programs, but most people feel lost when these topics are discussed because they are usually directed to specialists in the fields of investment and economics. In this article, I will try to simplify the topic for everyone and explain its importance.
Before we start discussing the topic, we must begin by defining these two terms:
Credit: means providing purchasing power to a person or entity
Debt: is a promise to repay on a specific date
When you take a loan from the bank, it gives you purchasing power “credit”, while you are obligated to repay an amount on a certain date “debt”.
Most people think that debt and credit is bad in itself, and there is some truth to this belief, but it can also be a good thing. In order to know whether it is good or bad, we must know what income purchasing power produces for the benefit of the borrower.
If you take a loan in order to buy a TV, this is considered to be a bad thing because there is no source of income to repay the loan with. This type of loan is known as a consumer loan, and it's the least favored type of loan that an individual can take, because this loan will reduce your purchasing power in the future in exchange for the satisfaction of a momentary consumer desire.
On the other hand, if you take a loan to buy a device for making fresh juices in order to sell these juices in the market, this is considered favorable because you are generating income that enables you to repay the loan. This type of loan helps individuals or companies increase their production capacity and earn money. As such, the loan will not reduce your wealth in the future, because you will have additional income to service it and keep the rest.
If your income growth rate is higher than the debt growth rate, this is a good thing. On the contrary, if the debt growth rate is higher than the income growth rate, this is bad. Debt simply takes from your spending ability in the future and increases it in the present. It will reduce your spending power in the future as this money will be used to service/pay off your debt, unless you are earning above the serviceable amount. If not, you may default on the payment and get into financial and legal issues.
At the economy level in general, the goal is to spend on productive activities to stimulate economic growth and enable countries to pay off debts.
But there's a problem.
Between 2000-2020, the global debt ratio increased by 185 trillion dollars, but only stimulated economic growth by 46 trillion dollars. These numbers are frightening and indicate the existence of an imbalance hinder economic growth (IMF).
This problem is being solved at the present time by printing money (a topic we will discuss in other articles) and one of the consequences of this policy is the presence of companies known as “zombie companies”. For these companies that have profits less than their monthly debt repayment, this policy leads to the development of a cyclical economic wheel, where the economy flourished for a period and then collapses. Here is a video of the author of this theory discussing the idea in greater depth https://youtu.be/PHe0bXAIuk0
Therefore, a loan is a double-edged sword. It can be a great tool for increasing productivity, or it can be a tool that could lead its owner or company into bankruptcy. I will conclude this short article with some tips that may benefit the reader in this matter.
1- Try as much as possible to stay away from consumer loans
2- The loan can benefit you greatly if you know how to use the capital to increase your income, but if you do not have the knowledge and experience, it may be best to avoid it
3- If you want to invest in companies, always look at their debt to income ratio. Usually, if this ratio is 20% or less, this is healthy. If it's between 20% and 35%, it is mild, and anything higher than that is considered a risk.
Sources:
https://www.imf.org/external/datamapper/datasets/GDD
https://www.statista.com/statistics/268750/global-gross-domestic-product-gdp/
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