Shakespeare was right. In Hamlet, one character, Polonius, counsels his son “neither a lender or borrower be.”
While not entirely realistic, then or now, it does have a grain of truth in it. Too much debt limits one’s flexibility and options. If you borrow too much, you are forced to service that debt with resources that can’t be used for other things. If you lend too much, you are at risk of never seeing your money again (or being forced to take less when your borrower defaults).
Cash Flow Impacts Personal, Corporate and National Choices
This is as true for individuals as for sovereign nations and corporations. You can’t eat your shoes or your car.
You may have assets but without cash flow, the grease that keeps the system running smoothly, you can only keep going for so long. Just ask your neighbor who has lost a job and run out of unemployment benefits. While the house, car and stereo all are assets with value, unless he can turn them into cash he can’t use them to eat. And when you’re forced to sell them, don’t expect to get the same sort of cash money price for them. Boon to the buyer but not to the seller.
Debt Crises and Dominoes
Earlier this year, the banking crisis in Greece occupied the top spot in the headlines. While a loan from the EU backed by the Eurozone’s largest and most healthy economy so far, Germany, placed a bandage over the immediate crisis, structural problems persist. This has led the Greek government to roll out a number of stringent and very unpopular austerity measures.
At the time, the open question was how would this crisis in Greece impact the rest of Europe. No country in the developed world has been spared by the current global recession and slow down. Would this create a domino effect where weak economies lost the faith of the markets and were forced into their own crises?
The Story of the PIIGS – Scarier Than the Bedtime Story
The targets to watch were the PIIGS of Europe: Portugal, Ireland, Italy, Greece and Spain.
Each of these economies have structural deficit issues and are the weakest links in the Eurozone chain.
Just like the children’s tale, these little PIIGS are threatened with being gobbled up but in this case by the firm hand of the market in the form of higher interest rates and loss of investor confidence needed to keep their debts financed.
Sure, there is the potential for bailout from other Eurozone members. While Germany continues to be a relatively strong economy, it alone cannot support all of these economies.
So Ireland is the latest victim to the excesses of easy credit. Now their economy and banks are saddled with real estate loans gone sour and no one to buy the leftovers. Even Great Britain, not part of the EU, has its own issues that they are trying to tackle by implementing severe cuts in their social services, government programs and employment.
Cash Flow and Jobs Closer to Home
Looking back to 2008, the loss of faith in the financial system by nearly everyone cut off the money lifeline to otherwise solvent businesses. Companies with lots of assets (real estate, machinery, equipment and workers) lacked the cash to continue operations. Typically, a business (and governments, too) finance themselves from short-term borrowing to cover operational and payroll costs while waiting on the collection of accounts receivable.
But when the faith in getting repaid dried up so did the credit forcing many to the brink.
Eventually, here in the US we saw the Fed and the federal government step in to provide the needed liquidity to the system.
Now while other economies are being forced to make unpleasant choices about their economic structure and priorities, we in the US continue to avoid any real adult discussion about our own issues. Since market investors continue to buy up our public debt, we continue to run as if nothing has changed.
As the world’s primary reserve currency, we continue to benefit from the world’s use of the US dollar as a safe haven. But as has happened to Greece, Ireland and companies like Lehman Brothers before them, a flick of a switch can change investor sentiment and the near-term financing needed to keep our economic engine running can be shut off.
Whether or not this will lead the political classes to do what is right in the long-term (beyond the next election cycle) to get our finances in order is another open question. The President’s debt commission has come out with a number of laudable, if not popular or pleasant, options that offer ways to share the pain to make sacrifices that will keep us on track for continued economic growth and national security. Unless we follow through and take up the hard choices that have otherwise been forced on other nations, we risk our own crises more nightmarish than we have seen as we are forced to make bad or worse choices with limited options.
Let the adult conversation begin.