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Are we rich or do we just look rich?
Stock markets across Europe tumbled more than 3% last night on the news of debt problems at Dubai World, a government investment company in Dubai. Banks who are the major creditors for Dubai World were the worst hit, with the Royal Bank of Scotland share price falling by 8%. Yesterday, the Shanghai stock market also closed 3.6% down on fears of higher defaults in bank loans. Both Dubai and China have been global examples of explosive growth in the past few years. When we look at pictures of the major cities in these countries, we see beautiful tall buildings and well-dressed people so it looks like these countries are doing well but of course what we cannot see is how much of the developments are funded by debt.
When I first came to Australia from Asia, I was amazed at how rich everybody seems to be. Everyone lived in a nice house, had a couple of nice cars, and went away for holidays every year. Normal wage earners owned yachts and horses and drove porsches. They lived lifestyles that only rich people in Asia could afford. I wondered how they could afford to pay for such affluent lifestyles and I found out about the magic of credit or debt. Most people here and in other Western countries are comfortable to live with a high level of debt whereas most Asians don’t and prefer to save their money instead of borrowing money to buy things. I was always taught by my parents to spend less than what I earn and to always put away something for a “rainy day”.
Below is a picture that shows global public debt that can be found on the Economist website. Dark green areas are the places with the highest debt. As you can see, with the exception of Japan, Asia has relatively low debt compared with the Western countries and some countries like China even have savings which they could tap on to fund stimulus packages in a crisis. Unfortunately, I cannot find an equivalent picture for global private debt. If I could, Australia will show up as dark green as our household debt level is among the highest in the world.
Is debt good or bad? According to Robert Kiyosaki (author of the book Rich Dad Poor Dad), there is “good debt” and “bad debt”. According to him, “good debt” is debt that enables you to buy assets that increase in value. “Bad debt” is debt that is used to buy assets that decrease in value (he calls these doodads) like cars and golf clubs. So basically, debt can be good if the money is used productively to generate more money so you can pay back the loan plus interest, and make a profit. Unfortunately, most of today’s debt is not used for productive things. Governments are borrowing to pay for fiscal spending. When you visit Japan, everyone has a high standard of living because the government has been borrowing large amounts of money to spend on public works and social services. Japan’s public debt is currently at 180% of GDP and with an aging population, it is hard to see how this debt can be repaid. The US is quickly headed in the same direction. Their public debt just crossed 12 trillion dollars (see US debt clock) in November 2009, which is 2 trillion more than their debt in September 2008.
Lenders generally do no complain as long as the borrower can manage to service the interest payments. However, they start to worry about the safety of their capital when the borrower has trouble servicing the debt, like Dubai World today. They will want to recall their loans and will be reluctant to lend. Will this event trigger another global credit crunch and another flight to safety?
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