Question

write business blog entitled myths about financial management: debt doesn't matter

Answer 1

Myth #1: All debt is bad.

In reality: It’s true that carrying a balance on your credit card or a high-interest loan can cost a lot—significantly more than the amount you initially borrowed. But not all debt will hold you back. In fact, certain types of debt, like mortgages and student loans, could help you move forward in life and achieve your personal goals.

They’re often thought of as “good” debt because the debt is funding an investment—a home or an education, which can be financially beneficial. The interest rates on mortgages and student loans are typically much lower than those on personal loans or credit cards, and the interest may be tax deductible. Even so-called “bad” debt like using a high interest rate credit card can be beneficial in some cases. Note that it is possible to take on too much good debt.

No matter what kind of debt you take on, make sure you shop around for the best rates and never borrow more than you can afford to pay back on time.

Myth #2: Credit cards should be avoided.

In reality: As long as you pay off your card balance in full each month to avoid interest, making purchases with credit can be worthwhile. Many credit cards offer a rewards program. If you make all your everyday purchases with your card, you could quickly rack up points you can redeem for cash, travel, electronics, or to invest.

Also, demonstrating that you use credit responsibly can help you increase your credit score, making it easier to buy a car or a home later on. It may even earn you a lower interest rate when you borrow in the future.

It can be difficult to dig out of credit card debt, but if you control your spending and pay the card off every month, it could pay you back.

Myth 3: The U.S. will default on its debt

Although much hype surrounds the possibility of a U.S. debt default, especially after the debt ceiling fiascos of 2011 and 2012, the likelihood is infinitesimally small. One of the reasons the U.S. has been—and continues to be—a traditional safe haven for global investors is that investors know very well that the U.S. has nearly unlimited taxing power and a huge asset base.

The total assets owned by the U.S. government are far greater than its total debt outstanding, with an approximate debt-to-assets ratio of 10%.1 This would be akin to someone with roughly $1 million of debt and a bank account with $10 million of cash or other assets. And this estimate of the U.S. government’s assets is conservative, not accounting for the significant amount of buildings owned.

In other words, the federal government could – if needed – force liquidation of these assets to pay its entire stock of debt nearly 10 times over before defaulting. This is before even considering increasing taxes on the private sector.

Myth 4: The U.S. debt is out of control

The U.S. debt is at elevated levels, but the current debt-to-GDP ratio is manageable.

In absolute terms, U.S. government debt, measured as total debt held by the public, is $13 trillion –a record high. A broader measure of U.S. debt, which includes the debt the government owes to itself, totals $19 trillion. But absolute debt levels do not tell the whole story, as it is important to consider the size of our debt in comparison to the size of the economy, which is also at a record high.

In this context, the debt-to-GDP ratio stands at approximately 77%; an elevated level, but hardly a record. For instance, the ratio reached a high of 108% in 1946, reflecting the costs of World War II. While the debt-to-GDP ratio is projected to increase, it is not expected to explode through the next decade. The Congressional Budget Office (CBO), a non-partisan government organization, projects an increase in net debt as a percentage of GDP – from 77% in 2016 to 86% in 2026 Research suggests that high levels of government debt can be damaging to long-term growth, potentially leaving an economy more susceptible to shocks

Myth 5: Rising rates will explode the debt

While rising rates would certainly cause the government’s net interest expense – its cost to service the debt – to increase, it will not cause it to explode.

First, rising net interest expense only becomes destabilizing if it contributes to a problematic shift in the country’s overall debt dynamics (a massive surge in debt-to-GDP, for example). But any rise in interest rates would almost assuredly be the result of a healthier economy and inflation expectations. This matters a lot, because if both GDP and the debt rise in lockstep, the debt-to-GDP ratio does not actually grow.

A closer look at this dynamic through the lens of the CBO’s forecasts posits that the yield of the 10-year U.S. Treasury will average 2.3% in 2017, 2.8% in 2018 and 3.6% in 2026 . But the forecasts also project economic growth of 2.4%, 2.2% and 1.9%, respectively. As a result, the CBO sees federal net interest payments rising slightly from 1.4% of GDP in 2017 to close to 2% in 2020 and 2.6% in 2026. Overall, net interest expenses are not set to increase as dramatically as many previously thought. This in large part is due to the view that interest rates are expected to stay lower for longer. A last important point is that much of the U.S. government debt that was issued in the past 7 years was done so at record low rates. This cheap debt has locked in coupon payments, that will not increase as interest rates rise.