Good Debt or Bad…It All Needs to be Repaid

Good Debt or Bad…It All Needs to be Repaid

Earlier this year, the Australian government got involved in a bit of a debt shell game. Rather than label all debt as, well, debt, the government reclassified its overspending habits. We now have ‘good’ overspending and ‘bad’ overspending.

Spending on infrastructure projects, for example, is considered good debt. The idea being that over time these projects will create enough economic growth to more than pay for themselves, atop the interest payments.

Bad debt falls into spending on recurrent needs, like public services and welfare payments.

Now, there is some merit to this idea.

If you think about your own household or business, good debt might be taking out a $40,000 loan on a new work ute. It’s a hefty loan, but you put the ute to good use and earn $20,000 per year more than you could have without it. That’s more than enough to cover your interest payments and repay the principal within a few years. At the end of which you’re debt free and still have a working ute earning you extra income.

You can think of bad debt as taking out the same loan for the same ute…only you just drive it around to impress your friends. Now you need to repay the hefty loan and interest without earning any extra income. And you’re doing so on a depreciating asset. Let’s say it takes you five years to pay off the loan, plus the $10,000 or so in interest over that time. You’re now out $50,000 for a five-year-old ute worth around $20,000.

But in most cases, distinguishing between ‘good’ debt and ‘bad’ debt can get a lot murkier…fast.

Take housing for example. Property prices in most of Australia’s capital cities are at (or near) record levels. And it’s driving Aussies into record levels of debt.

From Domain:

With cash interest rates at a record low and house prices near record highs, the nation’s household debt-to-income ratio has climbed to an all-time peak of 189 per cent, according to the Reserve Bank of Australia.

That means there are an increasing number of people who have little cash for discretionary spending – on everything from cars to electrical appliances and new clothes – as their pay packets get consumed by large mortgages and high rental payments in the country’s red-hot property market.

So long as house prices keep going up, you could consider this ‘good’ debt. The capital growth will allow you to sell at any time, pay off your debt, and walk away with a profit. Of course, when house prices fall (and they will eventually), your good debt will be looking pretty darn bad.

The key then, to distinguishing between good and bad debt in property, is all in the timing.

The same holds true for government spending. Borrowing huge sums for poorly planned and poorly timed infrastructure projects isn’t going to return anything…except losses to you, the taxpayer.

As a Markets & Money reader, it likely won’t come as any surprise to you that the Australian government is quite good at getting the spending targets wrong. At least when it comes to growing the economy. From ABC News:

Research compiled by big investment bank Morgan Stanley has found that while China is using around $6 of debt to create $1 of GDP (Gross Domestic Product), Australia is using $9 for the same dollar of growth.’

With federal government debt surpassing $500 billion this month, I’d think twice before labelling any of that as ‘good’ debt.

This week in Markets & Money

On the Queen’s Birthday holiday you heard from Phil Anderson. Phil’s the controversial economist who spearheads Cycles, Trends and Forecasts. I won’t go into why he’s controversial. (You can discover that here.) In Monday’s Markets & Money, Phil showed you how the real estate cycle continues to turn. And how it’s happening right before your eyes. It’s not only a crucial cycle to understand for property markets, but for stock markets as well. And Phil shared one quirky indicator you can keep your eye on to help tell you precisely where we are in the ever turning real estate cycle. You can find all of that here.

On Tuesday, Vern took a look at the surprisingly unsurprising trouncing that Theresa May took in the UK vote. The youth, Vern notes, turned out for Jeremy Corbyn in droves. The carrot he dangled? A pledge to possibly write off £30 billion of student debt. There’s a small hitch though. Apparently Corbyn doesn’t have a plan to fund that promise. How wonderfully ‘politician’ of him. Vern went on to address a rather unhappy email from a reader suggesting that ‘taxing the rich’ offers a simple solution to Australia’s debt problem. Click here for Vern’s no-holds-barred response.

Fresh back from a holiday in Fiji, Jason tackled the exchange traded fund (ETF) gold market on Wednesday. Specifically, he looked at Van Eck’s decision to restructure its holdings of the Junior Gold Miners ETF [NYSE:GDXJ]. This decision had a devastating impact on the share price of many junior gold miners. While you may have been told ETFs offer a ‘simple’ way to invest in the market, Jason explains that’s far from true. ETFs are, in fact, far more complex than you may realise. One pitfall is the potential lack of liquidity when the market heads south. For the other pitfalls, and how to avoid them, you can read the full story here.

On Thursday, I looked at the government’s latest backdoor plan to eliminate cash. The first proposal is to abolish cash payments over $10,000. You probably don’t make many cash payments of that size. So the government reckons it can get that through without much fuss. Of course, it ignores the fact that inflation could erode this amount to $800 (current value) in less than 50 years. It also proposes putting a ‘use-by date’ on your $100 bills. No more hiding a few notes under your mattress for a rainy day. Spend it or lose it. For the full story, and a promising alternative currency free from government meddling, you can find Thursday’s edition here.

Jason returned with part two of ‘How to build your own junior gold ETF’ on Friday. Jason sounded a few more notes of caution on ETFs in general. First, unlike with shares, you’re not the rightful owner of any of the stocks held by the ETF. If the ETF provider goes under during difficult times, you may not get your money back. Jason offered a warning sign to keep your eye on. One that can tell you when it’s time to sell your ETF holdings, before the majority panics and runs for the exit. And he provided an alternative to investing in ETFs — a way to build your own sector-tracking fund.

That’s all for today. Enjoy your weekend.

Cheers,

Bernd

Bernd Struben

Bernd Struben

Managing Editor at Markets & Money

Bernd Struben is the Managing Editor of Markets & Money. He holds a degree in Economics and is a published novelist. Bernd’s career spans multiple countries on four continents.

With his diverse background, he brings unique business insight and a libertarian twist to his columns and analysis in Markets & Money.

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