Friday, January 2, 2015

Bad Debts: Countries?

We all know that debt can be good or bad.

As a consumer, if we use debt to buy TVs, sports cars, eat at fancy restaurants and buy excessive luxury goods, we are taking on bad debt. If we use debt to fund our education to get more skills or start a business and earn money from it, it can be good debt.

As a business, if it uses debt to pay for unnecessary purchases, expensive staff and bad investments, then it is taking on bad debt. If it uses debt to fund an expansion, seize an investment opportunity to either reduce cost or increase revenues, it can be good debt.

As stewards of our own personal finances, most of us know the perils of debt. In fact, most of us avoid the bad debt and only take on the good debt. Even then, some people are uneasy having any debt at all, even if it is good debt, but I leave that up to personal preference. Which one is better? I'd leave that up to debate. Having good debt or no debt are both good options in my books.

As retail investors, we know that companies with a lot of debt have to be inspected very closely. Are they taking on good debt, or bad debt? Do they have enough money to repay their debt now if they had to? Will they generate enough money in the future to be able to repay their debts? Companies with no or little debt run into few problems, but they may also be short changing themselves an extra tool that they can use to take advantage of situations and grow faster. However, at the end of the day, most of us know that generally speaking, we should invest in companies that know how to control their debt.

The basic equations are here:

Debt > Income means Net Negative = BAD
Debt < Income means Net Positive = GOOD

Now, all that is fine and well, but wait. Why does it stop there? Why don't we ask about... Countries?

Countries have debts too. Singapore has one of the highest debt-to-GDP ratios in the world. Does that make us a "bad" country?

Personally, I do not think so. Singapore runs a balanced budget. Singapore takes on cheap debt and uses it for investing. We're like a freaking bank. Lend at 2%, make 10% and pocket the difference. Don't believe me? Scroll down to Q7 and Q8. People that thinks the "gahmen" steals our money and that CPF is broke, please kindly exit my blog now. Also, please consider moving to another country. Don't forget to take your "stolen" CPF money with you.

Singapore is fine. We make more money than we spend. And we borrow cheap money so that we can pocket the difference. It's a fantastic strategy. I do like what I am seeing, let me tell you that.

However, turning on to 2 other countries that are decently high on the debt-to-GDP ratio, and we have Japan and the USA.

If you'd like to know more about Japan's debt problem, just watch the video below. I think it does a fantastic intro about taxes, interest expense, borrowing and the current inflation targeting. Don't mind the horrible background music, I hated it too.


Basically, as I've said it before, Japanese policymakers are crazy. Japan as a country doesn't have the ability to repay back it's debt. Japan's interest rate can never go up meaningfully back to a "normal" environment because interest rate expense would kill it. The only thing that they can do is to inflate out of their debt. However, this charade doesn't last long, because once investors look at real returns, they will know that something isn't right. Once faith in the Japanese system is gone, that's when we're going to get a financial Fukushima event on our hands where everyone will be exiting Japan. How long will it take for people to realize Japan's insolvency? I don't know, but I would never, ever, buy a Japanese Government Bond (JGB). It would literally have to be over my dead body.

The USA, economic powerhouse of the last century, now how bad can they be, right?


This video was made in Feb 2014. Now in 2015, the US debt has crossed the $18 trillion mark. US GDP for Q3 2014 is $17.5 trillion. Now, I don't think it takes a rocket scientist to figure out that if someone has more debt than their income, that's a problem.

The USA has 2 things going for it. First, they aren't so far down the rabbit hole like Japan is. They are on the fringe of being called batshit crazy like Japan. They might actually still be saveable if they make massive MASSIVE amounts of reforms. So they not quite there exactly there with Japan yet, but they are trying their best. The good ol' American can-do spirit. Secondly, US dollars is the de facto global currency (as of now). Since US dollars are still being used by other countries as settlement with each other, it also means that the demand is more than just domestic. This helps prop up the USA since there is demand for dollar-denominated assets to spend their dollars on. However, once people lose confidence in the dollar, I think things can go south rather quickly. China and Russia have already been reducing their treasury holdings.

My point is that why don't we look at countries the same way we look at ourselves and companies? There is no double standard. Anything (person / corporation / government) taking on massive amounts of bad debt and not having a plan for repaying any of it back is a recipe for disaster. 

Now, just observing from my comfortable third-party point of view, let's just say if these 3 countries were stocks, I'd short Japan, avoid USA and long Singapore.

Just sayin'.

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