I am leveraged (via my mortgage) about 600% of my GDP (yearly salary). This seems realistic for me, why is it not realistic for the government? Especially when the government's spend directly correlates with their future income.
Not saying that 356% is bad, I’m not an economist, but just because you’re leveraged higher than that on a mortgage tells us very little about whether or not 356% is bad or not.
For certain it matters what that government debt is going to pay for. Debt for infrastructure (and therefore future growth) is quite a bit different than debt to finance consumption, for example.
and so that one person who would really prefer a particular house/location (because it's a great house/location) would pay just a little bit more and guarantee that he/she gets it.
Guess what happens then?
Every single asset class has experienced significant inflation over the last 50 years. Banks created 30 year mortgages because of demand. Demand occurred as a result of actions by the federal reserve. The FHA, not really a bank but rather a government entity, started the trend.
I suppose 'bank' can be bad shorthand for mortgage lenders, but whatever.
There will always be people rich and liquid enough to buy houses in cash without ever involving a bank.
It includes private sector debt as well.
If total government debt was 356% of GDP, we would be in huge trouble. Fortunately that’s not what this number indicates.
Again, maybe it’s good and maybe it’s bad. But we can’t tell that by making analogies to a single mortgage. They’re just different beasts.
Could you ELI5 why? Is it because we wouldn't be able to keep up with interest payments on the debt given the fact that we're actually already cash flow negative as is?
"Lifestyle" in case of government spending being the levels of healthcare, education, social services, war, tax & tariff rates, capital controls, etc.
If you don't want to be crushed by interest payments, eventually you'll need to pay up, and that means inflation, possibly hyperinflation, and a crash of a lot of systems that we take for granted.
I don't understand where this belief came from. Even standards/orthodox/right-leaning economists agree.
Unless the US is suddenly also incapable of producing (and this is impossible), you won't ever have hyperinflation even if the fed did twice the QE they are already doing only to reimburse US gov debt.
Printing ever-increasing amounts of money to finance expenditures that you can't afford will definitely result in correspondingly huge inflation. I don't know if it will qualify as hyper, but you are very much not going to like it.
We could be printing 10x money that we are printing now. We aren't, and we're not short of paper. There's a very real cost to increasing money supply – by printing, QE, or whatever fancy names you call it – even if many people don't realize it yet.
As long as asset inflation is seen by the general population as "stocks / housing are going up, therefore the economy is booming" we have a chance to maintain the illusion of normalcy, but eventually enough people will catch on where the real inflation numbers are hidden, and it's not gonna be pretty.
Inflation is not driven just by economic fundamentals, it is just as much driven by people's expectations, and trust in the system. Economic models assume rationality, which, along with trust in government, is increasingly in short supply, and that is an economic problem as much as it is a social one.
Can we - all of us - graduate a bit in our sophistication here ?
I agree with your statement and don't need any of this explained to me - there is, in fact, a too-simplistic, oft-made analog to personal, household finances. People would do well to understand what governments (particularly sovereign issuers borrowing in their own currency) can do that they, in their household, cannot.
Yet at the same time, I grow tired of the pedantic scolding of the "dummies" that don't understand modern finance.
I - a relatively sophisticated, learned observer - have a hunch that at the very margins government finance collapses all the way back down to the simple rules of household finance.
I hope to never be vindicated in this hunch ...
On what exactly do you base this hunch? Because it hasn’t held true, ever.
Argentina has given us two examples of it just in the last 20 years. Not a perfect example as the Argentine debt was not denominated in a currency they could print ...
I would further point to the "Nixon Shock" as an example where a country (the US) that can borrow in its own currency was forced by (global) economic realities to undertake what some would label a "soft default".
I am on my way to lunch and am limited by what comes to mind in just this fleeting moment - I beg your pardon for my dearth of examples.
[1] https://en.wikipedia.org/wiki/Nixon_shock
[2] https://www.livemint.com/Money/57inMm5EbLi1soOnOrMk1J/Did-th...
If Activision-Blizzard borrowed its debt in World of Warcraft gold, they would never be in default. The same applies to countries that print their own currency.
I hope we can indulge one another with such things here.
I believe that in the very long run (many decades) the growing debt cripples the the government, hurting its productivity along with trust on its proper functioning. (Japan, Italy are around here)
Growing debt is not a good sign even for governments, unless the money goes fully into investments for the future. Many times though it goes into liabilities.
Eventually, currency gets hurt and global capital moves on, leading to its failure. There is always competition, other govs might be doing things a little better.
In this situation, its "I'm able to do this, so why not the government?"
On the flip side, I’d argue that mortgages and personal finance in general doesn’t tell us much about how governments should treat debt. The nature of government debt, how it’s financed, and what it’s used for is just so different from personal debt that any analogy between the two gives us very little information.
What's so special about 1 year that a government shouldn't borrow more than 1 year of GDP? Why not ten years or 1 month?
Government debt on the other hand is uncollateralized and "secured" by two intangible things: tax receipts and central banks. Taxes are obviously a significant headwind for economic growth, and while necessary, should be as low as possible. So increasing taxes is not desirable. The second way is through inflation vis-a-vis Central Banks (so called debt monetization). Inflation is an implicit tax on everyone, and as we know, like taxes, too much inflation is a very bad thing.
Governments have three ways to retire their debt, and all are pretty bad: 1) they can raise taxes which impedes growth and done in the extreme can cause a recession, which then reduces taxable income in a negative feedback loop 2) they can debase their currency causing inflation so that the money they have to pay back is worth less, which is also really bad when done excessively 3) or they can either default which unlike your house, is catastrophic because there is nothing for creditors to repossess
And the above is without getting into the topics about utility: your house will provide utility for decades whereas most debt has been accumulated to fund social programs which need continuous funding, unlike your house which is funded once and amortized over decades.
What does this mean for our deficit long term? Does the deficit even matter? To what degree? Everything you said is true. It makes it seem like we will most likely never live in a time where the government is cash flow positive (some kind of surplus that is used to pay down debt).
But very little reason to retire debt; there are arguably good reasons to try to manage the debt-to-GDP ratio within broad parameters over the long term, but mostly that is about trying to constrain the long-term growth rate of total debt below long-term economic growth rate, not reducing debt on an absolute basis.
It is possible for the debt-to-GDP ratio to be sub 100% and a financial ecosystem to be on the brink of collapse because the people borrowing the money earn too small a share of GDP to repay, and it is possible for the debt to GDP ratio to be well over 400% whilst consisting entirely of people borrowing money to make sensible, easily repaid long term investments. The reality is somewhere in between.
Second, a mortgage is a secured loan used for capex: You have borrowed a lot but you used that money to buy an assert worth as much or more so your personal balance sheet still looks fine and the lender can repossess the asset if you don't pay. Basically for debts you need to look at 2 things: balance sheet, i.e. how the debts/liabilities stack up against assets, and cash flow, i.e. whether you can service the interests on the debts.
The issue with government borrowing is that it is largely used to finance a level of spending that exceeds income. So instead of a mortgage I think a more apt comparison with personal finance would be if you used your credit card to finance a life style above what your income allowed. The difference is that governments can get away with much more of that than individuals can, but it will still come back and bite them at some point.
The fact that a home goes up in value over time does not seem natural to me.
In 30 years time, won't people prefer to buy a house that is 10 years old, compared to one that is 40 years old?
Why is it normal that housing prices go up?
Land is finite, and becomes more in-demand as the population increases. When homes appreciate in value over time, I reckon that's mostly the result in land being more in demand and/or asset inflation.
Don't forget the other part I mentioned: asset inflation (here the asset is the land and structure). Money supply has grown over time: https://fred.stlouisfed.org/series/M2
That makes sense.
But then other investment vehicles should also do fine.
I suppose it then comes down the fact housing can have a higher leverage than any other investment vehicle.
So buy a house, but don't pay it off.
Anecdote, but illustrative: Myself and a friend bought houses in 2020 of comparable size. My friend bought a build in a new neighborhood (technically put the money down in '19), I bought a 30+ year old house in an older neighborhood.
Thanks to COVID, none of the businesses to support that new neighborhood actually materialized. My friend has to drive to the nearest convenience store, and has to hop on the highway to go to any other business. I can (and do) walk to my local convenience store, pharmacy, grocery store, pizza joint and mechanic. And I can bike or e-scooter to various parks, restaurants and healthcare.
Accordingly, my old fixxer-upper of a house is worth quite a bit more than my friend's brand new house.
Land prices go up because the desirable land (land given value by its qualities, whether inherent or through value added through improvements) becomes more desirable.
Land prices also go up when money is cheap (low interest rates), as do other assets. In those circumstances, house prices (the house, not the land) will depreciate slower than usual because having a deteriorating house is better than having cash.
Note, the government will do anything to support housing prices because voters and homeowners heavily overlap.
- Mortgage deduction on taxes
- 0% interest rates
- Bailing out lenders
- Heavy zoning that has made new apartment buildings somewhere between impossible to uneconomical to build.
- In CA we have P13 to further limit supply.
Housing prices going up, even in a pandemic are not a surprise.
For about a year I dated a forensic accountant with a Ph.D. whose job it was to untangle and uncook books. We got on the subject of mortgages. She said you should never buy a home that costs more than double your yearly salary. If you make $60,000 a year, as she made when she bought her home, then you can afford a $120,000 home. If you make $100,000, then you can afford $200,000.
Entirely too many people, including apparently you, are severely overleveraged on their home loans.
There's absolutely no scenario where your situation makes financial sense to people with in-depth financial education, who are also not beholden to what we've come to accept as the "norm" for financial services.
The reasons she listed for this are myriad. 1) You have to save for retirement. Most people usually do this in the form of stocks, bonds, ETFs, etc., 2) you have, or should be, putting away a minimum of six months of your income in order to survive a job loss, and she recommends at least one-to-two years for people with advanced degrees (M.A., M.S., M.B.A., etc.) because the average time it takes to find another position for advanced professionals is something along the lines of 8-9 months, 3) you have other expenses such as your auto loan or loans, food, insurance, etc., all of which costs money.
Those are only some of the many areas of cost that she and I discussed while we were dating.
There's absolutely no amount of money you can make where your 600% figure makes reasonable financial sense... even if you make $1 million a year, you're still in a $6 million home. Hell if you made $10 million, that's a $60 million home. After taxes, there's still no scenario where that makes good financial sense.
Lastly, I don't want you to think I'm personally attacking you - there's a lot of people in your boat, but its a boat in which no one belongs. These levels of debt are dangerous... the 2008 financial crisis proved that.
Getting a home for 2x your household income is basically impossible in this day unless you’re one very lucky remote worker who enjoys living in the middle of nowhere.
I’d say the upper threshold of 4x your annual income is where you’d likely want to throttle back. Any higher, you’re in very high risk or can’t afford it. But trying to get a home for below 3x your income? Basically impossible for most people.
What about the opportunity costs? Buying a cheap home makes you miss out on market appreciation dollars, has less rental value, is likely in an area that has a higher likelihood of impacts from market downturns, etc.
Also being an ultra cheap-ass has opportunity costs such as costing you personal relationships.
Using your analogy, the rule of thumb in real estate is that a property shouldn’t cost more than 356% of your GDP (yearly salary). Said another way, your mortgage is no more than 28% of tour gross monthly income.
Same with requirements for large downpayments (20% traditionally) - more skin in the game for the buyer, along with more cushion for the bank to make their money back if the market is down when a default happens.
Thinner margins, higher leverage happens near the top of debt cycles (typically) as lenders get desperate for return, and amp up risk. The type of leverage it allows also inflates asset prices, as money is 'easier' and people who want asset x can leverage higher to get it, increasing demand.
If you make $100,000 a year, you can't afford a $600,000 home. Too bad, so fucking sad. More people need to be told this, by everyone down the line, from their bankers to their parents.
And you're making far more tradeoffs than just three holidays per year, the nicest food, etc.. That level of debt means you miss out on investment opportunities when they present themselves. GameStop might have been one of the most recent and dramatic ones I've ever seen. I wish I had known about Roaring Kitty / /u/DeepFuckingValue a year ago. I've been looking for some investment vehicle to park a significant sum for awhile now. After watching his videos, I would have easily dropped $25,000 there. Unfortunately I didn't know about it. But what's even worse is knowing something is going to take off and not having much - or even worse, any - money to invest.
When Facebook IPO'd, I only had $10,000 to invest, but I was able to purchase for $18.50 per share. Would that I had had $100,000...
(in this situation GDP is more like the value you create for your company whereas salary is like tax revenue)
if you manage to pay of your debt, and then end you own an asset that is presumably worth more than the total of all your payments - so for you that migt make sense.
If you owned 600% of your personal GDP and all you were doing was buying food and booze - i.e. current consumption - that would be a HUGE problem.
Problem is most of the debt that govt is taking on is of the food and booze variety - i.e. spending money on things that will be consumed today, and counting on future generations to pay for your poor choices.
At the macro level, it's not about governments per se, it's about demographics.
Govs have some effect, e.g. car seat regulations lowering the birth rate in the U.S., but legislative/regulatory priorities reflect the wider culture.
It's also a correlation study, and I'd hesitate to quote it as fact currently.
As an example, the US federal budget is under $5 trillion, US GDP over $20 trillion (getting a good view is extremely difficult, as states, counties, cities, etc. also have income, and borrow money, and that situation differs by country)
The government has nothing to sell.
Better analogy is that you have 600% GDP in student debts, and you don’t have a realistic plan to repay it because you studied liberal arts.
Governments have assets and the legal right to others’ assets (e.g. taxation).