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Sep 10

Government Deficits, Debt, Bankruptcy and You!

Governments around the world are facing spiraling deficits and growing debt – even bankruptcy.  We are facing a global fiscal crisis that threatens our way of life.  Why is this happening? What can we do?

A Government Debt Problem?

We are living on an inordinate amount of debt.  Our lifestyles are being paid for with credit cards with ever increasing balances and interest charges.  It simply cannot go on indefinitely.  Someone will have to pay for all this (the debt and the interest) at some point.

In some ways our forty-year long spending frenzy reminds me of the last days of the Roman Empire.  We are sitting around eating peeled grapes in our togas while the barbarians are banging at the gates demanding peeled grapes.  We seem oblivious to all of the very obvious warning signs that we simply cannot lay around eating peeled grapes by ourselves all day.  Who will pay for all of these peeled grapes?  We all will, eventually, but our children might face the most dramatic price.

This problem is not localised to Canada (where I live); it is a worldwide crises of overindulgence and selfishness.  Look at the recent government debt crisis and rating downgrade in the US, the seemingly endless stream of bankrupt governments in Europe; the list seems to get longer and deeper red each and every day.  Quite simply, we are spending more than what we have.  The debt collector is coming and we will have to pay for all this stuff eventually (or have it repossessed).

Investing in our Future?

Almost invariably, I hear politicians talking about “Investing in our future”.  They say it because it is an easy sell.  Who could argue with investing in the future?  The problem, however, is that this always means the government spending more money (on top of an already out of control amount of existing debt).  Since when does spending more money that you don’t have equal an investment?  Since never.

I would be a strong candidate for the most-financially-irresponsibe-father-ever award if I said, “Well, my debt is already out of control from overspending on stuff I can’t afford.  I think I better get those awesome new rims for my Ferrari while I still can. I’ll just pass the debt on to my children.  In any case, someone else will pay for it.  At least I’ll get that upgrade that I’ve been dreaming about for eleven minutes”.   I am not being flippant here.  This is precisely what we are doing (or allowing to happen).

Deficits and Debt

There is often some confusion about the difference between a deficit and a debt.  We have a responsibility to understand both so that we can make informed decisions and take responsible actions.  I’ll try to explain the difference this way:

1)  Imagine that you have a new credit card (this will not be too hard to do for most of us).

2)  Now imagine you go and charge some stuff on it after you get it.

3)  The end of the month comes and your bill arrives.   If you pay it all off at the due date, you do not have a deficit.  If you pay less than the full amount, the amount of your balance that you did not pay is called a deficit (you are spending more than what you can pay for).  This deficit becomes a debt that you will have to carry forward to the next month.

4)  The following month, you charge some more items on your credit card.  The next bill comes.  On it, you will have all of your new purchases plus the interest charges from the previous month on your outstanding balance (your debt).  Pay it all off and your deficit and your debt are now zero.  Pay off only a portion of your new purchases and this is another deficit which again gets added to your total debt the next month.

5)  Run a deficit each month and your debt will add up very quickly.  You will be responsible for an increasing amount of interest charges each month.  This will reduce the amount of credit that you have available to you on your credit limit and take away your hard earned after tax dollars with increasing interest charges.

6)  Keep this cycle going each month and your credit limit may soon be reached (like what recently happened with the US government).  At this point, you either need to negotiate an increase in your credit limit (like the US government recently did) or declare bankruptcy (like the governments of Greece, Portugal, and Ireland have come perilously close to).  None of these options are really great for your credit rating and a reduced credit rating means that lenders will charge you even higher interest, thereby increasing the turbulence and momentum of the downward debt spiral.

Interest Charges on Our Debt

Interest is what we or our government pays for the privilege of borrowing money from others.   One of the biggest problems we face is that the interest on our debts (personal and governmental) reduces our monthly cash flows and reduces our ability to spend or save our money in other ways.  This can really have an impact.

Look at the Government of Canada, for example.  The irony here is that I keep hearing about how great the Government of Canada is at managing its finances and that everyone else should look to Canada as a role model for fiscal restraint and responsibility.  Let’s take a look at some highlights (or perhaps more aptly named, lowlights):

Government of Canada Spending (2009-2010_

The Annual Financial Report of the Government of Canada Fiscal Year 2009–2010 shows us the enormous costs of debt.  Take a look at public debt charges (they totaled about $30 billion dollars) or approximately 10.7% of government spending.  Interest charges alone were significantly more than the costs of national defense (about $21 billion dollars).  In short then, our entire military budget plus about another $10 billion dollars (roughly the cost of all federal children’s benefits) are being paid for on our government credit due to the cost of interest on national debt.  That’s right!  We are paying for all federal transfers that benefit our children and our entire military budget with money that we do not have.  We are putting these expenses on our government credit card.

Each new budget deficit will only add to this debt and make our ability to pay for things even more difficult as interest charges continue to eat up more and more of our income.  This is very concerning to me as a taxpayer who will retire one day and as a father who has a young daughter (I can’t help but wonder what will be left for her?  What will be our national legacy for our children?).

Spending Our Way out of a Recession

I worked in the financial services industry for a number of years.  I have taken a wide variety of financial planing and financial industry related courses and consider myself to be reasonably knowledgeable about money stuff.  One of the key components of a personal financial plan is to establish an emergency fund (normally about six months salary).  This emergency fund is there to help you to get by in the case of an emergency (e.g. after losing your job, a serious heath issue, etc.).

One of the things that is disturbing about how many governments operate is that there is never any emergency fund available.  Governments simply borrow more money when they need it (taxpayers are picking up the tab after all).  This is, perhaps, not at all too surprising given the way that politics works.   What politician would be intelligent enough and brave enough and foresighted enough to state that they will be making cuts (and/or taking a rare surplus) and putting it in the bank for a rainy day?  The public outrage would so incredible and they would be sealing their own political fates and that of their party.

The cyclical nature of the economy should come as no surprise.  We all know that there are times that things are going well followed by times that things are not going well.  As national stewards, our governments have a responsibility to accept this and to prepare for it – period.

In this sense, we have mostly ourselves to blame.  We get the government that we deserve.  Insisting on more services and benefits while, at the same time, demanding that we pay less taxes is nonsensical and incompatible with the reality.

Ironically, however, it is the citizens that are ultimately responsible for national debts.  We are simply postponing the inevitable.  All of our stuff will have to be paid for eventually.

Avoiding a Crisis

Be Informed

Understand deficits and debt and how debt can lead to very serious problems in the long run.  Take the time to research how your government gets its money and how it spends it.  Hold them accountable.

Think about the Future

Debt needs to be repaid.  Either we pay for it now while the problem is more manageable or postpone paying it and face a much bigger problem later on (which could also very well become the problem of our children).

Expect the Best

Accept the reality of our debt problem and work towards finding a solution.  Think about ways to do things better and share these ideas with others and with politicians.  Instead of only asking about how a politician plans to make your life better or lower your taxes, also ask them what they plan to cut or how they plan to do things better in order to reduce our deficits and ultimately our debt.   Politicians need to be made aware that responsible spending is a top priority so that we can continue to afford the things that we value in the future.

A Pipe Dream

I would also be amenable to paying off my portion of the national debt (approximately $17,000 dollars for each and every Canadian) right now, if it meant that I would no longer need to fund this debt with my taxes.  A pipe dream, I know, as the government relies on my continued tax paying ability as collateral for future loans (in order to fund its debt).  Nonetheless, I do like to dream sometimes.

Prepare for the Worst

I hate to say it, but I do not see how Old Age Security, pensions, health care, and education, etc. will continue to be affordable in the years to come (not that they are affordable currently).  The proverbial poop will hit the fan sometime.  It is my view that it is the least politically active and vocal that will pay the price when most dramatic dramatic cuts will need to be made.  I am planning my finances with the idea that many of the government services that we receive today will be greatly reduced and/or even eliminated as I get older.  I also acknowledge that increased tax pressure may also be put onto me later in life in order to pay for those who did not plan with these things in mind.  I figure I’ll need to save about $60 billion in order to fund my retirement so I visit froogalism.com each and every day.

In Summary

We are facing government debt crises around the world because we have taken too much for too long without paying for it.  We have borrowed this money and continue to do so.  This type of problem is prone to snowballing and it is very concerning both for me and the future I envision for my daughter.  We need to acknowledge this as a problem and take concrete steps to fix it even though it will be uncomfortable and painful and no one wants to be the generation to pay for the excesses of another generation.  I understand this, but also acknowledge that the problem is still there and that it is growing.  We and our politicians need to act responsible and do the right thing.

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I also wanted to remind you that froogalism.com is offering a free $25.00 gift card for Amazon to all of its readers from the US or Canada.  All you need to do is link to my site on your website (read all of the details here).  Savings and free stuff?  Yes, all of this and more is yours at froogalism.com!

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