Only in weird government accounting does the 44 cents of economic output bought with $1 in debt count as “growth.” From Simon Black at sovereignman.com:
Exactly ten years ago, in the middle of the summer of 2008, the world was only two months away from the most severe financial crisis since the Great Depression.
At the time, the size of the US economy as measured by Gross Domestic product was around $14.8 trillion– by far the largest in the world.
And the US national debt back then was about 64% of GDP– roughly $9.5 trillion.
Fast forward a decade and take a snapshot of the same numbers: US GDP has grown nearly 35% to $19.9 trillion.
But the national debt has soared 122% to over $21 trillion.
The debt-to-GDP ratio in the United States is now 106%, meaning that the national debt is larger than the size of the entire US economy. Yet the debt keeps growing. Rapidly.
Now, debt isn’t really the problem here. The problem is the way that it’s been used.
Debt (affectionately referred to as ‘other people’s money’) can actually be a great way to enhance investment returns when used wisely and judiciously.
Private equity fund managers use debt to acquire businesses through what’s known as a ‘leveraged buy-out’, where they’ll put up a portion of the cash they need, and borrow the rest.
I did this a couple of years ago, for example, when I purchased an Australian-based business for $6 million.
A local bank offered to finance most of the acquisition with a $4.5 million loan at around 5.75%.
That meant I only needed to write a $1.5 million check for a business that was earning nearly $2 million annually.
It was a no-brainer, because I knew there would be more than enough money to make the loan payment (less than $500k annually) and still generate a substantial return on investment.
Real estate investors do the same when they purchase property.
If you have, say, $1 million, you could pay cash for a single property that costs $1 million… or you could use that money as a down payment and buy a $5 to $10 million property.
If the investment is a good one, the cash flow will more than cover the loan payments, and you’ll end up making a lot more money.
To continue reading: The root of the debt crisis: every $1 in debt generates just 44 cents of economic output