/ 29 July 2011

America’s raison d’etre: Raisin’ debtors?

America's Raison D'etre: Raisin' Debtors?

Although far removed from many a South African’s radar, the decision about whether the $14.3-trillion United States debt limit will be raised is a matter of global importance — offering simple lessons on basic finance.

As the world holds its breath while Democrats and Republicans continue to duke it out over America’s debt, opinion remains divided over what the crisis means for the global economy.

If the US ends up defaulting on its debt it may not mean the end of our financial reality, analysts say, but it will shock a global market yet to recover from the worst financial crisis since the great depression of the 1920s. Whatever Americans do next might determine the globe’s financial course of action in the future.

Yet what should be a case of doing what is best for the country has instead turned into a game of political football, with both Republicans and Democrats trying to score points ahead of the 2012 US presidential elections.

But as the high-brow economists at home and abroad grapple with the facts and figures, the man in the street is left scratching his head thinking: What does this all mean?

Family matters
Perhaps-the easiest way of explaining this potential disaster is the analogy of the debt ridden family.

Imagine a family of a mother named Deborah and a father called Ralph, with two children, that borrows $100 000 to fund their household expenditure.

This spending includes everyday expenses as well as things like medical insurance and long-term projects such as home improvements.

When the loan is taken they have enough money coming in to fund their repayments, and the family keeps paying their monthly installments in good faith.

As is the case with most families, the children are very different to each other. The first child — let’s call her Jane, is independent and careful with her money, while her twin brother Jim is quite the opposite, blowing his cash at the drop of a hat and is still pretty dependent on pocket money from his parents.

But then disaster strikes: the family falls on hard times, and suddenly they don’t have enough money to service their debt.

At first everyone seems to be in a bit of denial, as everyone carries on as before, but dipping into their various lines of credit to finance their daily expenses — and even fund their repayments on the original loan.

But eventually Mom and Dad finally realise they are going to have to have a sit down to decide what they can do to get themselves out of their financial quagmire.

They must decide whether to borrow more and refinance the indebtedness, or cut down on expenses?

Ralph believes the family needs to cut back immediately, everyone must tighten their belts and stop forking out for non-critical expenses. In particular, this means no more extra money for Jim. He’ll just have to suck it up like everyone else.

Deborah, on the other hand, wants to remortgage the house to make sure keep everyone can continue to meet their financial obligations — including Jim’s extra allowance, and his medical insurance and so on.

Ralph thinks Deborah is talking crazy — arguing that it’s madness to pay debt with even more debt, even though they did so a couple of years ago when they needed to fund a hunting trip he went on.

But Deborah feels that by not borrowing more money they will have abandoned Jim and possibly Jane too, if she ever needed help.

There goes the neighbourhood
So if you have been following the debt ceiling crisis at all, you would have picked up that Ralph and Deborah represent the Republicans and Democrats respectively, while Jim and Jane signify the different parts of America’s voting constituency – those dependent on government funding or support and those who are relatively independent, financially.

Throwing this into the global context of how the rest of the world is affected, one might say it’s akin to the richest family in town going bust and their property value plummeting, dragging the rest of their street’s prices down with it.

The problem with this analogy is that it wouldn’t just be the value of one street of an international neighbourhood potentially being dragged under. If America defaults on its debt, the whole world will be rattled by economic aftershocks.

We’re good for it
But, while it’s safe to say there is a chance the US won’t service its debt in the short term, it would be foolhardy to bet on the Yanks failing to repay their debt in the long run.

With an economy that still dwarfs the surging dragon of China and roaring tiger of India, a little default along the road won’t necessarily mean the end.

Referring back to Ralph and Deborah, if they have a decent enough record of paying their debt back (like the US do), not being able to pay your mortgage and other utilities for one month doesn’t automatically result in a couple of heavies arriving at your door to break your kneecaps.

So like most people will experience in their lives — missing a payment on their debt won’t be quite the calamity some have made it out to be.

The only thing that is certain when that happens is a drop in your credit rating, something that debt rating agencies have threatened to do if the US defaults — dropping them from AAA to AA. There is even a thought that a default might allow for a positive outcome, with the US and the world realising that world’s biggest economy is not invincible.

Keeping up with the Joneses
From a South African perspective, the immediate lesson to be learnt from this is how we should not allow our finances to get out of control.

Just as we would take heed from the lessons we could learn from our neighbour going bust and losing everything, South Africa needs to take note that living beyond its means does not work in the long run.

While there is no Ralph and Deborah in South Africa’s picture, rather just a singular powerful parental figure looking after our own Jannies, Lindiwes, Racksas and Bronwyns; it remains true that pandering to their every request for an allowance increase doesn’t help.

Especially if those above-inflation allowance increases are only given to the few children who already have a means of support, while the majority of their siblings are left to live on the scraps from their brothers’ and sisters’ tables.