The Myth of Debt-Free Living
by Gary North
April 20, 2011
I have set up a free website for people who are deep in consumer debt.
I am a great believer in getting out from under the burden of consumer debt. But I am not a believer in getting out of debt. There is a reason for this. The only way to get out of debt is to die.
Here are two great myths of the American dream: (1) financial independence; (2) debt-free living.
Why are they myths? Because life involves both.
Finances require money. Money involves the division of labor. We are all interdependent. Even a hermit is dependent on others: the owners of the land he secretly lives on and secretly poaches on.
People say "financial independence" when they really mean "no dependence on a salary." They can achieve this if they own lots of income-generating assets. They do not have to show up at a job. But they are not financially independent. They are dependent on all those people whose productivity enables companies or governments to keep paying on the assets that the job-free people have invested in. This is not financial independence. It is independence from a salaried job. Let's keep our terminology clear.
Trust fund kids are not financially independent. They are dependent on the decisions of their trust funds' managers, who are in turn dependent on the productivity of the companies whose shares and bonds they have purchased.
In a division of labor economy, there is no independence.
Second, what about debt-free living? Why is it a myth? Let me offer an example.
FEAR OF DEBT
One of my subscribers has a problem. He must overcome his young wife's fear of debt. He wants to invest in real estate. But he faces a problem: "My wife is very risk-averse. She doesn't like debt."
She is 27. He is 32. It is clear that his wife does not understand debt. She is in debt up to her ears.
She is five years younger than he is. On average, American wives outlive their husbands by 4 years. So, in terms of statistical probability, she will have no financial support from him in her last nine years of life. If he retires early, they will live off of their savings. Then he will die, leaving her with reduced capital for her final years. She may have no capital remaining by age 80.
In those not-so-golden years, she will be physically weaker than she is today. She will probably be unable to earn money in the labor market. She will be dependent on others.
She has lifetime obligations that are inescapable: she will consume resources. That is what life requires. If she ceases to be able to work to pay those obligations, she will become dependent on others to pay. For her to think that she can safely live debt-free is to think that others are in some way in debt to her: the government, the pension fund asset managers, or her children. Maybe all of them.
She is saying that she is offering credit today – FICA taxes, pension investments, care for her children – and that these investments will pay off. If they don't, she will die in a hovel, unless she and her husband invest wisely.
Debt is inescapable for as long as we live. We will owe others whatever our support in old age will require.
We can begin to prepare now to deal with this in mind, or else we can roll the statistical dice and say, "I'll pass this debt onto someone else. I hope they pay off." In short, the person tries to get his future debt paid by others.
Politicians around the West have made promises to their entire populations regarding retirement living. They have promised voters that, in their old age, the government will take over their medical expenses. In most Western European nations, the government already pays for most medical costs.
This expense will bankrupt all nations without exception. The governments' statisticians have known this for at least two decades, but the politicians keep this hidden from public view as much as possible.
Voters are like rich, ugly heiresses: they want to be lied to. If they didn't, they would not re-elect politicians who do not publicly announce the inevitable bankruptcy of socialized medicine and old-age retirement programs. They reject any candidate who tells the truth about Medicare. In short, "Don't tell me I'm a rich, ugly woman. Tell me I'm beautiful, and you just can't live without me." Her wish is their command.
Voters do not want to save enough money for their retirement. They want to eat, drink, and be merry, and then go onto a tax-funded life-support system. They do not want to hear about "tomorrow we die." They reply: "That's old-fashioned thinking. That's mere accounting. That's ideology." They do not want to count the cost. They want their cake, and they want to eat it, well into their nineties. And they want someone else to fund it.
This desire is universal in the West. Voters look at the costs of old age, which are very high for most people, and they want to pass on the Old Maid's expenses to younger voters.
So, politicians make a promise: "Pay taxes today that fund the expenses of oldsters, and we promise to pass on the costs of supporting you to younger voters when you're old." In short, "You're beautiful, and I just can't live without you."
The voters forget the obvious: younger voters giveth, and younger voters taketh away. When the existing arrangement seems to be front-loaded with costs and back-loaded with benefits, younger voters are going to pull the plug. They are going to say, "We won't pay." In short, "You've spent your inheritance, you ugly old hag. I'm outta here."
All the talk about burdening out children and grandchildren with enormous debt is naive. Talk changes nothing. There are no revisions in the programs. When older voters hear the words, "burdening our children with debt," the vast majority conclude: "Yea! Stick it to them good and hard! We deserve everything we can squeeze out of them."
This reliance on politicians' promises will backfire on the oldsters who vote for them today and expect to be paid. The kids – all grown up – will have the votes to elect a new generation of Congressmen and Senators, who will announce revisions in the programs. The revisions will come at the expense of new entrants onto the rolls of the old-age welfare programs.
The modern welfare state began in Prussia in the 1880s, when conservative Chancellor Otto Von Bismarck got the legislature to provide government-funded old age programs. The modern welfare state will abandon those programs. The state giveth, and the state will take away.
RUNNING UP THE TAB
Oldsters think they are in the catbird's seat politically. They can get politicians to keep the Ponzi scheme rolling. They do not save as much as they should. They borrow from the future politically. They buy the good life today on the assumption that the state will take care of them in their old age.
They are running up the tab. They think that younger voters will pay off their tab.
As they get closer to the day of reckoning, they refuse to change their habits. They do not look at a retirement calculator. They do not estimate how much income they will need, and for how long, and at what rate of price inflation, to live in comfort in the last 15 years of their lives (men) or 29 years (women). Here is one. Are you willing to do the homework? Your peers aren't.
They think they are not going in debt, but they are. They think others will pick up their tab. They think they have the votes to coerce others to pay their tabs. They do have this power today; they will not have it a decade from now, let alone two decades from now.
They do not think of themselves as accumulating debts. They think they will get through old age by passing on the debts of old age to others. Because they do not understand that future voters will renounce their obligations, either openly (national default) or by hyperinflation, or by raising the age for access to collect these benefits.
They are adding to their debts, yet they do not perceive this. Why not? Because they really believe the mantra: "We're passing these debts to our grandkids." They are not incensed by its implications. They rejoice in its implications.
It started with our parents and grandparents in 1935: Social Security. The mindset of the New Deal was to get something at the expense of someone else. It escalated in 1965: Medicare. This has become the outlook of the West. It has accelerated.
China is taking advantage of this. China has no developed welfare programs for oldsters. So, their people save for the future. Their supply of capital increases. Their output increases. They are not burdened with FICA taxes. They are not expecting anyone to care for them in their old age, other than their one son. Half of them have no son.
Westerners stick it politically to everyone's children and grandchildren. The Chinese assume that they will be responsible for aged parents and themselves, so they save close to half of their income, if we are to believe the statistics provided by the Chinese government. This generation of Chinese does not expect the state to care for them in their old age. They are working hard to accumulate capital, so that they will not fall into poverty in old age. They do not expect everyone else's children to pick up their tab in old age.
REAL ESTATE AS A SOLUTION
When people ask me what the best way to retire is, I say "With a new career."
Most of them reply: "That's not what I mean. I do not want to work after age 65."
I ask them to go through the following mental exercise. First, estimate how much monthly income it would take today for them to be comfortable if they lost their job and could not get a new one.
They come up with a figure. Let's say that it's $5,000 a month before taxes.
Second, I tell them that they need about six 3-bedroom, 2-bath houses that generate $1,000 a month net income before income taxes.
It is possible to get this in some regions from a house that costs under $150,000.
Their goal should be to own six debt-free houses at age 65.
If they buy one house per year for six years, using owner-financed financing, they can then sit back and let renters pay off the mortgages.
They could buy one a year for a decade. They may want to own ten. Or maybe they can sell two or three of them and pay off the others.
This is the strategy recommended by John Schaub.
My view is that it's better to take on real estate investment debt today, when you are young, and let renters pay it off. Then, at age 65, you have a portfolio of ten debt-free houses or more. Your renters will pay you until you die.
You now have motivated people to pay your expenses. They don't pay you because they have a contract with you. They pay because they want a roof over their heads. They are highly motivated to pay your debts.
You have spread your risk. You will not be heavily dependent on government. Your children will not regard you as a burden. You will not be dependent on a pension fund, which may or may not fulfill its obligations.
We cannot escape debt. Debt is basic to life. It is therefore a question of how we secure income to pay off our debt.
Taking on real estate debt at low rates to buy a bargain-priced home is a way to build up a portfolio of houses that will provide income when you are old and infirm.
There is no escape from debt. Anyone who tells you that you can ever live debt-free has not thought through the implications of what he is saying.
It is possible to live debt-free on a net basis. You can have monthly income that more than pays for your monthly debt. But there is always the possibility that your income will disappear.
I contend that it is more likely to disappear if it comes from the government than from renters.
Gary North is the author of Mises on Money. Visit http://www.garynorth.com. He is also the author of a free 20-volume series, An Economic Commentary on the Bible.
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