Don’t let debt decide your future

You’re a young family with two kids and another on the way.

As your little family unit is growing, you decide it’s time to buy a house you can really settle into – somewhere safe and close to good schools.

The mortgage puts you into huge debt. If we consider the average Melbourne house price is $650,000 and if both adults are earning the average before tax Australian wage of approximately $75,000 ($53,260 after tax), just under half of your combined after-tax income goes towards paying it off (assuming an interest rate of 4%).

That’s if you’re lucky. Not many dual income households are earning $150,000. Research by McCrindle suggests the average household annual gross income is more likely to be $107,276.

Now let’s hypothesise a little.

Your partner works at a factory. It’s been downsized in recent years, with rumours there will be more job cuts, or perhaps an imminent closure with jobs being shifted overseas.

With your partner’s specialised skill set, the prospect is a bit of a worry, to say the least.

Your own job is not totally secure, either. You hear the words ‘dying industry’ flown around and it makes you nervous.

But with two little ones, and another child on the way, now is not the time to stop spending money – you have needs, and so do your kids. So you borrow money from your parents to make ends meet.

The situation you find yourself in is as follows: multiple debts, a family that’s about to grow by a further 25%, and relatively uncertain sources of income.

The way many people see it, your household is now a small replica of Australia’s current economic position: in enormous debt (predicted to go up another $11 billion over the next three years) and about to lose the AAA credit rating, with a future of increasing underemployment bolstered by the prospect of many jobs being lost to automation. Not to mention, a growing list of human needs and services for which you are responsible.

So far it sounds like the future is all doom and gloom, notwithstanding your love for your growing family. Yet, there must be a way forward and what is crucial is how the situation is handled now by those in power.

Letting the bust happen

Several economists believe the solution is letting a tired, propped up economy (ironically in Australia it is currently being propped up by the housing and construction industry) run its course and letting it eventually make a natural recovery in its own time – on the basis that continuous growth is simply a prevailing myth.

Treasurers, economists and large financial institutions are routinely asked how they will stimulate or maintain growth. The question of whether or not unceasing growth should be the aim or not is no longer a question, apparently.

Getting back to the analogy of the household as a mini economy – with the latest of three kids just born, it would be strange if the first question from visiting friends was, “So, how do you plan to afford baby number four?”

We don’t expect nuclear families to just expand indefinitely – after a certain point that would clearly become dysfunctional and counterproductive.

Yet when it comes to economics, we are only happy with infinite growth, and see no place for periods of contraction or stagnation.

Stimulus spending = growing debt

No government wants to be the one to carry a country through an economic downturn. Governments have used the Keynesian idea of public stimulus spending – on infrastructure, as a typical example – to hold off a recession as common practice for a long time.

It’s a bit like eating sugar as a quick energy boost. It feels good at the time, and delivers a short-lasting shot of vitality. But later, when you eventually stop, you’ll crash that little bit harder.

Many see our current situation as being like this. With the decision to lower and maintain super low interest rates, and put individuals and households into more debt, it could all be just more short-term tactics which only exacerbate the core problem.

But when the average person finds themselves facing a big debt, what’s the first solution that springs to mind?

Higher income to service bigger debts

When a financial stocktake makes someone realise they’re in serious debt, what’s the first thing they might do? Look for ways to earn more to pay it off. That’s where jobs become so important.

Of course, when stimulating the economy to avoid a recession, half the point is to avoid a rise in unemployment and the loss of jobs.

With many industries reliant on mining natural resources and fossil fuels, that’s problem number one for our future employment rates – globally, we are shifting away from fossil fuels, and the mining industry continues to remain volatile.

Problem number two is the oft-written about trend towards automation. There’s no question it’s coming, and as technology advances, our ‘test run’ with quirks like self-serving counters at the supermarket or fully computerised telephone ‘customer service’ will begin to look elementary.

Lower level and junior positions will be the first to go. But even industries like legal services will be vulnerable (here is a lawyer robot replacement already in operation).

So while super low rates have represented an open invitation for individuals and families to go into debt, we may be facing a future where there’s less employment to help people pay their crippling dues.

Why now may be the time to save

Individuals can’t control what the government does from day to day, but they can influence their own spending habits. While low interest rates present a temptation to go into debt you wouldn’t otherwise consider, perhaps remember that your mortgage, and indeed the country’s debt, will need to be paid off sooner or later. That money has to come from somewhere.

Which is fine if you can accurately predict both costs and income for the next 30 years.

But consider this: historically, there are only a few routes governments can take to pay off public debt. There’s good ol’ raising taxes, and there’s drastic cuts to budgets/benefits – both of which, mind you, will raise an individual’s cost of living and reduce their ability to pay down debt. There’s also unpopular moves like raising the retirement age.

A somewhat more desperate measure, adopted most prominently by the US, is to repay debt by printing more money. That leads to inflation, and high inflation won’t help your money situation either. Depending on how big the debt and how much money is printed, this tactic could even lead to runaway inflation.

Hyperinflation – when the real value of money decreases quickly and prices for goods and services rapidly increase – the situation spirals as people tend to spend more in an effort to get rid of their devaluing currency before it loses even more value, hence the term ‘runaway’.

So none of those options are ideal for the average person, particularly those with a young family or a large mortgage who are already working within a tight budget.

Whether the future holds higher taxes, higher costs of living or a waylaid recession that takes jobs down with it – when looking at your future, rather than a narrow focus on growth, be sure to keep one eye firmly on the ramifications of debt, too.