If you have Rs.100 in your pocket, then you cannot spend Rs.200. It’s very logical, right? The good news is that today’s world is no longer logical! It’s indeed very easy to spend more than what you have. But it’s equally important to analyse the cost of this extravagance.
A country spending way beyond its means will surely have a far greater impact than a school kid overshooting his pocket money. As the scale of this lavishness increases, the following two distinct trends are observed:
(1) The system of financing the gap becomes more and more complex
(2) The person spending gets more and more distant from the one paying for it.
Let us now see a few examples to understand fully how this evil system works.
A child and his pocket money
A school-going child has Rs.1,000 as pocket money savings and wishes to buy a video game DVD worth Rs.2,000. In a normal scenario, the child will comfortably make a gullible puppy face in front of the elders (technically may be called ‘financers’) and get the money. The advantage of being a child is that he rarely has to return it back. The amount involved is relatively negligible and the ones affected are close family members, pretty harmless.
Credit card — The prodigal’s best friend
Generally, anyone who wants to spend, what he is yet to earn uses a credit card. No doubt, when used wisely, a credit card is a wonderful source of free credit, but sadly, not all are wise. According to RBI, 1 in every 10 credit card holders defaults on payment. As of March 2011, there were 1.8 crore credit cards with average spending of Rs.41,862. Thus, we can estimate the defaults, at 10% of spending, to be Rs.7,536 crore.
Now, who pays for these? For the defaults made good by the customers, he pays a whopping 36% interest. But if he is unable to pay, the bank has to write them off. The real pinch is felt by the private shareholders of these banks and the government in case of nationalised banks. Not to forget, the management where the remuneration is linked to the profits, also feels the heat.
I owe you money? . . . Oh! Sorry, it just went down the drain . . .
Jean Paul Getty said, “If you owe the bank $100, that’s your problem. If you owe the bank $100 million, that’s the bank’s problem.”
No statement explains the paradox better! When huge corporations do business with others’ money, it’s not them but the lenders who have to worry about the state of business. One of the most recent examples is of a ‘reputed’ airline company. According to a leading broker’s estimate, the debt exposures of that particular airline company maybe a whopping Rs.10,000 crore. Using the corporate veil, the management will safely escape from the liability they have created. So, the ones ultimately shelling out Rs.10,000 crore may include banks, shareholders and creditors. Imagine thousands of crores going down the drain, in times of monstrous rise in cost of living and record high interest rates!
Banks going bust!
It’s not always that the banks that are on the losing side. Some clever devils in dark suits manage to pass on their mistakes to unsuspecting investors. Since banks are traditionally considered conservative, and people like you and me, easily fall for such dud schemes. And soon the bubble bursts, in turn, making everyone burst into tears. Take the example of the most monumental fall of recent times, the Lehman Brothers. With a debt equity ratio of 35 to 1, it was a ticking time bomb. Its debt was close to US $613 billion at the time of default. The damage does not end there. Bail-outs and stimulus packages followed the 2008 crisis from which the world has still not fully recovered. The total impact of the whole global economic crisis has cost trillions of dollars, millions of jobs and countless hungry stomachs. Consider this; the family of a jobless daily labourer has to go hungry while the ones responsible for overshooting their means enjoy barbeque parties in lavish bungalows! The ones suffering include creditors, shareholders, governments, taxpayers, citizens and the list goes on.
What is bigger? Bankrupt countries!
Greed has no limit. What happens when governments spend beyond their means? Countries go bankrupt! Some casualties include Argentina, Zimbabwe and the latest one, Greece. Greece had pushed very hard to enter the European Union so that it could use the Euro to borrow cheaply. The interest rate it used to pay on its borrowings before joining EU was 10-11% which fell to 3-4% immediately after adopting Euro. So, it kept mounting debt. Before it could repay the old one, it took a new, bigger loan. The proceeds were not always used to repay the old loan, but to fund their spending spree. It should be noted that the pension entitlement in Greece is around 92% of last salary that too at a time when Greece has a very fast ageing population. Since the adoption of Euro, the average wage of public sector workers doubled. These, along with large-scale tax evasion are some of the reasons for the mess this country finds itself in. Portugal, Spain and Italy too are sitting ducks. The impact of this looming crisis shall be more than anyone can ever fathom. Ripples of this crisis shall affect billions of people and deeply hurt the global economy.
Conclusion
Credit is the reason any business or economy runs. However, if you cross your limits, the impact will be felt at places and by people beyond your imagination. The only way to prevent such damage is by knowing your limits. We should not confuse limits with restrictions, no one likes restrictions! However, by setting budgetary limits we can ensure no one suffers. For articles like us, it has to start by managing the whole month’s expenses within the stipend earned. Being a disciplined money manager is not the job of the faint hearted! The whole marketing world is conspiring to raid our wallets. It is for us to protect it and keep the spending within limits. Yes, tough task!!
