II pillar

There is no doubt that we are living in extraordinary times. At the end of March, the economies of the world’s biggest countries were partly transferred to a special regime and many economic sectors were more or less shut down. Those who could do so worked from home, but not every product and service can be created and delivered to customers by virtual means.

In just a couple of months, an enormous amount of value went ungenerated around the globe. This was the price we paid to hopefully avoid even greater social and material ruin. The virus has yet to be conquered, but our adversary has grown a little more familiar. And the more familiar it becomes, the less fear it creates.

Stock investors, in particular, have shown themselves to be a fearless bunch. By the end of May, the S&P 500 Index, which reflects the stock prices of major US companies, had risen from its lowest point in March by 39%, while the EURO STOXX 50 Index, which reflects the value of large European companies, saw a 32% increase.

Although the pension funds of LHV were doing some aggressive buying on the stock markets in the second half of March, I could hardly have dreamt of such a rapid rise at the time. I do not think that such a reaction from the markets is adequate, even when taking into account the support packages issued by central banks and governments to keep the economy alive, which were unprecedented in their extent.

Although the stock markets are said to be an indicator of the health of the economy, empirically, this has not been the case for at least the last 10 years. Rather, the drop in interest rates on the bond markets has indicated what kind of economic growth might be expected in the future.

The stock markets, on the other hand, have followed the logic that bad news is good news. This means that when the economy is in a tight spot, central banks and governments come up with ways of avoiding a drop in asset prices.

During crises, such economic stabilisation may be justified. The problem, however, is that the economic model based on an ever-increasing leverage effect has become incredibly fragile and even the smallest rise in interest rates could lead to an economic crisis.

Investment or expense

I cannot agree with those who argue that taking out a loan is entirely self-evident and suppose that money borrowed today will basically never have to be repaid. I think it is dangerous to forget the wisdom of our parents: loans belong to others.

Taking out a loan in order to consume more now implies restricting consumption in the future, which is irrational. If everyone were to act in this way, it would mean a swift increase in wages today and serious unemployment tomorrow, should future consumption decrease more or less by the same amount previously spent.

Money should only be borrowed for investment, and this too only when the return on the investment will be higher than the interest payable on the loan. Otherwise, it reduces our full income as well as our wealth. In theory, this is easy to understand. In practice, however, the problem seems to lie in the fact that investment is rather a vague concept.

Flippant, careless and arrogant attitudes towards borrowing are further exacerbated by the fact that loans can be obtained with growing ease and lower interest rates. Can a cottage which stands empty for most of the year, requires heating during winter and work from time to time and on which land tax is payable be considered an investment?

Travelling and studying broaden our horizons, and offering self-development opportunities to youngsters assists in moving life forward, but is investment truly the right term for such activities? Not every good deed will bring in more money than is outlaid on it. Yet to make it possible for us to take any good and morally right actions, we must also be economically prudent.

How are your balance sheet and cash flow looking?

In light of the above, not every expense qualifies as an investment – only the allocation of funds preceded by a comprehensive cost-benefit analysis can be considered one. I suspect that companies conduct such analyses more thoroughly than individuals or governments.

This can already be seen in the fact that companies prepare an income statement, balance sheet and cash flow statement at least once a year. Governments do prepare a state budget, but I have not heard of them making any effort to put together a substantial balance sheet.

Many individuals do not analyse their expenses at all and spend as much money as they have in their wallet and bank account. The heavier the burden of debt, the more important it is to monitor your balance sheet and the movement of your money (i.e. your cash flows).

In today’s rapidly-changing world, is a professional higher education diploma in, say, business management which is acquired with a student loan of any value if there are no specialist jobs to be found? Is a hospital, half-empty due to a lack of doctors and financed by credit, an asset or a liability?

A situation where the value of assets falls below the cost of liabilities is called bankruptcy. A situation where there is not enough income to service loans is called insolvency.

With growing indebtedness – even if interest rates are low at the moment – comes a higher risk of bankruptcy and insolvency because liabilities (loan amounts) are usually fixed, but asset prices can fluctuate enormously.

When interest rates are at a historic low, it is also dangerous to ignore the fact that such a development is in no way an indication of accelerating economic growth or recovery.

Presumably, it is also a sign of the times, exceptional as they are, that the most powerful country in the world is being led by a man who has declared, “I’m the king of debt. I love debt!” and whose CV lists the bankruptcy of four of his companies. In spring 2016, when then presidential candidate Donald Trump was asked about the future servicing and repayment of US government debt, he gave the following answer: “I would borrow, knowing that if the economy crashed, you could make a deal.”