It looks to be another roller coaster week in the stock market amid ongoing fears that Greece will soon default on its debt and that the situation in Italy is worsening, with no easy out in sight. Of course there are other factors that create volatility in the market now, but the European debt crisis magnifies the ongoing issue we have with debt in this country and in our own personal finances. What can we learn from this expanding global problem? To me, the events in Europe are sending us two very critical messages.
The first message is the inevitable damage that comes from being in debt and how critical it is that you are debt free. The second message is that you absolutely must depend on nobody but yourself for your future, certainly not any government. Certainly not our government.
Sound extreme? I don’t think so. The good news is that you can control your financial future. Do the right things, the smart things, and you will be able to shape the life you want to live. It is up you to take control and it is imperative that you start now.
The Destructiveness of Debt. Debt is an addictive thing and rationalizing living beyond your means is far too often a ticket to disaster. When it comes to debt, the price must eventually be paid, the bill will become due whether it is a person or a country. When that bill comes due, it is a price that nobody would wish for—a declining quality of life and a tomorrow no better than today, but worse, often much worse.
To me, the clearest message from this debt crisis is that if you have any debt, that you should get rid of it. Now. It’s an achievable goal and over a million people do it every year. If you have any debts other than a first mortgage, make 2012 the year they began to truly get rid of it once and for all. It will be one of the best things you ever do for yourself and for your family.
Depend only on yourself. This is not just a European problem. We will inevitably be facing the same problems right here. The unavoidable fact is that there is no way our government can meet its future obligations and that you absolutely must depend on yourself to save and provide an income through your retirement years.
Right now the interest on the federal debt eats up 14% of federal revenues, an historically high number. By running a huge deficit we’ve been able to make the payments, but there’s a time bomb built in. The 14% is based on a current interest rate of about 2%. There is no way that rates will stay at that level. Historically, normal long term interest rates are closer to 5%. If rates go to 5%, that alone would mean that the current federal budget of $3.7 trillion, a budget that already has over a trillion dollar a year deficit, would have to be cut by 20% just to cover the increased interest payments. That’s a 10 year shortfall of $7.4 trillion as compared to the current struggle in Washington to come up with $1.2 trillion in cuts over the next 10 years.
To make matters worse, what we see in Europe is that as the risk increases that those governments may not pay 100% of what they owe, the interest rate on their debt becomes a lot higher yet. (Even in the current 2% environment Spain is already at 5.5%, Italy at 6.2%, and rising.) The end game is inevitable. The country involved either pays a lot less than what it owes (Greece today is at 50% or less) or just defaults outright, as many countries have in the past.
So what will our government do? I see two options and personally I think they’ll do both. The first is to encourage inflation at some point and use an inflation index for what they are supposed to pay that is less than the true inflation rate. It just so happens that this very thing has just been proposed today in Washington.
The second option is to index all entitlement programs—Social Security and Medicare, perhaps even government pensions—and index them heavily. Indexing, in short, is the more you make, perhaps even the more money you have saved, the less you will receive from the program. Medicare is indexed now. Make enough money and you pay up to twice as much and more. Going forward, the cut-off numbers, and your benefits, are unavoidably going be a lot lower, as the government cannot come anywhere near to meeting its obligations. A similar structure is bound to be the future of Social Security as well.
To prevent the kind of civil uprisings like we’re now seeing in Greece, our government will have no choice but to see to it that everyone eats and has basic medical attention. When they do there will, quite frankly, be very little left over. If you make enough money to cover basic living expenses like basic rent, food, medical coverage, and a car that runs, you will end up being indexed to the point where you are getting very little from the government and will essentially be on your own. If you have not accumulated enough money on your own to sustain your lifestyle into your retirement years, you will end up living a life far less than what you have envisioned or would ever wish for.
For a broader perspective on U.S. debt, see U.S. Is Bankrupt and We Don’t Even Know It.
In summary, the signals are clear. You cannot depend on the government to meet its obligations. You MUST depend 100% on yourself. Do the things I’ve laid out in Money Smart, on my site and in my blogs. Have no debt, save 15-20% of your income, invest safely and wisely, and see to it that your financial future is under your control. Things are uncertain in Europe and the struggles in America are challenging, but I believe in the future and I believe in you. Let’s take a lesson from this European debt crisis to eliminate all personal debt and create a plan where we are in 100% control of our own financial plans. Your future depends on it.
Some more articles on debt elimination:
Eliminate Debt, What Is Your Debt Ceiling?, The Reason People Fail at Debt Reduction, Do You Really Need More Money?