Avoid Debt

There is no question that we live in an inflationary environment.  Since World War 2, prices have gone up almost every single year.  Some years are worse than others.  But even if prices are going up at 2% per year, it still eats away at your savings.

I will sometimes hear advice that it is financially savvy to take on debt because you can pay back the debt with dollars that have depreciated.  This can be right at times, but we also need to understand that it can be very bad advice in certain situations.

First, we live in an unpredictable world.  We also live in a world with booms and busts, courtesy of the Federal Reserve and other central banks.  While the general trends may be inflationary, we also see times when prices are stable or even pulling back in some areas.

Imagine the poor person who took this advice of taking on debt in 2005 in regards to buying a house.  He thought, “I will just buy a house and pay back the loan with money that is worth less in the future.  As long as it is a fixed rate loan, the interest rates won’t matter.”

But things wouldn’t have worked out too well with this strategy.  It would have become evident in 2008 when everything came crashing down.  In some areas of the U.S. you could have bought the same house for half the price in 2011 as would have been paid five years earlier.

The point here is that it is very hard to predict and time the market and the economy with any certainty.

A second factor to consider is interest rates.  Right now, the Fed is creating new money out of thin air at an unprecedented pace, yet interest rates have remained low.

If you have money available, why would you take out a loan and pay interest when you are probably earning less interest with the money you have?  In other words, it doesn’t make much sense to take out a loan at 5% interest when you have money sitting in the bank earning one-tenth of a percent in interest.

A third factor to consider is the type of debt you are taking on.  This can be a major difference.  I strongly advise against any credit card debt (that isn’t paid off each month), unless it is for an emergency or it is a special rate of zero percent.

Even if prices are rising as fast as the interest rate on your credit card, which is highly unlikely, it still doesn’t make much financial sense.  Also, most credit card purchases are for consumer goods and services and not for investment purposes, which is all the more reason not to have any credit card debt where you are paying interest charges.

Overall, I think it is best to avoid most debt, even in an inflationary environment.  There are exceptions of course.  Taking on debt may be ok for buying a house, as long as you realize that the house you live in is a consumer good.  Generally, I think a home loan is ok as long as it is the same as what you would have paid for rent anyway.

Car loans are ok as long as it is needed transportation.  I don’t think it is smart to take out a big loan for a car that costs more for its luxury than its ability to transport.

Student loans are a tricky subject, but this could be a good form of debt in some cases, particularly for high-salaried occupations such as a surgeon.  But student loans can also be the worst form of debt too, particularly if it doesn’t lead to a high income.

In conclusion, I think it is best to avoid debt as much as possible, even in an inflationary environment.  If you are going to hedge against inflation, don’t do it by paying interest on a loan.  That isn’t going to make you money.

Instead, invest your money in inflation hedges.  In order to get wealthier, you need to collect interest, not pay it out to someone else.