Highlight text to annotate itX
So why is what he produces (GDP) important if it isn't money in his pocket? It's fairly
common knowledge that as you grow, produce more, or increase GDP that you are able to
increase your income. It's very important to point out that by shrinking, producing
less or decreasing GDP your income decreases. This is one of the reasons the magic card
company continues to raise Bill's limit, because if he produces more he can make more money.
It's very important to say that these are not solid theories. The fact remains that
there are numerous factors that go into Bill's production capability, income and expenses.
For now let's forget about all the other factors and just assume how much he produces is the
only direct impact on his income.
In our current debt based money system it's very easy to compare increase in production
as happiness (growth/boom) and decrease as sadness (recession/bust). We have been trained
to believe that in order to dig out of our debt we need to grow. While this is true,
based on the numbers above, the only way he can keep growing more is by spending more
money. He can't spend more money because his credit card company won't raise his limit,
yet. If he can't spend more money he will not produce as much, thus not making as much.
So let's get back to bill take a look at the worst case scenario. Let's assume his magic
card company won't raise his limit. Based on what we worked out above, his is still
over spending by about $2 a day, while shut down. He will immediately need to cut that
amount a day, just to keep from running out of money.
What does this new situation look like, because we know that by spending less he is not going
to be able to produce as much. If Bill had to stick to this new budget for the next year,
it's logical to assume that he will produce less. How much less? Well he used to produce
about $438 a day ($160K a year) and now only produces about $423 a day ($154,525 a year).
This represents a 3.42% decline in growth.
Now for simplicity let's just assume that a decline in growth is directly related to
income. If Bill is producing less than before, he is now going to make less money than before.
If we assume it's a 3.42% decline in income, that means he went from making $28,000 a year
to $27,042 a year. But wait, that's a problem because Bills expenses are exactly $28,000
a year, he is now short $958 a year. This means that he has to cut another $958 a year,
but not from his interest payment.
What we saw happen above is when Bill cut his expenses it resulted in less production,
which then resulted in less income, which resulted in him cutting more expenses. Where
does it stop?
Let's pause for a moment. This is just some food for thought, very basic simple terms
to relate to real life. If Average Bill was a real person do you think he should be frightened
he will make less money in the short term? Do you think he should cut expenses? If this
were you, would you be able to continue on this path of overspending? Do you think that
you should make drastic choices now to get on a path to cut your debt, or would you try
and fix it later?
I was surprised to hear that this particular 5th grader would choose cutting spending.
I explained that if Bill were a real person, it's unlikely that he would be able to keep
spending like this and eventually he would be forced to make some really difficult choices.
Here is a consolidated snapshot of Average Bill's issues:
He realizes that just balancing his budget isn't going to be enough because he has to
make that huge interest payment each month that will never go down unless he begins to
pay down some of his debt. Concerned that reducing his expenses reduces his production
which reduces his income, Bill is quite nervous about cutting spending. He quickly thinks
about the alternative of trying to create more things to increase his income somehow.
It seems without the magic card increase that he will never be able to get out of this cycle,
but the reality is that he can. Yes cutting spending did cause a decrease in income and
production, but lets take a closer look, see he cut about 20% of his expenses which resulted
in only a 3.42% reduction in GDP. So for every 5.85% reduction in expenses he can expect
a 1% loss in GDP (and likely equal income loss). At some point, because the decline
of expenses is faster than the loss of GDP Bill will reach a point when he breaks even,
long before it hits zero.
I want to go back to Bills Debt to income ratio. Forgetting the broken debt based monetary
system, forgetting all external factors, how much debt can Average Bill sustain? Here is
where is "gets real" because for the Average American, lenders like to see this number
around 36. Yes look back above, and 36% is not a typo (check your ratio at Bankrate.com).
Unfortunately for us we can see we are far above that number and there is a good chance
our magic card company might not raise our limit.
Let's figure out how much Bill can reduce in expenses and see if we can free up some
money to begin paying off the debt. Let's also look at what Bill would need to do to
reach that 36% ratio.
If Average Bill is able to take the excess income every year and apply it to his debt,
in the debt reduction scenario he would have $4,485 each year to pay down his debt. It
would take about 38 years to pay off our debt with this budget. In an ideal scenario Bill
would be able to reduce his debt by $16,956 a year and pay it off in about 10 years.
Let's just see what this looks like in real life for America.
How do you put the loss of GDP into perspective?