Encyclopedia > Debt

  Article Content

Debt

Debt is that which is owed. People or organisations often enter into agreements to borrow a sum of money and pay it back with interest over time, or at a later date. The amount of money outstanding is debt. Debt is normally subject to interest, and so it is possible for the debt to increase through time if it is not repaid fast enough.

Debt is normally denominated in a particular monetary currency, and so changes in the valuation of that currency can change the effective size of the debt. This can happen due to inflation or deflation, so it can happen even though the borrower and the lender are using the same currency.

Also, the form of debt involved in banking gives rise to a large proportion of the money in most industrialised nations (see money and credit money for a discussion of this). There is therefore a complex relationship between inflation, deflation, the money supply, and debt.

Lendings to stable financial entities such as large companies or governments are often termed "risk free" or "low risk". This is because the debt and interest are highly likely to be repaid. However, if the value of a currency has changed in the meantime, the purchasing power of the money repaid may vary considerably from that which was expected at the commencement of the loan. So from a practical investment point of view, there is still considerable risk attached to "risk free" or "low risk" lendings, even though in terms of the amount of a currency that will be returned there may not be.

Table of contents

Effects of Debt

Debt allows people and organisations to do things that they otherwise wouldn't be able to. Commonly people in industrialised nations use it to purchase houses, cars and many other things. Companies also use debt in many ways.

The properties of debt have been blamed for exacerbating economic problems. For example, during the onset of the Great Depression there was deflation, which effectively made debt throughout society grow. This resulted in a contraction of consumtion[?] since the borrowers were on average people who had to consume less due to the increased proportion of their earnings going towards repayments while the lenders were on average people who would invest their extra purchasing power. The reduction in consumtion reduced business activity and caused further unemployment. Also in a direct sense, more bankruptcies occurred due to increased effective debt than otherwise might have been the case.

Bonds

Large organisations can break their debt into many small units of debt. These small units of debt are known as bonds. Each bond entitles the holder to the remaining repayments on that unit of debt. Bonds can be traded during the repayment period, and so ownership of the debt is seen as a form of investment.

Because bonds are traded on a regular basis, they have a fluctuating price. This implies that the overall debt represented by the total number of any particular type of bond also has a fluctuating price.

Inflation Indexed Debt

Borrowing and repayment arrangements linked to inflation indexed units of account are possible and are used in some countries. For example, the US government issues two types of inflation indexed bond - TIPs and I-bonds. These are one of the safest forms of investment available, since the only major source of risk - that of inflation - is eliminated. A number of other governments issue similar bonds, and some did so for many years before the US government.

In countries with concistently high inflation, ordinary borrowings at banks may be inflation indexed also.

Nonstandard Approaches to Debt

It is possible for some organisations to enter into alternative types of borrowing and repayment arrangements which will not result in bankruptcy. For example, companies can sometimes convert debt that they owe into equity in themselves. In this case, the lender hopes to regain something equivalent to the debt and interest in the form of dividends and capital gains of the borrower. The "repayments" are therefore proportional to what the borrower earns and so can not in themselves cause bankruptcy. Once debt is converted in this way, it is no longer known as debt.

Similar arrangements could exist for individuals in that they could agree to repay a percentage of their earnings for a set amount of time in return for a sum of borrowed money. The lender would need to evaluate the future earning capacity of the borrower (this is possible and is often done anyway when lending), but more difficult would be the necessity to track how much they do in fact earn during the "repayment period". Typically, only governments can track earnings of individuals in such a way, and so such arrangements are only currently of use to governments. It is possible to view a portion of taxes as such a form of repayment in return for the cost of government services previously "lent" to citizens, for example education when the citizen was young or government paid maternity leave for the citizen's mother to look after them. Such views occasionally form part of justifications and structuring of some taxation. Some taxes in some countries are only collected from individuals that have received particular services, such as university education. Such an arrangement provides an incentive for the government to make the education useful, since they are sharing in the proceeds from it.

Type of debts



All Wikipedia text is available under the terms of the GNU Free Documentation License

 
  Search Encyclopedia

Search over one million articles, find something about almost anything!
 
 
  
  Featured Article
Input device

... device - Wikipedia <<Up     Contents Input device Any of a number of devices used for communicating with a machine, typically ...