Debt

Debt is that which is owed. A person or company owing debt is called a debtor. An entity to whom debt is owed is called a creditor. Debt is used to borrow purchasing power from the future. Companies use debt as a part of their overall corporate finance strategy.

Effects of debt

Debt allows people and organisations to do things that they otherwise wouldn't be able or allowed to. Commonly, people in industrialised nations use it to purchase houses, cars and many other things too expensive to buy with cash on hand. Companies also use debt in many ways to leverage the investment made in their private equity.

Related Topics:
Investment - Private equity

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This leverage, the proportion of debt to equity, is considered important in determining the riskiness of an investment; the higher more debt per equity, the riskier.

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Debt as a whole is a sign of optimism, a society believes in its future (earnings especially), and of lack of work ethic, a society postpones the solution to present problems (when it compensates a fall in revenues, perceived as short term, by an increase in debt for instance)

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Excesses in debt accumulation have been blamed for exacerbating economic problems. For example, prior to the beginning of the Great Depression debt/GDP ratio was very high. Economic agents were heavily indebted. This excess in debt, equivalent to excessive expectations on future returns, accompanied asset bubbles (stock market). When expectations corrected, deflation and credit crunch followed. deflation effectively made debt more expansive and as Fisher explained this reinforced deflation agin. In order to reduce their debt level, economic agents reduced their consumption and investetment. The reduction in demand reduced business activity and caused further unemployment. Also in a direct sense, more bankruptcies occurred due to increased debt cost caused by deflation, and the reduced demand.

Related Topics:
Great Depression - Deflation - Consumption - Bankruptcies

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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.

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See: Perils of the debt-propelled economy by Henry C K Liu

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http://www.atimes.com/atimes/Global_Economy/DI14Dj01.html

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