When President Nixon took the United States off the gold standard in 1971, debt became the economic lynchpin. Today, the world economy can only function and grow if people borrow money. This completely transformed the strategy of how to create wealth.
Your savings account at the bank is an asset to you but a liability to them because they have to pay you interest on that account. The only way for the bank to offset that liability and make money is to lend your money out at a higher interest rate to a borrower.
The world banking system operates on the fractional reserve system. Which, simply put, means for every $1 you save the bank can lend $10 (or $40 as they could in 2004). It’s for this reason the banks love borrowers; it’s how they make their money.
An increase in the fractional reserve increases money supply, ie: they can print more money to lend. Conversely, if the fractional reserve is lowered, less money is available to borrow, the economy slows, and interest rates go up.
Thanks for the banking lesson, but how does this affect me?
With governments’ ability to dictate the amount of money that can be printed, every dollar you save becomes subject to their mandates. With more money being printed and debts unable to be repaid, the dollar becomes inflated and the purchasing power of your savings is destroyed. With decreased purchasing power, your savings isn’t much of an asset is it?
What can I do?
- Either invest in commodities, such as gold or silver…
- or because you’re becoming financially educated, use debt to acquire assets.
Q: What is the difference between a liability and an asset?
A: Liabilities take money from you and assets send money to you.
Most people confuse liabilities with assets, and instead of using debt to acquire assets, they use it to purchase liabilities and throw themselves into the fire.
If you’re unsure whether something is a liability or an asset, ask yourself these questions:
Q: Does it make me money or increase in value?
A: Yes. That’s an asset.
Q: Does it cost me money or decrease in value?
A: Yes. It’s a liability.
If you want to be rich, you must know the difference between an asset and a liability and how to use debt to your advantage.
For example, did you know the government rewards you for good debt? Investors who buy, improve, and hold real estate get two essential tax benefits.
- Depreciation –
It’s a deduction for the wear and tear on the building. What’s more is if the annual cash flow from your building is less than the depreciation, you can show a loss on your tax return and apply it to other income. Cha-ching!
- Amortization –
It’s the cost of borrowing money, such as loan origination fees and points. You’re allowed to take this deduction even if the bank loaned you the money to cover the fees.
Be aware however, and this is really important, that while debt can make you very rich, it can also make you very poor.
So how do I avoid hurting myself?
Start small. Learn how to manage real estate, tenants, and structure deals. It is the management of debt that gets people into trouble, NOT the use of it.
When acquiring an asset, true investors use as little, if any, of their own money as possible. Should they use their own money, the goal is always to get it back quickly. The strategy to return your initial capital needs to be part of the planning stages of any deal, not an afterthought.
Debt makes the world go round, and the government is here to recompense you for it – as long as you use it the way they want you to.
The upside to using debt the way the government desires?
It can make you very rich, and in today’s world it’s how to create wealth.