Effects of Debt |
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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. 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.
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 consumption 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.
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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