Sunday, January 9, 2011

How Debt Works

Debt is the residue of credit-use.

Credit-use -- think of it as "extra spending" in the economy -- helps the economy grow. But it doesn't come free. Credit-use creates debt, and debt has to be paid back. Paying back debt creates an "equal and opposite" drag on the economy, which must eventually balance out against the boost resulting from credit-use.

What makes credit-use an efficient way to generate growth? What makes it inefficient? It all comes down to relative size: The amount of new credit used over the course of a year, versus the accumulation of debt which is the result of having put credit to use in years past. Boost versus drag.

In an economy with little debt, existing debt creates little drag on the economy. That drag can easily be be offset by a little credit-use. But as the years go by, the little uses of credit can accumulate into substantial debt.

To offset the drag of accumulating debt, new uses of credit must become larger -- and then larger yet, if there is to be any "boost" from the new credit-use. As time goes by, greater and greater amounts of new credit-use are required to offset the depressing effect of accumulating debt. This is the snowball effect of credit-use.

Based on an earlier comment.

For more on the topic of Credit Efficiency see

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