Monday, February 11, 2013

On the Difference between Credit and Debt

Cuttings from mine of 5 Feb:

No debt produces anything. New uses of credit can sometimes be for productive purposes. But after that money's spent, nothing remains but the evidence that it was credit we were spending: Nothing remains but the debt. And the cost of debt over time is equal to the economic boost we get from credit use. Equal, or greater.

Borrow a dollar today, spend it today, and boost the economy today. Tomorrow, all that remains is a dollar of debt, the cost of interest on it, and the cost of repayment. These costs do not boost the economy. Just the opposite. This is true, no matter who borrowed the money. It is true, no matter what the money was used for.

To boost the economy, a new use of credit must be large enough to completely offset the drag created by existing debt, and then some. But the use of credit makes existing debt bigger. See the problem?


The Arthurian said...

From the Washington Post (h/t Roger Erickson), an example of how debt is misunderstood:
"The fact that debt is so often used poorly, to paper over problems or fund ephemeral spending, represents a serious and potentially crippling problem. But that is not an indictment of debt; it is an indictment of what is done with it."

Debt is not "used" at all. Credit is used. Debt is the evidence that we used credit.

The distinction would not matter, except that using credit boosts the economy, and debt hinders it.

Luke Smith said...

Credit is like the fuel for an economy; debt is like deadweight which kills efficiency.

The Arthurian said...

Come to think of it, Luke, your words stuck in my head when I read them:

Before the Great Recession, American households had 30% more debt than they did disposable income. Households' actual disposable income was gone and in its place, substituted, was debt. Of course, Americans are creditworthy and have no problem obtaining credit. Credit is the fuel of the modern economy but debt is the dead weight which kills fuel efficiency.

Good stuff.

nanute said...

Well, with borrowing costs (interest rates), being as low as they are right now, it would seem like fuel efficiency can't get any better. All of this misguided concern with government debt and the insistence that it must be paid down now, is just plain adding fuel to the fire. Want to free up capital for consumption and investing? Automatically reset all consumer debt rates to half the current rate and see what happens.

The Arthurian said...

Ahh, Nute. Low interest rates are one thing. Low accumulated debt is quite another. But you've given me an idea for a new post...

The Arthurian said...

...scheduled for the 16th, Nute.

Thanks. I love it when thoughts turn into posts.

nanute said...

...Low interest rates are one thing. Low accumulated debt is quite another.... I couldn't agree more. I think that was the main point I was trying to make with the idea of lowering the rate of interest on all private debt. A jubilee would be even better, but that ain't gonna happen. I await the 16th post. Thanks. Nanute

The Arthurian said...

Holy crap, based on the timestamp of my comments, looks like it took seven and a half hours to put that post together. (I hope it's worth it!)

Hey... Suppose everybody thought a jubilee would be even better, but everybody figured it just couldn't happen. Then it would never happen, for no reason.

I suppose you are right that it ain't gonna happen. But... it's frustrating, you know?