Friday, May 31, 2013

Undertow



New uses of debt (whether public or private) give a boost to spending, a boost that increases employment.

The equal and opposite reaction would be to pay down debt. This reduces spending. It creates a drag on the economy, an undertow. It reduces employment.

But we don't normally repay debt -- not before we've borrowed more, anyway. So we keep getting new boosts from the use of credit, or from the increases in debt I mean. And the undertow created by payback is minimal.

But debt accumulates. And as debt accumulates, the undertow gets bigger: The cost of a growing debt makes the economy sluggish. Increases in debt do not boost a sluggish economy as they do an economy with little debt.

Each new increase in debt adds to the accumulation. In order to compensate for the growing undertow created by accumulating debt, new increases in debt must grow larger. Larger increases aggravate the problem, making the undertow worse, so that it takes a larger addition to debt to create the same little boost.

2 comments:

paul said...

Debt service is approximately 10% of the outstanding balance, so the debt circuit is like a container with a drain in the bottom.

In order to keep it filled or increase the level it takes more and more borrowing but...

The money to repay debt doesn't come from more borrowing...the asset side is saved downstream either as private savings or retained earnings.

The funds for payments come mainly from public spending...if that isn't adequate to meet the debt service requirement along with other leakages the credit system breaks down.

In other words borrowing can't fund it's own debt service...because of saving or accumulation of the funds.

The funds must come from another source.

It's that simple.

It follows that private debt is borrowed ultimately against future public spending, the only sustainable source of income to the domestic economy.

Gene Hayward said...

Might be of interest. Just saw this on The Economist Webstite. Reminds me of the Dot races at the ballpark during the 7th innning stretch.

Seems like if at this point in time the Blue Dot is ahead of the White Dot then that economy has not de-leveraged enough and would be in your doghouse (not a reference to your new pup! :))

http://www.economist.com/news/economic-and-financial-indicators/21578669-household-debt