A remarkable coincidence of boost and drag

Modified from clker.com

...the new uses of credit provide economic boost, while the cost of existing debt is a drag on growth. This duality is what eventually makes credit-use ineffective, as ever-larger new uses of credit are required just to offset the drag created by the debt from prior credit use.

- mine of 6 April 2012

If you use credit to boost the economy, you must use enough to fully offset the drag created by existing debt -- and more besides, to realize a boost. But each new use of credit enlarges existing debt. So new uses of credit must always grow larger.


The total cost of interest is a measure of the drag created by existing debt. We looked at it the other day. Here's my estimate again of interest paid on all debt in the US:

Graph #1: Estimated Total Interest Paid, billions of dollars

Having an idea of the total cost of interest gives us a feel for the economic drag created by existing debt. I want to compare that drag to the economic boost we get from new uses of credit.

In Graph #3 of the 26th I showed "all the debt I know about". The change in debt from one year to the next is a measure of new credit use, recorded as an addition to existing debt. So we can use "change from year ago" of total debt as a measure of new credit use, and compare those values to the cost of debt as measured by interest paid:

Graph #2: The Cost of Debt (blue) and New Uses of Credit (red)

A remarkable coincidence: It's a horse race from the early 1950s to the late 1990s. Or maybe it's no coincidence at all.


When new uses of credit (red) are more than the cost of existing debt (blue) we can say credit use boosts the economy. Such moments are clearly visible before the 1974 recession, before the 1980 recession, after the 1982 recession, and since the late 1990s.

Before the 1990s it was generally true that when new use of credit ran above the cost of interest, the economy experienced growth; and when new use of credit dropped, coming close to the cost of interest, the economy experienced recession. This is exactly as I describe in the opening remarks of this post.

More recently, the economy seems not to behave according to this rule. Specifically, in the years sometimes described as a "macroeconomic miracle" -- the latter 1990s --new credit use (red) runs below the cost of interest. And then in the 2000s new credit use shows a massive spike, yet economic performance was pitiful. It seems that since the 1990s, some other complication has been inhibiting growth.