Tuesday, January 14, 2014

Operational differences between credit and debt

Excerpted & revised from mine of 5 Feb 2013

McArdle:

By the end of this year, the federal debt held by the public will probably be something like 78% of GDP. That may not be high enough to exert a serious drag on growth, but it's getting pretty close.

Seventy-eight percent of GDP, huh? You can see that at the right end of the blue line in the graph below:

Graph #1: Federal Debt (blue) and Everyone Else's Debt (red)
(Both relative to GDP) (Federal "held by the public" per McArdle)
Click Graph for FRED Source Page

78% is about where everybody else's debt (the red line) was in the early 1950s. Since then, everybody else's debt went up. If Federal debt at 78% is getting pretty close to being a serious drag on growth, as McArdle says, then how about other debt at 100% or 200% or 300% of GDP? Of course it is a serious drag on growth! All debt is a drag on growth.

You might say but Federal debt doesn't produce anything!

No debt produces anything. New uses of credit can sometimes be for productive purposes. But after that money is spent, nothing remains but the evidence that it was credit we were spending: Nothing remains but the debt.

Debt is evidence of credit use. Debt is the cost associated with credit use.

Borrow a dollar today, spend it today, and boost the economy today. Tomorrow, nothing remains but a dollar of debt, the cost of interest on that debt, and the cost of repayment. These costs do not boost the economy. Just the opposite, in fact. This is true no matter who borrowed the money. It is true, no matter what the money was used for.

Clearly, the bigger debt is the bigger problem.


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 using credit makes existing debt bigger. See the problem?

4 comments:

Gene Hayward said...

Art,

Love the way you put the distinction between credit and debt and its ramifications for future consumption. I posted it on my blog for my students with my shallow twist on it. THANKS!!

http://haywardeconblog.blogspot.com/2014/01/understanding-difference-between-credit.html

jim said...

Art

"But after that money is spent, nothing remains but the evidence that it was credit we were spending: Nothing remains but the debt."

That is not at all true. The debt instruments are left and they behave very much like money. Debt instruments are particularly money-like to people who want to save money. And there is a strong incentive for people to want to save money in a world where health insurance, employment and retirement are not guaranteed.

The problem with getting rid of debts is further compounded because you're taking away someone's savings (or making it more difficult to hold savings) which has a tendency to increase people's desire to save.

-jim

Jazzbumpa said...

Please do yourself a favor and don't read the McMegan.

JzB

The Arthurian said...

As usual, Jim, you are focused on "a world where health insurance, employment and retirement are not guaranteed."

I don't like that world and I don't want to live there. I want to live in the "normal" pre-crisis world where it might be possible to have sustainable growth instead of this pathetic flatline.

"Debt instruments are particularly money-like to people who want to save money."

Oh, I like that insight.

//

You disagree when I say "Nothing remains but the debt." Then you say "the debt instruments are left". Same same.

I know I don't need to point out to you that the cost of debt is not money that we gather up and shoot out into space. One man's cost is another man's income. We both know it. I shouldn't have to say it every time I use the word "debt".

The cost of debt to those who owe it, is money that comes out of circulation. The income from debt to those who own it, is money that goes into saving (as you point out).

Surely you can see that it becomes more difficult to make those debt payments, when the ratio of circulating money to savings falls low. Surely you can see it is much easier to make those payments when more circulating funds are available and fewer savings are making demands on it.