Wednesday, February 18, 2015

It's not that complicated

The Real Effects of Debt, PDF, 34 pages, by Stephen G Cecchetti, M S Mohanty and Fabrizio Zampolli, 2011. They evaluate government debt and non-financial corporate debt and household debt. The opening sentences of the Abstract:

At moderate levels, debt improves welfare and enhances growth. But high levels can be damaging. When does debt go from good to bad?

Dammit, no. Debt is not a flashing light that sometimes flashes red and other times green. Debt is always bad, period. Debt is the cost that is associated with credit use. Credit use is always good, and debt is always bad.

You may want to finesse that a bit, and say credit use is sometimes good and sometimes bad, and I won't argue with you. But please understand: I'm saying it my way to emphasize a point. Credit-use is demand. Credit-use is spending, and spending is demand. But credit-use doesn't cost anything, while it's still just credit-use. It's like getting stuff for free. That's why it's good. That's why it boosts the economy.

But then, a month or so after you use the credit, you get the bill. Now it's not credit-use anymore. Now it is debt. And now it's like paying for something, without getting anything. That's why debt is always bad.

Don't argue with me, dammit, I'm trying to make an idea simple.

In the PDF they say moderate levels of debt improve growth. But that's wrong. It's the credit-use that improves growth, because credit-use is demand. It's debt that harms growth, because the payment is disconnected from demand, and with debt there is payment but no demand.

Moderate levels of debt improve growth? Not really. Moderate levels of debt harm the economy less than high levels of debt. Moderate debt is easier to bear, because moderate credit-use can balance against it. When you have high levels of debt, it takes high levels of credit-use to offset the drag from the debt.

To understand debt, keep three principles in mind: Debt always hurts the economy. Credit-use always helps the economy. And credit-use always creates debt.

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