Friday, September 18, 2015
Debt vs Credit Use
It sometimes confuses people when I distinguish between debt and the use of credit. I say things like: Using credit is good for the economy, and debt is bad for the economy.
I think the confusion arises because people don't distinguish between debt and credit use as I do. Okay. So try this on for size:
It is not because we owe money that the economy becomes vigorous. It is because we spend more money than our incomes allow.
Now you'll probably say in the not too distant past we spent way more than our incomes allowed, and the economy was awful.
Yes. Because there was already a massive accumulation of existing debt, the stuff that's bad for the economy. There was so much of it that we couldn't spend enough more than our incomes to make the economy good again. The bad outweighed the good.
And if you notice, it's the good thing -- the borrowing and spending beyond our income -- that adds to existing debt and makes the bad thing a bigger problem.
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10 comments:
"It is not because we owe money that the economy becomes vigorous. It is because we spend more money than our incomes allow."
I dont think the "more money than their incomes allow" is correct. Most everyone keeps their payments within their income flows, a very few dont but not usually by their own choice but because they do not have steady incomes.
My mom and I have different philosophies for car buying. She puts aside 300$/mth until she saves enough to go buy a car without a finance contract. So she waits 4 or five years to buy a car. I go out today and finance it on the best terms I can get and usually have payments of well less than 300$. I end up paying more for the car over time but I do not reduce my monthly consumption by as much as my mom does. She claims she doesnt have a car payment (but of course she does). So I purchase the $25,000 car today (even though I dont have 25000 in my savings) but its still not "more than my income will allow". Its more than I have saved at that point but Im paying over time easily within my income flows. She just waits til she has saved a lump sum and then spends it.
She's not right, nor am I, but if everyone did like my mom we would have less car sales today and more in five years.
The credit extension to me adds demand today but I have a debt build up that I must pay back out of my income. As long as I keep it a reasonable percentage of my income Im fine. Problem is, too many people do not have sufficient and reliable incomes to engage in enough of these credit contracts.
Greg, I was trying to distinguish between the owing of money that was borrowed, and the spending of money that was borrowed. You know, debt versus credit use.
"The credit extension to me adds demand today but I have a debt build up that I must pay back"
Yeah, yeah, that was the point!
BTW, Greg,
"Most everyone keeps their payments within their income flows, a very few don't"
But in both cases they are spending beyond their income. Whether they can afford it or not is a separate issue, ceteris paribus and all that.
Well Art, how do you buy a house or a car without "spending beyond your income" as you call it?
I already described the only two ways to buy a car, the way my mom does it or the way I do it. There are costs to both and yes I end up paying more (but over a longer period of time) but she is usually deferring more present consumption than I am.
But the way my mom does it is not better for the economy than mine is. If everyone did it her way starting tomorrow there would be fewer cars bought tomorrow because not very many people have previously deferred enough income to be able to make a purchase of a car. There would also be fewer of everything bought tomorrow if we only spent what we currently had and used no credit. The only way my way of doing it becomes problematic is if I don't have enough reliable income to continue to service my debt.
The banking/credit cartel does a great job of getting people to extend beyond what their reliable income can support and the business sector does a great job of keeping workers incomes suppressed. Thats the problem
Greg, the topic of my post is captured in the title: the difference between "credit use" and "debt". I don't understand why you keep bringing up your mom. I don't understand why you ask "how do you buy a house or a car without 'spending beyond your income'". I don't understand why you find it necessary to point out that there would be less "of everything bought tomorrow if we only spent what we currently had and used no credit." I did not say anything about not using credit.
I said there is a difference between using credit and having debt.
The opposite side of the credit coin is debt. When I use credit I automatically incur a debt, they are inextricably linked. You cant separate credit and debt.
You started out with the statement;
""It is not because we owe money that the economy becomes vigorous. It is because we spend more money than our incomes allow."
Although I don't really like the wording "spending more than their incomes allow" I think that just another way of saying using credit. So if its the use of credit that invigorates the economy then it is in fact true that it is because we owe money that the economy becomes vigorous because the the use of credit always leads to us owing money. You cant use credit without creating a debt.
Yin and yang. Greg. Shadow and light. Heads and tails. Up and down. Buy now and pay later.
"Buying" stimulates the economy. "Paying later" does the opposite.
or like this: buy now, pay later. The use of credit (now) and the paying back (later) are separated by time. At the moment of credit use, the paying back has not yet started. And by the time the paying back starts, the benefit from credit use has dissipated. So, the effects are different, the effects on the economy.
The fact that "You cant use credit without creating a debt" is the reason any economy that relies on credit for growth will ultimately suffer a financial crisis.
""Buying" stimulates the economy. "Paying later" does the opposite."
Depends. When I use my credit card (for convenience) and pay it all back next month I do that not because I didn't have the money (bank balances) at the time of purchase but because I didn't want to convert those bank balances to cash. I use the card now and transfer bank balances later. That is macroeconomically the same as just using cash at time of purchase.
Now, buying something on credit that requires multiple months of payment to payback is different. How many months matters, how much in interest it costs matters, how reliable your income matters. The longer the term the more these other factors matter.
At any one time, usually, there are people buying now and people paying later. When more and more start the paying later or stop the buying now we see a slump. The question of the last 8 years seems to be why do people stop buying now or increase the paying later.
"The fact that "You cant use credit without creating a debt" is the reason any economy that relies on credit for growth will ultimately suffer a financial crisis."
How can there not be credit growth? Every growing economy is going to have and should have a growing number of credit relationships, it seems to me its simply the cost of the credit that is the issue not the fact that private exchanges usually involve credit.
"And by the time the paying back starts, the benefit from credit use has dissipated. So, the effects are different, the effects on the economy"
Im not sure how to think about the part "the benefit from credit use has dissipated". The benefit isn't just a one time thing. Its not like the only benefit happens at the instant the credit gets created. Take buying a home entertainment center. I go to Best Buy and spend 3600 on a TV and accessories. I get a 12 months same as cash credit contract. Best Buy gets to use the 3500 immediately to pay folks like vendors, employees salaries etc. Those folks are using those dollars to do other things long past the time of my transaction, they don't dissipate very quickly. I am now paying at 300/month for 12 months to Best Buy. So what are the different affects on the economy when I start paying back?
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