The drag created by the cost of interest is greater than the boost arising from new borrowing

Debt is an asset. And debt is a liability. If I owe you money, for you it's an asset; for me, a liability. But it's important to remember where the problem arises. When debt becomes a problem, it is because the liability became a problem. If the payments take too much of my income, it's a problem.

When debt as liability becomes a problem, debt as asset becomes a problem: If I can't pay you the income you're planning on, it's a problem for you, too.

The simple and obvious solution is to make sure debt never gets big. That way, if debt ever does become a problem, at least it's not a big problem. But maybe that's too simple. Nobody seems to think it's a good idea. Everybody seems to think we should maximize debt right up to the absolute limit and then maybe just a little more, to see if we're there yet.

And then we have a problem.


An increase in debt -- or a new use of credit; it's the same thing -- an increase in debt creates a "boost" for the economy because it is extra money put into the spending stream. Paying down the loan creates a "drag" for the economy because money is taken out of the spending stream.

As a rule, though, the accumulation of debt increases from year to year. There's an increase in debt every year. As a rule. Crisis creates an exception to that rule, but in a normal economy debt increases every year. If I borrowed 80 last year and pay it back this year, but also borrow 100 this year, then there was a net increase of debt. And that creates a boost to the economy.

To see the boost we only look at the increase in debt. Not the total debt.

So I want to look at what we gain by borrowing money. I want to look at the boost and ignore the drag. And -- oh, but the interest. We do have to pay the interest on all that debt we're ignoring. That cuts into our boosted spending.

New borrowing is a boost, and interest payments are a drag, and we'll otherwise just ignore debt for now. I put that on a graph:

Graph #1: Annual Increase in Total Debt (blue) versus Total Interest Paid (red)

The interest on debt is generally larger than the increase in debt. It's a net loss to the transaction economy.

The next graph counts new borrowing as a plus and interest costs as a negative. It shows the difference. When the blue line goes below zero, interest takes more money out of the economy than new borrowing puts in:

Graph #2: Money that New Lending Added to the Economy minus Money Paid as Interest

Most of the time, interest takes more money out of the economy than new borrowing puts in. If that's true, it explains why economic growth has been getting slower since the 1970s: The drag created by the cost of interest is greater than the boost arising from new borrowing.

The obvious exception occurs between 2002 and 2006, where the blue line rose to a sharp peak. New borrowing for that brief time was increasing at such a rapid pace that it managed to produce a net gain for the economy.

And yes, we're still paying for it today.