How I Think about Credit and Debt
Since we are going to use the terms “credit” and “debt” a lot, I’d like to
start with what they are and how they work.
Credit is the giving of buying power. This buying power is granted in
exchange for a promise to pay it back, which is debt. Clearly, giving the
ability to make purchases by providing credit is, in and of itself, a
good thing, and not providing the power to buy and do good things
can be a bad thing. For example, if there is very little credit provided
for development, then there is very little development, which is a bad
thing. The problem with debt arises when there is an inability to pay it
back. Said differently, the question of whether rapid credit/debt
growth is a good or bad thing hinges on what that credit produces
and how the debt is repaid (i.e., how the debt is serviced).
Almost by definition, financially responsible people don’t like having
much debt. I understand that perspective well because I share it. For my
whole life, even when I didn’t have any money, I strongly preferred
saving to borrowing, because I felt that the upsides of debt weren’t worth
its downsides, which is a perspective I presume I got from my dad. I
identify with people who believe that taking on a little debt is better than
taking on a lot. But over time I learned that that’s not necessarily true,
especially for society as a whole (as distinct from individuals), because
those who make policy for society have controls that individuals don’t.
From my experiences and my research, I have learned that too little
credit/debt growth can create as bad or worse economic problems as
having too much, with the costs coming in the form of foregone
opportunities.
Generally speaking, because credit creates both spending power and
debt, whether or not more credit is desirable depends on whether the
borrowed money is used productively enough to generate sufficient
income to service the debt. If that occurs, the resources will have been
well allocated and both the lender and the borrower will benefit
economically. If that doesn’t occur, the borrowers and the lenders won’t
be satisfied and there’s a good chance that the resources were poorly
allocated.
In assessing this for society as a whole, one should consider the
secondary/indirect economics as well as the more primary/direct
economics. For example, sometimes not enough money/credit is
provided for such obviously cost-effective things as educating our
children well (which would make them more productive, while reducing
crime and the costs of incarceration), or replacing inefficient
infrastructure, because of a fiscal conservativism that insists that
borrowing to do such things is bad for society, which is not true.
I want to be clear that credit/debt that produces enough economic benefit
to pay for itself is a good thing. But sometimes the trade-offs are harder
to see. If lending standards are so tight that they require a near certainty
of being paid back, that may lead to fewer debt problems but too little
development. If the lending standards are looser, that could lead to more
development but could also create serious debt problems down the road
that erase the benefits. Let’s look at this and a few other common
questions about debt and debt cycles.
How Costly Is Bad Debt Relative to Not Having the Spending that the
Debt Is Financing?
Suppose that you, as a policy maker, choose to build a subway system
that costs $1 billion. You finance it with debt that you expect to be paid
back from revenue, but the economics turn out to be so much worse than
Since we are going to use the terms “credit” and “debt” a lot, I’d like to
start with what they are and how they work.
Credit is the giving of buying power. This buying power is granted in
exchange for a promise to pay it back, which is debt. Clearly, giving the
ability to make purchases by providing credit is, in and of itself, a
good thing, and not providing the power to buy and do good things
can be a bad thing. For example, if there is very little credit provided
for development, then there is very little development, which is a bad
thing. The problem with debt arises when there is an inability to pay it
back. Said differently, the question of whether rapid credit/debt
growth is a good or bad thing hinges on what that credit produces
and how the debt is repaid (i.e., how the debt is serviced).
Almost by definition, financially responsible people don’t like having
much debt. I understand that perspective well because I share it. For my
whole life, even when I didn’t have any money, I strongly preferred
saving to borrowing, because I felt that the upsides of debt weren’t worth
its downsides, which is a perspective I presume I got from my dad. I
identify with people who believe that taking on a little debt is better than
taking on a lot. But over time I learned that that’s not necessarily true,
especially for society as a whole (as distinct from individuals), because
those who make policy for society have controls that individuals don’t.
From my experiences and my research, I have learned that too little
credit/debt growth can create as bad or worse economic problems as
having too much, with the costs coming in the form of foregone
opportunities.
Generally speaking, because credit creates both spending power and
debt, whether or not more credit is desirable depends on whether the
borrowed money is used productively enough to generate sufficient
income to service the debt. If that occurs, the resources will have been
well allocated and both the lender and the borrower will benefit
economically. If that doesn’t occur, the borrowers and the lenders won’t
be satisfied and there’s a good chance that the resources were poorly
allocated.
In assessing this for society as a whole, one should consider the
secondary/indirect economics as well as the more primary/direct
economics. For example, sometimes not enough money/credit is
provided for such obviously cost-effective things as educating our
children well (which would make them more productive, while reducing
crime and the costs of incarceration), or replacing inefficient
infrastructure, because of a fiscal conservativism that insists that
borrowing to do such things is bad for society, which is not true.
I want to be clear that credit/debt that produces enough economic benefit
to pay for itself is a good thing. But sometimes the trade-offs are harder
to see. If lending standards are so tight that they require a near certainty
of being paid back, that may lead to fewer debt problems but too little
development. If the lending standards are looser, that could lead to more
development but could also create serious debt problems down the road
that erase the benefits. Let’s look at this and a few other common
questions about debt and debt cycles.
How Costly Is Bad Debt Relative to Not Having the Spending that the
Debt Is Financing?
Suppose that you, as a policy maker, choose to build a subway system
that costs $1 billion. You finance it with debt that you expect to be paid
back from revenue, but the economics turn out to be so much worse than
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