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.

This is an extract from Ray Dalio's Big Debt Crises published by Bridgewater