My late mother was frugal. Having been raised during the Depression years of the 1930s, she was staunchly opposed to debt. She frequently told me, “If you can’t pay for something with cash, don’t buy it.” I never saw her use a credit card, and rarely did she write a check.
Many would agree with my mother, and perhaps if more people followed her advice, households wouldn’t be $10 trillion in debt and the federal government’s national debt wouldn’t be $7 trillion. But would we be better-off?
Here’s what I mean. Although I certainly admired my mother, she was wrong about debt. Clearly debt can be over-used, and each year thousands of households file for bankruptcy because they can’t meet their debt payments. But at the same time, millions of households use debt logically and responsibly.
Consider this situation. A young family with children has been renting an apartment. They would really like to raise their children in a home they own with more space and a yard. But the family doesn’t have $200,000 in cash needed to purchase a home.
The solution: Borrow the money, buy the home and enjoy it, and repay the loan while living in the home. This is a very logical and natural use of debt. Effectively it allows the family to draw on income they will have in the future in order to purchase an asset—the home—they will use now and for years to come.
In fact, the vast majority, about 94 percent, of household debt is used in this way to buy homes, other property, vehicles, and an education. All of these are assets with multiyear lives. One rule to use in financing these assets is to never have a loan repayment period that exceeds the life of the asset. For example, you wouldn’t want to borrow money for 30 years to purchase a vehicle lasting only 10 years.
Hold on a minute, did I slip in “education” as an asset for which debt financing makes sense? Yes I did, and education sure is a long-lasting asset, because people use it to earn more income in the future. In today’s economy, paying for more education is, perhaps, the best expenditure a person can make. So, borrowing for education is not foolish, but instead is smart.
OK, so maybe you buy my arguments that some kinds of household debt can be justified. But what about borrowing done by the government? How in the world can it be justified as responsible?
Government borrowing can be justified as long as it follows the same rule as for household borrowing—borrow for a long-lasting asset and repay the debt while the asset is being used. In this way, both today’s and tomorrow’s citizens who benefit from the assets will pay for them. There are many government projects that meet this definition, such as military equipment, roads, schools, and other public buildings.
Local and state governments generally follow this rule, borrowing only for “capital” projects. In fact, separate operating and capital budgets are usually kept in city halls and state capitals. But the federal government doesn’t follow this rule. All federal spending is lumped into one budget, so federal borrowing could be used to fund salaries and printer ink as well as roads and tanks. A big step forward would be taken by the feds if they kept one budget book for day-to-day operations and another for roads, buildings, and equipment.
Anyone can over-use debt or use it for illogical purposes. But this shouldn’t take away from the fact that there are sensible reasons for borrowing that I bet even my mother would have approved.
Michael L. Walden is a William Neal Reynolds distinguished professor at North Carolina State University and an adjunct scholar of the John Locke Foundation.