University of Applied Sciences Bremerhaven, 31/10/2006

„Debt is bad“ – A refutation

von

Jens Kaulbars

„Debt is bad“ – A refutation

Throughout all the times since humans started to exchange goods for trade, there has been the common opinion that debt is a bad, sometimes even shameful thing to have. Thus it is not astonishing that in Shakespeares’ Hamlet Lord Polonius advises his son Laertes: “Neither a borrower nor a lender be” (William Shakespeare, 1598- 1602, Act 1 Scene 3), for this clearly expresses the point of view people had and many still adopt. However this would mean a generalization of the term “debt”, which cannot be made that easily: “To say that all debt is bad is to say that all debt is alike – which is simply not true” (Tim Cestnick, 2005, p.16).

If one explains debt as “just borrowing money, which gives us greater opportunities and enhances our quality of life” (Lucy Robinson, 2006) it may not be the entire truth, but it sounds far more convenient. Moreover, this quote implies that there is something other than bad debt: good debt.

Now the question occurs, what actually is good debt?

It is the idea of borrowing money to invest, which means using other peoples’ money to create wealth. From the view of businesses and private households alike, good debt provides long-term financial payoff.

From the economical point of view, borrowing money means that there is cash available at hand, cash that will be used to buy something or invest in something. This in turn is an injection in the circular flow model and will create profit somewhere. There are three main indicators to look at when differentiating between good and bad debt. The first is the purpose of borrowing, the second the rate of interest and the third is the possibility to deduct interest from tax. This is best explained with some examples, whereat it does not matter if the examples are taken from the business world or from the world of private households, because the principle stays the same.

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