I think this is a pretty simple question, and the pragmatic answer isn’t that difficult either. However, it seems to get lost in the noise when people are talking about large entities such as companies or governments, and things like fractional reserve banking are included.
The general answer is “when you’ll be better off for having borrowed the money”. I know that sounds inane. Let’s expand a little.
The practical perspective: borrowing boils down into two things: results, and risk.
If we ignore risk, then we need to consider if borrowing money will allow us to make more money, and enough to pay back both the loan and the interest. Borrowing money to buy tools to increase your factory output, or your worker’s efficiency, enough to pay back on the debt and more, is a good use of debt. Borrowing money to aid the borrowing of more money is bad. Borrowing money that depends on the successful borrowing of money in the future to provide results, is probably not good.
This brings us to the other dimension of the equation: risk. What is the chance that borrowing the money will pay off in results, and what is the chance that we’ll not be able to pay back the loan? If we are borrowing money for a risky endeavour, then we should expect to pay more interest, as that is how the lender takes compensation for the added risk.
Pricing risk, and judging the degree of risk in a loan is a difficult task, and one not really solved. The only mathematical tool I know of that I think has much veracity is the Kelly Criterion, which has mostly been ignored by the financial community.
The monetary perspective:
In the monetary perspective, we look at how money and the system as a whole are affected. We still care about individual borrowers, but we are really looking at the effects on everyone that participates in that system.
Borrowing creates money.
When we borrow, we are creating money. A bank generally only has to keep as a reserve a fraction of the money it lends out, so the simple act of borrowing creates money. However, there is no free lunch. That money does not enter the system unless it is actually used, and it is only beneficial if it actually increases the value of the system by being used.
Borrowing moves money from the future to the present.
For the cost of paying interest, borrowing allows us to buy things today that we could only have bought in many years time if we were forced to save the money. A classic example is a 30-year mortgage. A mortgage allows a buyer to get most of the benefits of owning a house 20 or so years before he would otherwise be able to afford the house.
Borrowing integrates risk from the present into the future.
If anything goes wrong during the repayment period on a loan, the borrower may find himself unable to pay. Any unexpected event that limits the ability of a borrower to pay could happen any time during the life of the loan. Generally, borrowers are given very little leeway in making payments late. And, once a borrower is in arrears, the chances are good that the extra load of catching up will make it even more difficult for him to keep up with his payments. These problems pile up over time.
Thus, the act of borrowing carries more risk than simply saving money and spending it when there is enough.
Money is not the same as value, and we shouldn’t create money without creating value to match.
Moving money from the future to the present means little if that money is not used to do something meaningful. The money needs to be used to genuinely increase the value of the world: it has to be used to make something, or be used to make it easier for someone to make something. If not, the borrower has simply paid interest to temporarily create and then destroy money. Money is used to measure the value of things. Creating money without (eventually) creating added value in the world to match that money devalues the money. If there is more money being used to measure the same amount of value, then each bit of money must represent less value.
Paying back a loan destroys money, and defaulting on a loan does so even faster.
When a loan is paid back, the money that was created is given back to the bank. This money cannot be used as a reserve for new loans, and as such it effectively disappears. The exception to this is the interest paid by the borrower. This is in excess to the original loan amount and adds to the amount of money in the system. Because there are multiple banks, and money borrowed is paid to third parties and ends up deposited in banks, further multiplication of money does actually occur, but this is not the case with a single bank.
When a borrower defaults on a loan, and the bank writes it off, the money that was created disappears in one fell swoop, but the bank is forced to make up all of the difference out of money that it was using for reserves. Thus defaulting on a loan destroys far more money than paying back a loan.
Thus, it is only a good idea to borrow (or lend) when the money is used to create more value than is represented by the interest paid on the loan.
If the required value is not created, then the extra money in the system devalues all money, punishing all members of the system holding money. If more value than money is created, money becomes more valuable too, and it becomes harder to borrow money as it is more difficult to pay off existing debts. This is self limiting, and also limited by the fact that if more value is being created than money, someone is undercharging for their product, which doesn’t usually last long.
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