Image: Anthony Mirhaydari

Anthony Mirhaydari

If you're like most Americans, you've got a love-hate relationship with debt.

On one hand, its wide availability in the modern era has enabled expanded homeownership, compensated for stagnant wages and kept the country from having to make hard choices on things like taxes, federal spending and entitlements.

On the other, our deep-down fiscal Puritanism knows that too much debt is a bad thing. It encourages blatant consumerism and me-too, right-now gratification. It greases the skids of pork-barrel spending out of Washington. And it fueled the housing bubble.

What's worse, after years and years of credit-fueled indulgences, the bill has come due. It's big. Really big. And it's acting as a drag on growth. According to Credit Suisse strategist Andrew Garthwaite, excess debt in the developed world now totals $8 trillion, or 20% of rich-world gross domestic product.

Until that chunk of change is dealt with -- until we start paying it down, default on it or grow the economy so that it doesn't look so big -- the recovery's not going to take flight, the job market won't normalize and home prices will stay down.

And the only way out is through more debt, at least in the short term. That may seem counterproductive. But here's why it's true.

The risk of runaway debt

First, a review of the overall problem is needed. Over the past few months, I've talked a lot about risks related to the West's debt burden. It's a big deal. Further, it underpins the problems we're facing now: the eurozone crisis; the August downgrade of America's AAA credit rating; and the shrinking effectiveness of extraordinary monetary policy out of the Federal Reserve and other rich-world central banks.

Too much debt? © MSN Money

In the United States, as shown in the chart above, the rise in debt was driven first by consumers during the housing boom. Now, it's the government.

You can also see this in the feebleness of the current recovery. Credit Suisse economists point out that GDP growth in 2011 was the weakest in a non-recession year since 1947. Job growth was moribund as the number of Americans participating in the labor force continued to shrink, falling to levels not seen since the early 1980s. And corporate investment has "rebounded" to the lows seen in the depths of the 1991 and 2001 recessions. Not exactly worthy of a spike-the-football touchdown celebration.

Malaise in the West

Late last year in "Investing for a year of chaos," I highlighted studies by Nomura Research Institute's Richard Koo, who is based in Hong Kong and is an expert on Japan's long, debt-driven malaise. Koo believes that Western economies face something similar to the post-1990 Japanese experience -- namely, a prolonged slump caused by persistent deleveraging.

This happens as large parts of the economy focus mainly on minimizing debt -- a change that throws many of the economy's natural motivators into reverse. Businesses delay buying equipment that would help boost profits, governments don't fund new infrastructure projects to increase competitiveness, and households put off buying the latest gadgets.

In the corporate sector, you can see it in the growing cash hoards on balance sheets. In households, you can see it in the falling levels of mortgage debt as people give their devalued homes back to their lenders. The banks see this in meager demand for new loans. The government hears it in political clamoring over debts and deficits.

The risk, according to Koo, is that households become too poor to save and repay their debts and the economy falls into a depression in a downward spiral of lower home prices, loan losses and layoffs. This is the debt-deflation spiral (.pdf file) that Irving Fisher warned about during the Great Depression. The gist of it is that lower asset prices (for things like housing) encourage debt liquidation, which weakens the economy, encouraging even lower asset prices, a weaker economy and yet more liquidation.

Until households start to recover, businesses will be loath to spend on expansion and investment. And the weaker economy that results further damages the government's finances. The cycle feeds on itself.

The other risk is that governments, which act as the borrower and spender of last resort in these situations, tighten their belts prematurely. This, as I've said before and has been borne out in the economic research (.pdf file), was responsible for the 1937 double-dip that extended the Great Depression. And it was also responsible for the 1997 and 2001 slowdowns that extended Japan's deflationary spiral.