Big boom
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In an economy with credit, we can follow the transactions and see how credit creates growth. Let
me give you an example: Suppose you earn $100,000 a year and have no debt. You are creditworthy enough to borrow $10,000, say, on a credit card. So you can spend $110,000 even though you only earn $100,000.
Since your spending is another person’s income, someone is earning $110,000. The person earning $110,000 with no debt can borrow $11,000, so he can spend $121,000 even though he has only earned $110,000. His spending is another person’s income and by following the transactions we can begin to see how this process works in a self-reinforcing pattern.
But remember, borrowing creates cycles and if the cycle goes up, it eventually needs to come
down. This leads us into the Short Term Debt Cycle.
As economic activity increases, we see an expansion – the first phase of the short term debt cycle. Spending continues to increase and prices start to
rise. This happens because the increase in spending is fueled by credit which can be created instantly out of thin air.
When the amount of spending and incomes grow faster than the production of goods: prices rise. When prices rise, we call this inflation.
The Central Bank doesn’t want too much inflation because it causes problems. Seeing prices rise, it raises interest rates. With higher interest rates, fewer people can afford to borrow money. And
the cost of existing debts rises. Think about this as the monthly payments on your credit card
going up. Because people borrow less and have higher debt repayments, they have less money
leftover to spend, so spending slows…and since one person’s spending is another person’s income, incomes drop…and so on and so forth.
When people spend less, prices go down. We call this deflation. Economic activity decreases and we have a recession. If the recession becomes too severe and inflation is no longer a problem, the central bank will lower interest rates to cause everything to pick up again. With low interest
rates, debt repayments are reduced and borrowing and spending pick up and we see another
expansion.
As you can see, the economy works like a machine. In the short term debt cycle, spending is constrained only by the willingness of lenders and
borrowers to provide and receive credit. When credit is easily available, there’s an economic
expansion. When credit isn’t easily available, there’s a recession. And note that this cycle is
controlled primarily by the central bank.
The short term debt cycle typically lasts 5 to 8 years and happens over and over again for decades.
But notice that the bottom and top of each cycle finish with more growth than the previous cycle and with more debt. Why? Because people push it, they have an inclination to borrow and spend more instead of paying back debt. It’s human nature. Because of this, over
long periods of time, debts rise faster than incomes creating the Long Term Debt Cycle.
Despite people becoming more indebted, lenders even more freely extend credit. Why? Because everyone thinks things are going great! People are just focused on what’s been happening lately.
And what has been happening lately? Incomes have been rising! Asset values are going up! The stock market roars! It’s a boom! It pays to buy goods, services, and financial assets with
borrowed money! When people do a lot of that, we call it a bubble. So even though debts have been growing, incomes have been growing nearly as fast to offset
them. Let’s call the ratio of debt-to-income the debt burden.
So long as incomes continue to rise, the debt burden stays manageable. At the same time asset values soar. People borrow huge
amounts of money to buy assets as investments causing their prices to rise even higher. People
feel wealthy.
me give you an example: Suppose you earn $100,000 a year and have no debt. You are creditworthy enough to borrow $10,000, say, on a credit card. So you can spend $110,000 even though you only earn $100,000.
Since your spending is another person’s income, someone is earning $110,000. The person earning $110,000 with no debt can borrow $11,000, so he can spend $121,000 even though he has only earned $110,000. His spending is another person’s income and by following the transactions we can begin to see how this process works in a self-reinforcing pattern.
But remember, borrowing creates cycles and if the cycle goes up, it eventually needs to come
down. This leads us into the Short Term Debt Cycle.
As economic activity increases, we see an expansion – the first phase of the short term debt cycle. Spending continues to increase and prices start to
rise. This happens because the increase in spending is fueled by credit which can be created instantly out of thin air.
When the amount of spending and incomes grow faster than the production of goods: prices rise. When prices rise, we call this inflation.
The Central Bank doesn’t want too much inflation because it causes problems. Seeing prices rise, it raises interest rates. With higher interest rates, fewer people can afford to borrow money. And
the cost of existing debts rises. Think about this as the monthly payments on your credit card
going up. Because people borrow less and have higher debt repayments, they have less money
leftover to spend, so spending slows…and since one person’s spending is another person’s income, incomes drop…and so on and so forth.
When people spend less, prices go down. We call this deflation. Economic activity decreases and we have a recession. If the recession becomes too severe and inflation is no longer a problem, the central bank will lower interest rates to cause everything to pick up again. With low interest
rates, debt repayments are reduced and borrowing and spending pick up and we see another
expansion.
As you can see, the economy works like a machine. In the short term debt cycle, spending is constrained only by the willingness of lenders and
borrowers to provide and receive credit. When credit is easily available, there’s an economic
expansion. When credit isn’t easily available, there’s a recession. And note that this cycle is
controlled primarily by the central bank.
The short term debt cycle typically lasts 5 to 8 years and happens over and over again for decades.
But notice that the bottom and top of each cycle finish with more growth than the previous cycle and with more debt. Why? Because people push it, they have an inclination to borrow and spend more instead of paying back debt. It’s human nature. Because of this, over
long periods of time, debts rise faster than incomes creating the Long Term Debt Cycle.
Despite people becoming more indebted, lenders even more freely extend credit. Why? Because everyone thinks things are going great! People are just focused on what’s been happening lately.
And what has been happening lately? Incomes have been rising! Asset values are going up! The stock market roars! It’s a boom! It pays to buy goods, services, and financial assets with
borrowed money! When people do a lot of that, we call it a bubble. So even though debts have been growing, incomes have been growing nearly as fast to offset
them. Let’s call the ratio of debt-to-income the debt burden.
So long as incomes continue to rise, the debt burden stays manageable. At the same time asset values soar. People borrow huge
amounts of money to buy assets as investments causing their prices to rise even higher. People
feel wealthy.
