3 Rules of Thumb
- Don't have debt rise faster than income
- Don't have income rise faster than productivity
- Do all that you can to raise your productivity
3 Main Forces Driving the Economy
- productivity growth
- short term debt cycle
- long term debt cycle
Credit spends just like money
Total spend = cash + credit
Market == all buyers & sellers making transacions for the same things
Economy = total spending & total quantity sold
Biggest buyer == Fed govt & Central Bank
Central bank
- influences interest rates
- prints money
- ensures flow of credit
Credit is the most important part of economy and the most volatile
Rate of borrowing <=> interest rate
As soon as credit is created, it turns into debt
- asset to lender
- liability to borrower
Your spending == income for someone else
Creditworthy boorower has
- ability to repay
- collateral if he can't
Increased income => increased spending
Productivity matters most in the long run
- tends to be a linear line growth
Credit matters most in the short term
- volatile
Debt Swings (cycles):
- 5-8 years
- 75 years
When you borrow you create a cycle
In an economy without credit, you can only increase total spending by producing more
In an economy with credit, you can also increase total spending by borrowing
Credit is good when it creates income
- bad to buy a tv
- good to buy a tractor to harvest more crops
Borrowing creates cycles
Credit fuels spending which drives prices of goods up
Inflation == prices rising
As debt repayment rises (due to more borrowing), people spend less
Recession == lowered spending
Central Bank will increase interest to battle inflation, and lower interest to battle recession
Human nature is to borrow and spend more instead of paying down debt
Lenders will continue to extend credit if the economy is "good"
Debt Burden == debt to income ratio
Long Term Debt Peak == At some point debt repayment rises high enough that people stop pending
For most of the works, long term debt peak happened in 2008
Deleveraging At some point, interest rates cannot be reduced any lowered further
- businesses cut spending
- debts are reduced through defaults and restructuring
- wealth is redistributed from haves to have-nots
- govt prints new money
Austerity == cuts in spending
- deflationary
- business cut costs
- higher unemployment
- people run on the banks
- banks default on their debts
Depression == severe economic contraction
When an individual defaults on a debt, the lender loses the (credit) asset
Debt restructuring causes income and asset values to drop
In a depression,
- Govt collects less taxes
- Govt has to stimulate economy (spend more)
- budget deficit increases
Govt has to raise taxes, or borrow
- taxes tend to be increased on the wealthy
Depressions tend to cause social tensions within the country and between countries
- 1930s led to WWII
When Central Bank can't lower interst rates anymore, they have to print money, which is inflationary
To stimulate the economy:
- Central Bank lends money to Govt by buying Bonds
- Govt can run deficit and increase spending through stimulus and unemployment benefits
- This lowers the Govt's Debt Burden
Inflation and Deflation have to be balanced, leading to "good" delevaraging
Beautiful Deleverage
- debts decline relative to income
- real economic growth is positive
- inflation isn't a problem
- achieved by having balance of cutting spending, redistribute wealth, printing money
- economic and social stability can be maintained
Spending (cash or credit) is what matters
Central Bank must
- pump up income growth
- get rate of income growth higher than rate of interest on accumulated debt
Income must grow faster than debt
Printing money is used to combat accumulation of interst on debt
- can be dangerous, causing unacceptably high inflation
Lost Decade:
- 2-3 years depression
- 7-10 years reflation