How the Economic Machine Works

The single most important sentence throughout: One person’s spending is another person’s income.

Credit

Beyond cash spending, a large portion of people’s spending comes from credit. One person’s debt is another person’s asset.

Credit is perfectly normal — much of the wealth in society is actually credit. Credit is a simultaneous need of both borrowers and lenders. A credit transaction is complete when the borrower finishes repayment.

Credit activity creates cycles: short-term cycles last 5–8 years, long-term cycles last 75–100 years.

Credit isn’t all bad — there’s productive credit and unproductive credit.

For example, using credit to purchase productivity tools can be considered productive credit, because those tools generate income, which in turn can be used to repay the credit.

Cycles

Credit cycles are essentially borrowing from your future self. If you spend tomorrow’s money today, the cycle begins.

Productivity

Accumulation of knowledge raises your standard of living.

Innovative and hardworking people increase their productivity faster than complacent and lazy ones. But it takes time — you can only see the results over the long term. Credit, however, can make the latter group appear to have improved living standards and productivity in the short term.

In a society without credit, increased spending can only come from increased productivity. But in a society with credit, spending can be increased through borrowing. And one person’s spending is another person’s income.

Deleveraging

The long-term credit cycle has a trough, and many bad things happen during that trough. For example, the Great Depression in the US, and Germany channeling that trough into war.

The Great Depression was caused by massive credit defaults.

For governments, methods of deleveraging include:

• Cut spending
• Reduce debt through defaults and restructuring
• Redistribute wealth
• Print money

But you can’t print too much money. Say the debt interest rate is 2% and income growth is 1% — the debt burden won’t decrease. Income growth needs to exceed the debt interest rate. But since printing money is so easy, it can lead to excessive inflation.

A harmonious deleveraging is eventually followed by a period of reflation.

For borrowers, methods of deleveraging include:

• Reduce debt
• Extend repayment periods
• Lower interest rates

Final Rules of Thumb

• Don’t let debt grow faster than income.
• Don’t let income grow faster than productivity (or you’ll eventually lose competitiveness).
• Do everything you can to raise your productivity.