3 Rules of Thumb

1. Don’t have debt rise faster than income
2. Don’t have income rise faster than productivity
3. Do all that you can to raise your productivity

3 Main Forces Driving the Economy

1. productivity growth
2. short term debt cycle
3. 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

1. ability to repay
2. 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