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Transaction 101
Building block of an economy machine
Everything in economy is driven by transactions
If we can understood transaction, we can understood the whole economy
Transaction - an economy is simply the sum of all transactions
Transaction - everytime you buy something, it happens
You have to give something in order to get something
Buyer - money or credit
Seller - goods, services or financial assets
Total Spending / Total Quantity = Price of a single item
A market consists of all the buyers and sellers making transactions on the same thing
An economy consists of all transactions in all of its markets.
In the market
Total Spending / Total Quantity = everything you need to know about the economy
Biggest buyer and seller is the government
A central government that collects taxes and spends money.
Central Bank controls the amount of money and credit in the economy. By influencing interest rates and printing new money.
Central bank is an important player in the FLOW OF CREDIT
Credit - most important of the economy because it's the because and most volatile part
Lenders and Borrowers
Credit helps both lenders and borrowers
Credit only happens when borrowers promise to re-pay and lenders believe them
Credit can be created instantly out of thin air
After that credit turns into debt
Debt is an asset to the lender
Liability to the borrower
In the future, borrower repays the loan plus interest, the asset and liability disappears therefore transaction is completed.
The borrower who receives credit
is able to increase spending
Spending drives the economy
Your spending is another person's income
Every money you earn, someone else has spent
So when you spend more, someone elses earn more
In order to buy something you can't afford
you need to spend more than you make
You're basically borrowing from your future self
Creating time in the future that is
A creditworthy borrower
In conclusion, Increase income allows increased borrowing which allows increased spending and since the other person's spending is naother person's income, it increases their borrowing. A self reinforcing cycle.
^ This leads to economic growth - which is a cycle
Borrowing creates cycles, if the cycle goes up, it eventually needs to come down.
Productivity Growth
Productivity Growth matters most in the long run but credit is matters most in short run. Productivity growth doesn't fluctuate unlike credit.
Debt is the big driver of economic swings because it allows us to consume more than we produce and forces us to consume less than we produce when we pay it back.
Debt swings in two big cycles
People don't feel much of the cycles because we are seeing them as days, weeks, imagine a zoomed in circle, we see it as instead flat line.
An economy without credit can only increase their spending if they increase their productivity
We live in an economy with credit therefore we can also increase spending by BORROWING
If you borrow money to buy a TV, it doesn't generate an INCOME that allows you to pay back the debt.
Point here is borrow money to increase your spending so that you can increase your income.
When the amount of spending and incomes (because of debt) grow faster than the production of goods, prices rise, we call it INFLATION.
Central Bank doesn't want inflation
Prices rise means raising of interest rate (why tho?)
Higher interest rates means fewer people can afford to borrow money, cost of existing debt rises. Because people now borrow less and has high debt repayment, people cut off spending to compensate with debt repayment therefore less money to spend. Since one person's spending is another person's income, income drop, it leads to a perpeutual cycle of income slowly dropping.
When people spend less, prices go down, deflation (why must it go down? why can't it stay at the top?).
Economic activity decreases, which is recession.
If recession is too severe and inflation is no longer a problem. The central bank lowers the interest rates.
Now lower interest rates means debt repayments are reduced, and borrowing and spending picks up again.
^ This is basically short term debt cycle. It only focuses on the aspects of the lender and the borrower.
When credit is easily available there's an economic expansion, when credit isn't easily available there's a recession.
This short term debt cycle is controlled by the central bank
Short term debt cycle typically lasts 5 - 8 years
The bottom and top of each cyle finish with more growth than the previous cycle and then more debt.
People have more inclination to borrow instead of paying back debt.
Despite people becoming more indebted
Lenders even more freely extend credit
BECAUSE everyone thinks things are going great
The focus people have is the now
Even though debts have been growing
Incomes have been growing nearly as fast to balance them
Debt burden = ratio of debt:income
Long as income stays to rise, debt burden stays manageable and people remain creditworthy
At the same time assets value SOARED
People borrow huge amounts of money to buy an investment, causing the assets price to rise EVEN HIGHER (wait why).
Despite the accumulation of larger debts, rising incomes and rising prices of asset values helps borrowers remain credit-worthy of borrowing credit.
At some point, debt burdens slowly increases
debt repayments continue to rise
Forcing people to cut back on their spending
And since one person spending is another persons income
Incomes begin to go down
Debt burdens have become too big
Now economy starts deleveraging
People cut spending, incomes fall, credit disappears
Assets prices drop
Banks get squazed
Stock market crashes
AS incomes fall and debt repayments rise
Borrowers get squeezed and are no longer credit worthy enough to get a credit
Borrowers can no longer borrow enough money to make their debt repayments
Borrowers are then forced to sell assets
The rush to sell assets floods the market, at the same time that spending falls
#myquestion what does it mean when a market is flooded?
This is when stock market collapse
As assets prices drop, the value of the collateral borrowers can put up drops
Makes borrowers even less creditworthy
Credit now rapidly disappears to people
Means Less spending
Less income
less credit
less borrowing
Repeating of cycle
This appears similar to recessision but the difference here is that interest rates can't be lowered to save the day #myquestion Why is that tho? Why is it that lowering interest rates in the recession can save the economy?
In recession, Lowering interest rates works by stimulating "borrowing"
Deleveraging however lowering interest rates doesn't work because interest rates are already 0%
Deleveraging borrower's debt has becoming too BIG
Lenders realize that debts have become too large to ever be fully paid back
Borrowers have lost the ability to repay and their collateral has lost value
Lenders stop lending
Borrowers stop borrowing
The economy is now no longer credit-worthy
