- Debt to Income Ratio
- Debt Service Payment to Income Ratio
Credit is "Money"
Most of what people think is money is really credit, and credit does appear out of thin air during good times and then disappear at bad times.
A big part of the deleveraging process is people discovering that much of what they thought of as their wealth was merely people's promises to give them money.
How to deleverage the Economy
Make income grow faster than debt, lowering the debt-to-income ratio. For the burdens from existing debt not to increase, nominal income growth must be higher than nominal interest rate.
Current U.S. federal Fund Rate:
2.2% - 2.5%
The amount of national (gross) income is equal to GDP
The debt burden cannot growth faster than gross income.
The primary beneficiary of QE
- Raise the market price for financial assets, generate capital gains for financial asset holders.
The process of QE creates a positive wealth effect.
The Root Cause of Debt Crsis
The vanish of credit.
Deleveragings Can Occur Without Depression
GDP and Growth In Demand
Growth in demand are commonly accompied by growth in spending. As gdp growth slower than growth in demand, the economy as a whole spend more than production (income). The gdp and spending difference increases the total debt of economy.
Three Forces and Interactions
Productivity growth rate is relatively constant across the 100 years span, economic growth follows the trend in general but variations did occur frequently.
The marjor swings of economic growth are due to expansions and contractions in credit - i.e. , credit cycles/debt cycles, 1) long-term debt cycles and 2) short-term debt cycles
An economy is the sum of the transactions that make it up. A transaction is an exchange of money/credit for goods, services or financial asset. A market consists of all the buyers and sellers involved in the transaction of the same nature.
The average price of any good, service or financial assets in a time span is the total amount of consideration given (money or credit) by the total amount received in this window. The market participators (buyers and sellers) have different motivations.
When buying in credit, the settlement of the transaction is actually delayed until the debt is paid off.
A credit-based transaction, as well as other cash settled transactions, would result in an increase in asset of both the seller and the buyer. The expansion of balance sheet for both the seller and buyer would then allow more credit transactions to occur. The process is self-reinforcing because rising spending generates rising income and rising net worths, which raise borrowers' capacity to borrow.
The economy expansion is highly correlated with the expansion of credit. As increase in demand would result in growth in production and economy, typically financed by credit growth. In a credit-based economy, strong demands equals strong real credit growth. Consequently, recessions and depressions are developed from declines in demand, typiclly due to a fall-off in credit creation. In such an economy, demand is constrained only by the willings of creditors and debtors to extend and receive credit.
The modern practice of supporting economy growth by credit expansion is the root cause of debt cycles.
The constrain of modern credit-based economy is relative size of money (cash) v.s. credit. The total amount of debt in the U.S. is about 16 times the size of money in existence.
Lending naturally creates self-reinforcing upward movements that eventually reverse to create self-reinforcing downward movements that must reverse in turn. Mostly due to the fact that it is increasingly difficult to convert debt into income.
Short-term debt cycle is controlled by central bank's monetary policy to tighten or ease credit.
The long-term debt cycle is determined by the relative speed of debt service payment growth and income growth.