Credit

How Borrowing Expands (and Contracts) the Economy**

Purpose

Explain what credit is, how it increases economic activity in the short term, and why reversing credit cycles create recessions.

Core Principle

Credit = Borrowing Today From Your Future Self**

When people, businesses, or governments take on credit, they increase spending now in exchange for reduced spending later.

Credit temporarily boosts demand above income.
Credit repayment reduces demand below income.

Credit is not money — it is future money pulled forward.

The Three Functions of Credit

Credit affects the economy through three channels:

1. Credit Expands Spending — The Growth Booster

When credit expands:

• households buy homes and cars

• businesses invest in equipment and hiring

• governments finance projects and programs

Because credit increases today’s demand, the economy grows faster:

More credit → more spending → more production → more jobs.

This is why credit booms feel like prosperity.

2. Credit Must Be Repaid — The Built-In Slowdown

Every credit expansion contains its own future contraction.

When debt payments rise:

• households cut spending

• businesses cut investment

• governments tighten budgets

Repaying credit reduces demand:

More repayments → less spending → slower production → job losses.

This is why credit cycles are self-correcting.

3. Credit Depends on Confidence — The Fragile Link

Lenders extend credit when they believe:

• borrowers will repay

• the economy is stable

• assets hold their value

Borrowers take credit when they feel:

• financially secure

• optimistic about the future

• confident in job and income stability

When confidence falls, credit stops flowing — even if interest rates are low.

Confidence drives credit.
Credit drives spending.
Spending drives the economy.

Types of Credit

Credit enters the economy through:

• mortgages

• auto loans

• credit cards

• business loans

• corporate bonds

• government borrowing

• margin debt

Different types create different cycle sensitivities.

The Credit Cycle

Every credit cycle has four phases:

1. Expansion
   Borrowing rises. Spending increases. Asset prices climb.

2. Peak
   Debts become large. Cash flows get tight. Lenders become cautious.

3. Contraction
   Borrowers cut spending. Defaults rise. Lending slows. Asset prices fall.

4. Repair
   Debts shrink. Confidence returns. Credit becomes healthy again.

This cycle repeats across decades.

The Credit Equation

Credit activity can be summarized as:

Spending = Income + New Credit – Debt Repayments

When new credit exceeds repayments → the economy expands.
When repayments exceed new credit → the economy contracts.

What This Explains

Understanding credit clarifies:

• why housing booms drive economic expansions

• why recessions follow periods of high borrowing

• why interest rates matter but confidence matters more

• why rising asset prices make borrowing easier

• why deleveraging (reducing debt) slows growth

• why governments step in during credit freezes

• why the 2008 crisis was so severe

Why This Comes After Money

Money is the baseline.
Credit is the amplification mechanism.

You must understand:

• money measures value

• credit increases demand

• credit cycles cause most recessions

• credit reversals move faster than economic fundamentals

Credit is what makes the economy grow faster than income — and fall faster than spending.