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Today I will explain to you how the economy actually works. Like a machine and for this we have to understand day cycles, especially short term day cycles. When economic activity increases, we see an expansion. This is the first phase of the short term day cycle. In this, spending keeps increasing continuously and prices also start going up.
Why does this happen Because the increase in spending is being fueled by credit, and credit can be created instantly out of thin air. When spending and incomes rise faster than the production of goods, prices go up. This is what we call inflation. Now the central bank does not like high inflation because it creates problems.
So seeing the prices rising, the central bank increases the interest rates. When interest rates go up, fewer people are able to borrow money and the cost of existing debts also increases. Like your monthly credit card payments go up. Because people now borrow less and their day repayments become higher.
When they have less money left to spend, spending slows down and one person's spending becomes another person's income. Therefore, incomes also start falling. This sequence continues like this. When people spend less, prices go down. We call this deflation. Economic activity decreases and we get a recession.
If the recession becomes too severe and inflation is no longer a problem, the central bank lowers interest rates again to revive everything. Lower interest rates reduce day repayments. Borrowing and spending starts increasing out of duty. And we get a new expansion. You see, the economy works exactly like a machine.
Spending in the short term day cycle is constrained only by this. These calendars and borrowers are so willing to give and take credit. Economic expansion occurs when credit is easily available. Recession occurs when credit is not available as easily. And note that this entire cycle is primarily controlled by the Central Bank.
Short-term day cycles typically last from five to eight years. And this keeps repeating over and over for decades. But notice one thing, the bottom and top of every cycle ends with more growth and more debt than the previous cycle. Why so ? Because people push it. They have an inclination to borrow and spend more rather than paying the day.
This is human nature. This is why, in the long run, days grow faster than incomes. And this creates a long term depth cycle. People become more inadapted than before. Yet lenders continue to extend credit even more freely. Why? Because everyone thinks everything is going great. People focus only on that.
Which is happening recently. And what is happening recently? Incomes are increasing. Asset values are going up. The stock market is rolling. This is a boom. At such times, it seems beneficial to buy goods, services and financial assets with borrowed money. When people start doing this too much, we call it a bubble.
So even though days are increasing, incomes are also increasing at almost the same pace, which offsets them. Let us call the debt to income ratio as debt burden. As long as incomes continue to grow, the day burden remains manageable. Also, asset values sour. People borrow huge amounts of money and buy assets as investments.
Due to which their prices go up even more. People start feeling wealthy. So despite so much debt accumulation, rising incomes and asset values keep borrowers credit-conscious for a long time. But obviously this cannot and does not go on forever. Day burdens gradually increase over decades. Due to which repayments become bigger.
There comes a time when day repayments start increasing faster than income, forcing people to reduce their spending. And that one person's spending is another person 's income. Therefore incomes start going down. Due to which people start having less credit and borrowing also starts decreasing. Debt repayments continue to rise, causing spending to fall further and thus reversing the cycle.
This is what a long term debt pick is. When debt burdens become so large that they are no longer possible to handle.
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