FEBRUARY 17
Debt Becomes the System
When the Economy Starts Depending on Borrowing
The Signal
Borrowing is no longer just something inside the economy. Credit has become part of what keeps money, spending and jobs moving.
The Reading
Imagine every bank saying tomorrow, “No more new loans.” No mortgages. No business loans. No car finance. Less borrowing means less debt. Then a family cannot get a home loan. A builder delays a project. A business cannot finance equipment. Another cancels expansion. Spending falls. Work slows.
Why? Because when a commercial bank makes a loan, it does more than create debt. It also creates new spendable money in the borrower’s bank account. That money pays a seller, builder, worker or business.
When the loan principal is repaid, that bank-created money is removed. Think of it this way: new loans create new spendable money. Repaying them removes that money.
Now imagine this across a country. If banks make far fewer new loans while old loans keep being repaid, less spendable money is created. People spend less. Businesses invest less. Construction slows and jobs become less secure. If the contraction becomes severe enough, it can help push the economy into recession.
Look around. Homes rely on mortgages. Businesses borrow to grow. Governments borrow. Financial markets hold debt. Once so much activity depends on credit remaining available, debt becomes part of what holds the system up.
The system does not just carry debt. Parts of the system depend on it.
First Principles
Bank lending can create new spendable money.
Repaying loan principal removes bank-created money.
When an economy depends heavily on credit, a sharp fall in lending can hurt spending, businesses and jobs.
Today’s Challenge
Half-fill a saucepan with water and bring it to the boil. Stay with it. Watch the water level fall as steam escapes.
Imagine the water is credit flowing through the economy. New lending is the fresh water topping it up. Let the level fall. Think recession: the system is running low.
Now imagine no fresh water arrives. Eventually the pot runs dry and burns. Think depression: a severe breakdown. Turn the stove off safely before the water gets low.
Now think through what could happen to a credit-based economy when the top-up stops. Find at least three scenarios.
Tomorrow’s Signal
Why Prices Rise