Korva is a scroll of the internet’s best ideas.
Borrowing pulls spending forward
Spending pulled forward
To buy something you can't afford, you spend more than you make, which means borrowing from your future self. That creates a later stretch in which you must spend less than you make in order to pay it back. Spending first and cutting back later is already the shape of a cycle, and it holds for an individual and for a whole economy.
An economy without credit
Imagine an economy with no credit. The only way to increase spending is to increase income, which takes more productivity and more work. Since one person's spending is another person's income, the economy grows every time anyone becomes more productive, and that traces a steady productivity growth line.
Credit around the trend
With credit, spending can run ahead of that line and incomes can rise faster than productivity, though only over the short run. Productivity growth doesn't fluctuate much, so it isn't a big driver of economic swings. The swings around the line come primarily from how much credit there is, and credit sets in motion a mechanical, predictable series of events in the future.
How did Minsky explain credit booms and busts?
Economist Hyman Minsky argued in the 1970s and 1980s that long stretches of stability push borrowers toward riskier debt. He sorted borrowers into three kinds: hedge borrowers who can pay interest and principal from income, speculative borrowers who can pay only interest, and Ponzi borrowers who depend on rising asset prices to refinance.
As the mix shifts toward the last two, the system becomes fragile. His framework is called the financial instability hypothesis.
How did Fisher link borrowing to time?
In The Theory of Interest in 1930, Irving Fisher treated the interest rate as the price of trading consumption today for consumption tomorrow. A borrower gets more now and gives up that amount plus interest later, while a saver does the reverse.
In his model, the rate adjusts until the amount people want to lend matches the amount others want to borrow.
Why does productivity growth shape living standards?
Output per hour worked determines how much a society can produce, and so how much it can consume per person over time. Bureau of Labor Statistics data show that US nonfarm labor productivity rose roughly 2 percent a year on average from 1947 to 2019.
At that pace, output per hour doubles about every 35 years.
More from Principles by Ray Dalio
