The big race to grow

1. Growth race

Business Cycles, Interest Rates and Central Banks

The modern debt phenomenon must be seen in light of recurring business cycles. Central Banks try to manage them through monetary policies. Governments support the fossil fuel-stoked growth of their real economies by increasing their money supply via fractional reserve banking. As money was gradually de-linked from physical substance (i.e. precious metals), the creation of money became tied to the making of loans by commercial banks. 

So, growth of money = growth of debt.

Business cycles can be gentle or rough, and their timing is random and largely unpredictable. They are also controversial: Austrian School and Chicago School economists believe they are self-correcting as long as the government and central banks don't interfere; Keynesians believe they are only partially self-correcting and must be managed.

In the worst case, the upside of the cycle can constitute a bubble, and the downside a recession or even a depression. A recession is a decline in GDP, employment and trade lasting from six months to a year; a depression is a sustained, multi-year contraction in economic activity. In the narrow sense of the term, a bubble consists of trade in high volumes at prices that are considerably at odds with intrinsic values, but the word can also be used more broadly to refer to any instance of rapid expansion of currency or credit that's not sustainable over the long run. Bubbles always end with a CRASH: a rapid, sharp decline in asset values.

Interest rates can play an important role in business cycles. When rates are low, both businesses and individuals are more likely to want to take on more debt; when rates are high, new debt is more expensive to service.  

When money is flooding the system, the price of money (in terms of interest rates) naturally tends to fall, and when money is tight its price tends to rise – effects that magnify the existing trend.

As Keynes advised, governments like businesses, borrow and spend to create infrastructure and jobs, becoming the borrowers and spenders of last resort during recessions. In the US since World War II, military spending has supported a substantial segment of the national economy -  the weapons industries and various private military contractors – while directly providing hundreds of thousands of jobs, at any given moment, for soldiers and support personnel. Critics describe the system as a military-industrial "welfare state for corporations".

The upsides and downsides of the business cycle are reflected in higher or lower levels of inflation. Inflation is often defined in terms of higher wages and prices, but (as Austrian School economists have persuasively argued) wage and price inflation is actually just the symptom of an increase in the money supply relative to the amounts of goods and services being traded, which in turn is typically the result of exuberant borrowing and spending. Inflation causes each unit of currency to lose value. The downside of the business cycle, in the worst instance, can produce the opposite of inflation, or deflation. Deflation manifests as declining wages and prices, due to a declining money supply relative to goods and services traded (which causes each unit of currency to increase in purchasing power), itself due to a contraction of borrowing and spending and to widespread defaults.

Business cycles and regulated monetary and banking systems, constitute the framework within which companies, investors, workers and consumers act. But over the past few decades something remarkable has happened within that framework. In the US, the financial services industry has ballooned to unprecedented proportions and has plunged society as a whole into a crisis of still-unknown proportions. How and why did this happen?

Mad Money

Investors are always looking for creative ways to turn a profit – sometimes by devising new methods that are not yet constrained by regulations. A few of these methods were particularly instrumental in the build-up to the 2007-8 crisis.

Let's define some crucial terms.

Leverage. It is a general term for any way to multiply investment gains or losses. Two important ways to attain leverage are by borrowing money and trading securities证券交易. An example of the former: a public corporation(i.e. one that sells stock) may leverage its equity by borrowing money. The more it borrows, the fewer dividend-paying stock shares it needs to sell to raise capital, so any profits or losses are divided among a smaller base and are proportionately larger as a result. The company's stock looks like a better buy and the value of shares may increase. But if a corporation borrows too much money, a business downturn might drive it into bankruptcy, while a less-leveraged corporation may prove more resilient弹性.

In the financial world, leverage is mostly achieved with securities有价证券.  A security is any fungible, negotiable financial instrument representing value. Securities are generally categorized as debt securities (bonds)债券, equity securities (common stock)股票 and derivative contracts. A derivative衍生物 is an agreement between two parties that has a value that is determined by the price movement of something else (called the underlying). The underlying can be a stock share, a currency, an interest rate. Derivatives can be used either to deliberately acquire risk (and increase potential profits) or to hedge against risk (and reduce potential losses). Derivatives: options, futures, and swaps. Prior to the crash of 2008, investor Warren Buffett called derivatives "financial weapons of mass destruction". Indeed, during the crash, a subsidiary of the giant insurance company AIG lost more than $18 billion on a credit default swap or CDS (essentially an insurance arrangement in which the buyer pays a premium at periodic intervals in exchange for a contingent payment in the event that a third party defaults). Société Générale lost $7.2 billion in January of the same year on futures contracts.