Credit Cycles

This is the third installment in The Rhythm of the $ystem series. To start reading from the beginning, click here:

Credit Cycles are the pillar in which to anchor your understanding of current economic conditions. They are continuously repeating patterns that are situated perfectly between long term (secular) and short term (momentum) trends. Therefor they are the easiest and most timely patterns to track for big picture analysis.

So, what constitutes a Credit Cycle?

According to Investopedia, “the credit cycle describes recurring phases of easy and tight borrowing and lending in the economy.”

One of the main drivers of economic growth is easy access to credit. Access to credit or lack thereof are what drive fluctuations in the supply of available money in the economy. Hence, credit cycles are the foundation on which to properly track growth and deterioration in the financial system.

This has been the case throughout history. Too much money supply, and prices spiral uncontrollably higher. Too little money supply, and payments are not able to be met which then seizes the entire system like sand in an engine.

While there are other factors to consider like larger macro environments, geopolitical events, etc., the Credit Cycle is one thing which can always be counted on to sway economies in at least a somewhat followable and predictable pattern for medium to long term financial planning (3 – 10yrs). This is due to the influence of readily available money in the system at relatively cheap or expensive borrowing rates.

Determining When a Credit Cycle Begins and Ends

A new Credit Cycle begins (and the last one ends) when the effects of newly lowered interest rates begin to positively impact the economy after a prolonged period of relatively higher rates. The effects of the lower rates, often accompanied by some sort of increased spending by the government to stimulate economic activity, stabilizes the economy and leads it out of a Recession or Downturn, and into a Recovery.

The end of a Credit Cycle begins when interest rates start a new trend higher which is brought upon by high inflation and/or due to an excessively hot economy.

The new rates take time to move through the gigantic economy and have an effect. Therefore, different industries feel the impact at different times. Banks are obviously first in line, which is why they’re so good at laying off employees and then rehiring at the most optimal times. These effects then filter down through the economy until it eventually gets to the consumer which is you & I, the typical person.

While interest rate trends can be spurred by a central bank (The Federal Reserve in the US), they can also be initiated by the bond market should the open market determine that the central bank is slow to act. The easiest way for the lay person to follow is by simply paying attention to the changes which The Federal Reserve (The Fed) initiates.

These Things Take Time

It is absolutely crucial to understand that changes in interest rate trends take time to have an effect on the economy. As in many months and even years. Therefor there is no reason to make drastic changes when the process begins. The good news is that this allows you to make small changes over weeks and months which will minimize the disruption to your life.

In the coming days expect to see posts regarding:

• Where we are in the current cycle and what that means.

• Skepticism of The Economy Tracker

Click the link below for the final installment in the The Rhythm of the $ystem series entitled, Skepticism of The Economy Tracker.

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