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At any given time, much of the monetary value present in an economy is based on credit. Businesses are given loans from banks and venture capitalists to fund major projects; consumers take out loans to make large investments such as buying a house or attending university, or apply for lines of credit to fund daily expenses between paychecks; banks borrow against the balances their customers have in savings and checking accounts to lend money; and the government spends money on credit of future tax revenue and using bonds.
In a booming economy, much of this credit is constantly in motion. Banks, businesses, consumers and governments all carry loan balances. Consumers pay money to banks and businesses, who use the money to pay off loans of their own to each other, the government, and back to the consumers in the form of reseeding savings accounts and paying wages. Balance sheets are constantly changing and updating who owes money to whom.
All credit by nature comes with a "due by" date: when you're given an amount of money, it's expected you will pay it back within a pre-agreed period of time. Most home mortgage loans, for example, have a 30-year term length, while microloans can have a repayment schedule lasting only a few weeks or months. Some credit systems allow for a revolving balance that is never zero, such as personal credit cards, but interest accumulates on those balances, and there is always a minimum payment involved.
The time delay between when money is issued and when it must be fully repaid creates an interesting phenomenon. More transactions can happen with that money before the credit is ultimately paid back. Essentially, it allows more monetary value to be used in transactions than actually exists in the economy. Alongside the true value-adding processes of refining and manufacturing goods, I suspect this phenomenon is responsible for a significant portion of the increased wealth we see in the modern world. And to be fair, it does lead us to have more prosperous lives than we would otherwise have.
However, there is a significant downside to this system. There must be some kind of fluidity in the system, which I like to think of as "velocity". Since credit is constantly in motion, being used elsewhere and requiring some kind of recuperation in order to pass the debt off to some other sector of the economy, the system must retain a constant momentum, always nominally paying off one balance while creating another with a new, extended repayment deadline.
Is it possible to measure this velocity, a "velocity of credit"? There exists an economic metric called the "velocity of money", which is often defined as the ratio of a country's gross national product to its money supply and measures how often a unit of currency is used to purchase goods and services in a given period of time. However, this metric measures the velocity of actual money in an economy, meaning the actual supply of currency provided by a central bank. It doesn't seem to capture the extra "purchasing power" (here used informally) afforded by the rapid shifting of credit balances to provide extra monetary value.
Perhaps we can take a look at the total amount of loans in an industry, irrespective of the industry's actual balance sheets. Suppose two companies A and B give each other loans of $1000, each with an annual interest rate of 1% and repayment due in 1 year. If we ignore that each company now has a liability of $1000, the total asset increase between the two is $2000--and the liabilities they've incurred only need to be paid off a year from now. Suppose further that each company uses that extra money to earn $1100 on top of their regular earnings. Each company could then use that extra money to pay off their loans in their entirety, or they could simply pay the $10 interest they accrue on the original loan over the year, and take out another $1000 loan from each other, and use the new loan to pay off the original balance. If they do, there is still $2000 of extra capital available in the industry (ignoring liabilities), the repayment of the capital is pushed back another year, and the companies have each walked away with an extra $90 they wouldn't have had without the loans. As long as the total interest owed on a loan is less than the amount of extra revenue each company can earn by taking out the loan, this scheme is profitable for both companies.
One possible definition of the "velocity of credit" is fairly simple. We could extend the above asset analysis to an entire economy rather than just one industry, by summing all current loan balances on a given date, and compare this number to the current real money supply. For example, if the US money supply was $10 trillion, and the current amount of total loan balances of US entities was $5 trillion, then the velocity of credit could be defined as the proportional velocity 0.5. This velocity could be useful in examining how much wealth is generally available in an economy beyond real cash, but it may not be useful in directly measuring the health of an economy.
Another possible definition is a bit more complicated, but potentially more powerful. The aforementioned national loan totals, as of a given starting date, could be used to construct a graph of the total amount of loan balances due on or after a given date in the future. For example, given a starting date of 2023-01-01, the date 2023-02-01 on the graph would show the sum of all loan balances (as of 2023-01-01) that are due on 2023-02-01 or later. This graph would represent all the extra capital available in the economy on that future date--a graph that eventually reaches zero as the longest-term loans reach maturity. If we fix a future date on the graph and advance the starting date, more and more loans will be issued on each passing day, causing the amount of available capital on that fixed future date to increase. One could define the velocity of credit (on that date) as the rate of this increase, measured in units of currency per day.
This second definition of the velocity of credit could show some interesting trends. For example, in times of economic hardship, fewer loans tend to be issued, other loans get paid off more slowly, and some loans are defaulted on. By comparing the velocity of credit on key dates in the future, such as one, four and twelve weeks from today, one might gain insights on how many loans are issued, for how much, and how those loans are being paid off.
Everything above is based on my own musings. I'm not an economist, and I don't know if these types of analyses are already being performed by decision bodies in business and government. I began thinking about this recently when considering the cost of living crisis in the UK and its similarities to the 2009 global recession. It seems when the economy is in a slump, an awful lot of money seems to simply vanish. I believe this has to with inflated money supplies driven by loan balances, and when loan obligations go unfulfilled, that artificial money disappears. Thus, I think some sort of measure of that artificial money's value and speed in the economy would be useful.
If anyone knows of any economics research into phenomena like this, I'd be interested to hear about it.
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[Last updated: 2023-08-17]