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Without further ado, this is what the image looks like:

Next, I will interpret each branch in turn, but before that, there are two points that need to be clarified:

First, this image provides a macro overview, capturing the main links while omitting the details.

Second, and most importantly, in this image, all money is compared to water. Why this metaphor? First, we need to understand the true meaning of money; money is merely an intermediary for the exchange of goods.

In the center of the image is a large circle; on the left are residents, and on the right are enterprises. The enterprises in the image represent all companies that can produce goods or services, which can include factories, supermarkets, intermediary companies, etc. Thus, the flow of water in this circle represents residents using money to purchase goods or services from various enterprises. After receiving this money, enterprises continue to produce goods or services, with the goods and services represented by water flowing back and forth between the two.

However, during this cycle, all residents do not spend all the money they have; each person tries to accumulate wealth little by little. Subsequently, part of the accumulated wealth flows into the housing market. Due to the high value and low liquidity of houses, the housing market has become a massive reservoir.

Additionally, part of the wealth accumulated among residents is saved, forming a savings reservoir. Currently, most residents' money is stored in banks, and the water from the savings reservoir flows into the banks.

However, banks are profit-making institutions and will not simply help depositors store money. Therefore, the money in banks is lent out in the form of investments, flowing into the hands of certain residents or enterprises that need funds. Since enterprises typically require substantial financial support for production, it can be said that each enterprise has its own reservoir. When these individual reservoirs are aggregated, they form the stock market.

From this perspective, the birth of the stock market aims to promote the efficient circulation of goods and services in the large circle in the middle. Through individual investors and financial institutions assessing relevant enterprises, extracting the essence and discarding the dross, what remains are well-managed enterprises, allowing more goods and services to flow into the large circle in the middle.

If the stock market lacks efficient and transparent regulation, then a considerable portion of the water in the stock market will flow into the reservoirs of certain individuals rather than into the large circle of goods and services circulation, which would be detrimental to the overall development of society.

Moreover, in addition to injecting production vitality into society through the stock market, bank funds can also adjust the flow of water in the large circle through corresponding monetary policies under the leadership of the central bank. Common monetary policies include adjusting credit scale, controlling money issuance, regulating market interest rates, and open market operations, etc.

After understanding how the "savings-bank-investment" cycle can promote the circulation of goods and services in society, there is another essential cycle, which is government-led.

In the continuous circulation of goods and services in the middle circle, residents and enterprises will gradually accumulate wealth and expand their reservoirs. As a result, with more water in the reservoirs, the water circulating in society decreases. Therefore, the purpose of taxation is to return the water from private reservoirs to the public, which is the main idea of the "taxation-government-finance" cycle.

In summary, the means employed by a government to regulate the economy can be divided into two main points:

Through fiscal revenue, that is, the process of wealth redistribution via taxation, and through fiscal expenditure to provide goods and services to society, maintaining stable economic operation. Fiscal expenditure can be further divided into two parts: direct market injection through government bonds and public expenditure for infrastructure investment led by the government. The combination of fiscal revenue and fiscal expenditure is collectively referred to as fiscal policy.

I believe everyone has guessed that the circulation of goods and services between residents and enterprises is the most crucial link; it is the center of social economic operation and the foundation for achieving national wealth. Whether it is the monetary policy adopted by banks or the fiscal policy led by the government, all policies are essentially aimed at enhancing the operational efficiency of goods and services in society.

So how can we ensure that water flows continuously like rivers and seas between residents and enterprises? First, the flow of water cannot stop; stagnant water becomes dead water. Looking back at history, we can see that every financial crisis has been triggered by the stagnation of water along the "bank-investment-stock market" route, and the subsequent Great Depression was a manifestation of the near-drying up of water flow between residents and enterprises.

The economy is the sum of numerous transactions, and each transaction is quite simple. A transaction involves a buyer and a seller, where the buyer pays money (or credit) to the seller in exchange for goods, services, or financial assets. A large number of buyers and sellers exchange the same type of goods, forming a market. For example, the wheat market includes various buyers and sellers with different purposes, engaging in different trading methods. Various trading markets constitute the economy. Therefore, what seems complex in reality is merely a combination of numerous simple transactions.

Economic entities can be divided into three main categories: government, enterprises, and households (residents). The government acts as both the coordinator and manager ensuring the smooth operation of the national economy, as well as a buyer of goods and services and a provider of public services. It also redistributes national income between households and enterprises through taxation and transfer payments. Enterprises are economic organizations that allocate scarce resources and engage in production and business activities, obtaining profits by continuously providing material products and services to the market. Households (residents) are providers of production factors such as labor and capital and are also the main consumers. In the national economic circulation system, economic entities provide products or services to each other at acceptable prices to maximize social welfare. As shown in Figure 1, the operation of the national economy in the real world includes both internal and external cycles.

The internal cycle, also known as the domestic cycle, refers to the transfer and allocation of goods and production factors within a country or region, where the prices of goods and factors depend on the supply and demand conditions of the country or region. The internal cycle can be simply understood as self-production and self-sale, where the entire process from production to sales to consumption is completed domestically. The external cycle, also known as the international cycle, refers to the flow of goods and production factors across national or regional boundaries, where the prices of goods and factors are influenced not only by domestic supply and demand conditions but also by the overall international market supply and demand conditions. Due to the inherent expansionary nature of market economies, under the influence of competitive mechanisms, enterprises will inevitably continue to expand market space to reduce costs, scale up, and improve efficiency, thus driving economic activities to break through regional limitations and form a trend of economic globalization.

The main system includes: central banks, financial regulatory agencies, the State Administration of Foreign Exchange, policy-based financial institutions, and commercial financial institutions.

Since the establishment of the China Securities Regulatory Commission in 2003, China has formed a financial regulatory framework of "one bank and three commissions," which continues to this day. Currently, China's financial industry implements a system of segmented operations and segmented regulation. The management of financial institutions in China is mainly reflected in the following three aspects: First, institutional management: including market access, establishment of branches, personnel appointment approvals, and terminations; second, business regulation: all aspects of financial products (prices, target audiences, governance mechanisms, etc.); third, operational monitoring: various non-site and on-site supervision based on compliance and risk prevention.

Since the establishment of the China Securities Regulatory Commission in 2003, China has formed a financial regulatory framework of "one bank and three commissions," which continues to this day. Currently, China's financial industry implements a system of segmented operations and segmented regulation. The management of financial institutions in China is mainly reflected in the following three aspects: First, institutional management: including market access, establishment of branches, personnel appointment approvals, and terminations; second, business regulation: all aspects of financial products (prices, target audiences, governance mechanisms, etc.); third, operational monitoring: various non-site and on-site supervision based on compliance and risk prevention.

Current Overview of the Financial System: Market Regulation of Monetary Policy Tools

(1) The People's Bank of China's Regulation of the Market: When the market needs more funds, the People's Bank injects money into the market. The main methods include "rediscounting" and "re-lending" to commercial banks, as well as purchasing government bonds issued in the open market. When there is a surplus of funds in the market, the People's Bank uses monetary policy for regulation. Monetary policy tools are divided into: general monetary policy tools, special monetary policy tools, and other monetary policy tools, as detailed below;

Market Regulation of Fiscal Policy Tools

(2) The Government's Regulation of the Market

The government's sources of funds mainly include taxes, state-owned enterprise income, administrative fees, and debt. An important source of government funds is also national and local bonds. The government can use fiscal policy to regulate total demand; currently, China implements an active fiscal policy and a prudent monetary policy.

The main methods of fiscal policy are as follows:

1. National budget. Mainly achieved through determining the scale and balance of budget revenues and expenditures, arranging and adjusting the revenue and expenditure structure to achieve fiscal policy goals.

2. Taxation. Mainly determined through tax types and rates to ensure national fiscal revenue and regulate the distribution relationship of social economy.

3. Fiscal investment. Adjusting industrial structure through national budget allocations and guiding the flow and volume of off-budget funds.

4. Fiscal subsidies. Directly or indirectly implementing fiscal assistance through fiscal transfers to achieve stable economic development and social stability.

5. Fiscal credit. A redistribution method for the state to raise and use fiscal funds based on the principle of compensation, including issuing public bonds and special bonds domestically, issuing government bonds abroad, borrowing from foreign governments or international financial organizations, and implementing compensated use of budgetary funds.

6. Fiscal legislation and enforcement. The state legally recognizes fiscal policy through legislation to ensure the achievement of fiscal policy goals.

7. Fiscal supervision. The state inspects and supervises the implementation of fiscal policies and fiscal discipline by state-owned enterprises, public institutions, and their staff through fiscal departments.

The China Investment Corporation and Central Huijin Investment Ltd. (referred to as "CIC") was established on September 29, 2007, in Beijing. It is a wholly state-owned company approved by the State Council of China, engaged in foreign exchange fund investment management, belonging to the Ministry of Finance. The company has a registered capital of 200 billion yuan, sourced from the Ministry of Finance through the issuance of special government bonds, amounting to 1.55 trillion yuan, making it one of the largest sovereign wealth funds in the world. The original intention of the company was to invest China's accumulated foreign exchange reserves abroad, ultimately used to reshape China's financial system. With the establishment of CIC, the company fully acquired Central Huijin Investment Ltd. from the People's Bank at the end of 2007, making Central Huijin its wholly-owned subsidiary, thus granting CIC control over major banks in China. Central Huijin Investment Ltd. (referred to as "Central Huijin") was established on December 16, 2003, with approval from the State Council as a state-owned investment holding company. Its main function is to invest in state-owned key financial enterprises, representing the state in exercising investor rights and fulfilling investor obligations without engaging in any other commercial activities or interfering in the daily operations of the state-owned key financial enterprises it controls. Central Huijin's controlled financial institutions include the China Development Bank, Industrial and Commercial Bank of China, Bank of China, China Construction Bank, China Everbright Bank, China Reinsurance (Group) Corporation, China Jianyin Investment Ltd., China Galaxy Financial Holdings Co., Ltd., Shenwan Hongyuan Securities Co., Ltd., and Guotai Junan Securities Co., Ltd.

The banking system includes:
Five major state-owned commercial banks (ICBC, ABC, CCB, BOC, and BOCOM), three policy banks, twelve medium-sized banks, one postal savings bank, 147 urban commercial banks, 85 rural commercial banks, 223 rural credit cooperatives, 63 trust companies, a series of financial and auto leasing companies, monetary brokerage firms, financial companies, 40 local foreign bank subsidiaries, and four large asset management companies. The market share of the five major state-owned commercial banks (ICBC, ABC, CCB, BOC, and BOCOM) holds 59% of government bonds, 85% of central bank bills, and 44% of all corporate debt. They provide 32% of interbank lending and fixed-income financing to other banks and offer 76% of financing services to non-bank financial institutions such as insurance companies and trust companies: the five major banks hold 58% of household savings and 50% of corporate savings, commanding half of the capital in the entire financial system.

The market share of the other twelve medium-sized commercial banks (such as CMB, CITIC, etc.) holds 17% of government bonds, provides 21% of corporate financing, and 25% of interbank lending: they hold 29% of corporate savings and 9% of household savings, accounting for about 10% of the entire financial system's capital.

According to the list of China's top 500 financial institutions published in 2014, the total asset scale of the top 500 has reached 170.41 trillion yuan. China's stock of financial assets is primarily dominated by banks, holding an absolute advantage, although there has been a declining trend over the past decade, it still stands at 90%. This indicates that China remains a bank-dominated financial system.

The major banks, ranked by total assets, are as follows: ICBC, CCB, ABC, BOC, China Development Bank, BOCOM, CMB, and Huaxia Bank. The total assets of the top ten amount to 92 trillion yuan, accounting for 61% of the industry.

The major trusts, ranked by managed trust assets, are as follows: CITIC, CCB, Industrial Bank, Zhongrong, Zhongcheng, Chang'an, Huatai, Ping An, and Yingda. The total assets of the top ten amount to 2.9 trillion yuan, accounting for 39% of the industry.

The major securities firms, ranked by total assets, are as follows: CITIC Securities, Haitong Securities, Guotai Junan, GF Securities, Huatai Securities, CMB, Weixin Securities, Galaxy Securities, and CITIC Jianyin. The total assets of the top ten amount to 978.1 billion yuan, accounting for 47% of the industry. The major fund management companies, ranked by managed fund size, are as follows: Tianhong Fund, Huaxia Fund, Harvest Fund, Southern Fund, ICBC Credit Suisse Fund, E Fund, GF Fund, Bosera Fund, and Huitianfu Fund. The total assets of the top ten amount to 2.08 trillion yuan, accounting for 57.3% of the industry.

First, the stock of bank assets accounts for over 90% of the financial industry assets, with the five major state-owned banks holding 43% of the total bank assets, meaning that the total assets of the five major state-owned banks account for about 40% of the entire social financial assets.

Second, the Ministry of Finance and Central Huijin jointly control the four major state-owned banks and the China Development Bank with an absolute advantage, controlling BOCOM and Everbright as the largest shareholders. This means that over 50% of China's financial assets are jointly controlled by the Ministry of Finance and Central Huijin.

Third, Central Huijin was originally regulated by the central bank but has now been transferred to a subsidiary of CIC, with the chairman of CIC being a deputy minister of the Ministry of Finance, indicating that Central Huijin and the Ministry of Finance are acting in concert, with the central government controlling half of China's financial industry through the Ministry of Finance.

Fourth, local governments and central enterprises control the vast majority of the remaining financial institutions, controlling the other half of China's financial industry.

Fifth, from both historical and current perspectives, joint-stock banks are mostly established by local governments and central enterprises, and most are still effectively controlled by them.

Sixth, from historical and current perspectives, urban commercial banks and rural commercial banks are often cash cows for local governments. Since the wave of banking reforms, local governments remain the actual controllers of urban commercial banks and rural commercial banks. Central banks, foreign capital, and private capital have shared in this feast, but most have not yet gone public, and exit channels remain unclear.

Overview of Financial Institutions

1. The equity structure distribution of trusts, securities firms, and funds is basically similar, close to that of joint-stock banks, mostly established by central enterprises and local governments. After years of equity changes, the transfer of private capital, local state-owned capital, central enterprise shares, and foreign capital has led to a relative diversification of most companies' shares, but local state-owned capital and central enterprise investment holding companies still firmly control China's major trusts, securities firms, and funds.

2. Insurance companies vary in size; the equity structure of large insurance companies is similar to that of state-owned commercial banks, controlled by the Ministry of Finance and Central Huijin, while small insurance institutions are similar to securities firms.

3. Private enterprises represented by Anbang Insurance have begun to emerge in the financial market, venturing into banks, securities firms, etc. Some institutions have achieved full licenses for banking, securities, and insurance. Unlike Anbang Insurance, they do not publicly stake claims in the capital market but instead form concerted actions through dispersed holdings or multiple companies, such as the Tomorrow Group led by Gang Jianhua.

4. The most important financial market infrastructure is almost entirely controlled by the government. The second most important institutions, although membership-based or corporate, have nominal member meetings, with key leaders appointed by the government.

The People's Bank of China decided to lower the benchmark interest rates for RMB loans and deposits for financial institutions starting from August 26, 2015, to further reduce corporate financing costs. Among them, the benchmark interest rate for one-year loans was lowered by 0.25 percentage points to 4.6%; the benchmark interest rate for one-year deposits was lowered by 0.25 percentage points to 1.75%; the benchmark interest rates for other loan and deposit categories, as well as personal housing provident fund loans, were adjusted accordingly. At the same time, the floating upper limit for interest rates on time deposits of more than one year (excluding one year) was relaxed, while the floating upper limit for interest rates on demand deposits and time deposits of less than one year remained unchanged. Starting from September 6, 2015, the reserve requirement ratio for RMB deposits of financial institutions was lowered by 0.5 percentage points to maintain reasonable liquidity in the banking system and guide stable and moderate growth of monetary credit. Additionally, to further enhance the ability of financial institutions to support "agriculture, rural areas, and farmers" and small and micro enterprises, the reserve requirement ratio for rural financial institutions such as county-level rural commercial banks, rural cooperative banks, rural credit cooperatives, and village banks was additionally lowered by 0.5 percentage points. The reserve requirement ratio for financial leasing companies and auto finance companies was lowered by 3 percentage points to encourage them to play a good role in expanding consumption. Since November 2014, the People's Bank has successively lowered loan and deposit benchmark interest rates four times, guiding financial institutions to continuously reduce loan interest rates, effectively alleviating the high social financing cost issue.

Since November 2014, the People's Bank of China has lowered the benchmark interest rates for RMB loans and deposits for financial institutions four times, with the benchmark interest rate for one-year loans lowered to 4.6% and the benchmark interest rate for one-year deposits lowered to 1.75%.

The macroeconomy currently faces a situation of unstable fundamentals and significant downward pressure. As one of the important tools of monetary policy, lowering deposit and loan interest rates aims to further reduce corporate financing costs to stabilize economic growth while intending to send positive signals to the capital market, serving an expected guiding function. Historical experience shows that interest rate cuts mean a loose funding environment for the stock market, which is a substantial benefit. After the interest rate cut, the A-share market tends to rise more than it falls; from February 21, 2002, to May 11 of this year, there have been 25 interest rate cuts, with the Shanghai Composite Index rising 14 times. Interest rate cuts directly benefit high-debt industries and stimulate residents' credit consumption for housing and automobiles to a certain extent. Industries such as real estate, infrastructure, non-ferrous metals, coal, and securities will benefit, reducing the pressure on funds flowing into the bond market and clearly alleviating the risk factors suppressing bond yields. The steep bond yield curve will be significantly corrected. As the intention to reduce financing costs becomes clearer, medium- and long-term bond yields are expected to decline significantly.

Current Financial Policy: Easing Liquidity - New Monetary Tools

Credit Asset Pledge Re-lending: On October 10, 2015, the People's Bank announced that based on the replicable experience formed from the pilot projects of credit asset pledge re-lending conducted in Shandong and Guangdong, it decided to promote the pilot of credit asset pledge loans in nine provinces (cities) including Shanghai, Tianjin, Liaoning, Jiangsu, Hubei, Sichuan, Shaanxi, Beijing, and Chongqing. Credit asset pledge re-lending allows banks to use existing credit assets (loans already issued) to pledge to the central bank to obtain new funds.

Essentially, this is a form of debt collateralized subprime lending. The central bank has recently used various new monetary tools, such as MLF (Medium-term Lending Facility), SLF (Standing Lending Facility), and PSL (Pledged Supplementary Lending), to ease monetary liquidity, reduce social financing costs, and support the real economy. Credit asset pledge re-lending, in total, is to hedge against the downward pressure on real estate and traditional industries, while structurally providing momentum for economic transformation. By setting different discount rates for credit assets, for example, setting a higher discount rate for credit assets that meet the requirements of economic transformation for small and micro enterprises and agriculture, the higher the discount rate, the more base currency can be obtained for financial institutions to provide positive incentives for lending to small and micro enterprises. Additionally, credit asset pledge re-lending helps to address the relative shortage of qualified collateral and high bad debts among local financial institutions, supplementing liquidity for small banks, such as urban commercial banks and rural credit cooperatives, preventing systemic financial risks, and holding strategic significance.

In early October 2015, the Ministry of Finance, together with ten institutions including China Construction Bank, Postal Savings Bank, Agricultural Bank of China, Bank of China, Everbright Group, Bank of Communications, Industrial and Commercial Bank of China, CITIC Group, Social Security Fund, and China Life Insurance, jointly initiated the establishment of the China Government and Social Capital Cooperation (PPP) Financing Support Fund. The total scale of the fund is 180 billion yuan, which will be used to support the development of PPP projects in the public service sector. The establishment of the fund is an important measure for the central finance and financial institutions to implement the "Guiding Opinions on Promoting the Government and Social Capital Cooperation Model in the Public Service Sector" issued by the General Office of the State Council (Guo Ban Fa [2015] No. 42) and is an important exploration for deepening fiscal and financial cooperation and jointly supporting the development of PPP projects. It has positive significance for innovating fiscal and financial support methods, optimizing the financing environment for PPP projects, and promoting the development of the PPP model. According to reports from the "Hua Xia Times," the Ministry of Finance has set up a 200 million USD sovereign loan, which will mainly be used for the preliminary expenses of PPP projects and has solicited opinions from various provinces. Additionally, the National Development and Reform Commission publicly solicited opinions on the "Interim Measures for the Management of Special Subsidy Funds for the Preliminary Work of Government and Social Capital Cooperation Projects" on September 28, indicating that future compliant PPP projects' preliminary work expenses will receive support from the national budget's special funds.

Since the launch of the PPP project over a year ago, the central and local governments have promoted over 1,800 PPP projects, with an investment scale of 3.4 trillion yuan. PPP is expected to become the project development model and investment direction in the coming years.

Industry Fund - Basic Elements

II. Main Financing Forms for Enterprises#

II. Main Financing Forms for Enterprises

II. Main Financing Forms for Enterprises

1. Corporate Bonds

Corporate bonds refer to securities approved by the National Development and Reform Commission, which are publicly issued by enterprises according to legal procedures and promise to repay principal and interest within a specified period. Corporate bonds are divided into general platform bonds, special bonds, project revenue bonds, and credit-enhanced collective bonds for small and micro enterprises, among others. Corporate bonds are mainly issued and listed in the interbank bond market, with investors primarily being institutional investors such as commercial banks, insurance companies, securities investment funds, securities firms, and enterprise annuities.

Under certain conditions, corporate bonds can also be issued and listed on the Shanghai Stock Exchange and Shenzhen Stock Exchange and can be issued to individual investors. Advantages of corporate bonds: large financing scale, long financing term, and relatively low financing cost.

Disadvantages of corporate bonds: the issuance process takes a long time, and the cultivation cycle for the bond-issuing entity is lengthy, including high requirements for building asset scale, optimizing asset structure, and optimizing income structure.

Funds circulate among these six major entities, endlessly. Next, let's clarify the functions of these six major entities and their interrelationships to see how money operates among them:

1. Banks

Referred to as the central bank, commonly known as "the central mother," is our national bank, led by the State Council, with the state as the investor.

There have been questions about the central bank, such as why no one seems to deposit money at the People's Bank. Now it is clear that the People's Bank is different from other banks; it does not aim for profit but is the source of "money." Simply put, the People's Bank acts like a financial manager for the state, overseeing the normal circulation of all state money, functioning as a "printing press" and "money shredder." When the market needs funds, the People's Bank activates the "printing" function to inject currency into the market; when there is an excess of currency in the market, the People's Bank activates the "money shredder" function to withdraw currency.

The People's Bank is the "bank of banks," the government's bank. Its primary methods of injecting money into the market are through "rediscounting" and "re-lending" to commercial banks, as well as purchasing government bonds issued in the open market. Therefore, the People's Bank mainly plays a role in regulation, supervision, and service.

2. Government

The government is similar to a company; it also needs funds to maintain daily operations and requires investment to build infrastructure such as railways and roads. Where does the government's funding come from? The main sources are taxes, state-owned enterprise income, administrative fees, and debt. Taxes are well-known; enterprises pay corporate income tax, and individuals pay personal income tax. State-owned enterprises dominate various monopolistic industries, generating substantial income. Administrative fees refer to various charges from administrative units, such as fines for illegal parking, as well as national and local bonds.

3. Commercial Banks

Commercial banks are the banks we usually deposit money in, such as Industrial and Commercial Bank of China, Agricultural Bank of China, Bank of Communications, and China Construction Bank. The essence of commercial banks is also a company, but they operate with money rather than ordinary goods.

Commercial banks primarily absorb public deposits, issue loans, and handle settlements. People deposit their savings in commercial banks, and the banks lend this money to enterprises, earning interest while providing depositors with a smaller interest rate. It's that simple. Now, due to low interest rates, fewer people are saving, but with the real estate boom, banks are providing loans to developers on one end and to homebuyers on the other, which has become the primary business of banks.

4. Financial Institutions such as Securities Firms and Fund Companies

Due to low bank interest rates that cannot keep up with inflation, more and more people are investing their money in financial products with higher returns, such as stocks and funds. Securities firms and fund companies play a significant role in investment activities, and their business is becoming increasingly diversified. For example, securities firms assist companies in going public (investment banking), help investors place stock orders (brokerage), manage wealth for the wealthy (asset management), and trade stocks themselves (proprietary trading), making their operations busier!

5. Enterprises

The goal is not to enrich securities firms but to make enterprises and individuals wealthy. Enterprises are the foundation and symbol of economic prosperity in developed countries. They contribute 65% of GDP and solve 75% of urban employment.

Enterprises rely on funds, which typically come from the founders' initial capital and profits generated from operations. Enterprises require manpower, thus addressing employment issues. Enterprises are heavily taxed, facing various taxes such as value-added tax, corporate income tax, and urban construction tax, resulting in limited surplus funds. To seek large-scale development, they often need to resort to financing.

Enterprise financing generally occurs through bank loans, venture capital institutions, and the stock market, which can be divided into equity and debt financing. By attracting equity investment, the company's current shareholders need to give up shares in the company, allowing investors to become new shareholders. The advantage is that there is no need to repay the money, eliminating debt pressure. Attracting debt investment essentially means borrowing money, which must be repaid with interest, but the advantage is that shares do not dilute.

6. Individuals

That’s you and me. We work hard, and earning money is not easy. A portion of our money is used for consumption, such as buying houses, cars, and groceries.

The essence of finance is the flow of funds, which gathers surplus funds from society to support the development of advanced industries, creating more social wealth. This is what we typically refer to as the primary market, which connects initial investors with initial investment targets. With the continuous development of the world economy, the layers of financial markets and trading methods are also evolving rapidly:

After the primary market, a much larger secondary market has developed, where investments are traded among each other to profit from price differences;

Following the primary and secondary markets, a derivatives market has emerged for hedging risks. Meanwhile, with the development of world trade, investment targets have expanded from bulk commodities, real estate, enterprises, and gold to the vast international foreign exchange market and sovereign debt market.

M is the total amount of money, V is the velocity of circulation; P is the price of goods, Q is the quantity of goods. The function of money itself is to better facilitate transactions, thereby improving transaction efficiency.

Modern currency is backed by "national credit." Modern currency is credit currency, and the fluctuation of currency value entirely depends on a country's strength and other countries' confidence in that country. The state and banks together reshape the concept of currency. The state regulates the entire society's credit scale and economic temperature through the banking system. A deposit of 100 dollars, with a reserve requirement ratio of 10%, can ultimately allow the total money circulating in society to reach 1,000 dollars. In the news, we often hear about base money (M0) and broad money (M2). In this example, 100 dollars is base money, and 1,000 dollars is broad money; the currency issued by each country is called base money.

The patience of a country's production capital determines the supply of funds, while the investment opportunities in society determine the demand for funds. The interaction between these two factors determines the cost of borrowing in society. In the issuance of government bonds and municipal bonds, previously non-transferable and non-tradable non-standardized "debt contracts" gradually transform into transferable and tradable "standardized contracts," which has an immeasurable impact on the development of human society. In the evolution of bonds, financiers have transformed cumbersome and illiquid debt contracts into easily tradable, smaller-denomination, and more liquid debt instruments in the capital market, a process known today as securitization.

The world's first bond was issued in the 12th century in Venice, Europe. At that time, Venice was embroiled in war, and as we know, war is very costly. Venice's tax revenue was limited, making it difficult to bear such a large war expense. So what to do? The Venetian government came up with a financial innovation, forcing every citizen to lend money to the government based on their ancestral inheritance amount, while promising to pay 5% interest annually, drawn from future tax revenues. This gave rise to a rudimentary form of bonds:

The debtor promises to pay the bond's interest from a future income source. This transforms a point-to-point unilateral "IOU" into an institutional, standardized debt contract that is homogeneous for everyone.

The scarcity of all items is eternal, while shortages and surpluses are the results of price manipulation. When prices are too low, people are forced to compete for the goods they need through means other than price, leading to shortages. Conversely, when prices are perceived to be too high, sellers must resort to means other than price to sell their goods, resulting in overproduction.

The impact of price manipulation leading to market shortages and surpluses:

1. Price controls inevitably lead to the dissipation of resource value.

2. Humans are animals that seek to minimize losses.

Interest is compensation for delayed consumption, and the consequences of regulation manifest in three ways:

1. People are unwilling to lend money to others.

2. The underworld emerges.

3. People will choose indirect methods to pay interest, increasing transaction costs.

The emergence of high transaction costs between individuals is alleviated by enterprises, which significantly reduce the cooperation transaction costs between people. Transaction costs limit the scale of enterprises; the larger the enterprise grows, the higher the internal costs become. Of course, the effect of teamwork is immeasurable; this is the power of cooperation.

When economic conflicts arise between different countries, there are two choices:

1. Cooperative competitive relationships. 2. Mutual threat relationships.

Typically, countries experiencing a debt crisis require several years to recover. The next round of a healthy economic cycle will exhibit the following characteristics:

1. Income and consumption rise one to two years later.

2. Economic vitality recovers from the bottom to the average level, taking about three years.

3. Initially, the exchange rate stabilizes, and the real exchange rate is undervalued (approximately 10% undervalued based on purchasing power parity), and the currency remains cheap.

4. Exports slightly rebound (increasing by 1%-2% of GDP).

5. After several years (averaging 4-5 years), capital flows back in. Foreign currency-denominated stocks also take about the same time to recover.

From a brief inflationary recession to a deep abyss of hyperinflation:

1. The emergence of hyperinflation: currency devaluation → inflation → money printing, repeating and escalating, ultimately leading to failure.

2. Basic principles for investing during hyperinflation: short the currency, transfer money abroad as much as possible, purchase bulk commodities, and invest in bulk commodity industries (such as gold, coal, and metals).

3. Hyperinflation will cause the currency to lose its role as a medium of exchange. A typical approach to hyperinflation is to issue a new currency with a solid foundation and gradually phase out the old currency.

War Economy

Through asset purchases or significant currency devaluation, actively promote debt monetization, resulting in higher public opinion economic growth rates, nominal interest rates, thus bringing about an economic turning point.

Implement stimulative macro-prudential policies, targeted protection systems, and important institutions, and stimulate high-quality credit growth.

Allow non-systemically important institutions to orderly collapse.

Governments balance between default, policy tightening (suppressing economic growth), and debt monetization, currency devaluation, and fiscal stimulus (promoting inflation).

The three "low leverage" debt relationships between social organizations are a necessary but insufficient condition for maintaining the stable structural operation of society and are also the root cause of traditional society's "de-financialization." The "debt spiral" leads to increased stability costs for society until the current regime becomes unbearable.

In enterprises, everyone's income differs, and there are many industries in society, each with different wages. We need to view this rationally. The explainable reasons are:

1. An employee's bargaining power depends on their opportunities elsewhere.

2. Marginal contributions determine team members' income levels.

3. The level and rhythm of wage income are determined by market factors.

Banks, bonds, stocks, and all monetary instruments help humanity accumulate scattered, point-like funds and invest them where they are most needed. Individuals, enterprises, wars, and the rise and fall of cities are all fundamentally driven by financial power, which helps us break through the limitations of time and space, enabling rapid and effective capital aggregation to achieve unit goals.

To keep the economy running, savings must be used for investment—this is something everyone can understand. Banks earn money from the interest on loans minus the interest on deposits. Having taken public deposits, they naturally need to lend them out, earning the interest spread.

However, their analysis also indicates that this practice can be influenced by rumors. For example, if a rumor spreads that a bank is in trouble, and a large number of depositors rush to withdraw their money simultaneously, that rumor could become a self-fulfilling prophecy—leading to a bank run and the bank's collapse. What was initially fine becomes problematic. Therefore, providing deposit insurance through the government and acting as the lender of last resort can prevent this issue.

The principle of national money printing is interconnected.#

How does printed money circulate around the world?

One route is that ordinary American citizens use this money not only to buy domestic goods but also to purchase items from around the world, buying from wherever it is cheapest. For example, in China, our foreign trade companies earn dollars, and they convert those dollars into yuan to spend domestically, which is how our massive foreign exchange reserves are accumulated. It is worth mentioning that foreign exchange reserves serve as collateral when converting to yuan, so they do not belong to the central bank and cannot be used freely; liquidity must be maintained.

Another route is that many wealthy individuals invest their money globally, going wherever the returns are high.

They can only buy goods or invest internationally. However, this reserve also serves as collateral and must maintain a certain level of liquidity. Aside from purchasing some goods, the remainder must be invested in liquid financial products, with most being limited to buying U.S. Treasury bonds. Americans pay you interest, and your money eventually returns to the U.S. This is akin to you desperately producing goods to sell to them, while they borrow money to buy your goods—this is the essence.

The second route involves investment money. When U.S. interest rates are low, wealthy Americans rush to borrow money from banks and invest it in countries with higher returns, profiting from the interest rate spread. When U.S. interest rates rise, the money is pulled back to the U.S. When dollars come to invest, domestic assets continuously rise, and when dollars flow back, assets will decline. This is the reason for many emerging countries experiencing financial crises.

5. How does the dollar affect the domestic economy? First, the yuan that is exchanged for foreign exchange reserves leads to an increase in domestic yuan, while the yuan cannot circulate freely worldwide, consequently causing the yuan to depreciate.

Second, foreign investment money. Foreign investors, as previously mentioned, seek interest rate spreads, so they will go wherever the returns are high, thus exacerbating the situation. For example, if real estate yields well, they will buy properties, driving up housing prices. If stocks perform well, they will buy stocks, pushing up stock prices. When they withdraw, everything declines.

6. The core issue is that the dollar is the world's currency, and the dollar is tied to oil. Every country's development requires oil, and oil-producing countries in the Middle East only recognize dollar transactions due to U.S. military power. Therefore, other countries must hold dollars. The source of dollars is that domestic production sells goods to the U.S., and the U.S. prints money, meaning the U.S. can acquire goods for consumption simply by operating the printing press, allowing domestic residents to buy goods from other countries at a very low dollar price. This is the first wave of shearing sheep. The U.S. instructs Middle Eastern countries to raise oil prices, initiates wars in the Middle East to reduce oil supply, and drives up oil prices. Other countries then require more dollars, while domestic currency increases, triggering inflation. The domestic currency depreciates, and the exchange rate becomes one dollar to seven yuan. At this point, the U.S. implements quantitative easing, lowering interest rates, allowing U.S. companies to enter foreign markets with large amounts of money to invest and purchase assets. For example, spending 100 dollars to buy 700 yuan worth of assets. After purchasing, they wait.

When oil prices recover, other countries find themselves holding too many dollars, and excessive domestic currency leads to a need to reduce currency supply to curb inflation. Subsequently, the exchange rate stabilizes at one dollar to five yuan. At this point, the Federal Reserve begins to raise interest rates, and dollars start flowing back to the U.S. 500 yuan can be exchanged for 100 dollars. In this process, the U.S. effectively gains 200 yuan for free. This is the second wave of shearing sheep.

After other countries develop for a few years and earn more money, the U.S. can repeat the same model and continue to shear sheep. It can also be said that for every 100 units produced by other countries, they must pay 50 units to the U.S. The U.S. can use this money for massive investments in research and development, yielding substantial outputs, continuing to crush the technology of other countries.

The implications of petrodollars should include two points: the first point refers to the fact that in international trade, oil must be priced and settled in dollars.

The second point refers to oil-exporting countries, after selling oil and obtaining dollars, purchasing bonds and other investments in the U.S.

Oil tycoons around the world sell their resources for dollars, but having cash is not enough; they must spend it. Thus, they rush to buy U.S. bonds or find other ways to return their dollars to the U.S. After the Americans receive the dollars, they soon go back to the oil tycoons to buy oil. Oil becomes dollars, dollars turn into U.S. bonds, and finally, U.S. bonds are exchanged for oil.

How does the economy operate? "Transaction-based understanding method."

The economy is the sum of numerous transactions, and each transaction is quite simple. A transaction involves a buyer and a seller, where the buyer pays money (or credit) to the seller in exchange for goods, services, or financial assets. A large number of buyers and sellers exchange the same type of goods, forming a market. For example, the wheat market includes various buyers and sellers with different purposes, engaging in different trading methods. Various trading markets constitute the economy. Therefore, what seems complex in reality is merely a combination of numerous simple transactions.

For a market (or for the economy), if you know the total amount of money and credit spent and the quantity of goods sold, you know everything about understanding the economy. For instance, since the price of any good, service, or financial asset equals the total expenditure (total $) by all buyers divided by the total quantity sold (Q), if you want to understand or predict the price of a good, you only need to predict total expenditure ($) and total quantity (Q).

However, each market has a large number of buyers and sellers, and their motivations for trading are inconsistent. Still, the main motivations for buying and selling are always easy to understand, making it less difficult to comprehend the economy. This can be illustrated with a simple chart. This perspective of explaining the economy is easier to understand than traditional explanations based on supply, demand, and price elasticity.

Important concepts you need to know in the economic framework are: expenditure ($) comes from two sources—money (money) or credit (credit). For example, when you go to a store to buy something, you can pay with cash or use a credit card. If you pay with a credit card, you create deferred payment credit (credit can be generated immediately as long as both parties agree), while paying cash does not create credit.

In simple terms: different markets, different types of buyers and sellers, and different payment methods constitute the economy. For convenience, we group them to summarize the economic operation framework:

• All changes in economic activities and fluctuations in financial market prices stem from: 1) changes in the total amount of money and credit (total $) and 2) changes in the quantity of products, services, and financial assets sold (Q), where the former ($) has a more significant impact on the economy than the latter (Q) because changing the supply of money and credit is relatively easier than others.

• To simplify analysis, buyers can be divided into several major categories: the private sector and the government sector. The private sector includes households and enterprises, whether domestic or foreign; the government sector mainly includes: the federal government (which also spends money on goods or services) and the central bank, which is the only entity that can create money and use it to purchase financial assets.

Compared to goods, services, and financial assets, money and credit can more easily increase or decrease due to supply and demand relationships, thus creating economic and price cycles.

Capital System (The capitalist system)

Economic participants buy and sell goods, services, or financial assets and pay with money or credit. In a capital system, this exchange occurs freely, and in this free market, buying and selling can be based on each party's interests and purposes. The generation and purchase of financial assets (i.e., loans and investments) are referred to as "capital formation." Capital formation can be completed because both buyers and sellers believe that the transactions they reach are beneficial to each other. Creditors are willing to provide money or credit based on the expectation of recovering more.

Therefore, the premise for this system to operate well is the presence of a large number of capital providers (investors/lenders) and a large number of capital recipients (borrowers, sellers of equity), where the capital providers believe they can obtain more than their investment in return. The central bank controls the total amount of money; the amount of credit is influenced by monetary policy, but credit can be easily generated as long as both parties reach an agreement on credit. The emergence of bubbles occurs when excessive credit is created, making it difficult to fulfill repayment obligations, leading to the bursting of the bubble.

When capital contraction occurs, the economy also shrinks because there is insufficient money and credit to purchase goods. This contraction commonly manifests in two forms: recession (more common) and depression. Recession occurs in the short-term debt cycle, while depression occurs during deleveraging processes. Recession is easy to understand because it happens frequently, and most people have experienced it; depression is relatively harder to understand because it does not occur often, and people do not experience it enough.

Short-term debt cycle: also known as the business cycle, the cycle arises from:

a) Growth in consumer spending or money and credit ($) outpacing growth in production (Q), leading to rising prices.

b) Rising prices prompt monetary policy tightening, reducing money and credit, thus initiating a recession.

In other words, recession is caused by the tightening of monetary policy by the central bank (often to combat inflation), which suppresses the increase in the private sector, leading to economic slowdown. As the central bank loosens monetary policy, the recession also ends accordingly.

To end a recession, the central bank lowers interest rates to stimulate demand growth and increase credit because low interest rates can: 1) reduce repayment costs. 2) lower monthly payments, thus stimulating related demand. 3) Due to the discount effect of lower interest rates on expected cash flows, the prices of income-producing assets, such as stocks and bonds, will rise, creating a wealth effect that stimulates consumer spending.

Long-term debt cycle: occurs when debt grows faster than income and money until it can no longer grow because the cost of debt has reached an extreme point, typically when interest rates can no longer be lowered. Deleveraging is the process of reducing the debt burden (debt/income). How to achieve deleveraging? Mainly through the following combinations:

1. Debt restructuring to reduce or eliminate debt.

2. Tightening the belt to reduce spending.

3. Redistribution of wealth.

4. Debt monetization (government purchases of debt to increase credit).

The occurrence of depression is a result of the economic slowdown caused by the deleveraging process. The occurrence of depression is due to the inability of the central bank to counteract the shrinking demand and reduced spending in the private sector by lowering the cost of money.

During a depression:

1. Many debtors repay more money than they originally promised.

2. Monetary policies aimed at changing repayment costs and stimulating credit growth do not work.

First: Interest rates cannot be lowered indefinitely, which is insufficient to encourage consumer spending and capital behavior (leading to deflationary depressions).

Second: The increase in money will flow into anti-inflation assets rather than increase credit (leading to inflationary depressions). The end of a depression is typically achieved through the central bank printing money to monetize debts and offset the impact of reduced private sector spending.

It should be noted that a depression is a slow phase of deleveraging; if managed well, deleveraging does not necessarily lead to a depression (refer to the earlier article "An In-Depth Look at Deleveragings").

The performance of the government during economic recessions and depressions can serve as a barometer for assessing the current economic situation. For example, during a depression, the central bank typically prints money to purchase large amounts of financial assets to compensate for the shrinkage of private sector credit, while such behavior does not occur during a recession. Simultaneously, during a depression, the government will also increase its spending to compensate for the reduction in private sector consumption.

The two types of cycles mentioned above are two important parts of the economic operation framework. Below is a more comprehensive introduction to the economic operation framework.

Economic Operation Framework: Three Major Forces (The three big forces)

I believe the driving forces of economic operation mainly come from:

1. Trend growth in productivity.

2. Long-term debt cycles.

3. Short-term debt cycles (business cycles).

4. Growth in productivity

As shown in the chart below, over the past 100 years, the real GDP growth per unit of capital has averaged just below 2% and has not fluctuated significantly. This is mainly because, over time, knowledge increases, leading to improvements in productivity and living standards. The chart shows that, in the long run, the productivity trend line fluctuates very little, even during the Great Depression of the 1930s. Therefore, we have reason to believe that time will bring the economy back on track.

However, looking closely, the deviations from the trend line fluctuate significantly in the short term. For example, during a depression, the economy can differ by 20% between peaks and troughs, with financial wealth losses exceeding 50% and stock prices dropping even more than 80%. The losses of financial wealth held at the onset of a depression are greater than shown in the chart because wealth also undergoes a transfer process (government wealth transfer through taxation and other policies).

For instance, the Great Depression did not occur because people forgot how to produce effectively, nor was it due to war or drought. All factors that create noise in the economy were present, yet the economy stagnated. Why didn't idle factories simply hire some unemployed workers to utilize abundant resources and boost the economy? The issue is that these cycles are not caused by uncontrollable events (such as natural disasters); the real reason lies in human nature and the operation of the credit system.

The fluctuations deviating from the trend line are primarily due to the expansion and contraction of credit, which is the credit cycle: 1) Long-term debt cycles (50-75 years) (the long wave cycles) 2) Short-term debt cycles (5-8 years), also known as business/market cycles.

Debt Cycles

We find that whenever we mention cycles, especially the fluctuations of long cycles, we tend to frown and think: predicting economic cycles is like fortune-telling. Therefore, before explaining the two types of debt cycles, let’s briefly explain cycles.

Cycles are merely patterns that repeat due to events occurring in a logical sequence. In a capital economy, the expansion and contraction of credit drive economic cycles and can be logically deduced. Although each method and timing may not be exactly the same, the patterns and logic are quite similar. If you've played Monopoly, you understand that both credit and the economy have cycles. At the beginning of the game, everyone has a lot of cash, and there are few hotels. Therefore, whoever owns the most hotels earns the most money.

As a result, players convert cash into physical assets, and as more hotels are acquired, the demand for cash increases. However, many players have little cash, forcing them to sell their hotels at a discount. In this game, initially, physical asset holders have the advantage, but as the game progresses, cash becomes king. The experts are those who understand how to maintain the best ratio between physical assets and cash, although the so-called best ratio is constantly changing.

Now imagine changing the rules of Monopoly to allow banks in the game to accept deposits and issue loans. This way, players can borrow money from tomorrow to acquire hotels and can also earn interest on deposits instead of letting their cash sit idle. If Monopoly could be played this way, it would be much closer to the actual operation of the economy.

Compared to a situation without borrowing, more money would be invested in physical asset hotels, and the total amount of debt would be many times the actual circulation. Those who become hotel owners through borrowing would have a larger cash gap, making the cycle more pronounced. When there is a large demand for withdrawals, banks and depositors will encounter difficulties, often leading to situations where cash cannot be withdrawn. Essentially, the economic and credit cycles operate this way.

Now, let’s discuss how the two types of debt cycles drive economic cycles.

Operation of the Economic System (How the system works)

When the economy operates at a high capacity utilization rate, prosperity occurs; in other words, demand can accommodate existing production capacity. In this case, enterprises perform well, and unemployment is low. However, the longer this situation lasts, the more productive capacity will be added with the help of credit. When demand decreases, it leads to lower production utilization, enterprise profitability issues, and rising unemployment. If this situation persists for a long time, enterprises can only reduce costs through debt and equity cuts.

Thus, economic prosperity equates to strong demand. In a credit-based economy, economic prosperity corresponds to actual credit and demand growing robustly. Conversely, deleveraging equates to weak actual credit demand. This contradicts many people's understanding; recessions or depressions are not caused by issues with labor productivity but rather by declines in demand.

Many people might say, since changes in demand lead production changes and serve as a barometer for determining the economic direction (prosperity or recession), if production utilization declines, profitability worsens, and unemployment rises, the government should simply stimulate demand to resolve economic weakness. Why doesn't the government simply solve the economic weakness by stimulating demand? We will continue to analyze this, and you will understand the difficulty.

Money (money)

Money is essentially used to solve your payment problems. Many people mistakenly believe that anything that can be used for payment is money, whether it's a dollar check or a simple promise to pay (credit). When you use a signed check to buy something from a store, is that money? Actually, it is not; in essence, you have not completed the transaction. Instead, you are merely promising to pay, creating credit.

The Federal Reserve misleadingly defines money as the sum of M1, M2, etc., but the money defined here is almost all credit or promises to provide money rather than money itself. For example, the total debt in the U.S. is about 50 trillion dollars, while the actual money in circulation is only about 3 trillion dollars, meaning that credit is actually about 15 times the amount of money. The problem is that many people create credit when buying things without caring about how they will repay the credit or how to obtain credit capacity. Therefore, in reality, the amount of money is far less than what should be paid.

Credit (credit)

As mentioned above, credit is a promise of payment that can be used to buy goods, just like money. Credit is as easy to pay as money, but unlike money payments, credit payments are not completed, and you need to repay later.

There are two ways to stimulate demand: using credit or not using credit. Using credit to stimulate demand is clearly easier. For example, in an economy without credit, purchasing goods and services must involve exchanging goods or services of equal value. Therefore, the only way to increase personal consumption and overall economic growth is to enhance production capacity, which is inherently limited. However, this also reduces the occurrence of excessive prosperity and extreme depression, maintaining a production growth rate of around 2% with small fluctuations.

However, a credit-based economy is different; credit can be obtained by using existing assets and future income as collateral. In this scenario, credit and consumption can clearly outpace money and income. To facilitate understanding, consider the following example:

I ask you to paint my office and promise to pay you in the coming months. Your income and personal net worth increase (I pay you with a credit card), thus adding an item to both our balance sheets (my debt to you and the increase in my office capital). You can go to the bank to apply for a loan, and the bank will be happy because its sales and balance sheet also improve, and then you will use the profits for consumption. This example illustrates that compared to money and income, debt and consumption expenditure are more significant.

Simultaneously, this process is also self-reinforcing. Increased spending leads to growth in income and personal net worth, which in turn enhances borrowing capacity and encourages more consumption expenditure. Therefore, monetary expansion is intended to support credit expansion because more money circulating in the system allows for better loan repayment, and the assets I acquire can be sold at higher prices due to increased money chasing them. Thus, monetary expansion enhances credit ratings and the value of collateral.

In the economic environment described above, the only barrier to growth is the willingness of both parties to borrow. Borrowing and increased spending only occur when credit is easily accessible and costs are low. Conversely, this will decrease. In the short-term debt cycle, the central bank controls the amount of credit in the private sector by managing credit costs (interest rates), while in the long-term debt cycle lasting decades, credit growth outpaces income growth, and excessive credit growth is always limited, leading to deleveraging.

In a capital system, the most fundamental requirement for creating credit is that both parties believe the transaction is beneficial to them because the borrower's debt is the lender's asset. The lender needs to believe that the agreed repayment, after tax rates, can outpace inflation; simultaneously, the borrower needs to pledge assets to obtain credit, thus they must have confidence in the value of the collateral to repay on time.

For investors, another crucial factor is liquidity, which is the ability to sell investment assets for cash and use cash to purchase corresponding goods and services. If I hold 100,000 in government bonds, I will assume these can be exchanged for 100,000 in cash and used to pay for goods and services worth 100,000.

However, due to the relative overvaluation of financial assets compared to actual circulating money, if many people simultaneously need to convert to cash, the central bank must either print money (risking monetary inflation) or tolerate large-scale defaults (leading to deflationary depression).

Monetary Systems (monetary systems)

The power that governments most want to control is the ability to create money and credit to manage a country's monetary system, mastering the levers for increasing and decreasing money and credit. Monetary systems vary over time and differ between countries. In ancient times, monetary systems were based on barter, involving the exchange of goods of equal value, commonly using gold and silver as mediums. When you trade using gold coins, you pay for goods of equal intrinsic value. If you promise to deliver gold coins, you are essentially creating credit, which does not have equal intrinsic value.

Lenders are willing to provide credit with the expectation of obtaining more money, believing that the money they lend will ultimately allow them to purchase more goods and services. They forgo current consumption to exchange for future consumption with credit. After credit is created, lenders may ask: Who controls the monetary system? How do I know that more money won't be issued, ensuring that I can buy more goods and services in the future? This question has different answers in different periods.

Generally, there are two types of monetary systems: one is a commodity-based monetary system (usually gold-backed), which includes both cash (linked to gold) and credit systems; the other is a fiat currency system, which includes only cash and credit.

The first type makes it difficult to create credit or promote credit growth because the public will hedge against government actions. As the amount of money increases, the value of money decreases; in other words, the value of basic goods exchanged for money increases. When its price rises above a fixed level, arbitrage opportunities arise, and those holding credit will sell their debts to others in exchange for cash, redeeming basic goods from the government at below-market prices. This reduces the circulating credit and cash, causing the value of money to rise, while all goods and services' prices decrease. The end result is reduced inflation and a slowdown in the economy.

Due to time constraints, the value of money will depreciate relative to any other goods. We can bind money to any commodity to understand how the monetary system operates. For example, in 1946, a loaf of bread sold for 10 cents; if the government binds the dollar to bread, today a loaf of bread costs 2.75 dollars. If the government keeps its promise, everyone will buy all their cash from the government to purchase bread, selling it at high prices in the market. This reduces the circulating money supply, lowers the prices of other goods and services, and increases the quantity of bread in circulation, causing bread prices to drop faster than others. If the actual supply and demand for bread do not change significantly due to the ability to exchange bread for money, this binding will significantly reduce economic vitality.

Conversely, if the government binds the dollar to eggs, in 1947, a dozen eggs sold for 70 cents, today selling for 2 dollars. If this is the case, credit growth is less constrained compared to bread. Therefore, in a commodity-based monetary system, the ideal scenario is to choose targets with minimal supply and demand fluctuations. Of course, if the chosen target is indeed bread, then the bakery would have the actual power to issue currency, leading to inflation. Gold and silver are relatively better targets, although they are not absolutely perfect.

In a fiat currency system, the growth of money and credit is not limited by the ability to exchange money for goods but is controlled by the central bank and depends on the willingness of both parties to create credit.

Governments generally prefer a fiat currency system to have more power to print money, increase credit, change the value of money, and redistribute wealth. Human nature is to seek immediate gratification, making it difficult for policies to consider long-term benefits, leading to unrestricted credit growth and debt crises. Governments only revert to a commodity-based monetary system when the monetary system loses control, excessively printing money to alleviate debt burdens, resulting in severe currency depreciation. When creating money becomes very difficult, governments abandon the commodity-based monetary system.

Historically, due to the "difficulties" of both systems, governments have always shifted between the two monetary systems, and once a choice is made, it usually lasts a considerable time, generally for decades. Central banks can control credit growth through methods such as lowering interest rates and adjusting the money supply, so the turning point for necessary transitions does not easily arise.

2. Long-term debt cycles (i.e., long wave cycles)

As previously mentioned, if debt and expenditure grow faster than money and income, this process is also self-reinforcing. More expenditure leads to growth in income and personal net worth, which in turn enhances borrowing capacity and encourages more consumption expenditure. However, debt cannot continue to grow indefinitely, just as you cannot rely on the oxygen supply in your oxygen tank to survive indefinitely. When borrowing, you need to ensure that you can both borrow and repay; the debt you incur now must be repaid in the future.

However, in reality, borrowing often does not consider much. When you borrow to consume, it gives the appearance of wealth, leading lenders to believe your credit is excellent, making them willing to provide credit without considering how repayment will occur in the future. When debt can no longer increase, this self-reinforcing process reverses. This is a dynamic long-term debt cycle. As long as credit does not disappear, such long debt cycles will exist.

When the cycle is on the rise, a self-reinforcing process occurs, where the growth of money corresponds to higher debt growth, with debt-driven consumption expenditure increasing and more assets being purchased. Rising expenditure and asset prices, in turn, promote further debt growth.

This is because lenders provide credit based on the borrower's:

1. Income or cash flow.

2. Wealth or collateral.

As both continue to improve, they self-reinforce to increase the amount of debt.

For example, if your annual income is 100,000 and you have no debt, the bank allows you to borrow 10,000, increasing your consumption capacity to 110,000 per year. For the entire economy, such an increase in consumption expenditure generates higher income, while stock and other asset prices rise, leading to higher property income and collateral capacity. During the rising phase of the overall economic debt cycle, both the amount of debt and the repayment portion will increase, potentially lasting for decades, accompanied by the central bank's tightening and loosening policies (leading to business and market cycles). However, this process cannot continue indefinitely because there will come a day when the repayment portion equals or exceeds the available loan amount, at which point expenditure will inevitably decline, leading to deleveraging. You will have to spend as many years at 110,000 as you did at 100,000.

High levels of debt can constrain the economy. The debt ratio (DEBT/GDP) in Chart 2 is more accurately described not by the debt level itself but by the cash flow that needs to be paid, including both principal and interest. When debt interest rates are low enough, the growth of debt levels does not significantly increase the repayment cash flow, thus not causing economic downturns (as seen after 1944). The following chart better illustrates this dynamic process.

The three lines in the chart represent the ratios of interest payments, principal, and debt repayment cash flow to disposable income (the household sector is an important economic sector in the U.S. and can be extended to other sectors). The chart shows that after the Great Depression, the debt burden reached its peak. So what triggered this trend reversal?

The peak of the long-term debt cycle occurs when:

1. The debt-to-income ratio is very high.

2. Monetary policy can no longer create credit growth.

Once this point is reached, debt can no longer continue to grow, initiating the deleveraging process. The trigger for deleveraging occurs when debtors cannot pay their due debts and interest, leading to a large number of defaults in the private sector and cost-cutting, resulting in numerous economic problems, such as high unemployment rates. The triggers for debt crises arise from various factors, with the most common being investors using leverage to purchase assets at high prices, expecting asset prices to continue rising, while in reality, their expectations are overly optimistic. The