Credit (from Latin credit, “(he/she/it) believes”) is the trust which allows one party to provide money or resources to another party wherein the second party does not reimburse the first party immediately (thereby generating a debt), but promises either to repay or return those resources (or other materials of equal value) at a later date. In other words, credit is a method of making reciprocity formal, legally enforceable, and extensible to a large group of unrelated people.
The resources provided may be financial (e.g. granting a loan), or they may consist of goods or services (e.g. consumer credit). Credit encompasses any form of deferred payment. Credit is extended by a creditor, also known as a lender, to a debtor, also known as a borrower.
Debt is an obligation that requires one party, the debtor, to pay money or other agreed-upon value to another party, the creditor. Debt is a deferred payment, or series of payments, which differentiates it from an immediate purchase. The debt may be owed by sovereign state or country, local government, company, or an individual. Commercial debt is generally subject to contractual terms regarding the amount and timing of repayments of principal and interest. Loans, bonds, notes, and mortgages are all types of debt. In finance, debt is one of the primary financial instruments, especially as distinct from equity.
The term can also be used metaphorically to cover moral obligations and other interactions not based on economic value. For example, in Western cultures, a person who has been helped by a second person is sometimes said to owe a “debt of gratitude” to the second person.
Ray Dalio, HOW THE ECONOMIC MACHINE WORKS:
Just like buyers and sellers go to the market to make transactions, so do lenders and borrowers. Lenders usually want to make their money into more money and borrowers usually want to buy something they can’t afford, like a house or car or they want to invest in something like starting a business. Credit can help both lenders and borrowers get what they want. Borrowers promise to repay the amount they borrow, called the principal, plus an additional amount, called interest. When interest rates are high, there is less borrowing because it’s expensive. When interest rates are low, borrowing increases because it’s cheaper. When borrowers promise to repay and lenders believe them, credit is created. Any two people can agree to create credit out of thin air! That seems simple enough but credit is tricky because it has different names. As soon as credit is created, it immediately turns into debt.
Debt is both an asset to the lender, and a liability to the borrower. In the future, when the borrower repays the loan, plus interest, the asset and liability disappear and the transaction is settled. So, why is credit so important? Because when a borrower receives credit, he is able to increase his spending. And remember, spending drives the economy. This is because one person’s spending is another person’s income. Think about it, every dollar you spend, someone else earns. and every dollar you earn, someone else has spent. So when you spend more, someone else earns more. When someone’s income rises it makes lenders more willing to lend him money because now he’s more worthy of credit.
A creditworthy borrower has two things: the ability to repay and collateral. Having a lot of income in relation to his debt gives him the ability to repay. In the event that he can’t repay, he has valuable assets to use as collateral that can be sold. This makes lenders feel comfortable lending him money. So increased income allows increased borrowing which allows increased spending. And since one person’s spending is another person’s income, this leads to more increased borrowing and so on. This self-reinforcing pattern leads to economic growth and is why we have Cycles.
In a transaction, you have to give something in order to get something and how much you get depends on how much you produce over time we learned and that accumulated knowledge raises are living standards we call this productivity growth those who were invented and hard-working raise their productivity and their living standards faster than those who are complacent and lazy, but that isn’t necessarily true over the short run. Productivity matters most in the long run, but credit matters most in the short run. This is because productivity growth doesn’t fluctuate much, so it’s not a big driver of economic swings. Debt is — because it allows us to consume more than we produce when we acquire it and it forces us to consume less than we produce when we pay it back. Debt swings occur in two big cycles. One takes about 5 to 8 years and the other takes about 75 to 100 years.