What is ‘credit’?

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“Credit is just the future tense of the language of money.”

This quote comes from Netflix’s brilliant film The Laundromat, succinctly defining the concept of ‘credit’ in one simple sentence.

Without credit modern capitalism would not exist, at least in its current state that we understand it.

Credit has allowed mankind to step away from the feudal, medieval economics of trading things that only exist in the present, and given us the tools to observe money in the future tense.

Before the modern era, if a farmer needed wood to build a new shed for his pigs, he’d offer the local carpenter something in his inventory (a couple of chickens or a cow for example) for the wood he needed. If the carpenter did not require what the farmer was offering and declined, the farmer was out of luck…no new shed for Mr farmer…sad pigs.

This was often due to people not trusting in the future being better than the present, and so were rarely willing to extend an offering of credit to others (an I.O.U).

You couldn’t blame them. This was back during a time where surpluses just didn’t exist for the majority of individuals and were reserved mainly for the Kings and Queens who took what they liked and hoarded the excess; everyday people consumed what they needed and no more.

As the idea of capitalism spread and became the mainstream, so did one of its key characteristics: credit.

Individuals and groups began offering money to people on the expectation that they’d get that money back with a little extra on top (interest).

Those that received these loans would then put that money into starting or expanding a business, enabling them to take on more employees and buy more equipment, which allowed them to take out larger loans as their creditors became more trusting, and so the process repeated itself.

The modern era of credit

Capitalism today is very much the dominant economic system. After the collapse of the Soviet Union in 1991, there appears to be very few alternatives actively being practised in the world today.

Of course, you have fantastic institutions such as the NHS, based on the ideas of socialism – public money is pooled through taxation and distributed across various governmental health departments in order to fund treatment and research – but capitalist practises still mean the NHS has to procure medicines and services from companies that are looking to make a profit from selling their medicines to it.

As the modern era dawned, so too did the functions of modern banking such as, ‘accepting deposits, moneylending and money transfers combined with the issuance of bank debt that served as a substitute for gold and silver coins’.

These banks serve as the go-to suppliers of credit. This is most popularly realised in the form of a credit card. On these cards are small to medium sized amounts an individual can use as and when they see fit and for almost any purpose, but with the expectation that the individual will pay back that amount within a set time (usually 6 weeks from the time of the purchase). It’s important to remember that credit on a credit card IS NOT your money, and belongs to the bank.

This can be an incredibly valuable tool to have if used properly but incredibly expensive if not. This expense usually comes in the form of interest owed on the sums the individual uses on the card.

This is not to be taken lightly. Credit card repayments have stalled significantly compared to credit lending since 2012, and have been a huge cause of average household debt now standing at over £15k in the UK.

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Source: finder.com

Credit lending is big business for banks and lending firms alike, with the latter recently and regularly appearing in news headlines for dubious (to put it lightly) lending practices, where extortionate interest rates on loans have far out succeeded those you might get with standard credit cards. For more on this just Google ‘Wonga’.

How is credit used positively?

Despite this, credit can often be used for good, and as mentioned above has been used to establish the modern economic world as we know it, funding a lifestyle and a level of comfort (especially in The West) our ancestors could only dream of.

The most obvious thing that comes to mind as a benefit of credit, is leverage. Credit is the means by which an individual can create ‘leverage’.

Leverage is a process whereby borrowed money (credit) is used to finance wealth creating assets and increase monetary returns. For example, establishing or growing a business or buying a house. Unless you have significant capital (cash) in order to finance these opportunities already, credit is an obvious and necessary option for many to create this kind of wealth.

At the same time, it must not be forgotten that with the more leverage comes more risk. The more that’s borrowed, the more that will be expected to be paid back to the creditors (banks, loan companies etc.)…see above.

Another advantage of credit comes in the form of a credit score. If an individual is seen as reliable by a creditor, and regular pays back money they owe on time and in full, then the higher their credit score will be; the higher the credit score, the more likely a creditor will be to lend them money in the future should they need it.

For those in the UK, you can check your credit score with a number of different companies: Equifax, Experian, Clearscore to name a few.

Bonus tip: this is also a great way of protecting yourself from identity fraud to see if someone has used your name and details to take out lines of credit.

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Given the regular audience of this blog, this has probably been a whole lot of preaching to the choir. But I hope is serves as a starting reference point to highlight the importance of credit and leverage when we look at it as wealth builders and creators.

Without these things, portfolios would not rise, business dreams could not be realised and the great companies of this world would not exist.

As with all these things however, it’s important to recognise the risks credit can bring and we should always be mindful that, with all the successes, come an equal number of failures.

If you’re struggling with debt, please seek help with one of the many charities and services here in the UK. There are a number of links in the Useful links/ resources section of this site, along with many more if you take the time to look them up online. You’re never alone.

 

 

 

Sources:

https://en.wikipedia.org/wiki/History_of_banking#17th–19th_centuries_–_The_emergence_of_modern_banking

https://www.investopedia.com/terms/c/credit.asp

https://neilkakkar.com/capitalism.html

https://en.wikipedia.org/wiki/History_of_capitalism#Today

https://www.theguardian.com/business/2019/jan/07/average-uk-household-debt-now-stands-at-record-15400

https://www.finder.com/uk/credit-card-statistics

https://www.investopedia.com/terms/l/leverage.asp

5 thoughts on “What is ‘credit’?

  1. Nicely written post on an important subject.

    I use Credit Karma for my credit score – it’s free and they give alerts if your credit score changes, which is a good warning if you haven’t recently done anything to warrant such a change.

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    1. I’ve been thinking of signing up to a credit checking score…more so for the identity fraud protection than anything, but it’d be nice to see in real time if my regular paying of credit has had a positive impact on my credit score.

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  2. An interesting post AMM, but I would argue that the pig farmer and carpenter didn’t need credit but ‘money’ (a common medium of exchange) for the pig farmer to ‘pay’ the carpenter for his work. Though I have no doubt that 5 seconds later, someone came up with I.O.U.s (credit) 🙂

    This is apparently how ‘money’ as we know it came about – you stored your gold at the local bank and you were given a bit of paper saying ‘this proves you are entitled to 50g gold in the vault’. Rather than head to the bank and take out the gold each time, people just started trading the bits of paper, as it was equivalent to actually having the gold. Of course the banks got greedy and started giving out more I.O.U.s than gold they had in the bank and thus fractional reserve banking was born heh Also interesting to note that interest on lending money was called ‘usury’ and was originally a sin!

    There was a good (funny) series on YouTube about this: https://www.youtube.com/watch?v=-nZkP2b-4vo

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    1. Wow! What an interesting insight, I’ll have to go and read up on that now. That video was fascinating! Yet another YouTube channel I’m going to spend hours watching everything they’ve ever published haha!

      Edit: I think we should go back to giant stone doughnuts as currency like the Yap islanders haha!

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