Why is excessive credit expansion a harbinger of an economic bubble?

Hello! Let's discuss this in simple terms.

Imagine you and your friends are playing a game where you build houses with building blocks.

Normal Market: Building Brick by Brick

Normally, you have a limited number of blocks, accumulated little by little by completing tasks (like earning money from work). If you want to build a tall building, you have to slowly save up blocks. This process might be slow, but the buildings you construct are solid because each block is real.

Here, "blocks" are like our own money.

Credit Expansion: 'Borrowing' Blocks from the Bank

Now, the rules of the game have changed. There's a bank nearby that's willing to lend you a large number of blocks, with very low interest and simple procedures. You think, "Wow, here's my chance to build!" You not only use all your own blocks but also borrow a huge pile from the bank.

Your building instantly grows tall and fast. Your friends see this and also rush to the bank to borrow blocks to build. The entire game scene looks prosperous, with tall buildings everywhere.

This "borrowing blocks" is credit expansion. When banks (or the entire financial system) make money (credit) very easy to borrow, the amount of money in the market suddenly increases.

Bubble Formation: Soaring Building Prices, but Unstable Foundations

Here's the problem. Although the buildings are very tall, many of them are built on "borrowed blocks."

Asset Price Soaring: Everyone rushes to buy things like houses and stocks with borrowed money. Think about it: there's a limited supply of goods, but suddenly there are several times more buyers and money. How can prices not rise? This is like in the game, where building plots are limited, and everyone rushes to grab them, naturally driving up land prices. At this point, asset prices have far exceeded their intrinsic value, and this is a bubble.
The Game of Pass the Parcel: You buy a house for 1 million (much of it borrowed), and next month it rises to 1.2 million. Your friend sees this and quickly borrows money to buy it for 1.2 million, hoping it will rise to 1.5 million next month to sell to someone else. Everyone feels that "buying means earning," and no one cares about the actual value of the house, only whether they can find the next person to take over. Credit expansion (borrowing money) provides a continuous "fuel" for this game.

Why is this a "precursor"? Because this game always comes to an end.

This prosperity, built on borrowed money, is very fragile. It's like a greatly inflated balloon; it looks beautiful, but a single pin can pop it.

What could be the tipping point?

Banks raise interest rates: Banks feel the risk is too high and decide to raise interest rates. The cost of borrowing money increases, many people can no longer afford to borrow, or can't repay their previous loans. The "bank" in the game no longer lends blocks freely.
Confidence wavers: Someone suddenly finds their house listed at 1.5 million can't be sold. Desperate to repay the bank, they have to lower the price to 1.4 million, 1.3 million... Others see this and start panic selling.
External shock: For example, a sudden economic crisis causes many people to lose their jobs, leaving them without income to repay loans.

Bubble Burst: A Mess

Once the tipping point occurs, what happens?

Asset Prices Plummet: Everyone wants to sell, no one wants to buy. Housing prices and stock prices fall sharply.
Debt Crisis: The house you bought for 1 million is now only worth 600,000. But you still owe the bank 1 million plus interest. Even selling the house won't cover the loan; this is called "negative equity." Countless individuals and businesses go bankrupt as a result.
Financial Crisis: When a large number of people and businesses can't repay their debts, banks accumulate mountains of bad loans and may even collapse themselves. This can lead to a paralysis of the entire financial system, ultimately resulting in a severe economic recession.

In Summary

Excessive credit expansion is like giving the economy a shot of hormones. In the short term, it can cause asset prices to skyrocket, creating a false prosperity. However, this growth is not based on real value creation (like technological advancements or increased productivity) but on the accumulation of debt.

Therefore, when the rate of credit (debt) growth in a country or region far exceeds its economic (GDP) growth rate, it means that a large amount of money has not entered the real economy to "build brick by brick," but has instead flowed into the asset market to "borrow blocks and blow bubbles."

This bubble will burst sooner or later, and excessive credit expansion is precisely the "blower" that inflates the bubble to a large and dangerous size. Therefore, it is widely regarded as the most typical and important precursor to a bubble.