First, please watch this 30 minute economics masterclass from one of the great hedge funders, Ray Dalio:
Ray believes there are 3 primary forces driving our global economy:
1. Productivity growth (how much more output can you get with the same or fewer inputs)
2. Short-term debt cycle (lasts 5-8 years)
3. Long-term debt cycle (lasts 75-100 years and is usually quite painful)
In the video’s conclusion, Ray offers 3 rules of thumb for policymakers and economists:
1. Don’t have debt rise faster than income
2. Don’t have income rise faster than productivity
3. Do all that you can to raise your productivity. That’s what matters most
Unfortunately, Ray believes we are at the end of a long-term debt cycle. If he’s right, this would mean many years of economic pain, which could come in forms such as: falling real estate and stock prices; inflation via Central Bank money printing; little-to-no real GDP growth; social disorder; austerity measures in the form of higher taxes and reduced public spending.
IANAE, just studied it in college!
My complete and messy notes below:
3 forces driving economy
1. productivity growth
2. short term debt cycle
3. long term debt cycle
Economy is sum of the transactions that make it up
Money + credit = Total spending
Total spending drives economy
Market = All buyers and sellers making transactions
Biggest buyer and seller is the federal government which is 2 parts:
1. Central Government
2. Central Bank (different because it controls amount of money and credit in economy); performs this function through two means
a. Interest rates
b. Printing money
CREDIT
Most important part of economy and least understood
Largest and most volatile part
Buyers and sellers = transactions
Lenders and borrowers = credit
Any two people can create credit out of thin air
As soon as credit is created, it creates debt
Debt is both an asset and a liability
When a borrower receives credit, they increase spending
Spending drives economy
Credit worthy borrower has a) ability to repay (eg, high income), and b) collateral if he can’t (eg, a house)
CYCLES
Productivity growth = GDP growth over time
Doesn’t fluctuate much..but Debt does
Debt occurs in cycles
Short term cycle = 5-8 years
Long term cycle = 75-100 years
Changes in productivity / GDP growth are usually driven by amount of credit
“Because we borrow, we have cycles”; due to human nature
Borrowing pulls spending forward, borrow from your future self
Any time you borrow, you create a cycle
Money vs Credit
Money is instant settlement of a transaction
Credit is starting a bar tab, a future promise
Most of what we call money is actually credit
Total US credit is 50T
Total US money is 3T
Let’s say you earn 100K, you borrow 10K on credit, now you can spend 110K, so someone is earning 110K, so he can borrow 11K on credit, and so on
Borrowing creates cycles, if it goes up, eventually comes down
Short term debt cycle – 5-8 years
1. Expansion – spending increases, prices rise, this causes inflation
2. Central Bank doesn’t want too much inflation, so it raises interest rates
3. With higher rates, fewer people can borrow, debt payments rise
4. Spending and prices go down, we have a recession
5. Central Bank lowers rates, debt payments reduced, cycle begins again
Over long period of time, debt raises faster than incomes, which causes:
Long term debt cycle – 75-100 years
1. Incomes rising, assets rise, it’s a boom; Debt:income rises (debt burden)
2. Over decades, debt burdens keep rising, debt repayments start rising faster than incomes, and then incomes start to go down, borrowing goes down
3. Cycle reverses itself, long term debt peak
US, Europe, this happened in 2008, Japan in 1989, and US in 1929
Begins DELEVERAGING
Incomes fall
Credit disappears
Asset prices drop
Stock market crashes
Real estate market tanks
But now lowering interest rates doesn’t work, they’re already low, so the stimulus ends
Rates hit 0% in 1930s and 2008
What do you do?
Debt burdens too high, must come down. 4 ways
1. Cut spending, aka “austerity”, this can lead to Depression
2. Reduce debt, this can lead to deflation
3. Central government redistributes wealth, governments raise taxes on rich, social disorder can break out
4. Central Bank prints money (especially when rates are already zero), this is inflationary, uses it to buy financial asset and government bonds
US did this in 1930s and 2008, so did other countries
only helps those who own financial assets
buys bonds, lends money to government, who then distributes to people
These 4 happened in every modern history deleveraging
Depression is when people realize much of their wealth…isn’t really there
Deflationary and Inflationary ways must be balanced
Can be beautiful Deleveraging:
Debts decline relative to income
Real economic growth is positive
Inflation isn’t a problem
Will printing money raise inflation? It won’t if it offsets credit
Printing money can be abused because it’s so easy
Key is to avoid unacceptably high inflation
Takes a decade for “Reflation” / “Lost Decade” of this deleveraging
3 rules of thumb:
1. Don’t have debt rise faster than income
2. Don’t have income rise faster than productivity
3. Do all that you can to raise your productivity, that’s what matters most