Ray Dalio is distinguished not only for founding Bridgewater Associates — the world's biggest hedge fund — or by his estimated net worth of $15 billion, but by his unique business philosophy and his tendency to explain it at length.
Every Bridgewater employee, for example, is given an exhaustive 120-page manual on Dalio's world view.
In late 2013, he produced and narrated an animated video that explains "How the Economic Machine Works" that simplifies the economy as the interaction of short- and long-term debt cycles over a productivity growth line. It's since gotten over 1 million views.
It's an engaging, animated explainer that covers the basics: the relationship between cash and credit, the government and the central bank, and inflation and deflation within 30 minutes. It's a great primer for anyone who could afford to be more financially savvy.
Here are some key points:
The economy is simply the sum of all transactions — the exchange of money and credit for goods, services, and financial assets — among individuals, banks, and governments.
The x-axis on the chart below roughly represents 75-100 years. The straight line is productivity growth, which doesn't fluctuate much. The large curves represent the long-term debt cycle and the smaller curves represent the short-term debt cycle, in which one curve represents 5-8 years.
An individual's spending is another person's income. If, for a hypothetical example, someone without debt makes $100,000, and they're eligible for a $10,000 line of credit, they can spend $110,000 that year, which is what someone else is making in cash.When spending outpaces the quantity of goods, prices rise. This represents inflation, the ascending half of the curves in the short-term debt cycle.To curb inflation, the central bank raises interest rates, which means that fewer people can afford to borrow money and existing debts grow more quickly. On a large scale, less spending means people's incomes drop and prices go down, and this is deflation. The central bank can lower interest rates to kick things up again.
The bottom and top of each short-term debt cycle finish with more growth and more debt than the previous one because people are inclined to borrow and spend more rather than paying off debt.
This leads to the top of the long-term debt cycle, called a bubble. As incomes and assets rise, borrowing increases. When the debt repayment grows faster than spending, incomes begin to go down, which then makes people less credit worthy. The cycle reverse itself.
In this process, a deleveraging, people cut spending, incomes fall, the stock market crashes, credit disappears, assets drop, banks are squeezed, and social tensions rise. The central bank can't lower interest rates any further because they're at 0%
To recover, people cut spending, banks reduce debt through defaults, the government redistributes wealth through higher taxes on the rich and social welfare programs for the poor, and the central bank prints money. If done effectively, a deleveraging can be "beautiful" rather than a total disaster.
Check out the full video below:
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