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"2015-11-03 22:45:01"
How The Economic Machine Works in 30 minutes by Ray Dalio
\\how the economic machine works in 30 minutes the economy works like a simple machine but many people don't understand it or they don't agree on how it works and this is led to a lot of needless economic suffering I feel a deep sense of responsibility to share my simple but practical economic template so what's unconventional this helped me to anticipate and to sidestep the global financial crisis and it has worked well for me for over 30 years let's begin though the economy might seem complex it works in a simple mechanical way it's made up of a few simple parts and a lot of simple transactions that are repeated over and over again a zillion times these transactions are above all else driven by human nature and they create 3 main forces would drive the economy number one productivity growth number to the short term debt psycho and number 3 the long term debt cycle well look at these 3 forces and how laying them on top of each other creates a good template for tracking economic movements in figuring out what's happening now let's start with the simplest part of the economy transactions an economy is simply the sum of the transactions that make it up and a transaction is a very simple thing you make transactions all the time every time you buy something you create a transaction each transaction consists of a buyer exchanging money or credit with the seller for goods services or financial assets credit spends just like money so adding together the money spent and the amount of credits band you could know the total spending total amount of spending drives the economy if you divide the amount spent by the quantity sold you get the price and that's it after 2 means action the building block of the Wall cycles and all forces in an economy driven by transactions so if we can understand trends actions we can understand the whole economy all market consists of all the buyers and all the sellers making transactions for the same thing for example there is only market of Harmar the stock market and markets for millions of things and economy consists of all of the transactions in all of its markets if you add up the total spending and the total quantity sold in all of the markets you have everything you need to know to understand the economy it's just that simple people businesses banks and governments or engage in transactions the way I just scribe exchanging money in credit for good services and financial assets the biggest by 2 important parts central and a central bank it's different for because it controls the amount of money and credit in the it does this by influencing interest rates and printing new money for these reasons as well see the central bank is an important player in the flow of read it I want you to pay attention to credit credit is the most important part of the economy and probably the least understood it's the most important part because it's the biggest and most volatile part just like buyers and sellers go to the market to make transactions soda lenders and borrowers lenders usually wanna make their money into more money come forward usually want to buy something they can't afford like a house or car where they want to invest in something like starting a business credit can help both lenders and borrowers get what they want borrower's promise to repay the amount they borrow called 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 promised to repay and lenders believe them credit is created any 2 people can agree to create credit out of thin air that seems simple enough the credit is tricky because it has different names as soon as credit is created it immediately turns into debt that is both an asset to the lender and a liability to the borrower in the future when the bar were repays the loan plus interest the asset and a liability disappear and the transaction is settled so why is credit so important because when a borrower receives credit he's able to increases spending and remember spending drives the economy this is because one person spending is another person's income think about it every dollar you spend someone else turns and every dollar you weren't someone else's spent so when you spend more someone else earns more when someone's income rises in makes lenders more willing to lend him money because now he's more worthy of credit a credit for the borrower has 2 things the ability to repay and collateral having a lot of income in relation to his dad 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 faraway which allows increased spending and since one person 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 psycho 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 inventive and hardworking raised their productivity in 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 the short run this is because productivity growth doesn't fluctuate so it's not swings dad 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 have to pay it back debt swings a Kirk into big cycles one takes about 5 day ears in the other takes about 75 to 100 years while most people feel the swings they typically don't see the most cycles because they see them too up close day by day week by week in this chapter we're going to step back and look at these 3 big forces and how they interact to make up our experiences as mentioned swings around the line or not due to how much innovation or hard work there is they're primarily due to how much credit areas let's first second imagine a it's my spending is to increase my which requires me to be more productive and do more work increased productivity is the only way for growth since my spending is another person's income the economy grows every time I else is more productive if we follow the transaction play this out see a progression uploaded growth why but because we borrow your we have cycles this isn't due to any laws or regulations it's due to human nature and the way the credit works think of borrowing as simply a way of pulling spending forward in order to buy something you can't afford you need to spend more than you may to do this you essentially need to borrow from your future self in doing so you create a time in the future that you need to spend less than you make in order to pay it back it very quickly resembles a cycle basically any time you borrow you create a cycle this is as true for an individual as it is for the economy this is why understanding credit is so important because it sets into motion a mechanical predictable series of events that will happen in the future this makes credit different from money money is what you settle transactions with when you buy a beer from a bartender with cash the transaction is settled immediately but when you buy a beer with credit it's like starting a bartender you're saying you promised to pay in the future together you end the bartender create an asset and a liability you just created credit out of thin air it's not until you pay the bar tab later that the acid in the liability disappear the debt goes away and the transaction is settled the reality is that most of what peace call my is actually credit the total amount of credit in the United States is about $50000000000000 in the total amount of money is only about $3000000000000 remember in an economy without credit the only way to increase your spending is to produce more but in an economy with credit you could also increase your spending by borrowing as a result an economy with credit has more spending and allows incomes to rise faster than productivity over the short run but not over the long run now don't get me wrong credit isn't necessarily something bad that just because of cycles it's bad when it finances over consumption that can't be paid back however it's good when it efficiently allocates resources and produces income so you can pay back the debt for example if you borrow money to buy a big TV does Xen generate income for you to pay back the debt but if you borrow money to say by a tractor and that tractor lets you harvest more crops and earn more money then you can pay back your dad and improve your living standards in an economy where credit we see how credit creates grow let me give you an example suppose you were in $100000 a year and have ... debt your credit worthy enough to borrow $10000 say on a credit card so you can spend $110000 even though you only earn 100000 since you're spending is another person's income someone is earning $110000 the person earning $110000 with no debt can borrow 11000 so he can spend $121000 even though he is only earn $110000 his spending is another person's income and by following the transaction we can begin to see how this process works in a self reinforcing padded but remember borrowing create cycles and if the cycle goes up it eventually needs to come down this leads us into push short term debt cycle as economic activity increases we see an expansion the first phase of the short term debt cycle spending continues to increase in prices start to rise this happens because the increase in spending is fueled by credit which can be created instantly out of thin air when the amount of spending and incomes grow faster than the production of goods prices rise when prices rise we call this inflation the central bank doesn't want to much inflation because it causes problems seeing prices rise it raises interest rates with higher interest rates fewer people can afford to borrow money and the cost of existing debts rises think about this as the monthly payments on your credit card going up because people borrow less and have higher debt repayments they have less money left over to spend so spending slows then since one person spending is another person's income income strata and so on and so forth when people spend last prices go down we call this deflation economic activity decreases and we have a recession if the recession becomes too severe and inflation is no longer a problem the central bank will lower interest rates to cause everything to pick up again with low interest rates debt repayments are reduced and borrowing and spending pick up and we see another expansion as you can see the economy works like a machine in the short term debt cycle spending is constrained only by the willingness of lenders and borrowers to provide and receive credit when credit is easily available there's an economic expansion when credit isn't easily available there's a recession and note that this cycle is controlled primarily by the central bank the short term debt cycle typically lasts 5 day here and happens over and over again for decades but notice that the bottom and top of each cycle finish with more growth in the previous cycle and with more debt why because people push it they have an inclination to borrow and spend more instead of paying back debt it's human nature because of this over long periods of time debts rise faster than incomes creating the long term debt side despite people becoming more indebted lenders even more freely extend credit why because everyone thinks things are going great people are just focused on what's been happening lately and what's been happening lately incomes have been rising asset values in the stock market roared it's a boom it pays to buy goods services and financial assets with borrowed money when people do a lot of that we call it a bubble so even though debts have been growing incomes have been growing nearly as fast offset them let's call the ratio of debt to income the debt burden so long as incomes continue to rise the debt burden stays manageable at the same time asset values for people borrow huge amounts of money to buy assets as investments causing their prices to rise even higher people feel well even with the accumulation of lots of dead rising incomes and asset values help are worse remain creditworthy for a long time but this obviously cannot continue forever and it doesn't over decades debt burden slowly increased creating larger and larger debt repayments at some point debt repayment start growing faster than income forcing people to cut back on their spending and since one person spending is another person's income incomes begin which makes people less credit worthy causing borrowing to go down debt repayments continue to rise which makes spending dropped even further and the cycle reverses itself this is the long term debt peak debt burdens have simply become too big for the United States Europe and much of the rest of the world this happened in 2008 it happened for the same reason it happened in Japan in 1989 and in the United States back in 1929 now the economy begins the leverage in that the leveraging people cut spending incomes fall credit disappears asset prices drop banks get squeezed the stock market crashes social tensions rise and the whole thing starts to feed on itself the other way as incomes fall in debt repayments rise borrowers get squeezed no longer credit worthy credit dries up and borrowers can no longer borrow enough their debt reap scrambling to fill this hole borrowers are forced to sell assets the rush to sell assets floods the market at the same time is spending falls this is when the stock market collapse of the real estate market tanks and banks get into trouble as asset prices dropped the value of the collateral borrowers can put up drop this makes borrowers even less creditworthy people feel for credit rapidly disappears less spending less income less wealth last credit less borrowing and so on it's a vicious cycle this appears similar to a recession but the difference here is that interest rates can be lowered to save the day into recession lowering interest rates works to stimulate borrowing however in a deliberate Jing lowering interest rates doesn't work because interest rates are already problem and soon hit 0 percent so the stimulation ends interest rates in the United States is 0 percent during that the leveraging of the 19 thirties and again in 2008 the difference between a recession and the leveraging is that in that these leveraging borrowers debt burdens have simply gotten too a big lenders realize that debts have become too large to ever be fully paid back borrowers have lost their ability to repay collateral has lost value they feel crippled by that they don't even want more lenders stop lending borrower stop borrowing think of the economy as being not credit worthy just like an individual so what do you do about a de leveraging the problem is debt burdens are too high and they must come down there are 4 ways this can happen one people businesses and governments cut spending 2 debts are reduced through defaults in restructuring 3 wealth is redistributed from the haves to the have nots and finally for the central bank prince new money these 4 ways have happened in every de leveraging in modern history usually spending is cut first as we just saw people businesses and even governments tighten their belts and cut their spending so that they can pay down their debt this is often referred to as a severity when bar were stopped taking on new debts and start paying down old debts you might expect the death burden to decrease but the opposite happens because spending is caught and one man spending is another man's income it causes incomes to fall they fall faster than debts repaid and the debt burden actually gets worse as we've seen this cutting spending is deflationary and painful businesses are forced to cut costs which means less jobs and higher unemployment this leads to the next step debts must be reduced many borrowers find themselves unable to repay their loans and a borrowers debts are lenders assets when a borrower doesn't repay the bank people get nervous that the bank won't be able to repay them so they rushed to withdraw their money from the bank banks get squeezed them people businesses and banks default on their debts this severe economic contraction is a depression Nnamdi big part of the depression his people discovering much of what they thought was their wealth isn't really there let's go back to the bar when you board of the year and put it on a bar tab you promised to repay the bartender you're promised became an asset of the bartender but if you break your promise if you don't pay him back in the century default on your bar tab then the act it has basically disappear many lenders don't want their assets to disappear in agreed a debt restructuring debt restructuring means lenders get paid back in less or get paid back over a longer time frame or at a lower interest rate than was first agreed somehow the contract is broken in a way that reduces debt lenders would rather have a little of something than all of nothing even though death disappears debt restructuring causes income and asset values to disappear faster so the death burden continues to get worse like cutting spending debt reduction is also painful and deflationary all of this impacts the central government because lower incomes and less employment means the government collects fewer taxes at the same time it needs to increase its spending because unemployment has risen many of the unemployed have inadequate savings and need financial support from the government additionally governments create stimulus plans and increase their spending to make up for the decrease in the economy n'gog Hermance budget deficits exploding lived in leveraging because they spend more than they earn in taxes this is what's happening when you hear about the budget deficit on the news to fund their deficits governments need to either raise taxes or borrow money but with incomes falling in so many unemployed who is the money going to come from the rich since governments need more money and since wealth is heavily concentrated in the hands of a small percentage of the people governments naturally raise taxes on the wealthy which facilitates a redistribution of wealth in the economy from the haves to the have nots the have nots who were suffering begin to resent the wealthy haps the wealthy habs being squeezed by the weak economy falling asset prices and higher taxes begin to resent the have nots if the depression continues social disorder can break out not only do tensions rise within countries they can rise between countries especially debtor and creditor countries this situation can lead to political change that can sometimes be extreme in the 19 thirties this led to Hitler coming to power war in Europe and depression in the United States pressure to do something and the depression increases remember most of what people thought was money was actually credit so when credit disappears people don't have enough money people are desperate for money and you remember who can print money the central bank can having already lowered its interest rates to nearly 0 it's forced to print money unlike cutting spending debt reduction and wealth redistribution printing money is inflationary and stimulative inevitably the central bank prince new money out of thin air and uses it to buy financial assets and government bonds it happened in the United States during the Great Depression and again in 2008 when the United States central bank the federal reserve printed over $2000000000000 other central banks around the world that could printed a lot of money to by buying financial assets with this money it helps drive up asset prices which makes people more credit worthy however this only helps those who won't financial assets you see the central bank can print money but he can only by financial assets the central government on the other hand can buy goods and services and put money in the hands of the people but I can't print money World War so in order to stimulate the economy the 2 must cooperate by buying government bonds the central bank essentially lends money to the government allowing it to run a deficit and increase spending on goods and services through its stimulus programs and unemployment benefits this increases people's income as well as the government's debt however it will lower the economy's total debt burden this is a very risky time policy makers need a balanced 4 ways that debt burdens come down nnova deflation need to balance with the inflation bill if balanced correctly there can be up beautiful day leverage you see at the leveraging can be ugly or can be beautiful how can a delivery Jing be beautiful even though it to leveraging is a difficult situation handling a difficult situation in the best possible way is beautiful a lot more beautiful than the debt fuelled unbalanced excesses of the leveraging in a beautiful de leveraging deaths decline relative to income real economic growth is positive and inflation isn't a problem it is achieved by having the right balance the right balance certain ex cutting spending that transferring their wealth and so the economic and social stability can 10 people ask if pre raise inflation it won't have it offsets falling credit remember spending is what matters a dollar spending paid for with money has the same effect on prices a dollar spending paid for with credit by printing money the central bank can make up for the disappearance of credit with an increase in the amount of money in order to turn things around the central bank needs to not only pumped up income growth but get the rate of income growth higher than the rate of interest on the accumulated debt so what do I mean by that basically income needs to grow faster than deck rose for example let's assume that a country going through a de leveraging has a debt to income ratio of 100 percent that means that the amount of debt it has is the same as the amount of income the entire country makes in a year now think about the interest rate on that debt let's say it's 2 percent if dad is growing at 2 percent because of that interest rate and income is only growing at around one purse you will never reduce the debt burden you need to print enough money to get the rate of income growth above the rate of interest however printing money could easily be abused because it's so easy to do and people prefer to the alternate she is to avoid printing too much money and causing unacceptably high inflation away Germany did during its de leveraging in the 19 twenties if policymakers achieve the right balance a de leveraging isn't so dramatic growth is slow but debt burdens go down that beautiful deal when incomes begin to rise borrowers to appear more credit worthy and when borrowers appear more credit really lenders be debt burdens finally begin for all able to borrow money people can spend more eventually the economy begins to grow again leading to the reflation failures of the long term debt cycle though the do leveraging process horrible if handled well all of them problem it takes roughly a decade or more for debt burdens to fall in economic activity to get back to normal since the term lost decade in closing of course the economy is a little bit more complicated than this template suggests however laying the short term debt cycle on top of the long term debt cycle and then laying both of them on top of the productivity growth long gives a reasonably good template first where we've where we are now and where we're probably had so in summary there are 3 rules of away from the first don't have debt rise faster than income because your debt burdens will eventually crush you second don't have income rise faster than productivity because you will eventually become uncompetitive and third all that you can to raise your productivity because in the long run that's what matters most this is simple advice for you when it simplifies for policy makers you might be surprised but most people including most policy makers don't pay enough attention to this this template is work for me thank you well I //

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