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How the Economic Machine Works

Ray Dalio, Founder of Bridgewater Associates

This 30 minute video explains, in a very clear and easy to understand way, how the economy responds to the short term debt cycle, the long term debt cycle and productivity growth.   Dalio believes we are currently in an economic period known as a “deleveraging” where the long term debt cycle is contracting.  The last time we had a period like this in the United States was in the 1930s. However, we have seen periods like this before in Japan, the UK, Spain, Italy and more. The damaging effects of this deleveraging can be astounding if mishandled. This can be seen in Japan’s experience over the past two decades (The Lost Decade), as well as in the US during the Great Depression. However, the negative effects of a deleveraging can be dampened if policy creates a “beautiful deleveraging.”

Ray suggests there are four ways to facilitate a “beautiful” deleveraging, where the credit bubble is slowly unwound.  This is accomplished though a perfect mix of:

  • Cutting spending (austerity)
  • Debt reduction (including restructuring and bankruptcy)
  • Printing money (this is inflationary and stimulative, offsetting the effects of austerity and debt reduction and creating more money to redistribute)
  • Income redistribution (transferring wealth from the haves to have nots)

In a nutshell the consumer and corporate sectors are delevered as the government takes on more debts. The central government is able to do this by running budget deficits financed by the central bank.  The central bank lends money to the government by buying government bonds with printed money. The central government then uses this money to fund government redistribution programs.  These programs consists of the central government buying goods and services from the people.  The central bank can also print money to buy stocks and bonds and drive up asset prices, making people more credit worthy.   As long as the economy grows and tax payments are enough to offset interest payments on the debt, we get a “beautiful deleveraging.”  In order for the beautiful deleveraging to be sustained however, income must grow faster than debt grows.

Ray suggests policy makers should consider the following:

  • Don’t have debt rise faster than income
  • Don’t have income rise faster than productivity
  • Do all you can to raise your productivity

Good advice.  I hope our policy makers are listening.

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Ken’s focus is on investment strategy, research and analysis as well as financial planning strategy. Ken plays the lead role of our team identifying investments that fit the philosophy of the Global View approach. He is a strict adherent to Margin of Safety investment principles and has a strong belief in the power of business cycles.
On a personal note, Ken was born in 1964 in Lexington Virginia, has been married since 1991. Immediately before locating to Greenville in 1997, Ken lived in New York City.

Categorized: Economic Commentary