Sunday, 1 February 2015

The Economic Machine | Ray Dalio

Ray Dalio is a giant in the Hedge Fund world. But this isnt a post about the social utility of Hedge Funds nor his place in it. Suffice to say, he has a unique investment philosophy that has built him a fortune of circa $15bn, a very unique company culture around radical transparency, he meditates daily and has Tony Robbins as his business coach.

What I really love is his articulation of macro economics in this 30 minute video. It's simplicity is genius and I think everyone in business should watch it.

Here is my summary:
- he has created an economic framework by which to understand the world of money, what he calls "the template"
- this template has 3 levers: productivity, short term debt cycle and long term debt cycle, which in the long run all have to intersect and be in equilibrium.
- any two people can agree to create credit and all credit is the creation of money
- credit creates debt. It allows greater spending by transferring the saving to consumption. this borrowing is a way of pulling spending forward, ie, borrowing from your future self, which implies less spending in the future.
- productivity matters most in the long run
- credit matters most in the short run
- debt cycles occur in two cycles: 5-8 years andd 75-100 years. these cycles are overspending and then deleveraging to the meet the productivity increases
- credit is bad when it promotes over consumption (spending that cant be paid back)
- credit is good when it promotes investment, ie, buying assets that produce an income
- credit can stimulate income and asset growth, through inflation. people then borrow more. eventually debt repayments exceed income, so they cut spending. this can become deflationary.
- long term debt cycles need a deleveraging people cut spending, incomes fall, credit dries up and borrowers are forced to sell assets as spending falls. markets fall and collateral also falls, making the debt even more painful and increasing the inability to repay such debt.
- in deleveraging  of a long term cycles is problematic because interest rates usually go close to zero therefore inability to stimulate the economy. debt becomes greater than the asset values.  no one wants to borrow anymore.
- 4 ways to deal with this:

  1. spending is cut - people, biz and govt (aka austerity) - this causes income to fall and so the debt burden can become greater
  2. debts are reduced - defaults increase and asset valuations fall further and wealth falls too! debt restructuring occurs which reduces debt.
  3. wealth is redistributed - low income groups need to be supported by more tax dollars. but tax dollars are falling in line with incomes. so usually taxes on the wealthy increase.
  4. central bank prints money and then buys financial assets - govt bonds - so then the central bank lends money to govt which allows the govt to boost spending and people's incomes

- people often mistake credit for money, so when credit dries up, money disappears.
- policy makers need to balance the 4 ways to rebalance the economy - a "beautiful deleveraging"
- and to fix things, policymakers need to ensure income growth is greater than debt growth


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