“The times ahead will be radically different from those we’ve experienced in our lifetimes, though similar to many times in history” – Ray Dalio
Do you ever take a moment to think about the how the economic machine works? Upon reflection, I have found that as individuals, as colleagues, as parents, and so on, we are often so caught up in our own lives and own progress – the micro – that we often forget to take a step back and look at the broader picture – the macro. As outlined by Ray Dalio, the founder of Bridgewater Associates, in “How the Economic Machine Works,” the economy is driven by three main forces: productivity growth, the short-term debt cycle, and the long-term debt cycle whereby the economy is made up of all of the transactions between buyers and sellers, and the total amount of spending drives the economy.
When we think about total spending within the United States, the government is the largest buyer and seller of goods and services. As Ray notes, it is important to be aware that the government consists of two critical parts, both important to understanding the economy – the central government and the central bank. The Central Government is responsible for collecting taxes and determining how funds will be allocated in the economy. The Central Bank, on the other hand, is responsible for controlling the amount of money and credit in the economy – the central bank may be, in my humble opinion, one of the – if not the – most powerful institution in the world. If we know that the amount of spending drives the economy, it becomes evident that this is the case. So, how exactly does it do this? Simple – through its power of interest rates and the printing of money – and by extension, credit, what Ray Dalio refers to as ‘the most important part of the economy and probably the least understood.’
Credit is incredibly important because it fuels consumption habits, beyond typical means, in the short term (remember that spending drives the economy). When credit is created, it becomes an asset to the lender and a liability to the borrow until the transaction is settled. So, why is there so much focus on spending? As Ray Dalio highlights, one person’s spending is another person’s income i.e., the economy is made up of all of the transactions between buyers and sellers. As you think about this, analyze different points in history where interest rates may have been near zero, where the government printed money to address hardships, where a currency was devalued because of the inability to meet obligations, etc. Look at the roaring 20’s, the Great Depression, Germany after the World Wars, the U.S. in the 1970’s, the dot com era, the Great Recession, the COVID-19 pandemic. Do you see a pattern? As Mark Twain noted, while history may not repeat itself, it often rhymes.
Sources: 1. Cristian Carrillo, https://quetzalcapitalgroup.com/
2. Ray Dalio, ‘How the Economic Machine Grows’
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