Basically, I’m sharing with you a YouTube material. Obviously, it is smoothly going explanation of economy. It is crucial for you to understand how world around you operates. Economy is one of the answers! Raymond Dalio is an American billionaire investor, hedge fund manager, and philanthropist. Dalio is the founder of investment firm Bridgewater Associates, one of the world’s largest hedge funds. The video below descibes how American economy works. However, it is still worth to watch it.
Trust me, you are able to change your life!
Economy is easy- few simple parts, simple transations by zillion times.
3 main forces that drive economy: – Productivity Growth – Short Term Debt Cycle – Long Term Debt Cycle
An economy is simply the sum of the transactions that make it up.
Each transaction consists buyer If we understand transactions then we can understand economy.
Market consists all the buyers and all the sellers. The biggest buyer and seller is the government.: Central Government: collects taxes and spends money
Central Bank: controls the amount of money and credit in the economy
– Interest rates
– Printing money
Credit is the most important part of the economy and probably at least understood
When Interest Rates is low then everything is cheaper so people want to get credits.
If you spent more, then someone earns more.
Credit Worthy Borower:
1. The Ability to Repay
2. Collateral if he can’t
High Income= High Borrowing= High Spending =High Income=High Borrowing… (High Productivity) CYCLES
Productivity Growth doesn’t change that much! Debt swing occur in two big cycles. One takes about 5 to 8 years and the other takes about 75 to 100 years.
Swings around the line are not due to how much innovation or hard work there is, the’re primarly due to how much credit there is.
Let’s for a second imagine an economy without credit. In this economy, the only way I can increase my spending is to increase my income, which required me to be more productive (do more work).
The middle line which increasing on the diagram is the productivity (e.g. more workers, machines etc.) The credits= it’s due to human nature and the way that 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 make. 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, anytime you borrow you create a cycle. This is as true for an individual as it is for the economy.
Understanding credits is essential because they set into motion. It is a mechanical, predictable series of events that will happen in the future.
This makes credit different from money.
Money is what you settle transaction with.
When you buy a beer from a bartender with cash, the transaction is settled immediately. By using credit card, you’re saying you promise to pay in the future. Together you and the bartender create an asset and a liability.
The reality is that most of what people call money is actually credit.
The total amount of credit in the United States is about $50 trillion and the total amount of money is only about $3 trillion.
Remember, in an economy without credit, the only way to increase your spending is to produce more. In an economy with credit, you can also increase your spending by borrowing.
Credit is bad when finances over-consumption 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, it doesn’t generate income for you to pay back the debt.
Credit creates growth.
Suppose You earn $100,000/year and have no debts so you are creditworthy enough to borrow $10,000 dollars= so you can spend $110,000 even though you only earn $100,00 dollars. So there is next person who earns $110,000/year can borrow e.g. $15,000 dollars= cycles Borrowing creates cycles. If the cycle goes up, it eventually needs to come down.
Short Term Debt Cycle
Spending continues to increase and prices start to rise- this happens because the increse in spending is fueled by credit.
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 too much inflation.
Seeing prices rise, it raises interest rates. With higher interest rates, fewer people can afford ONLY to borrow money. And the cost of existing debts rises.
Because people borrow less and have higher debt repayments, they have less money leftover to spend, so spending slows When people spend less, prices go down= DEFLATION.. Economic activity decreses and we have a recession The central Bank will lower interest rates to cause everything to pick up again.
With low interest rates, debt repayments are reduced.
When credit is easily available, there’s an economic expansion.
Notice that the bottom and top of each cycle finish with more growth than the previous cycle and with more debts. Powerful people push it!
They have an inclination to borrow and spend more instead of paying back debt.
Debts rise faster than incomes creating Long Term Debt Cycle Because everybody thiks thungs are going great! People are just focusing on what’s been happening lately.
More Income. More Valuable Assets. More Borrowing= We called it a BUBBLE
incomes have been groowing nearly as fast to offset debts. Let’s call the ratio od debt-to-income the Debt Burden. (So long as incomes continue to rise, the debt burden stays manageable)
People borrow huge amounts of money to buy assets as investments causing their prices to rise even higher.
People feel wealthy even with the accumulation of lots of debts, rising incomes and asset values help borrowers remain creditworthy for a long time.
This obviously can’t continue forever.
Over decades, debt burden slowly inrease creating larger and larger debt repayments.
When debt burdens have simply becoming too big there are crisis e.g. 1929 and 2008.
In a deleveraging; people cut spending, incomes fall, credit disappears, assets prices drop, banks get squeezed etc. people feel poor When it happens, people who borrowed things are rush to sell assets e.g. houses etc. and then the banks can buy it for very low prices!
In Recession, lowering interest rates works to stimulate the borrowing.
Interest rates in the United States hit 0% during the deleveraging of the 1930’s and again in 2008 The difference between recession and a deleveraging is that in a deleveraging borrowers’ debt burdens have simply gotten too big and can’t be reieved by lowering interest rates.
How to solve Delevering? The problem is debt burdens are too high and they must come down.
4 Ways this can happen:
1. Cut Spending (people, business and governments cut their spending) 2. Reduce Debt (debts are reduced through dfaults and restructurings) 3. Redistribute Wealth (wealth is redistributed from the ‘haves’ to the ‘have nots’) 4. Print Money (the central bank prints new money)
These 4 ways have happened in every deleveraging modern histrory (e.g. USA 1930s, England 1950s, Japan 1990s, Spain and Italy 2010s Austerity= when borrowers stop taking on new debts, and start paying down old debts, you might expect the debt burden to decrease. Borrower’s debts are a lender’s assets.
Depression= people discovering much of what the thought was their wealth isn’t really there.
Many lenders don’t want their assets to disappear and agree to debt restructing.
Debt restructuring means lenders get paid back less or get paid back over a longer time frame or at a lower interest rate that was first agreed.
All of this impacts the central governmentbecause lower incomes and less employment Deficit- spend more than the government has
The government need to get money from rich people e.g. raise taxes. If depression will take too long it might cause revolution and change in politics etc. Remember, most of what people thought was money was actually credit. So, when credit disappears, people don’t have enough money.
The Central Bank can print money. Having already lowered its interest rates to nearly 0, it’s forces to print money. Printing money is better way than e.g. weal redistribution.
The Central Bank- the Federal Reserve printed over two trillion dollars. The Central Bank can print money but it can only by financial assets.
Central government can buy goods and services and put money in the hands of the people, but it can’t print money
Central bank and central government must cooperate to stimulate economy
By buing government bonds, the Central Bank essentilly lends money to the government, allowing it to run a deficit and increase spending Deflationary and inflationay ways need to balance in order to maintain stability.= BEAUTIFUL DELEVERAGING
How can a deleveraging be beautiful? In beuaitful deleveraging, debts decline relative to income, real economic growth is positive, and inflation isn’t a problem. Inflation isn’t a problem then.
Spending is what matters. A dollar of spending paid for with money has the same effect on price as a dollar of 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.
Income needs to grow faster than debt grows. – E.g. the amount of debt is the same as the amount of income of entire country makes in a year.
– If debt is growing at 2% because of that interest rate and is only growing at around 1%, u will never reduce the debt burden.
You need to print enough money to get the rate of income growth above the rate of interest.
The key is to avoid printing too much money and causing unacceptably high inflation, the way Germany did.
Growth is slow but debt burdens go down= the beauty of deleveraging When incomes begin to rise, borrowers begin to appear more creditworthy.
Reflation process after that
3 Golden Rules 1: Don’t have debt rise faster than income. 2: Don’t have income rise faster than productivity.* : ) 3: Do all that you can to raise your productivity.
Iggyigi 