How the Economic Machine Works Summary – Ray Dalio

What is an Economy

  • 3 main components of the economic cycle: Productivity Growth, Short-Term Debt Cycle, Long-Term Debt Cycle
  • Economy is the sum of all the transactions. Transaction is defined as the buy and sell for goods, services, and financial assets
  • Total spending is what drives the economy. All cycles and forces in an economy are driven by transactions

Roles in the Economy

  • Biggest buyer/seller in the market are the government: Central government and central bank
  • Central government: collect taxes and spends money
  • Central bank: Control the amounts of money and credit in the economy by influencing interest rates and printing money

Role of Debt

  • Creditworthy borrower: has ability to repay and collateral if he can’t
  • Productivity grows overtime but is steady. Therefore, productivity does not contribute to the swings in the economic cycle
  • Debt allows for us to consume more than we product when we acquire it, and forces us to consume less in the future for when we must pay it back

Debt and Economic Cycle

  • Short-term cycle: when credit is easily available, it produces an expansion and vice versa. Central bank controls the short-term cycle through interest rates. Debt continues to increase, but the economy continues to expand in the long-term.
  • Long-term cycle: At some point, debt repayments grow faster than income and then the bubble bursts. Economy begins deleveraging, asset prices drop, stock asset crashes, income drops, credit drops. Lowing interest rates can’t stimulate economy since interest rates are already nearing 0.
  • Short-term cycles: 5-8 years
  • Long-term cycles: 75-100 years
  • Depressions last about 2-3 years and it takes 7-10 years for the reflation period
  • Credit is bad when it finances over-consumption that can’t be paid back, but is good if it efficiently allocates resources so you can pay back the debt
  • Inflation: When spending increases faster than the increase in supply in goods/services, prices increase

How to Recovery from Recession

  • 4 ways to recover from a recession: cut spending, reduce debt, redistribute wealth, print money
  • If central bank prints money, it can only buy financial assets => stocks + government bonds
  • Central government can buy goods and services and put money in the hands directly to people, but they cannot print money
  • To stimulate the economy, central bank buys government bonds which is lending money to the government to stimulate the economy

3 Rules of Thumb:

  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