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LESSON SUMMARY
This lesson was created by billionaire Ray Dalio. His net worth is $16 billion USD and he is the founder of the world’s largest hedge fund. In his video, you’ll learn that the economy is simply the aggregated sum of all transactions. The transactions are heavily dependent on credit, since more credit will create more economic activity and grow the economy, in the short run at least. Once you understand how credit works, you’ll understand the most overlooked and misinterpreted concept in larger market cycles. This lesson has the following points:
1) Why do we have cycles in the economy: The premises to understand the economy is to understand that one man’s spending are another man’s income. The natural implication of this is that the more we spend, the more the society earns. We can spend both the money that we have and money that we don’t have (credit) which will spur economic growth and a positive cycle. At some point of time, money has to be repaid, and we can now spend even less than our income. This is a negative cycle. Cycles simply comes from credit.
2) Is Credit Bad: It would be logical to assume that credit is bad, since a world with no credit won’t have cycles. However, credit is also a good thing. It’s good when it’s used to make investments that grow employment and in turn the economy. It’s bad when it’s used to buy useless things that don’t create income to repay your debt.
PRESTON’S THOUGHT ON THE ECONOMIC MACHINE
So the gentleman that made the video is Ray Dalio. Ray is probably one of the most respected leaders in the investment world and his net worth is 16 billion dollars. That video is his take on macroeconomics. I completely agree with his approach. In fact, Ray personally wrote a 300-page guide to understanding macro-economics as an investor, and it can be found here: Ray Dalio’s Notes
I’m posting up-to-date information on our current economic condition at the following location: Preston’s updates on the Current Deleveraging. I highly recommend people pay close attention to this thread.
So here’s my point. When you watch Ray’s video, you’re going to see how the current market conditions are not normal (as of 10 FEB 2015). First, having interest rates at near-zero for 8 years is NOT normal. That is a tall tale sign of a 75-year to 100-year deleveraging process. I’m of the opinion that we have made mediocre progress in alleviating the credit crisis from 2008, but I still think there is a lot of deleveraging that still needs to take place. I get the impression that we are probably going to see signs of deflation in the short term (because that’s the inherent nature of a deleveraging), but in the long term (within the next 5 years), I really think we’ll see inflation. How much, I don’t know. But I would not be surprised if similar aspects from the 1970’s return.
When you watch Ray’s video, you get a real sense of how important it is to monitor the amount of credit in the overall system. More importantly, the amount of credit in the global economy. I really think that the catalyst for the next market crash may not be induced by the US economy. It might be Europe or China (as they have even bigger or growing problems). Since we are dealing with a world economy at this point, the debt to the GDP of the world economy is very important to monitor. Since the 2008 crash, the world economy has increased its global debt by 57 trillion dollars. Here’s an amazing report written by McKinsey and Company in February 2015 on this topic: McKinsey World Deleveraging Report
So in short, I’m paying very close attention to the supply of money and credit in the economy. This becomes the key driver because interest rates might not be a good indicator of when the next crash is coming (which is the typical indicator). The other key driver is the overall income growth relative to the overall interest obligation on the growing global debt. The current situation is a total anomaly from your typical business boom-bust cycle.
The last thing I want to do is be a fear-monger, but I do want to share with you my thought process and how I’m seeing things. I think we are in for an interesting couple of years ahead of us. Hopefully, Stig and I can help you navigate the rough waters that lie ahead.
Sincerely,
Preston
Written on 10 February 2015
