“Credit is important because it means borrowers can increase their spending. This is fundamental because one person’s spending is another person’s income.” Ray Dalio

Ray Dalio is one of most successful hedge fund managers and founder of Bridgewater Associates. He credits much of his success to guiding principles that he has used to make decisions both in his professional and in his personal life.

How the Economic Machine Works – “The economy is like a machine. At the most fundamental level it is a relatively simple machine, yet it is not well understood,” explains Ray Dalio.

Economic principles discussed:

• Economy – The economy is simply the sum of all transactions repeated again and again over a long period of time. Money and credit account for the total spending in an economy.
• Transactions – the exchange of money or credit between a buyer and seller for goods, services or financial assets.
• Markets – “All buyers and sellers making transactions represent the market. For example, we have wheat markets, stock markets, steel markets, oil markets and so on.The combination of all of these sub-markets is the entire market, or the entire economy.” Ray Dalio
• Governments – the biggest buyer and seller of goods, services and financial assets. The government consists of two parts: the central government that collect taxes and spend money; and, the central bank which controls the amount of money flowing through the economy. It does this by influencing interest rates and printing more money.
• Central Bank – The Central Bank can only buy financial assets, not goods and services. To support the economy, the Central Bank buys Government bonds which gives the Central Government the ability to buy goods and service.
• Price – the result of total spending / quantity sold.
• Credit – Credit “is the most important part of the economy because it is the biggest and most volatile part”. Credit can be created out of thin air — in fact, in 2016, the US$50 trillion of the US$53 trillion in the economy was credit, as opposed to ‘real’ money. Credit is important because it means borrowers can increase their spending. This is fundamental because one person’s spending is another person’s income. Credit is bad when it finances over-consumption and borrowers are unable to pay the debt back.
• Lenders – lend money to make more of it. When lenders believe borrowers will repay, credit is created.
• Borrowers – borrowing is pulling spending forward which relates to borrowing money to buy something you can’t afford, such as a house, a car, a business or stocks. Borrowers promise to repay the amount borrowed (the principal) with interest. Borrowing creates cycles.
• Debt – Debt allows you to consume more than you produce when it is acquired, and forces you to consume less when you have to pay it back. “When credit is issued it becomes debt. It’s a liability for the borrower, and an asset for the lender. It disappears when the transaction is settled.
• Interest Rates – When interest rates are high, borrowing is low. When interest rates are low, borrowing is high.
• Spending – one person’s spending is another person’s income. Total spending is the sum of money spent plus of credit spent.
• Income – one person’s spending is another person’s income
• Monetary Cycles – economy expansion and recession cycles.
• Inflation – inflation is when prices rise. When spending is faster than the production of goods, it means that we have more demand than supply, which results in inflation.
• Deflation – when spending decreases, prices tend to decline.
• Expansion – growing markets and increasing transactions
• Recession – Economic activity decreases, and if unchecked this can lead to a recession.
• Bubbles – when the price of assets far exceed the value of the assets
• Debt Burden – When incomes grow in relation to debt, things are kept in balance. But a debt burden emerges when debt growth exceeds income growth. This debt to income ratio is the debt burden.
• Productivity – innovation and hard working raises productivity, which equates to the amount of goods and services produced.

Three rules of thumb for life

Source: Ray Dalio

According to Dalio, there are “three rules of thumb” with which to navigate the economy, be it in your own businesses, organisations you work at or your personal finances.

1. Don’t have debt rise faster than income (because debt burdens will eventually crush you).
2. Don’t have income rise faster than productivity — it will eventually render you uncompetitive.
3. Do all you can to raise productivity — in the long run that’s what matters most.

References:

1. https://www.nofilter.media/posts/ray-dalios-economic-machine-12-minute-summary
2. https://www.amazon.com/gp/product/1501124021/ref=as_li_qf_asin_il_tl_nodl?