We’ve all been through hard times at some point. Loss of a job, our house goes down in value and stays there for years, the stock market crashes 50% seemingly out of nowhere. We’ve also experienced good times – where most everyone is employed if they want a job, stocks and housing ticks upward, people are buying new cars, going out to eat, and spending money. Each of these up and down cycles can go on for years. So why does this even happen? This How The Economic Machine Works Video by Ray Dalio explains just this.
Every 7-10 years throughout modern history the economy tanks and it seems to blindside us all. These are actually part of economic cycles, driven by mechanical forces in our society, laws, but rooted mostly in human nature, as illustrated by Ray Dalio in this video called The Economic Machine. They happen over and over again like clockwork, in nearly every single country, throughout modern history going back centuries.
“History doesn’t repeat itself but it often rhymes.”Mark Twain
Why Focus On This Now?
The fact is that our current monetary system and overall system ruleset creates cycles. I wanted to write this now (November of 2019) because we are now in the longest economic expansion (cycle) in U.S. history – at 124 months or 10.3 years – with assets like housing and stocks at all-time highs, where even many people with great jobs and situations still cannot afford where they live. Inflation keeps ticking up, and even basic things continually get more expensive, which leads to the need to work even harder to maintain the same quality of life.
I’ve done my best to outline some key points and definitions as to how things mechanically relate to one another, and what they actually mean at their core level. Armed with this knowledge of how the playbook actually works, we can begin to read between the lines and to notice what’s happening in the economy around us.
Relating to Home & Asset Ownership
And how does this relate to home ownership and owning assets in general? By understanding the basics of how the mechanics of our economic work and having even somewhat of a gauge on the economic climate, we can adjust and make smarter decisions in our lives. As Dalio states – we can track the movements and figure out what’s happening right now. Many us us have painful recent memories and experiences from the 2008 Great Recession, when the real estate bubble burst and spun the whole world into crisis. Many of those markets that got crushed have still not recovered to prices from even 10+ years ago. You will see how this is clearly explained as the ending of the long term debt cycle.
In no way is this meant to be political, attempting to have bias, or sell anything. The intent is to speak strictly to the mechanics of how our economy work and bring awareness so that we may empower ourselves. This economic system as described is no different from how a car engine works or how 1’s and 0’s are converted inside a computer to show you everything on your screen right now.
If you’re seeing this system for the first time, I can imagine some of the potential disbelief and shock, perhaps anger and the absurdities of at least parts of it. I was there with you, and even went down a “doom and gloom” rabbit hole for a bit too. But I would encourage us all to step back and see it for what it is – as a system that simply cycles up and down. After all, we live in this society and for better or for worse, this is the way it’s set up, at least for now. Use this knowledge to empower yourself, stay out of “economic hot water”, and to thrive going forward. The more we understand the whole system we live in in a psychological and mechanical way, the better decisions we can make for ourselves.
About Ray Dalio and Origins of the Video
Ray is the founder of Bridgewater Associates, with $150B+ under management and has 1,700+ employees at his hedge fund, considered to be the most successful hedge fund in history. While he’s a billionaire himself, it seems clear to me that over the past 6-7 years he has switched from pure money-making mode to trying to give back and teach what he’s learned so that we all can benefit from this knowledge. He’s created a number of books, videos, apps, and many long topic posts (See his LinkedIn Posts) teaching on the subject of the economic machine, cycles, laws, and society as they function within a system, so that we can have a better gauge on what’s going on around us.
This video featured here was his first and most popular, now with over 10M views now, and I’d like to share it with you and outline some of the key points within it. We’ll be doing a lot more posts on the subtopics covered within this, but I would urge you to watch the whole video, and along with it, think about how it relates to yourself now or in the past, and notice what’s going on around you right now that might relate to where we are in these cycles.
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So without further ado, here’s the video! It’s about 30 minutes long and I have included a summary of the key points with illustrations below it if you’d like to scroll through those as well. It might be helpful to pause it throughout and to relate or think about things that you notice going on around you that would fit into the template described. And again while you can’t predict what may happen next, it’s important to note that these general economic systems have not changed in hundreds of years, and are present in most countries throughout the world.
The Video – How the Economic Machine Works
Key Takeaways From the Video – Basics & Credit – Part 1
The economy is a simple machine. A few simple parts and simple transactions that are repeated over and over again. These transactions are driven above all else by human nature.
Three main forces that drive the economy –
- Productivity Growth
- Short term debt cycle – usually 5-8 years
- Long term debt cycle – usually takes 75-100 years
*All images are screenshots from the video and full copyright and ownership rights are credited to Ray Dalio and the owners of the video.
Added all together, and the last 75-100 years looks like:
What’s an Economy? – Simply the sum of all the transactions taking place. Every transaction has a buyer exchanging money or credit with a seller for goods, services, or assets. Credit (or debt) spends just like money, so money + credit = total economic spending. This total drives the economy. That’s it!
All cycles and all forces in the economy are driven by transactions, so if we understand these we understand the whole economy.
The biggest buyer and seller is our Government, which includes the Central Government and the Central Bank – called the Federal Reserve in the USA.
The Central Government collects taxes and spends money while the Central Bank controls amount of money and credit in the economy.
The Central Bank does this with only two tools:
1 – Influencing interest rates
2 – Prints money
The Central Bank is the most important player in the flow of Credit – the most important part of the economy and least understood. It is the biggest and most volatile part.
What’s credit then? Lenders and borrowers have their own market where lenders want to make money on their cash, and borrowers need to borrow money for something they can’t afford, or pay in cash.
Borrowers repay their Principal, plus an additional amount called interest. When interest rates are high, there is less borrowing because it’s more expensive. When interest rates are low, there is more borrowing because the cost of money is cheaper.
When credit is created, this now turns into debt.
Why is credit so important? Because when a borrower receives credit, they are able to increase spending. Spending drives the economy. One person’s spending is another person’s income. When you spend more, someone else earns more.
If a borrower has a lot of income relative to their own debt, lenders are much more willing to lend more. Increased income allows for increased borrowing, which allows for increased spending.
Since one person’s spending is another person’s income, everyone benefits! This leads to more spending, more borrowing, and more income!
Stay Tuned for Part 2 on Cycles, Inflation & Deflation
We hope you liked the first part of the video and illustrations. It’s obviously better just to watch the whole video through, and perhaps multiple times as well to grasp it fully. Again I think it’s great to stop and pause, and take notice of things you see in the news, or how this system relates to yourself in your own life. Part 2 is coming up soon!