How Does the Economy Actually Work? Ray Dalio Explains

Ray Dalio is the founder of Bridgewater Associates, known to some as “the world’s richest and strangest hedge fund.” He has appeared on this blog before, talking about the upsides of negative feedback. Now Dalio has put together a beguiling 30-minute video that tries to explain how the U.S. economy actually works. Don’t be ashamed if you find out a lot you didn’t know — as Dalio makes clear, most policy makers don’t know much about the economy either.

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  1. Benjamin says:

    Hidden due to low comment rating. Click here to see.

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    • Phillip says:

      You misunderstood the video. Money is both cash and credit. For a long time now credit has been most of money. So erasing debt would erase a lot of money and lead to huge deflation, but the central bank is off-setting that by creating more cash. If we did have an all cash, no credit society than the world wouldn’t end. The economy would just grow slower with less cycles.

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  2. texagg04 says:

    Interesting and simplistic.

    Still seems to hide economic woes in the smoke and mirrors of the national debt. Keynesians pretend like the national debt doesn’t matter, which according to this video’s explanation — that is to say, the video doesn’t explain the national debt — can just keep increasing and increasing ad infinitum.

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    • phillip says:

      When the economy returns to expansion, the expansive policies get cut back and tax income rises faster than spending. This allows the government to pay back the debts it accumulated. This happened during the economic recovery of the 50s and 60s. The alternative to not using expansive policies is greater deflation and longer deleveraging period which increases national debt even more. Just look at Japan. They delayed policy and ended up 200% in debt.

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  3. Ray says:

    Mostly made sense to me, however, I am not convinced about the ‘long-term debt cycle’. It seems that the last two major downcycles in the US, the current recessions and the Great Depression, were consequences of a short-term cycle becoming exaggerated in the wrong market. In our current situation, the problem hit in the housing market; since a house represents a large portion of spending for most consumers, the housing bubble hit consumers disproportionately than other bubbles causing a depression in consumer spending. Since consumer spending is vital to the economy, the crises spreads to the rest of economy.

    In the case the Great Depression, the bubble hit the stock market, squeezing investors and producers. Without capital, the producers produced less, employed less and the economy was predictably affected. Contrast that with the current situation, where the producers (i.e. companies) are reportedly sitting on piles of cash because expansion cannot be rewarded when consumers are pulling back.

    To be sure, I am not convinced there is no ‘long term debt cycle’ either. But it seems suspect given that there are a great number of players in the economy all at different points in their own personal cycles; is there really a force that causes them to align every 75-100 years? Or is it simply a random thing where the frequency of bubbles and the number of critical markets line up to make a crisis approximately every 75-100 years?

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    • texagg04 says:

      Considering we’ve only had data for the last 100 years, it’s hard to confirm any cycle, as anything prior to that is based on scant data, speculation and best guesses.

      Sort of like climate scientists making future predictions on the scant data we have.

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  4. Dave says:

    Really enjoyed, thanks

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  5. Steve says:

    Excellent video, but I think it leaves out one important point – where does the money to fund lending come from? It comes from savings. And savings can only be generated by some actors in the economy spending LESS than they possibly could. It also under states the problem of good lending/good debt vs. bad lending/bad debt. The implication is that all spending and all debt is good, but the difference between borrowing to by a tractor and borrowing to buy beer is very real and important.

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    • Ryan says:

      Savings doesn’t exist. Savings is merely another form of spending. Savings is basically an investment in the bank, so that the bank can create more credit.

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  6. Deepak says:

    I found the difference between deflation and recession very enlightening and informative. Saving helps the economy grows slower but Hey life is long marathon not a 100 meter dash, so what are we in a hurry for?

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  7. Julien Couvreur says:

    I understand the need for popularization, but that does not mean falling into sloppy thinking.
    This video is a weird mix of Keynesian (“spending drives the economy”) and Austrian (credit expansion fuels unsustainable boom) approaches, and it seems to butcher both.

    Here are some of the mistakes from Austrian perspective:

    -No differentiation of credit from savings and credit from central banks or fractional reserve banking. This is important because with credit in the market (the former case) when debt is repaid, income does not fall as the author mistakenly claims. Also, in that case, credit has to match savings and the interest rate regulates the exchange between savers and borrowers.

    -”When credit is easily available, there is an economic expansion.” It’s incorrect to call this boom an expansion, as it is illusionary and unsustainable. What typically happens is that the central bank fixes the interest rate below the natural interest rate by printing money, this means additional borrowing despite the fact that savers didn’t choose to save more. This would clearly lead to an imbalance of debt.

    -The author implies that borrowing automatically leads to more spending, which leads to more income, which is more creditworthiness and allows for more borrowing. What he ignores is that when borrowers increase their spending, savers have to simultaneously defer their spending (so there cannot be an aggregate self-reinforcing effect). Again, it is only when the central bank expands credit and prints money that this condition can be broken.

    -The author claims that credit unavoidably drives the business cycle. That is only correct with credit expansion by government and the central bank. It is not a feature of credit per se. The business cycle can be avoided if the central bank didn’t try to fix an essential price, namely the interest rate. Like all prices, the interest rate serves a regulating purpose in market activity (like street signals). Mess with that and you get discoordination (people making plans which by construction cannot be mutually compatible and successful).

    -Printing money cannot work as a real solution (24m00s in the video), as it only recreates the conditions of the boom, namely unsustainable relative prices. Central banks cannot stimulate at the micro level to correct relative prices. Money printing is a very blunt policy instrument which affects overall prices and creates further price distortions (Cantillon effect, as new money flows through the economy in non-neutral manner).

    It’s difficult to cover rigorously the Austrian Business Cycle Theory in the space of a comment. More detailed references are easy to find (see Mises, Hayek or Rothbard).

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  8. Ryan says:

    By this man’s logic, the central bank should just print money. That’s all it takes to get out of a deleveraging. The other three deflationary measures don’t achieve any position ends by his logic.

    I don’t agree with him, but that’s the logic of the argument if you take what’s presented.

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