what is up everyone I'm rose and welcome
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in 2013 Ray Dalio released a 30-minute
video called how the economic machine
works and this video is a summary of
that summary before we get started have
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Valeo says that although the economy
seems really complicated it's actually
very simple how the economic machine
works is a template that helps you
understand the economy and once you
understand this template you can apply
it to any situation any country any
moment in time to understand why
economies behave the way they do
according to Ray Dalio there are three
main forces that drive the economy
productivity growth the short term debt
cycle
and the long term debt cycle over the
long term the economy grows as a result
of productivity when automobiles the
Internet all these new technologies came
out it increased the output or the
productivity of each person so that the
overall economy was more productive so
the economy works just like that at the
end of the day the economy is driven by
productivity war productivity equals
more economic growth however the economy
isn't that simple because there are
other factors in place
specifically credit credit is basically
the ability to borrow money and spend
more than you earn and the availability
of credit is a hugely important driver
of the economy because it enables people
to spend more and more spending equals
more economic activity which equals more
jobs which equals more spending and so
on and so forth let's say you make say
70 thousand dollars a year but you have
a credit card with a ten thousand dollar
credit limit that means you can spend
eighty thousand dollars a year even
though you don't actually make eighty
thousand without credit the only way you
could actually spend more than you make
is by working harder to earn more and
getting a raise or in other words
increasing your productivity this is
true on a macro level as well if
businesses can
borrow money in order to grow for
example a cupcake shop that borrows
money in order to open a second location
then they can create more jobs which
creates more income for people which
creates more spending and so on and so
forth
get the picture so credit helps the
economy grow really fast even if the
level of productivity isn't necessarily
rising most of the spending in the
economy is done on credit not on actual
cash just to give you an idea in raised
Allianz video he says that the US
economy operates on 50 trillion dollars
of credit and only 3 trillion dollars of
actual cash so you've got all this
spending on credit which enabled the
economy to grow faster than the
productivity curve and then what happens
now is inflation inflation is when
prices rise because demand is greater
than supply and the thing about
inflation is that the government doesn't
like it nobody likes inflation so in
order to keep inflation in check the
central bank raises interest rates it's
like if the interest rate on your credit
card went up you'd probably stop using
your credit card and you'd have to cut
down on spending in order to service
your higher monthly payments so it's the
same with the economy when the central
bank raises interest rates that causes
the economy to shrink instead of growth
on the flip side if the economy is
shrinking too much and it's on the brink
of recession the central bank can save
the economy by cutting interest rates
this would make credit cheap again and
that would encourage spending and revive
the economy once again this dance
between interest rates the availability
of credit and economic growth is what
Ray Dalio calls the short-term debt
cycle interest rates have a huge impact
on the availability of credit and
therefore on the economy that's why if
you follow the news at all you'll often
see headlines about the Fed the nickname
for the United States central bank also
known as the Federal Reserve investors
and business people are obsessed with
trying to figure out whether the Fed is
gonna cut rate or raise rate because
it's that important for the economy so
now you know that the economic machine
is driven by three things productivity
and the short-term debt cycle and the
long-term debt cycle we've talked about
the first two things but what
the long-term debt cycle with every new
short-term debt cycle the total debt
level in the economy ends up higher than
where it was in the previous short-term
debt cycle so you can imagine over the
decades debt burdens tend to increase
not decrease for example when you first
graduate college you don't have a lot of
income so you probably don't have a lot
of debt but as you get promotions and
you start making more money you'll
probably be able to buy a house you'll
buy a car and you'll be able to take
debt for these things because you have
enough income to qualify for these loans
so you know that's totally fine you have
a ton of ton more debt than then when
you were younger but your income is also
a lot higher so really all in all
everything's fine
however raise a leo's point is that
there's always a reckoning day and
that's when the long-term debt cycle
comes to a head one day the debt reaches
a critical mass where your income no
longer can sustain your debt at that
point you have no choice but to cut back
on spending when this is happening on a
macro level in other words a country
level then business is cut back on
spending government's cut back on
spending and there's a serious drop in
economic activity the peak of the
long-term debt cycle occurs after a
series of many short-term debt cycles
when the debt burden becomes too high
and at that point what Ray Dalio calls
ap leveraging is necessary in other
words when the debt burden has become
too high and it has to come down the end
of a long term debt cycle is a very
risky time for the economy and they're
much trickier to navigate than
short-term debt cycles because at the
end of a short-term debt cycle a little
bit of tweaking with interest rates
usually does the trick
lower rates to stimulate the economy and
boom we're back off to the races
but with long-term debt cycles interest
rates are already really low so the
government can't cut rates any more as
Ray Dalio explains there's four ways the
debt burden can come down one people
businesses and governments cut spending
to debts are reduced through defaults
and restructuring three wealth is
redistributed from the haves to the
have-nots and for this
Bank prints new money the first way that
I described which is cutting spending
and taxing the wealthy and and
restructuring debts through defaulting
these are all really harmful for the
economy
however the fourth method where the
central bank prints new money out of
thin air is the only deleveraging method
that is actually stimulative to the
economy this is exactly what the US did
during the Great Depression and again
during the 2008 financial crisis in 2008
the US central bank or the Fed printed
two trillion dollars of new money and
used it to buy financial assets and
government bonds this helped increase
the availability of credit it also
helped fund government stimulus programs
and also unemployment handouts so all of
this really helped the u.s. to get out
of these crisis and depressions however
too much of a good thing can also be bad
even though printing money can help a
country get out of a financial crisis it
can be harmful if they print too much
money too fast and that's exactly what
happened to Germany in the 1920s when
hyperinflation broke loose and people
were like carting shopping carts of cash
to go buy one piece of bread so that's
hyperinflation and it's not good
basically all four methods of
deleveraging whether it's cutting
spending defaulting and restructuring
taxing the wealthy or printing money all
of these if used in a balanced way then
debt burdens will go down without too
much inflation or deflation and that is
what Ray Dalio calls a beautiful
deleveraging he explains that long-term
debt cycles are normal and somewhat
predictable but the de leveraging that
has to happen afterwards can be a tricky
process if policymakers don't handle it
well it could lead to a depression and
even to a social revolution in light of
all the news headlines these days about
a pending recession I think it's
especially important to understand
what's going on in the economy right now
in a recent interview with Fox Business
Ray Dalio says that were quite far into
the short-term debt cycle and we're very
late into the long-term debt cycle in
other words we're due for a downturn in
closing
how the economic machine works by Ray
Dalio is a simple but powerful framework
for understanding the economy in the
past present and future his framework of
laying the short term debt cycle over is
a long term debt cycle and then laying
those things on top of the productivity
growth curve gives us a pretty good idea
of where the economy is right now
and where it's probably headed if you
want to learn more about the coming
recession and different ways to prepare
for it and also about investing in
general make sure you also check out
these two videos right here and if
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investing with rose always remember to
go after your dreams unapologetically
and to live life on your terms until
next time bye guys
