I want to talk about Ray Dalio and one of the articles I read recently. The article is called “The Changing World Order”, and it is linked at the bottom of this post! It took me three to four hours to get through his article. It’s dense and long, but it was eye opening so I wanted to make a quick summary for you. In this article, Ray talks about money, credit and debt. Essentially all entities run on money, credit and debt. It is how the financial system works. This applies to people, corporations, countries and any entity. They all run on money, credit and debt.
How the Cycle of Money, Credit and Debt Starts
Money is a medium of exchange that is a store hold of wealth. That could be the dollar that we use right now, but it could also be gold, real estate, art, stocks, bonds or other assets. For all of these entities, if they have a large enough net worth, they can spend above their means by borrowing and using credit to take on debt. If you are acting as a company, you can get a loan from the bank and take on debt. This debt is an asset to the banks. They expect to make more money once you return back their money with interest. Meanwhile you use that money to invest in other things to improve your business and ideally make more money than what you’re borrowing and paying interest on.
This cycle goes on and on and expands the economy. However, the cycle does not succeed smoothly when income decreases and expenses increase. When that happens, there’s a contraction between the amounts. When the debt is large enough, people default on their debt. We have cycles of economic growth and recessions because of borrowing and spending. Eventually borrowing leads to the point where income is less than the amount that was borrowed, and debt piles up. At this point, the government is required to step in. They create monetary policy and fiscal policy to “cool” down the economy from growing too fast. Ultimately, the cycle completes over and over again.
The Government Intervenes
Another thing to understand about money and credit systems, is that the government can print money. However, not all the money that is being printed is equal. The American dollar is a reserve currency. This means it is the currency used the most for international transactions. We account for 55% of international transactions. The Euro is 25%. This gives the U.S. a lot of leverage, because everyone else needs to use our money. With coronavirus, the U.S. government was able to print money and give out stimulus checks. However, people don’t understand that we can print money because of the leverage we have as a reserve currency.
Other countries who don’t have that benefit cannot print more money, because nobody wants to use their currency. Everybody wants our money, thus we are able to raise a lot of money and get a lot of investors. However, printing more money does not mean creating more wealth. You also need to be productive. Productivity means, as an economy, people are working jobs and producing more goods and services to increase the overall GDP of the economy.
Money and credit is beneficial when it’s given out, but it’s depressing when it has to get paid back. This is why our economy goes through many cycles. Ray Dalio explains that short-term debt cycles happen every five to eight years as the economy increases. This is followed by a recession like that of 2001. Then this is followed by growth, like the growth between 2001 and 2008. That is followed by a crash, like the 2008/2009 crash. Now this is happening again – from 2009 until 2020. Now we are seeing signs of a potential recession because of the growth that previously happened.
Ray talks about a long-term debt cycle that lasts 50 to 75 years. Ray says that we’re nearing the end of one of these long-term debt cycles. This is actually a bad sign, because after a long-term debt cycle ends, it can lead to a depression. A depression is different from a short-term recession. Depressions can last a few years or even 10 years. The Great Depression lasted longer than ten years.
The Steps to a Long-term Debt Cycle
#1 Low Debt and Hard Money
It’s important to emphasize that a long-term debt cycle starts off with little debt or hard money. Back when hard money was used as the primary form of currency, societies used hard money such as silver and gold, because it is transferable and valuable. Gold and silver have intrinsic value – they are limited in nature.
#2 Claims on Hard Money
Over time, people realized that carrying around gold and silver was not sustainable, so banks would store the hard money and issue paper claims on this hard money. At first the amount of hard money in the bank equaled the claims on notes. Eventually, the bank will realized they could loan out more notes than the amount of hard money they actually had. This is how credit was created! Credit helps the economy grow, but it cannot last forever.
#3 Debt Increases
Income will start to decrease, and more debt is acquired. People cannot pay back their debts. Now the government does not have enough money, and there is outstanding debt with no one to pay it back. As people start panicking, they try to get their hands on hard money. This is called a Bank Run. The banks do not have enough hard money, because they lend out more than they have.
#4 Debt Crisis
Because of the Bank Run, the government has to step in to bail out banks, or else the bank must default. This is a Debt Crisis. When hard money and notes became too constrictive on these banks, the government needed to come up with an alternate solution to hard money.
#5 Fiat Money
In the years leading up to 1971, the government was spending a lot of money on military and social programs, and they took more debt from investors. People start to realize the U.S. government was not going to able to pay back their debt. The debt was growing astronomically more than the amount of hard money and gold inside their banks. This is when Fiat money was created. Fiat money is government-issued currency that is not backed by an asset. Now money is not issued off of the gold standard, it gives the government the ability to print more money. Unfortunately this leads to inflation – printing money needs to be strategic.
#6 Fight back to Hard Money
The last part of the debt cycle is to fight back into hard money. We are already late into a debt cycle. For the banks in 2008 and 2020, interest rates are near 0%. Normally banks lower interest rates to boost the economy, but this is not possible since the interest rate is already near 0%. They have to create money out of thin air, and this means taking on debt. Ray says at the start of a short-term debt cycle it is acceptable to take on debt. However in the late stages of a long-term debt cycle it is extremely risky. This is because there is a high chance the debt is defaulted or devalued.
This is my takeaway from Ray Dalio’s article “The Changing World Order.” I have linked the article at the end of this post if you want to read the entire article. If what Ray says is true, we are in a long-term debt cycle and the government has printed out more money. This is very risky.
How this affects our lives
People need to use money productively, or this will create more and more debt. We are already at an all time high of debt. It will be very interesting to see what happens in the future. Will the economy move to a different form of money? Cryptocurrency? Or will another country become the reserve currency? I don’t know what’s going to happen, but it is definitely something to think about. If you enjoyed this post, and if you want me to make more like this, comment below!