How The Economic Machine Works By Ray Dalio (10 Min Summary)

what is up everyone I'm rose and welcome back to my channel 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 you subscribed to my channel if not what are you waiting for my channel is all about investing for beginners and you're gonna learn a ton about how to be smart with your money so make sure to subscribe and hit a notification bell for new videos like this every week ray 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 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