How Does the Economy Really Work?

Raymond Dalio (commonly referred to as Ray Dalio) is an American billionaire investor, hedge fund manager, and philanthropist. Dalio founded the investment firm Bridgewater Associates in 1975 at age 26, which has become one of the world’s largest hedge funds. In 2012, it actually was the largest hedge fund in the world.

In 2012, Dalio appeared on the annual Time 100 list of the 100 most influential people in the world. As of January 2023, he is one of the world’s 100 wealthiest people.

Dalio has refined all his lessons into principles that he and his firm abides to. He has also published a very well-written book called “Principles: Life and Work” that covers these, which we would highly recommend.

In the below 30 min video, Dalio answers the question, “How does the economy really work?“. This simple and easy to follow animated video offers a good insight into the 3 driving forces of the economy:

• productivity growth
• the short debt cycle (5-10 years)
• the long debt cycle (75-100 years)

In a recession, there are 4 levers that can be used to get the economy back on track. These has been used in every recession during the last 100-150 years. These are:

1. Cut spending (austerity)
   
   
2. Reduce debt (default), which leads to banks collapsing and asset values dropping.
   
   Debt restructuring: lenders get paid back less, or get paid back over a longer period of time or at a lower interest rate than first agreed upon. This leads to deflation. The government spend more than they earn in taxes, on financial support to the vast number of unemployed citizens and on stimulus plans.
   
   
3. Wealth re-distribution: raise taxes for the wealthy, which leads to re-distribution of wealth. This leads to increased tension between the rich and the poor, which sparks revolutions. This could further lead to political change, which in some cases are extreme.
   
   
4. Print more money: since the central bank has already lowered their interest rate to more or less 0% (as of January 2018), they then decide to print more money, leading to inflation. The new printed money is then used to buy financial assets and government bonds. The central government must buy goods and services to stimulate the market and on unemployment benefits. In order for this to work, the central bank and the central government must cooperate. For this to work, the income growth rate needs to be higher than the debt growth rate (consider the interest on the existing debt).

The video also covers economic concepts like credit, deficits and interest rates, and allows a break down of the basic driving forces behind the economy, how economic policies work and why economic cycles occur.