Posted by: CS | October 25, 2013

Cartoon Economics

Economics, including the work of Nobel Laureate Milton Friedman, is all bosh, according to Ray Dalio, founder of Bridgewater Associates, the world’s largest hedge fund. The secret of successful investing, according to Mr. Dalio, is to dispense with Econ 101 and recognize that only two things matter: productivity and debt. To understand how these variables affect incomes and markets, Mr. Dalio has released a 30-minute cartoon video available via the New York Times, which explains all.

Debt, says Mr. Dalio, is the key to understanding economic cycles. Most people borrow when young – to buy cars, houses, etc. — then accumulate savings in middle age. This, according to Dalio’s cartoon, gives rise to short-term economic cycles of rising and falling debt, which in turn give rise to cycles in rising and then falling economic demand.

Now let’s think about that. Folks do indeed tend to borrow when young, then pay back and accumulate savings later on. But that creates no cycle of rising and falling debt. Populations do not pass through youth and middle-age in synchrony. My debt is balanced by your savings. The overall level of debt has nothing to do with the individual’s cycle of debt.

So much for Dalio’s explanation of short-term business cycles. As for the long-term, he says, folks just borrow more and more and more till, well, until they decide enough is enough, then they deleverage, which takes years and years, and that’s what we’re going through now.

LOL. And this guy’s worth $13 billion. But then his business formula is pretty simple. Two percent off the top on the money you place with him, plus 20% of the gains. Why don’t we all run a hedge fund, I wonder? I guess the clever bit is selling the service to rich investors who you’d think would know better.

Here let me offer a similarly simple-minded but more plausible explanation of business cycles. Sure debt has something to do with it. But in countries with a democratically elected government, the short-term fluctuations in debt are chiefly the result of government fiscal and monetary policies, including central bank interest rate policies, aimed at insuring reelection of the incumbent party. The pattern is thus to tighten the interest-rate screws early in the mandate, while opening the monetary flood-gates a year to 18 months before the next election. There’s your short-term business cycle.

The long-term cycle is also debt-driven but it is, in fact, not a cycle at all, but a random walk with lengthy excursions in either direction. The reason that, in the long-run, debt tends to accumulate, if in fact it does, reflects many processes including the accumulation of wealth in the hands of the few, which means economic expansion is possible only if falling interest rates allow the many to increase their borrowing; plus the ingenuity of financial services industry in creating and lending money.

The tendency for a period of high debt to be followed by a long and painful deleveraging can also be for many reasons. But in the present circumstances, it is clear that many individuals in the US and Europe are being forced to deleverage as the result of falling incomes. And for many, falling incomes are a consequence of globalization, which has off-shored their jobs to the Third-World. Automation, which has substituted machines for people, has also eliminated jobs thus reducing incomes and forcing debt reduction, often through personal bankruptcy.

(Your best bet, incidentally, if you’re wondering how to invest is to avoid the likes of Dalio like the plague, and follow the advice of Nobel prize winner Eugene Fama: diversify, diversify, diversify.)


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