How The Economic Machine Works by Ray Dalio (3)

That means that the amount of debt it has is the same as the amount of income the

entire country makes in a year.

Now think about the interest rate on that debt,

let's say it is 2%.

If debt is growing at 2% because of that interest rate and

income

is only growing at around only 1%, you will never reduce the debt burden.

You need to print enough money to get the rate of income growth above the

rate of interest.

However, printing money can easily be abused because it's so easy to do and

people prefer it to the alternatives.

The key is to avoid printing too much money

and causing unacceptably high inflation, the way Germany did during its

deleveraging in the 1920's.

If policymakers achieve the right balance, a deleveraging isn't so dramatic.

Growth is slow but debt burdens go down.

That's a beautiful deleveraging.

When incomes begin to rise, borrowers begin to appear more creditworthy.

And when borrowers appear more creditworthy,

lenders begin to lend money again. Debt burdens finally begin to fall.

Able to borrow money, people can spend more. Eventually, the economy begins to

grow again,

leading to the reflation phase of the long term debt cycle.

Though the deleveraging process can be horrible if handled badly,

if handled well, it will eventually fix the problem.

It takes roughly a decade or more

for debt burdens to fall and economic activity to get back to normal

- hence the term 'lost decade.'

Of course, the economy is a little more complicated than this template

suggests.

However, laying the short term debt cycle on top of the long term debt cycle

and then laying both of them on top of the productivity growth line

gives a reasonably good template for seeing where we've been,

where we are now and where we are probably headed.

So in summary, there are three rules of thumb that I'd like you to take away

from this:

First: Don't have debt rise faster than income,

because your debt burdens will eventually crush you.

Second: Don't have income rise faster than productivity,

because you will eventually become uncompetitive.

And third: Do all that you can to raise your productivity,

because, in the long run, that's what matters most.

This is simple advice for you and it's simple advice for policy makers.

You might be surprised but most people — including most policy makers — don't pay enough attention

to this.

This template has worked for me and I hope that it'll work for you.

Thank you.