Ray Dalio's 'How The Economic Machine Works' in under 8 minutes! Financial Education

Ray Dalio is an American investor and hedge fund manager. He founded Bridgewater in 1975 in New York. In 2013, it was listed as the largest hedge fund in the world.

In 2008, Dalio published "How the Economic Machine Works: A Template for Understanding What is Happening Now". A video version of the essay is available on Dalio's channel on YouTube (@principlesbyraydalio).

The video was viewed over 38 million times on YouTube in the last 10 years! It is also available in many world languages.

An extensive document, named 'How the Economic Machine Works – Leveragings and Deleveragings', is available at economicprinciples.org.

My video is an effort to further simplify Dalio's economic template so that interested but busy viewers can digest it in under 8 minutes!
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Footage of the video is used for educational purposes only with fair use in mind. The copyright of all footage remains with the original owner. I just want to say: Thank you, Ray. You made a very difficult topic easy for someone who does not understand economics.

Music is used with a license from Storyblocks through a subscription.
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Transcript:

The economy works like a simple machine. It’s made up of a few simple parts and a lot of simple transactions that are repeated over and over again a zillion times. These transactions create 3 main forces that drive the economy.

Productivity Growth
Short-term Debt Cycle
Long-term Debt Cycle

You make transactions all the time. Every time you buy something you create a transaction. Each transaction consists of a buyer exchanging money or credit with a seller for goods, services, or financial assets.

If we can understand transactions, we can understand the whole economy.

Credit can help both lenders and borrowers get what they want.
When a borrower receives credit, he can increase his spending.

Productivity matters most in the long run, but credit matters most in the short run. This is because productivity growth doesn’t fluctuate much, so it’s not a big driver of economic swings.
Debt is — because it allows us to consume more than we produce.

Debt swings occur in two big cycles. One takes about 5 to 8 years and the other takes about 75 to 100 years.

The only way I can increase my spending is to increase my income.

Money is what you settle transactions with. What people call money is actually credit. But in an economy with credit, you can also increase your spending by borrowing.

Suppose you earn $100,000 a year and have no debt. You are creditworthy enough to borrow $10,000, say, on a credit card. So you can spend $110,000 even though you only earn $100,000.

Since your spending is another person’s income, someone is earning $110,000. The person earning $110,000 with no debt can borrow $11,000, so he can spend $121,000 even though he has only earned $110,000.

When the amount of spending and income grows faster than the production of goods: prices rise. When prices rise, we call this inflation.

The Central Bank doesn’t want too much inflation because it causes problems. Seeing prices rise, it raises interest rates. With higher interest rates, fewer people can afford to borrow money.

When people spend less, prices go down. We call this deflation. Economic activity decreases and we have a recession. If the recession becomes too severe and inflation is no longer a problem, the central bank will lower interest rates to cause everything to pick up again.

People borrow huge amounts of money to buy assets as investments causing their prices to rise even higher.

As incomes fall and debt repayments rise, borrowers get squeezed. They are forced to sell assets. The rush to sell assets floods the market. This is when the stock market collapses, the real estate market tanks, and banks get into trouble.

The problem is debt burdens are too high and they must come down.
There are four ways this can happen. One, people, businesses, and governments cut their spending. Two, debts are reduced through defaults and restructurings. Three, wealth is redistributed from the ‘haves’ to the ‘have nots’, and finally, four, the central bank prints new money.

Since governments need more money and since wealth is heavily concentrated in the hands of a small percentage of the people, governments naturally raise taxes on the wealthy which facilitates a redistribution of wealth in the economy.

If the depression continues social disorder can break out.
In the 1930s, this led to Hitler coming to power, war in Europe, and depression in the United States.

People are desperate for money and you remember who can print money? The Central Bank can.

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

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.
Second: Don’t have income rise faster than productivity.
And third: Do all that you can to raise your productivity.