Maryani Nenden

Higher School of Translation and Interpretation

Lomonosov Moscow State University
27 November 2016

Overview Video
How The Economic Machine Works
By Ray Dalio

The economy might seem complex but it works in simple mechanical way. The
economy is like a machine. At the most fundamental level it is a relatively simple machine. It
is made up of a few simple parts and a lot of simple transactions that are repeated over and
over again a zilion times. The transaction is driven by human nature and they create 3 main
forces that drive the economy:
I think those factors also can drive economic
1. Productivicity growth growth, such as:
2. The short term debt cycle Accumulation of capital stock
Increases in labor inputs, such as workers or
3. The long term debt cycle
hours worked
Technological advancement

An economy is simply the sum of the transactions that make it up and a transaction is
a very simple thing. A transaction consists of the buyer giving money (or credit) to a seller and
the seller giving a good, a service or a financial asset to the buyer in exchange. Credit spends
lke money, so adding together the money spent and the amount of credit spent, we can know
the total spending. The total amount spending drives the economy. If we divide the amount
spend by the quantity sold we got the price. That is a transaction. It is the building block of
the economic machine. All cycles and all forces in an economy are driven by transaction. So,
if we can understand the transaction we can understand the whole economy.
A market consists of all the buyers and sellers making exchanges for the same things.
For examples: the wheat market consists of different people making different transactions for
different reasons over time. An economy consists of all of the transactions in all of its
markets. So, while seemingly complex, an economy is really just a zillion simple things
working together, which makes it look more complex than it really is.

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 People, businesses, banks and governments all engage in transactions. They are
exchanging money and credit for goods, services and financial assets. The biggest buyer and
seller is the government, which consist of two important parts:
1. Central Government that collects taxes and spends money
2. Central Bank which is different from other buyers and sellers because it controls the
amount of money and credit in the economy.
The Central Bank is an important player in the flow of credit. Credit is the most
important part of the economy. It is the most important part because it is biggest and most
volatile part. Just like buyers and sellers go to the market to make transactions, so do lenders
and borrowers. Lenders usually make
their money into more money and People use credit for many personal reasons, but
borrowers usually want to buy the compelling motive typically relates to the
desire to purchase something today and pay for
something they cant afford or they
it in the future. With a loan, someone can make
want to invest in something like a large purchase and spread the costs out by
starting a bussines. Credit can help making installment payments over time.
both lenders and borrowers get that
they want. Borrowers promise to
repay the amount they borrow, called the principal, plus an additional amount, called interest.
When interest rates are high, there is less borrowing because it is expensive. When interest
rates are low, borrowing increase because it is cheaper. When borrowers promise to repay and
lenders believe them, credit is created.
That seems simple enough but credit is tricky because it has different names. As soon
as credit is created, it immediately turns into debt. Debt is both asset to the lender, and a
liability to the borrower. In the future when the borrower repays the loan, plus interest, the
asset and liability disappear and the transaction in settled. The credit is important because
when a borrower receives credit, he is able to increase his spending. Spending drives the
economy. This is because one persons spending is another persons income. When someones
income rises it makes lenders more willing to lend him money because now he is more worthy
of credit. A creditworthy borrowe has two things:
1. The ability to repay. Having a lot of income in relation to his debt gives him the ability to
repay.
2. Collateral if he cant. In the event that he cant repay, he has valuable assets to use as
collateral that can be sold. This makes lenders feel comfortable lending him money.

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 Increase income allows increased borrowing which allows increased spending. And
since one persons spending is another persons income, this leads to more increased
borrowing and so on.
This self-reinforcing pattern
leads to economics growth and make a
Economy is recurring, fairly predictable, general
Cycles. A cycle is nothing more than a pattern of periodic fluctuations and move
logical sequence of events leading to a through four stages of (1) expansion, (2) peak, (3)
repetitious pattern. In a market-based recession, and (4) recovery.

economy, cycles of expansions in

credit and contractions in credit drive economic cycles and they occur for perfectly logical
reasons. In a transaction, you we have to give something in order to get something and how
much you get depends on how much you produce.
Over times we leraned and that accumulated knowledge raises are living standards
and we call that productivicity growth. Those who were invented and hard-working raise
their productivity and their standards faster than thise who are complacement and lazy, but
that isnt necessarily true over the short run. Productivity matters most in the long run, but
credit matters most in the short run. This is beacause productivity growth doest fluctuate
much.
Because we borrow, we have cycles. This is not due to any laws or regulation, it is due
to human nature and the way that credit works. Think of borrowing as simply a way of
pulling spending forward. In order to buy something we can not afford, we need to spend
more than we make. To to this, we
essentially need to borrow from our Money is a solid object, once you spend it, its
gone. and credit is not solid, instead kind of an
future self. In doing so we create a time
iou to the bank. Basically whats happening is the
in the future that we need to spend less bank loan your money every time you need it
that we make in order to pay it back. It ( charge you for it too) and then at the end of the
very quickly resembles a cycle. month you have to pay it back.

Basically, anytime we borrow we create

a cycle. The credit set into motion a
mechanical, predictable series of events that will happen in the future. This make credit
different from money. Money is what we settle our payments with. Some people mistakenly
believe that money is whatever will buy we goods and services, whether that's dollar bills or
simply a promise to pay (e.g., whether it's a credit card or an account at the local grocery).

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The most of people call money is actually credit. As we known that in an economy without
credits the only way to increase our spending is to produce more. But in an economy with
credit we can also increase our spending by borrowing. As a result, an economy with credit
has more spending and allows incomes to rise faster than productivity over the short run, but
not over the long run. Credit is not necessarily bad just causes cycles. It is bad when it
finances over-consumption that can not be paid back. However, it is good when it effeciently
allocates resources and produces income so we can pay back the debt.
In an economy with credit we can follow the transactions and see how the credit
creates growth. We known that borrowing creates the cycles and if the cycle goes up, it
eventually needs to come down. This leads us into the Short Term Debt Cycle. The short-
term debt cycle, also known as the business cycle, is primarily controlled by central banks
policies. As economic activity increases, we wee an expansion the first phase of the short term
debt cycle. Spending continous to incrase and prices start to rise. This happens because the
increase is spending is fueled by credit which can be created instantly out of thin air. When
the amount of spending and incomes grow faster than the production of goods: prices rise.
This condition called inflation.
The inflation can cause problem for The Central Bank because seeing prices rise, it
raises interest rates. With higher interest rates, fewer people can afford to borrow money and
the cost of existing debts rises. When people spend less, price go down. This condition called
deflation. Economic activity decreases
and we have a recession. If the Banks set interest rates base the rates they charge
recession too severe and inflation no on economic factors including the level and
growth in Gross Domestic Product (GDP) and
longer a problem, the central bank
inflation. It also cites interest rate volatility the
will lower interest rates to cause ups and downs in market rates as an important
everything to pick up again. With low factor banks look at. These factors all affect the
interest rates, debt repayment are demand for loans, which can help push rates
higher or lower.
reduced and borrowing and spending
pick up and we see another expansion.
In the short term debt cycle, spending is constrained only by the willingness of lenders and
borrowers to provide and receive credit. When credit easily avaiable, there is an economic
expansion. When the credit is not easily avaiable there is a recession. The short term debt
cycle typically lasts 5-8 years and happens over and over again for decades.

HOW THE ECONOMIC MACHINE WORKS "4

 Debts rise faster than incomes. That is creating the Long Term Debt Cycle. The
process is self-reinforcing on the upside because rising spending generates rising incomes and
rising net worths, which raise borrowers capacity to borrow, which allows more buying and
spending. Despite people becoming
more indebted lenders even more Debt/income ratio will rise as long as the deficit
exceeds debt times the income growth rate.
freely extend credit because everybody
just focusing on whats been happening
lately that incomes have been rising, asset values are going up, the stock market roars. It pays
to buy goods, services, and financial assets with borrowed money. When people do a lot of
that, we call it bubble. Even though debts have been growing, incomes have growing nearly as
fast to offset them. Since one persons spending is another persons income, incomes begin to
go down. This situation makes people less creditworthy causing borrowing to go down. Debt
repayments continue to rise which makes spending drop even further and the cycle reverses
itself. This condition is the long debt
peak. Debt burdens have simply When the level of debt gets excessive, the
increased purchasing power and new money
become too big. The economy begins
supply can outstrip a nations ability to produce
deleveraging. In deleveraging, people new goods and services to meet the heightened
cut spending, incomes fall, credit demand. Prices rise. Inflation ensues.
dissapears, assets prices drop, banks
get squeezed, the stock market crashes,
social tensions rise, and a whole thing starts to feed on itself the other way. Scrambling to fill
this hole, borrowers are forced to sell assets. The rush to sell assets floods the market. This is
causing the market collapes, the real estate market tanks and banks get into trouble. People
feel poor. Credit rapidly dissapears. There are less spending, less income, less wealth, less
credit, less borrowing and so on. This is a vicious cycle.
The different between a recession and deleveraging is that in deleveraging borrowers
debt burdens have simply gotten too big and can not be relieved by lowering interest rates.
Lenders realize that debts have become too large to ever be fully paid back. Borrowers have
lodt their ability to repay and their collateral has lost value. They feel crippled by the debt.
Lenders syop lending and borrowers stop borrowing.
These are four ways have happened in every deleveraging in modern history:
1. Cut spending (People, businesses, and governments cut their spending).
2. Reduce debt (Debts are reduced through defaults and restructurings).

HOW THE ECONOMIC MACHINE WORKS "5

3. Redistribute wealth (Wealth is
redistribute from the haves to the
have nots.
4. Print money (the central bank prints
new money).
The deleveraging can be ugly or it
can be beautiful. Even though a
deleveraging is a difficult situation,
handling a difficult situation in the best
possible way is beautiful. A lot more
beautiful than the debt-fueled, unbalanaces
excesses of the leveraging phase.
In a beautiful deleveraging bebts
decline relative to income, real economic
growth is positive, and inflation isnt a
problem. It is achieved by having the right
balanced. The right balance requires a
certain mix of cutting spending, reducting
debt, transferring wealth and printing
money so that economic and social stability
can be maintaned. But the key is to avoid
printing too much money and causing
unacceptably high inflation. If
policymakers achieve the right balance, a
deleveraging is not so dramatic. Growth is
slow but debt burdens go down. When
incomes begin to rise, borrowers begin to
appear more creditworthy. When that is
happened, lenders begin to lend money
again and debt bundens finally begin to fall.
Eventually, the economy begins to grow
again leading to the reflation phase of the
HOW THE ECONOMIC MACHINE WORKS
I think islamic economy system is the good
alternative solutions for economic problem. It
has been proventhat Islamic banks did not
experience anysignificant impact fromthe 2008
financial crisis. An Islamic bank is a bank that
prohibitsinterest. Creditors and debtors alike
share profits and losses and Islamic finance
prohibits all forms of speculation and trade that
have risks and uncertainties such as naked-short
selling where there is uncertainty of future
return. Islamic banks are untouched by the
current crisis because:
Islamic Banks are more focused on
conservative products and avoid exposure to
high risk financial instruments;
The principle of Islamic Banks is to maintain
the banks primary function as a mediator
between the parties that are in surplus of
funds to those in deficit or in need of funds;
Islamic banks only facilitate and finance real
assets;
Speculation and gambling is forbidden.
Islamic banks are believed to not be affected
by the crisis because its banking system is not
involved in trade payables and there is no
market speculation;
Because of the profit sharing system, the
banks management performance should
always be considered. If the bank experiences
losses then the losses will be borne also by the
depositors;
Islamic banks do not borrow funds on the
inter bank markets, the funds are derived from
their own deposits;
It is free from speculative and derivative
elements.
"6
long term of cycle. Though the deleveraging process can be horrible if handled badly, if
handled well, it will eventually fix the problem.
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 weve been, where we are now and where we are probably headed. In
summary, there are three rules of thumb that could take away for this:
1. Dont have debt rise faster than income, because our debt burdens will eventually crush
you.
2. Dont have income rise faster than productivity, because you will eventually become
uncompetitive.
3. Do all that we can to raise our productivity, because in the long run, that is what matters
most.

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