Ray Dalio's Economics Principles

Hi Steemians! A couple of weeks ago, I was fortunate to attend a talk by Ray Dalio. For those who do not know Ray Dalio, he is the founder of one of the world's largest hedge funds, Bridgewater Associates. He is a billionaire investor and philanthropist. He is also my source of inspirations. Side note, my friends and I jokingly call him Ray "Dai lou" in private, which means "big bro Ray" in Cantonese. People who speaks Cantonese should get the pun. I thought that is quite a fun nickname 😁. Jokes aside, in the talk, Ray Dalio shared some economics principles and I think they make a lot of sense. Therefore, I will like to share them with you here in this post.

By the way, I was lucky to get a free copy of "Principles" by Ray Dalio. I have not started reading it though.

4 Big Forces and 2 Levers

Ray believes there are 4 big forces in economics:

1. Productivity
2. Short-term debt cycle
3. Long-term debt cycle
4. Politics

Ray thinks that in the long run, productivity matters the most. As technology advances, human productivity rises and therefore economies grow. However, we know that economies do not grow linearly. That is because the market as a whole overestimate and underestimate the value of productivity growth at different points in time. As such there are short-term debt cycles and long-term debt cycles. In addition, politics also play a part in economic growth as governments have 2 levers that can be used to influence short-term debt cycle,

• Monetary policy
• Fiscal policy

Ray had to write a 263 page paper to explain these concepts, so I won't attempt to explain them in this comparatively short article or mine. Instead, I recommend you to listen to Ray explain these concepts to you directly in the 30-minute video below:

3 important equilibrium

In addition, Ray believes in 3 critical equilibrium and each time one or more of these equilibrium is/are toppled, there will be an adjustment in the market to bring things back to equilibrium:

• Debt growth should be in line with the income growth that is required to service debts
• Rates can’t be too high or too low for long (Economic capacity utilization is neither too high or too low)
• Projected returns of equities should be higher than projected returns of bonds which are higher than projected returns of cash by appropriate risk premiums

Let's look at the first equilibrium, Debt growth should be in line with the income growth that is required to service debts. Imagine Adam who has a monthly income of $3000. Over the next one year, being spendthrift, he incurred $150,000 worth of credit card debt at about 2% interest (or $3000) per month. However, his income did not grow at all. Adam is now in a precarious situation and is at a high risk of default since he is likely not able to service his debt moving forward. Similarly, at a macro level, when a country amass too much debt and they are unable to generate enough revenue to service those debts, they will also be at risk of default.

Next, rates can’t be too high or too low for long. Ray believes that economic operating rates and inflation rates can’t be too high or too low for long. He thinks that if an economy is depressed or too hot for long, that will lead to changes to reverse it.

Finally, projected returns of equities should be higher than projected returns of bonds which are higher than projected returns of cash by appropriate risk premiums. This is quite a mouthful, but essentially, what it meant is that risk/reward ratio of investments should make sense. Equities are known to be more risky than bonds, so projected returns of equities should be higher than bonds. By the same argument, bonds should provide better returns than just holding cash in your bank.

My thoughts on where are we now

After understanding these concepts, it is natural to ask where are we now. Outside cryptocurrency trading, I am also a stock & options investor. In my opinion, we are at a state where the equilibrium are already toppled. Just focusing on the US economy alone, the country's government debt is equivalent to 105.40 percent of the GDP in 2017. This is a sign of the first equilibrium toppling.

Next, the US federal funds rate had been near zero for many years since 2009 to 2016. Only in the past one year or so, has the Federal Reserve started to adjust rates upwards. As mentioned by Ray, it is not sustainable to keep rates low for too long and it has to be adjusted eventually. But is it too late to only do so now?

Finally, US 10-year treasury bonds yield is now close to 3%, while the the S&P 500 dividend yield is at a mere 1.9%. It is a clear sign of the 3rd equilibrium toppling. All these indicators made me skeptical in putting my money in stocks right now. Of course, I am not a financial advisor and please do your own research when it comes to investments.

Let me know your thoughts after watching the video. Where do you think we are at the economic cycle? Do you think that the equilibrium has been toppled? Thanks for reading and I look forward to your comments!