1732689806
Ray Dalio
Notes
This type of cycle—where a strong growth upswing driven by debt-financed real estate, fixed investment, and infrastructure spending is followed by a downswing driven by a debt-challenged slowdown in demand—is very typical of emerging economies because they have so much building to do.
…when the costs of debt service become greater than the amount that can be borrowed to finance spending, the upward cycle reverses…Typically debt crises occur because debt and debt service costs rise faster than the incomes that are needed to service them, causing a deleveraging…the debts (i.e., the promises to deliver money) become too large in relation to the amount of money in existence there is to give.
…the biggest risks are not from the debts themselves but from:
- the failure of policy makers to do the right things, due to a lack of knowledge and/or lack of authority
- the political consequences of making adjustments that hurt some people in the process of helping others
There are four types of levers that policy makers can pull to bring debt and debt service levels down relative to the income and cash flow levels that are required to service them:
- Austerity (i.e., spending less)
- Debt defaults/restructurings
- The central bank “printing money” and making purchases (or providing guarantees)
- Transfers of money and credit from those who have more than they need to those who have less
In the early part of the cycle, debt is not growing faster than incomes, even though debt growth is strong. That is because debt growth is being used to finance activities that produce fast income growth…they produce accelerating strong asset returns and growth. This process is generally self-reinforcing because rising incomes, net-worths, and asset values raise borrowers’ capacities to borrow.
…defining characteristics of bubbles that can be measured are:
- Prices are high relative to traditional measures
- Prices are discounting future rapid price appreciation from these high levels
- There is broad bullish sentiment
- Purchases are being financed by high leverage
- Buyers have made exceptionally extended forward purchases (e.g., built inventory, contracted for supplies, etc.) to speculate or to protect themselves against future price gains
- New buyers (i.e., those who weren’t previously in the market) have entered the market
- Stimulative monetary policy threatens to inflate the bubble even more (and tight policy to cause its popping)
The fastest rate of tightening typically comes about five months prior to the top of the stock market. The economy is then operating at a high rate, with demand pressing up against the capacity to produce. Unemployment is normally at cyclical lows and inflation rates are rising. The increase in short-term interest rates makes holding cash more attractive, and it raises the interest rate used to discount the future cash flows of assets, weakening riskier asset prices and slowing lending. It also makes items bought on credit de facto more expensive, slowing demand. Short rates typically peak just a few months before the top in the stock market.
A cash-flow problem means that an entity doesn’t have enough cash to meet its needs, typically because its own lenders are taking money away from it—i.e., there is a “run.” A cash-flow problem can occur even when the entity has adequate capital because the equity is in illiquid assets. Lack of cash flow is an immediate and severe problem—and as a result, the trigger and main issue of most debt crises.
Most of what people think is money is really credit, and credit does appear out of thin air during good times and then disappear at bad times…a big part of the deleveraging process is people discovering that much of what they thought of as their wealth was merely people’s promises to give them money. Now that those promises aren’t being kept, that wealth no longer exists.