Running the Economy- VI
So far we have come across the main components of an economy - transaction, credit creation, short debt cycles, recession, inflation, printing money, etc. We are about to end our series with this episode of getting stabilized after plowing through economic grievances and hardships in the aftermath of improper credit circulation.
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The deflationary ways need to
balance with the inflationary ways to maintain stability. If balanced
correctly, there can be a Beautiful Deleveraging. You see, a deleveraging can
be ugly or it can be beautiful. How can a deleveraging be beautiful? Even
though deleveraging is a difficult situation, handling a difficult situation in
the best possible way is beautiful.
A lot more beautiful than the
debt-fuelled, unbalanced excesses of the leveraging phase. In a beautiful
deleveraging, debts decline relative to income, real economic growth is
positive, and inflation isn't a problem. It is achieved by having the right
balance. The right balance requires a certain mix of cutting spending, reducing
debt, transferring wealth, and printing money so that economic and social
stability can be maintained.
People ask if printing money
will raise inflation. It won't if it offsets falling credit. Remember, spending
is what matters. A dollar of spending paid for with money has the same effect
on the price as a dollar of spending paid for with credit.
By printing money, the Central Bank can make up for the disappearance of credit with an increase in the amount of money. To turn things around, the Central Bank needs to not only pump-up income growth but get the rate of income growth higher than the rate of interest on the accumulated debt. So, what do I mean by that? Income needs to grow faster than debt grows.
For example:
let's assume that a country going through a deleveraging has a debt-to-income ratio of 100%. 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 the 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 1920s.
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 policymakers. You might be surprised but most
people — including most policymakers — don't pay enough attention to this.
Everything we learned here was based on the understanding of Ray Dalio, an American billionaire running the world's largest hedge fund- Bridgewater associates and a well-known philanthropist delivering his success principles.
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