Thursday, February 9, 2012

How the economy works...

A follow-up to my previous post, I just finished reading an excellent paper - may be the best I have read yet - by Ray Dalio. He does a brilliant job of explaining how he believe the economy works. He creates a distinction between recessions - which are a part of a normal business cycles - and deleveragings - which happen rarely but have enormous corrective consequences. Chart 3 on page 10 and the table on page 19 are profound, they have made me think in new ways.
Sadly, a topic on China has to be a part of every frikkin' post I make eh? US and the world in 1929, Japan in 1989 and the US and the world in 2008 - this is what we have so far. Next in line is, China (and the world?) in 2012/15. I am saying this based on his outline of how credit growth always creates an illusion of prosperity; the prime reason is that during a massive credit growth period like Japan in the 1980s, people start believe that they are wealthy based on the 'wealth' that their assets hold. Sadly, people like to forget that they have outstanding liabilities against those assets.
When a turning point finally arrives, and when a larger proportion of the community decides to cash in on their wealth, that is when that supposed wealth dissolves. It is similar to how he (Ray) explains the distinction between money and credit. Most of us confuse wealth or credit with money - an example, if we believe that our house is worth INR 15 Mn, we feel better and spend better. When the market value of that house or that stock portfolio or gold increases, we believe we are wealthier just based on how much we could potentially get when we eventually do sell it. However, when we turn to sell it (which for the market as a whole) is in times of stress, that is when the assumed value starts eroding. This, my friends, is what will happen to the Chinese economy soon enough.

Do have a look at page 19 of the paper and see how long the increase in fed rates continued when it last touched near zero, which was in 1932. 251 months. The US has only recently touched zero.

On an semi-related note, two of the reasons I believe that the US will still emerge as the superpower of the world:
An episode of Undercover Boss where the CEO of Baja Fresh was of Korean descent. He went to his stores where he interacted with people of four 'races?' - Philippines, Jordan, Mexico, American. All of them were rather american and when I saw the size and the quality of the organisation that Baja Fresh presented itself as, I saw why the US will continue to excel.

This video shows how the US has evolved, and why it will continue adapting to a changing world.

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