How much do you know about the operation of the economy?

The economy operates like a simple machine, yet many people fail to understand this, leading to many unnecessary economic losses.

In the previous article about hedge funds, I mentioned to everyone the founder of Bridgewater Associates, Ray Dalio, who is good at macro research and analyzes economic cycles.Here, I would like to share with everyone Ray Dalio's simple and practical economic analysis model.

Although this model does not conform to conventional traditional economics, it has helped him predict and avoid the global financial crisis and has been used for more than 30 years.

The economy may seem complex, but it actually operates in a simple mechanical way.

The economy is composed of a few simple components and countless simple transactions that are repeated over and over again:These transactions are primarily driven by human nature, thus forming three very main economic forces:

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1. Improvement of productivity; 2. Short-term debt cycle; 3. Long-term debt cycle.

You will learn how to combine these three forces together to derive a good economic model, so that we can follow the economic trend and understand what is currently happening.Let's start with the simplest part of the economy - transactions.

Economics is nothing more than the sum of countless transactions, and transactions are something that happen all the time.

In each transaction, the buyer uses money or credit to exchange goods or services or financial assets with the seller.

Credit is the same as money when it is used.

So by adding the spent money and credit together, you get the total expenditure.The total expenditure is the driving force of the economy.

By dividing the total expenditure by the volume of sales, you get the price:

The above is the transaction itself.

A transaction is the most basic component of the economic machine. All economic cycles and dynamics are caused by transactions. Therefore, understanding transactions means understanding the entire economy.A market is composed of all buyers and sellers of the same commodity.

For example, the corn market, the steel market, the oil market, and millions of other markets.

Economy is constituted by all transactions in all markets.

By dividing the total expenditure and sales volume of all markets, you can obtain all the information needed to understand the operation of the economy.Individuals, businesses, banks, and governments all engage in transactions in the aforementioned manner, using currency and credit to exchange goods, services, and financial assets.

Governments are the largest buyers and sellers, and they consist of two components:

Central Government—collects taxes and spends money

Central Bank—controls the amount of money and credit in the economy

Among them, the central bank exerts this control by influencing interest rates and issuing more currency, thus playing a significant role in the circulation of credit.Credit

Credit is one of the most important components in the economy, as it is the largest and most unpredictable part of it. However, it is also the part that most people understand the least.

Lenders and borrowers are no different from buyers and sellers who trade in the market.

Generally, lenders hope that their money will generate more money, while borrowers want to purchase something they cannot afford at present.Credit lending can simultaneously meet the needs of both the lender and the borrower. The borrower promises to repay the loan as principal, along with an additional amount as interest.

When the interest rate is high, borrowing will decrease because the interest to be paid is higher;

When the interest rate is low, borrowing will increase because the loan becomes cheaper.

If the borrower promises to repay the debt, and the lender believes in this commitment, then credit is created.

Any two people can create credit out of thin air through an agreement.Credit may seem simple, but it is actually quite complex, as it goes by other names as well.

Once credit is granted, it immediately becomes debt.

Debt is an asset for the lender and a liability for the borrower.

Once the borrower repays the loan and pays the interest, the asset and liability will disappear, and the transaction will be completed.

Why is credit so important?That is because once a borrower obtains credit, they can increase their spending.

Do not forget that spending is the driving force of the economy.

This is because one person's spending is another person's income.

For example, for every dollar you spend, someone earns a dollar; and for every dollar you earn, someone else must have spent a dollar. The more you spend, the more others earn.

If someone's income increases, their creditworthiness will improve, and lenders will be more willing to lend money to them.Creditworthy borrowers possess two conditions:

Repayment capacity and collateral.

1. If the income is higher than the debt, the borrower has the repayment capacity;

2. If unable to repay, the borrower can also use valuable assets that can be sold as collateral, such as houses, stocks, etc.

Income increase -> Debt increase -> Expenditure increase

Since one person's expenditure is another person's income, if income increases, then debt will increase, leading to increased expenditure; this will cause further increase in debt, and further increase in expenditure, and the cycle continues.This self-driven model has led to economic growth, and it is precisely for this reason that economic cycles have emerged.

Economic Cycles

In a transaction, in order to obtain something, you must give up something else. In the long run, how much you get depends on how much you produce.

Our knowledge continues to grow over time, and the accumulation of knowledge will improve our standard of living, which we refer to as an increase in productivity.

A person who is good at innovation and diligent will improve productivity and living standards faster than those who are complacent and lazy. However, in the short term, it may not be reflected.Productivity is the most critical in the long term; but credit is the most important in the short term.

Improvements in productivity do not fluctuate dramatically, hence they are not a significant driving force behind economic cycles, but debt is this driving force.

We can make consumption exceed output through borrowing, but during debt repayment, we have to make consumption fall below output.The fluctuations in debt volume have two major cycles:

One cycle lasts for about 5-8 years;

The other lasts for about 75-100 years.

Most people, although they can feel the fluctuations, are too close to them and only perceive a small segment of the fluctuation, usually not considering it as a cycle.How do these three forces interact with each other, and how do they manifest in everyday economics?

(Note: The original text seems to be incomplete, as it does not specify which three forces are being referred to. The translation assumes that the context is about three unspecified forces and their impact on daily economic activities.)