Ray Dalio has been right about a whole lot of things in this economy, and he told The Economist that all of his ideas come from a 20 page document called his “Template for Understanding.”
One nugget of wisdom that has been super helpful over the last decade is Dalio’s theory on credit cycles. He says there are two types. There’s the business cycle, which can last between five and eight years, and the long-term debt cycle, which can last between 50 and 70 years.
Business cycles tend to end in recession because Central Banks intervene and drive up interest rates, which in turn reduces borrowing and demand.
A long term cycle ends in deleveraging way because a “shortage of capable providers of capital and/or a shortage of capable recipients of capital (borrowers and sellers of equity) that cannot be rectified by the central bank changing the cost of money.” Plus, politicians don’t understand them.
An ordinary recession can be ended by the central bank lowering the interest rate again. A deleveraging is much harder to end. According to Mr Dalio, it usually requires some combination of debt restructurings and write-offs, austerity, wealth transfers from rich to poor and money-printing. A “beautiful deleveraging” is one in which all these elements combine to keep the economy growing at a nominal rate that is higher than the nominal interest rate.
Knowing that, you’ve probably guessed which one Dalio thinks we’re in.
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