Continuing From Part 2

In this article, we cover the final third of Ray Dalio’s video called How The Economic Machine Works. If you’d like to recap Part 2, Click Here. You can also tune into the video again by watching here –

We left off in Part 2 on a low note, where the video talks about the economy falling into a recession, which can eventually become a severe depression caused by too much debt in the system. Ray Dalio defines this stage of the cycle in his other great book Big Debt Crises, where he tells us the story, play-by-play, of exactly how some of the historical debt crises have played out (like the 1930s and 2008).

When the economy is in this stage it is called a deflationary depression. The book is very academic, but I personally found it fascinating. He not only describes things from a monetary ruleset or systems standpoint but includes newspaper headlines from the exact days as the crises play out. It’s also a bit eerie how newspaper headlines and articles from almost 100 years ago are very similar to what we read today.

Deflationary Depression

The term isn’t necessarily in the video, but he does define it in his book mentioned above. It means that due to the debt in the system is essentially evaporated or eliminated, among other things, things actually start costing less. So the value of a $10 dollar bill, for instance, buys more. This is because the amount of goods and services remains the same, all else being equal, but there is less actual money and credit to go around, meaning that the same dollar will buy more stuff.

There are a few things playing out here, but we saw this in 2008 – especially in housing. The stock market was cut in half in 2008, and housing (especially in some markets like New York, Florida, Nevada, California, and others) got crushed, dropping 50 to 70% or more. Things like wages, goods and services, rent, and other assets like baseball cards, antiques, exotic cars all usually drop in value.

To The Video! Turning Around The Deleveraging Process

So how do countries stop the bleeding? If we are going to continue with this version of the economic system (countries usually do), we have to eliminate debt in the system, which has become too large to ever be paid back. We are crippled and the math simply doesn’t work. The economy itself is now uncreditworthy.

There are four ways to do this –

  • People, business, government cut spending
  • Debts are eliminated through defaults and restructuring
  • Wealth must be redistributed from the wealthy to the not-wealthy.
  • Central Banks print money – out of thin air.

Some variation of these four things has happened in every single country in modern history to turn around deleveraging. Examples include the USA 1930’s, England 1950’s, Japan 1990’s, Spain and Italy 2010’s.


You may have heard the term Austerity before, which just means that governments cut their spending and tighten their belts. The aim is to pay down old debts, with the goal of incomes rising due to better creditworthiness.

But the opposite ends up happening. Because one person’s spending is another person’s income, with less spending, now incomes fall. They fall faster than debts are repaid, and the debt burden actually gets worse! Now the recession/depression effects are amplified.

The Spiral Continues

It is deflationary and painful. Businesses cut costs, unemployment rises, incomes fall, and still, more debt must be reduced. Borrowers don’t repay the banks, and the bank assets decrease (because debtors don’t have the money to repay), and people run on the banks to get their cash out. Banks are squeezed and are now at risk of defaulting themselves – having no more left to operate or lend out.

Wealth is destroyed, and people discover that what they thought was wealth isn’t really there. When a company goes out of business, your stock is now worth zero. When you can’t pay the mortgage, you lose it.

Government Stimulus Spending

The government is affected because lower incomes and lower employment mean less tax revenue. At the same time, it needs to increase spending to create stimulus, help the unemployed, and the general population. The government budget deficits now explode. We hear about this on the news all the time. They must either raise taxes or borrow money.

Tax the Rich

Throughout history – sometimes they need to get more money from the wealthy, and taxes are raised on them. The population needs help and resent the wealthy.

Social tensions rise, and social disorder can break out. This includes conflict between countries that are debtors and creditor (opposites) nations.

War is Possible

The crisis can lead to extreme political change – think Hitler, the war in Europe, and the U.S. Great Depression in the ’30s. Pressure increases to end the depression somehow, and often extreme solutions are agreed upon.

It’s important to note that what most people thought was money, was actually credit/debt, and that has now disappeared. The entire world needs money, and who can print money? The Central Banks can. Printing is often the last resort within this particular economic system. So there is no choice – either change the system or print.

And so they print…

Money gets created out of nothing and is used as a tool to try to keep the economy going. Like it or not, this is how it works, and the Central Banks will always print to get out of a crisis.

Printing more money means there is more in the system now, and therefore is inflationary. This stimulates the economy, asset prices, and so forth, and now we start the up-cycle one more. This new money is distributed throughout the economy through various measures. This happened in the ’30s and again in 2008.

The Central Banks buy assets themselves with this newly created money, driving up asset prices to try to stimulate. For example – in 2008, the Federal Reserve printed over $2 Trillion!

History Repeats Itself

Here is a graph of the amount of money printed in the ’30s and then again just a few years ago. There are many factors involved, but if you’re wondering why things like groceries, housing, cars, and the stock market have shot up since then – this can explain a lot.

Notice how, in a very short period of time, the money printing proportionally went off the charts compared to just a few years earlier. This is the magnitude of what Central Banks do to try to turn things around, and it happened all around the world –

Sidenote – You Must Own Assets Longterm

We mentioned in Part 2, but we here at Attainable Home feel it’s so important that it’s worth repeating. And that is –

Unless you own assets longterm, you will not benefit from this system.

When money is printed, it drives up the price of everything due to there being more of it in the system. This is the definition of inflation. If you do not own assets, you will not be participating in the runup of asset price growth. This is no different than stocks or housing going up in price over time. It also means that the cost of living goes up, and all else being equal, your wages need to increase with it over time just to keep up.

By owning assets, your money is working for you, typically without the need for your time to be put into it, so it’s earning money for you as values go up.

There are millions of articles, resources, blogs, etc on the subject of personal finance, investing, getting wealthy, and all of that. But what we’re describing here is the underlining framework of why we even need to do those things. This is the ruleset and system that every one of those things is based upon.

We will be covering a lot of those topics in the future if we feel we can provide more value than what’s out there already, but another way to describe the recipe for success on achieving this for yourself is:

  1. Save as much money as you can vs. expenses
  2. Invest this saved money in a diversified manner into quality assets over time (Ray Dalio is big on efficient diversification)
  3. Be mindful of these cycles if you can. Watch for bubbles and overpriced/overvalued assets
  4. Ride the wave up over time
Riding the wave up, even through short-term debt cycles.

A Warning Against Market Timing

While even the best investors out there, like Warren Buffett and Charlie Munger warm against, and state that you should not try to time markets. What does help if you find yourself in a deflationary/down cycle is having cash. Cash buys more assets in the middle of a recession or depression because there’s less of it, so it’s more valuable (economics supply & demand).

Inversely, when you’re at the top of the cycle, everything is more expensive for that same dollar, meaning you can’t buy as much. This also has to do with the “buy low, sell high” advice we always hear about.

Central Bank Limitations

Central Banks can only buy assets due to the laws of the country and the structure of the economy (for various reasons). The government is the entity that can distribute cash throughout society and to the people in multiple ways, like tax cuts and tax credits.

The government does this by selling bonds to the Central Bank in exchange for this new cash. The Central Bank essentially loans out new money to the government. Then the government runs a deficit and usually increases spending through stimulus and unemployment benefits. Government debts go up, but this increases peoples’ income.

A Beautiful Deleveraging

If done correctly, the economy’s total debt burden is lowered. It is a very risky time. You need to balance all four ways the debt burdens come down, and deflation must balance with inflationary ways to maintain stability.

If done correctly – this is what Dalio calls a “Beautiful Deleveraging.” Handling the situation is the best way possible can be considered “beautiful.”

When done correctly –

  1. Debts decline relative to income
  2. Real economic growth is positive
  3. Inflation isn’t a problem
  4. Social stability is maintained

This is why printing money doesn’t always create inflation. It won’t if it is offsetting falling credit in a recession or depression. New money is taking the place of evaporated credit from the last cycle.

Incomes Must Rise Faster Than Debt

To turn things around, we now need to get incomes rising faster than debt. For instance, if the entire country’s debt has an interest rate of 2%, but incomes rise at 1%, the debt burden continues to get worse, and you’ll never reduce it.

They will print money enough to grow incomes faster than debt, but it must be responsible. It’s too easy to create too much, and this can lead to hyperinflation if not careful. (Germany in the 1920s with the Weimar Republic).

So when done right – incomes rise, borrowers become more creditworthy, lenders lend again, spending increases, debt burdens fall, and the economy begins to grow again in a reflation phase of the long-term debt cycle.

The Lost Decade

This part of the cycle can usually take a decade or more and is sometimes coined by the term “The Lost Decade.”

If you bought at the top of the cycle in the tech bubble of 2000, or at the height of the housing bubble in 2018, it may have taken about a decade or more to get back to breakeven in some situations. This would be your Lost Decade, and it does unfortunately set people back years in terms of wealth building.

But when the balanced/beautiful deleveraging is working, the downfall isn’t so dramatic, and we start the up-cycle again, even if it takes years.


Growth is slow, but debt burdens go down. Incomes begin to rise. Borrowers become more creditworthy. Lenders begin to lend again. With people being able to borrow more, they now spend more. My spending is your income, and your spending is my income. We have now entered the reflation phase. Now we’ll ride this wave. Surf’s up!

Devaluation Of The Currency & Trying to Create Inflation

Here is another good visualization of how we can use the U.S. Dollar to represent how this plays out over time:

Courtesy of

You can see clearly how when during the crisis in the ’30s, the value of the U.S. Dollar rose in purchasing power. Due to cash being able to buy more “stuff” in a recession/depression, prices coming down. But for the rest of the time, you can see how the Central Bank has worked really hard to keep inflation going, and thus it devalues the currency over time. To reference the article from –

$100 in 1913 would only be worth about $3.87 today.

In other words, if you spent $3.87 in 1913, that would be like spending $100 today. Throughout history, as long as the Central Banks and governments have the tool of printing money to achieve their goals of ongoing inflation (and thus devaluing the currency), they will. This is the point Ray Dalio makes throughout his video and in other interviews.

So, yes – in the end – you know, when it gets bad enough, they’ll always print.

Ray Dalio

In Closing

Things are more complicated than all of this, but if we lay the short term debt cycle on top of the long term cycle, and run the productivity growth line on it, it gives a clear picture of how this all works.

This template gives us a pretty good picture of where we’ve been, where we are now, and possibly where we’re headed.  Ray Dalio gives us three rules to follow to keep ourselves not only out of hot water but to thrive in the system we live in. And this is really what it’s all about.

The Three Rules of Thumb

1. Don’t have your debt rise faster than your income.

If you always have more income coming in than debts to pay, you will stay solvent. Too much debt/credit and the inability to pay these off is the reason that governments, businesses, and people will go bankrupt.

2. Don’t have your income rise faster than productivity – this will make you uncompetitive.

Another way to say this is that if incomes go to high, that means things also cost more (goods, services, etc), and therefore others will not be able to buy as much of it, possibly making you uncompetitive vs others. On a worldwide scale – entire economies can lose out because goods and services become too expensive vs. other countries.

3. Do all that you can to raise your own productivity, because in the long-run, productivity is what matters most.

Ray Dalio states that these three things are simple advice of us personally, but also for the policy-makers.

Conclusion On The Series

I realize there was a ton of information here and I did my best to outline everything, and also add in some thoughts of how we can operate in our own lives to get ahead.

The concepts are enormous in nature, but this is why we wanted to spend this specifically. We can understand the system that we live in and what’s going on around us, because it affects us every single day.

To take a few things from Part 1 again –

As we near the end of 2019 here, the economy has now been in the longest expansion (short-term up-cycle) in history. While we cannot predict the future, we can look around to perhaps gauge where we are in the cycle and have clues as to what may come next.

We can also tune into what’s happening right now. Things include:

The U.S. Federal Reserve resorting to money printing once again (Fourth time since the Great Recession in 2008), the government running $1 Trillion deficits, housing prices become unaffordable in many markets, stock markets at all-time highs, and the list goes on.

While a lot of this may seem nuts, it should be reiterated that neither Ray Dalio, nor I in writing this article, mean for any of it to be political, “doom-and-gloom”, or sell anything. It’s not to push any certain agenda, other than attempting to help others understand the system we live in and get ahead.

This economical system works just like a machine, operating purely based on the rules, inputs, and outputs it receives. And that is the whole point Dalio is trying to make.

We would love to know your thoughts, opinions, and personal stories that may surround this topic. The more we can all help each other to understand these kinds of things, the further we can go to prosper in our own lives.

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