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@jairekrobbins
6 October 2020

Key Takeaways From: The Mechanics of The War Economy – Ray Dalio

Jairek Robbins

As people are wondering about what is happening in the economy amid the coronavirus pandemic, Ray Dalio, the manager of the largest hedge fund in the world, has shared his views on what he thinks is happening.

Dalio explains that the closest comparison of what is happening today can be found in what happened to the U.S. and other major economies during the world wars. He specifically singles out the 1930s and 1940s as closely mirroring the economic situation today both in terms of what is happening and how governments are responding to the situation.

The following are the key issues that Ray Dalio sees as pivotal during this pandemic.

An Emerging World Power Challenging an Existing One

According to Dalio, one of the major factors to watch during this time are the issues around the tensions between China (an emerging world power) and the U.S. (an existing world power).

You may have seen the news or read the widely publicized accusations and counteraccusations about the way China handled (or failed to handle) the outbreak of the novel coronavirus. The U.S. has gone as far as claiming that the World Health Organization is working at the behest of China rather than working as an independent UN agency.

The conflict between these powers didn’t just sprout around the virus. Long before the pandemic, the trade war between China and the U.S. had taken shape with each country imposing tariff and non-tariff barriers on select products from the other power.

The extent to which this challenge on the supremacy of the U.S. affects how major world leaders respond to the economic effects of this pandemic will determine how soon the world recovers and gets economies growing again.

Related: Big Picture in a Tiny Nutshell, by Ray Dalio

The Role of Central Banks

Ray Dalio points out that in a war economy, a point is reached when governments can no longer raise taxes to finance the war (in this case fund the stimulus packages) and central banks or the Fed has to step in and print money to inject liquidity into the economy.

The trillions of dollars already announced in stimulus packages show that this phase has already been reached. The country can now expect the Federal Reserve to work closely with the Trump administration so that the taxation and spending side works in tandem with the monetary/credit side of regulators.

For example, while the Fed can buy financial assets, this step cannot on its own put money in the hands of ordinary Americans. This is where stimulus packages announced by Washington come in. They give ordinary people and businesses the money that they need not only to stay afloat but to lay the foundation for a recovery. We can expect a lot more interventions to happen, but on a larger scale than what happened in the 1930s and 1940s.

Public Debt and Taxation

At this time when political polarity (both within the U.S. and externally) is at its greatest, it is unlikely that the government will raise taxes to finance its agenda. Ray Dalio points out that this is exactly what happens in war economies. Taxes are unpopular and governments can’t take the political risks associated with looking to taxes as a way of raising badly needed resources.

What therefore happens is that as public debt grows through deficit financing, most of the debt is carried by the government (through the credit offered by the Federal Reserve) so that individuals can do the best they can to rebuild their economic wellbeing.

At an individual level, it is important to note that the long term debt cycle is bottoming and that now isn’t the best time to use credit to finance luxuries or other expenses that don’t contribute to improving your productivity. 

Stimulus Packages and Interest Rates

Ray Dalio also points out that lots of people are concerned that all the money being printed and the additional debt being taken on by government in order to finance its COVID-19 stimulus packages will cause inflation/interest rates to spike.

However, Dalio asserts that this is unlikely to happen. It didn’t happen in 1930-1945, and it didn’t happen in the “war economies” that existed before the World Wars.

The key to keeping interest rates and inflation down is the work that the Federal Reserve (as well as other central banks) did during 1930-1945 and earlier.

The Federal Reserve, as it did in the past, will ruthlessly implement a policy of curbing the curve of bond yields (interest paid to government bond buyers) and other government securities. In practical terms, the Federal Reserve will buy any bonds that the government is unable to sell so that the government isn’t forced to raise the yield in order to attract private sector buyers.

What are the implications of this upon you as an individual? At least for the foreseeable future, interest rates are unlikely to spike, so now may be the time for you to think about ways to boost your productivity. For example, can you think of a profitable business that you can start or expand using the affordable credit which will become available as the stimulus package money (“helicopter money,” as Dalio calls it) trickles into the mainstream economy?

In Summary…

Trying to understand what is happening to the economy right now is like an ant trying to understand the universe. The ant is so tiny that its view of the world is an extremely limited one. Similarly, trying to understand the world economy right now during this pandemic by looking at the available lessons within our lifetimes is an exercise in futility because nothing like this has happened within the short years we have been around. It is therefore far better to look far into the past at other “war economies” so that we realize that what is happening has happened multiple times before, and how societies (governments, central banks, and individuals) responded is still the same that will happen this time around, except that it will be on a bigger scale given the dynamics of globalization. Ray Dalio gives valuable pointers on the way forward. See if his view makes sense to you or use his ideas to draw up your own “war plan.” Which way will you go?

To Your Success,

Jairek Robbins

Source: The Mechanics of the War Economy

 

 

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