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27 July 2020

Money, Credit, and Debt: Understand Them, Master Your Economic Wellbeing

Jairek Robbins

Wealth and power are pursued by everyone and every country, so it is important to understand how money and credit affect wealth and power so that you can grasp the drivers of politics not just within a country but between countries as well. This concept is clearly explained by Ray Dalio in the 2nd Chapter of an upcoming book titled The Changing World Order.

What Dalio has to share takes on even greater importance at this time when the financial wellbeing of millions of people around the world has been throw into a tailspin. 

Here are our key takeaways from his article on Money, Credit and Debt.

The Amount of Credit or Money isn’t Fixed

This may be shocking to many ordinary Americans and people around the world, but there isn’t a fixed amount of money or credit in the world. 

Governments easily create money and credit, and people are happy when this happens since it increases their ability to spend. However, prices usually go up as a result of this creation of money and credit, with the result that it gets harder to pay off debts. This explains why economic cycles of booms and bursts happen, and will always happen.

This same power that governments and central banks (the Federal Reserve) have to create money can also be used to constrict economic activity if inflation gets too high and economic activity is low.

This reality is important to grasp because an a layperson, you may have been unaware that the monetary policy of the nation may have had something to do with how easy or hard it can be for you to access credit or money to meet your spending needs, both for business and for personal purposes.

The Basics of Financial Health

Revenue and expenses are at the core of the basic financial realities, and this is captured in balance sheets, whether you write them or not. If your expenses are greater than your revenue, you must borrow or take from someone else to meet the shortfall. On the other hand, if your revenue is greater than your expenses, the excess must be put elsewhere (such as in savings or financial assets like bonds) or given to someone else. This applies to individuals, companies, and even countries. 

The world order changes in tandem to the changes in the incomes, expenses and savings of not just individuals, companies, nonprofits and entire countries as well. 

The Interconnectedness of Financial Wellbeing

When you cut your expenses in response to your reduced income or indebtedness, you hurt not just yourself but others whose income depends on your spending. This explains why a downward spiral of an entire economy quickly starts once some people’s incomes drop and their spending power reduces.

This interconnectedness also explains why during economic downturns, governments inject money and credit into some entities that are deemed to be “too big to fall.” It may appear as though the federal government is bolstering or rewarding the very companies that precipitated an economic crisis (such as what happened in 2008), but the truth is that by intervening in that way, the government is laying the groundwork for economic recovery for as many people as possible.

The Personal and Global Implications of Economic Interconnectedness

Think about your own financial position. What is your income right now and what would happen if your investments lost half their value? What additional sources of income do you have and how long can they meet your monthly expenses? 

Take this to a bigger level and think about the people around you, the companies they work for, and ultimately the country. What is its financial health on those yardsticks? The answers you get will show you what is coming not just to you but to the country as a whole.

If you and the people around you are struggling economically, chances are the economic health of the country is also at stake, and this can have wider implications beyond our borders.

For example, you have heard the saying that when the U.S. or another major world power sneezes, lots of countries around the world catch a cold. Therefore, the current dire straits of the U.S. economy are likely to precipitate global financial stress, and a possible change in the world order as we know it.

Money and Credit isn’t Equal to Wealth

Money and credit are linked to wealth, but they aren’t wealth. Many folks can’t distinguish between money and credit on one hand, and wealth on the other hand. This is understandable at some level because access to credit and money can help one acquire wealth. However, one of the biggest mistakes that many people make is to think that because they can access credit and money, they are wealthy. 

To clear this misunderstanding, wealth comes from being productive, so you can have lots of money and credit without being wealthy, especially when your productivity is low (no real goods or services made).

Related: Big Picture In A Tiny Nutshell

It is important that people grasp this distinction, especially now that the pandemic has triggered financial distress for lots of people and there is need to go back to the drawing board in order to plan a comeback. As an individual, think of ways to become more productive so that you can build real wealth. Of course access to credit and money can help you on this journey, but money and a high creditworthiness score shouldn’t mislead you into thinking that you are wealthy.

The Measures of Wealth are Fickle

When money and credit are flowing freely, the prices of goods and services go up, but this doesn’t mean that more wealth has been created. Similarly, during a credit crunch when prices are depressed, it doesn’t mean the wealth available has declined since the intrinsic value of an asset, such as a house, will remain unchanged. Only its perceived value changes. Market valuations are therefore just illusions.

Dalio brings this home clearly when he says that during a boom, the market valuation of a house can spike significantly. This doesn’t mean the intrinsic value of that asset has increased, it is the same house you had and it will stay the same even when a slump occurs and the market valuation drops.

Relying on market valuations, which are fickle, as a determinant of your wealth is therefore a risky undertaking. It is far better to accumulate real assets whose real value isn’t dictated by subjective market sentiments.

Dalio digs deep into how these economic concepts tie in with both national and international politics, and we think that if you take the time to digest at a personal level what is contained in this discussion, you will find it easier to extrapolate the broader implications of the cycles that keep happening. Charity, as they say, begins at home. Use this information to rethink your personal financial health, and as you get better in this area, empower many more people to take their own path on the same journey to a better position, financially. This will have a ripple effect of building a better community, and nation at large. One for all, and all for one. So, what steps are you planning to shore up your financial wellbeing in light of the ideas shared in this post?

To Your Succes,

Jairek Robbins



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Source: Money Credit Debt by Ray Dalio

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