Chapter 2: The Big Cycle of Money, Credit, Debt, and Economic Activity

Ray Dalio's LinkedIn article is Chapter 2 of a work-in-progress series previewing his forthcoming book, The Changing World Order, which he said would be published in the fall. Dalio argues that because wealth and power are what most people and countries want most, and because money and credit are the biggest single influence on how they rise and decline, understanding money and credit is a prerequisite for understanding domestic and international politics and the world order. He illustrates this with the Roaring '20s, the debt bubble and wealth gap that preceded the 1930-33 depression, and the political conflicts that followed, including the forces behind Franklin D. Roosevelt's election and his 1933 plan for the central government and the Federal Reserve to jointly provide substantial money and credit.

Dalio describes the fundamentals that apply to all entities, including people, companies, nonprofits and governments. Income and expenses determine net income, savings rise or fall accordingly, and assets and liabilities appear on the balance sheet. When spending exceeds income, an entity must draw down savings, borrow, or take from others. He notes that one person's spending is another's income, so spending cuts and defaults propagate through the economy in a self-reinforcing contraction that becomes political as people argue over a shrinking pie. He states that debt eats equity, since creditors are paid before owners when obligations cannot be met under the rules of the game.

Dalio writes that there is no fixed amount of money and credit, since governments can create it. Creating it raises spending power and tends to lift prices, but generates debt whose repayment is painful, which makes the cycle inherently alternating between a credit-creation phase of strong demand and a debt-repayment phase of weak demand. He explores a hypothetical in which the central bank lends at roughly 0% and keeps rolling over debts so they are never repaid, which he says would function as giving debtors the money while still being accounted for as an asset. He states that central banks could do this and that this is now happening.

Dalio concludes that the current problem is that for many entities incomes are low relative to expenses and liabilities are high relative to assets, a condition that can be masked because entities that appear wealthy may spend heavily, hold many assets, and hold substantial cash while still heading toward insolvency. He encourages readers to assess their own income, savings, asset risk and liquidity, and to evaluate counterparties on the same basis. The article is a conceptual framework rather than a market forecast, and it does not provide specific deal figures or market data.