The Canadian election has just ended, and all kinds of analyses, predictions, and countermeasures have come out. The scariest piece of advice is to sell your house quickly. Is capitalism so fragile? If someone is elected or loses, they have to sell their house? The capitalist system is bound to experience crises, and it is cyclical. Not only do people survive every time, but their living standards also rise step by step. What causes recessions and how to deal with them?
People are laid off, stocks depreciate, companies go bankrupt, house prices fall... These horrifying things without knowing the cause are likely to happen to anyone from the sky. For most people, even if they watch the financial news every day, they cannot predict when they will encounter such bad luck, let alone prevent it in advance. The economics we studied in the past made no achievements in terms of when economic disasters occur and how families can prevent economic cycle fluctuations. Therefore, ordinary families are almost nakedly exposed to the threat of economic fluctuations without any protection. No matter whether the economy is in the upswing, recovery, or downturn stage, there are always "experts" who predict that the economy will get worse, and these "experts" usually have a lot of background. We don't believe it, and we don't believe it. Over time, everyone becomes numb and relaxes their vigilance. Economic fluctuations will eventually come, and it is only a matter of sooner or later and whether they will affect our lives. Therefore, we should still understand the laws of the economic cycle. Even if we are unfortunate enough to be "shot", we will know how to "die".
There are too many books and articles about the business cycle, with different opinions and their own evidence. Last week’s article also introduced a view on the relationship between economic fluctuations and urbanization. Marx was the first to study the phenomenon of business cycles. He believed that the evil of pouring away milk and not giving it to the poor could only exist in capitalist society. The evil capitalism will soon be ended by the united proletariat. If he could survive now, he would definitely beat himself up. How can capitalism be destroyed so easily? The reason for pouring milk is that the price of milk in the city is too low, and no one pays the freight from the farm to the city. It's as simple as that. As for the desire of the proletarians of the world to unite, haha, Lenin discovered that it was the proletarians of the world who fought each other the most during World War I, and it was their bosses who made weapons. Other fake economists also have many grand theories, but they cannot stand the test of history. At present, there is only one theory about the business cycle that has not been overturned, and it has been proven to be correct time and time again.The credit cycle triggers the debt cycle. Several short debt cycles are superimposed into a long debt cycle, and economic crises usually occur at the highest point of a long debt cycle. This statement was put forward by Austrian economists, and Dalio of Bridgewater Associates proved this statement with actual investment practices. The economic cycle is the credit cycle. If ordinary people clearly understand the characteristics of the credit cycle and take corresponding measures, they can avoid the unexpected explosion of the wealth warehouse.
01 Artificially low interest rates are not a good sign
Seven billion people on the earth make 10 economic decisions independently every day, such as whether to eat steamed buns or hamburgers, buy a house or rent a house, etc. There are 70 billion economic decisions in a day. What impact do individual decisions have on the overall direction of the economy? The only economists on earth who can answer this kind of question are Austrian economists. Rothbard wrote an article, "Economic Depression: Causes and Cure," which is the most concise article I can find that clearly explains the causes and solutions to the economic crisis. It takes at least 45 minutes to read this article. I tried to use more concise words to explain the causes of the economic depression. If I fail, please find Rothbard's article and read it.
Austrian economics believes that the structure of capital is more important than the amount of capital. Capital must be linked to personal plans to be productive. Capital that is not included in plans is idle capital and has no value. The structure of capital refers to the combination of different capitals. Different combinations of capital produce different service flows, which represents the profit purpose that entrepreneurs want to achieve by combining different capitals. If entrepreneurs' plans generally make mistakes, the structure of capital will be chaotic, and its external manifestation will be the "business cycle." How can entrepreneurs collectively make mistakes at the same time? The reason is that government intervention gives the market the wrong signal, especially the government's intervention in the currency and banking system, specifically the intervention in interest rates.
Due to time preference, people tend to overestimate the value of current goods and are anxious to consume, enjoy and show off, so they underestimate the future. Interest can be seen as the price of holding back current consumption and delaying gratification. Interest rates, therefore, become a purely temporal phenomenon. The level of interest rates depends on people's level of impatience. If the level of impatience is low (they are in a hurry to consume), the interest rate will be high. If the level of impatience is high (they are not in a hurry to consume), the interest rate will be low. Everyone can resist immediate consumption, that is, the higher the level of impatience, the lower the interest rate. Seeing the high level of people's impatience, companies invested cheap funds with low interest rates into long-term production projects, and for a while they were unable to produce consumer goods. But what if this low interest rate is the result of government intervention? Entrepreneurs misread the signal of low interest rates. The result is that projects that originally had no return on investment become profitable because of the low borrowing costs for entrepreneurs. So entrepreneurs expand the scale of production and increase the input of production materials and labor. As a result, the prices of production materials and labor will rise, because the real level of intolerance is not high, and the labor force gets paid. After investing, they were consumed immediately, so the prices of consumer goods rose. Entrepreneurs invested in long-term production projects. The products were not produced yet, but the costs had already risen. This caused entrepreneurs to make common mistakes - the cost of the produced products was too high, they could not be sold, and the debts had to be repaid. As a result, large-scale corporate bankruptcies occurred, workers lost their jobs, and the economy was depressed. If interest rates are raised at this time, it will make matters worse. The government sees this situation and if it allows the economy to decline, the market will naturally eliminate companies that made mistakes and write off floating capital, causing a chain reaction to cause stock prices to fall; if the government intervenes again to further artificially lower interest rates and allow companies that made mistakes to survive, it will cause more companies to make mistakes. Although the stock market will be stabilized, it will harm the future. This is the explanation of the business cycle by Austrian economics, and it is also what has happened in Japan. It is also the current situation in which the United States is following Japan's example and heading towards the abyss.
The Abe government has used quantitative easing policy to artificially intervene in interest rates since 2001, 18 years ago. It has insisted on kicking the iron plate for many years because Abe believes that the iron plate does not move because it does not kick hard enough or for long enough. Japan's lifetime employment system and the government's reluctance to let companies go bankrupt have led to the government lowering interest rates to rescue those "damned" companies when a short-term debt crisis occurs, preventing them from clearing excess production capacity, and creating an embarrassing situation where pedantic companies are dead but not dead. The short-term debt cycle cannot be ended by corporate bankruptcy and employee unemployment, so it enters the next short-term debt cycle, which results in prolonging the long-term debt cycle. The culmination of the long-term debt cycle was the Great Depression, the Great Crisis.
After the Internet bubble, the U.S. government artificially lowered loan interest rates and encouraged Americans to borrow money to buy houses. When everyone was heavily in debt, they began to raise interest rates and cut leeks. This time it was not cut properly and it was uprooted: the homeowners didn’t even want their houses anymore, triggering the subprime mortgage crisis. Bernanke learned from Japan and used quantitative easing to artificially lower interest rates, saving Wall Street, but he also misled American companies. Powell began to raise interest rates and deleverage in 2018. He originally took a few steps in the right direction, but was pulled back to the wrong path by Trump, and began to artificially lower interest rates in 2019.
As soon as the U.S. cuts interest rates, I can see the joy in my circle of friends, and some people ask me when Canada will also cut interest rates. Interest rates have been artificially lowered to levels that cannot be lowered. When they are close to 0, the risk of major economic problems is highest. Unemployment and a collapse in asset prices are most likely to occur. At the same time, debts must be repaid. I can't be happy to see interest rates being artificially lowered, and I don't understand what the masses have to cheer about. Since I started writing this public account, I have been constantly advising readers: increase mortgage investment in housing and pay off your home as soon as possible, that is, transfer your debts to the tenants. But many people don’t take it seriously, thinking that since the interest rate is low, they shouldn’t be in a hurry to pay it back. I once again recommend that everyone get rid of their debt as soon as possible, because artificially low interest rates are not a good sign, and zero interest rates are the apex of a long debt cycle. Just look at the current interest rate level to know how far we are from the worst case scenario. Ultra-long-term low interest rates like those in Japan are a characteristic of an economy falling into ultra-long-term malaise. When will interest rates be raised? When will the economy enter an upward period?
02 How the economic machine works
Economic theory or reasoning that has not been tested in actual combat has no value. The above statement that debt cycles lead to economic cycles has been tested in practice by Bridgewater Associates, currently the most successful hedge fund. Dalio and his team not only weathered the financial crisis smoothly, but also gained a lot.
The point of view in the video program "How the Economic Machine Works" produced by Dalio is that the driving force for economic development is expenditure, and of every 53 dollars in expenditure, 3 dollars is currency and 50 dollars is loan. The credit cycle is the debt cycle, If you understand the debt cycle, you understand the economic cycle. If you understand the economic cycle, you can stay ahead of the stock market curve.
Since 50 out of every 53 dollars in the economy is a loan, credit policy determines the flow, width, and destination of money. The person who lends money is the lender, and the person who borrows money is the debtor. Debt defaults and debt crises occur when the debtor's income cannot repay the loan interest. Every debt crisis has been bailed out by the government, and the end result is that new money needs to be borrowed to pay off old debts. This is the peak of long-term debt. Henry Ford said long ago: If business problems are solved by borrowing money, it is equivalent to adding a new problem. But after so many years, most people don't understand what Ford is saying. They borrow money as long as they can, no matter what their problems are, just to delay it for a while. Dalio is a hedge fund boss who has clearly seen how the economic machine operates, and has taken full advantage of the characteristics of the debt cycle and the government's recklessness to increase his wealth. Shouldn't we learn from him?
03 Profiting from the inevitable recession
What’s the point of talking about so many signs of economic recession? Dalio has never said how he uses these judgments. People know that an economic recession is coming sooner or later, so they have to do something, right? Yes, the subtitle of the book "Antifragility" is "Profiting from Uncertainty", which is the answer everyone is looking for - profiting from crises and recessions.
Dalio’s views on investment can be summarized as follows. Although it is brain-burning, readers should understand it word by word:
“ For the capitalist system to work, appropriate interest rate differentials are a necessity. Essentially, one person's return is another person's cost of financing. This economic machine is run by major central banks. People who can afford to borrow money get cash , and receive a higher return than they need to pay back in interest. These spreads cannot be too large, but they cannot be too small either. The reason is that an interest rate spread that is too wide will encourage over-borrowing, while a spread that is too small will lead to under-borrowing. Since short-term interest rates are usually lower than the return on long-term assets, people will borrow money at short-term interest rates to buy long-term assets and profit from the interest rate difference. These long-term assets include businesses, the assets that make those businesses run well (capital investments such as factories or equipment), and stocks, among others.
Under this "borrow now, buy later" operation, assets tend to move higher, bringing returns to borrowers. This drives asset price increases and most economic activity, followed by leveraged long positions. In contrast, if cash has a higher expected return than bonds and/Or the expected return on stocks, investors holding cash would be rewarded and the economic tightening would come as bank lending slows.
Although stocks and bonds, bonds and Cash There is usually a positive spread between expected returns, but this is not always the case. If short-term interest rates were always lower than the returns on other asset classes, everyone would be borrowing like crazy Cash , and then hold assets with higher returns as much as possible. ”
The above paragraph is excerpted from Dalio’s long article, To Help Put Recent Economic & MarketMoves in Perspective. You can search and read it.
Let me briefly translate what Dalio means: As long as capitalism continues to dominate the global economy, the return on stocks should be higher than on bonds. This is also the view of Siegel, the author of "The Long-term Magic of the Stock Market"; bonds are a kind of debt, with fixed returns and a higher priority for repayment than stocks, so the returns should be lower than stocks, and should maintain a reasonable spread with stock returns. Under normal capitalist conditions, the return on cash should be lower than on bonds, otherwise who would lend their money out? After all, there is a risk of not getting it back if you lend it out. But, Bart, what if the return on cash is high? Isn’t it difficult to handle things? The logic doesn’t make sense. Isn’t everyone going to stop investing in bonds and stocks? But how can cash yield higher returns? This question is the core theme of this article: if you replace the "cash" mentioned in Darrie Owen with "mortgage", this problem will be solved. Let me replace it and see if I can understand it this time: Although stocks and bonds, bonds and mortgage There is usually a positive spread between expected returns, but this is not always the case. If short-term interest rates were always lower than the returns on other asset classes, everyone would be borrowing like crazy mortgage , and then hold assets with higher returns as much as possible. Cash can be borrowed, right? As long as the interest rate is low enough and the return on investment is high, why not borrow? Borrowed money must be repaid. As long as you don't repay it yourself and find someone else to repay it, it is a successful investment.
Summary: This article is a conclusion-explanatory article based on basic economic concepts and logical deduction. The conclusion is as follows: There are only three ways to invest - equity investment, debt investment, and borrowing money to invest. People who are good at investing need to make good use of a combination of the three methods. The third way, "borrowing money to invest", has not been written into any financial management books, let alone textbooks, but it was discovered by hedge fund expert Dalio. If interest rates are low enough, cash / Investing with borrowed money is better than investing in bonds or stocks.On the one hand, the government intervenes in interest rates, artificially lowering interest rates again and again, providing wrong market signals, allowing countries, companies and households around the world to continue to accumulate debt and accumulate risks; on the other hand, people do not know that there is a third way of investment - borrowing to invest. Then when the long-term debt cycle reaches its peak and large-scale debt defaults occur, ordinary people will find that they have lost their jobs and their assets have shrunk, but their debts still have to be repaid. I personally have only one piece of advice on how ordinary families can survive the economic downturn and even make a profit - Pay off your mortgage and borrow money to buy an investment property.
