Reallocate Investment Assets Consistent with Key Financial Growth & Risk Factors – “Basic Principle #3“

Comment on “Investing” versus “Trading”

Trading and investing both involve seeking profit in the stock market, but they pursue that goal in different ways. Imagine, today, you and your friend bought equal amount of seeds to sow in your fields but you sold them to someone in a day because you could earn profit. And your friend sowed the seeds and let them grow for a few years till they gave new seeds. He sowed the new seeds and continued this for years and sold a lot more seeds eventually than were bought. By investing his seeds he would have made profit quite different than what you made by trading your seeds. This is simply the difference in investing and trading. To learn the same in financial markets, let’s learn key differences between investing and trading.

Traders jump in and out of stocks within weeks, days, even minutes, with the aim of short-term profits. They often focus on a stock’s technical factors rather than a company’s long-term prospects. What matters to traders is which direction the stock will move next and how the trader can profit from that move.

  • Investors have a longer-term outlook. They think in terms of years and often hold stocks through the market’s ups and downs.
  • Traders often take advantage of small mispricing in the market.

Investors study a company’s potential for long-term growth or value, but traders often take advantage of small mispricing in the market, such as when political uncertainty in a foreign country temporarily pushes down the share price of a U.S. manufacturer.

So-called scalp traders might be in a position for just minutes. Day traders are focused on the trading day, while swing traders invest for days or weeks.  Once the temporary mispricing is corrected, a trader will move on to find the next temporary mispricing.

So there are typically 5 key differences between investing and trading.  They are:

  • Period:  Trading is a method of holding stocks for a short period of time. It could be for a week or more often a day! Trader holds stocks till the short term high performance, whereas, investing is an approach that works on buy and hold principle. Investors invest their money for some years, decades or for even longer period. Short term market fluctuations are insignificant in the long running investing approach.
  • Capital Growth:  Traders look at the price movement of stocks in the market. If the price goes higher, traders may sell the stocks. Simply, trading is skill of timing the market where as investing is an art of creating wealth by compounding interest and dividend over the years by holding quality stocks in the market.
  • Risk:  Undoubtedly, both trading and investing imply risk on your capital. However, trading comparatively involves higher risk and higher potential returns as the price might go high or low in a short while. Since investing is an art, it takes a while to develop. It involves comparatively lower risk and lower returns in a short run but might deliver higher returns by compounding interests and dividends if held for a longer period of time. Daily market cycles do not affect much on quality stock investments for a longer time.
  • Art Vs. Skill:  Let’s learn it this way, trading is a one day cricket match while investing is a test cricket. You would watch skillful players in the team who are expected to strike fours and sixes to score higher in a one day match. Whereas, the art of the game is seen in the test match! Similarly, traders are skilled, technical individuals who time the market and learn market trends to hit higher profits in the stipulated time. It is related to the psychology of the market. Investors on the other hand, analyze the stocks they want to invest in. Investing also includes learning business fundamentals and commitment to stay invested for a longer term. It is related to the philosophy that runs the business.
  • Insight into market timing/momentum vs. insight into company/market fundamentals:  Traders put money in a stock for a short term. They buy and sell fast to hit the higher profits in the market. Missing the right time may lead to loss. They look at the present performance of the companies to hit the higher price and book profits in short term. Investors keep themselves away from the trends and invest in value. They invest for a longer period of time keeping an eye of the stocks they hold. They patiently wait till the stock reaches its potential.

So should you trade or invest?  My thought is that trading is a full-time job… or at least a significant part-time job. If that is the job you want, trading is for you. On the other hand, since I’ve been fortunate to have a career working at jobs doing things that I enjoy, when it comes to financial planning I found that I enjoy being an investor, not a trader, just because of the time involved. I also found that the times when I have tried to invest based on market timing, i.e. trading, I found those trading techniques I’ve used are only advantaged for short periods of time. This is because when a trading technique becomes popular it no longer works, as everybody’s using the same system. In the 1960s when I was in college I was fortunate to have access to one of the first large-scale main-frame computers. I wrote and bootlegged on that computer some financial charting based programs that allowed me to invest in the market based on weekly momentum in stock prices. This trading partially paid my way through college. By the time I graduated however the large brokerage firms had also invested in the big computers of the time, and the market timing method that I had worked on was no longer generating a trading profit. In the 1980s I was able to work with a gentleman who developed the market timing tool, based on the data that was then available on money flowing in and out of bonds and stocks. Again that method worked very well for 3 years before others found it.  Then that particular timing method had no edge and its returns were reduced to zero. In the late-1990s I worked with a colleague who was using the then evolving social media platforms on the internet as a way to gain an edge on which stocks were going to move up and down in the next minute or so of trading. The method got about a 3 second advantage over the market and it was able to do well for about 6 months, until others developed similar systems and had computers sitting next to the major stock exchanges that could allow them to trade in millisecond time frames. Our method was again wiped out. As you can see I keep an eye out for trading techniques, but my experience has been that I personally, with the same or less time and amount of energy that I want to put into investing, do much better in doing research underpinning an attractive asset and then buying those that I think old long-term potential and for which I do not need to be checking on weekly, daily or by the second. That said I try and use some of the techniques of traders when it comes to knowing when is the right time to acquire and sell my major investment positions.

Impact: For small, personal investors with a job, investing over a period of time is more suitable than trading, because trading involves a near constant monitoring of the stocks in which one is trading.

Sources and References:


Key Factors that Affect a Financial Asset’s Risk Adjusted Growth

Factors That Affect a Financial Assets Risk Adjusted Growth

The Factors that affect a financial assets risk adjusted growth are varied.  The ones most commonly used to guide investing behavior are shown in the Table.

“Investing” Guidelines to Maximize the Financial Portfolio’s Risk Adjusted Growth

To maximize a Financial Portfolio’s Risk Adjusted Growth it is strongly recommended to diversify the holdings of a portfolio both by the assets classes (i.e. stocks, bonds, real estate) and also (2) the specific assets held in each class (i.e. which specific company stocks or ETFs being held).  The bucket #2 and #3 methodology does a good overall job of diversifying a portfolio, but it has to be tweaked by the following Guidelines to achieve the best performance.  For specific asset holdings, the later chapters on stocks, bond, etc. provides guidance on how to select them.

Investing Guideline #1: Asset Allocation and Reallocation/Rebalancing Consistent with a Country’s Wealth & Power Position

Relative Wealth and Power of Nations

At the world scale and over periods of centuries one wants to invest in places and at times when growth has a fundamental underpinning.  Ray Dalio looks at the wealth and power of nations vis-à-vis one another.  In the Figure it can be seen that currently the USA is waning and China is increasing.  Others are a mix.  Note too that this is a very long term trend pattern, so it is best applied to bucket #3 investments that too, should be long term.

Countries that are increasing in their wealth and power will be better places to invest than those that are not.  Another way to see this is in the value of a particular country’s currency versus a market basket of other major countries’ currencies. As the charts show, the U.S. is facing a headwind in the 2020s(second chart shows this better).

History of the Value of the US Dollar vs Other Currencies
Recent Value of the US Dollar vs Other Currencies

When the index is below both its 50-day and 200-day moving averages, it is a very bearish indicator. And if the 50-day (blue line) moves below the 200-day (red line), the currency will head much lower. Either way, in this case, chronic dollar weakness is bad news for companies that derive a large share of revenue from outside the US. A weak dollar means that foreign-currency-denominated revenue will convert into fewer dollars and act as a drag on earnings. Keep your eye on, and potentially avoid investing in US-based multinational corporations, as they are particularly vulnerable.


Investing Guideline #2: Asset Allocation and Reallocation/Rebalancing Consistent with the Long Term Debt and Four Turnings Cycles

The Long Term Debt and Four Turning Cycles occur usually once in a lifetime.  As such they are not typically events requiring ongoing financial planning efforts.  However, when they do turn, (at the fourth turning or when the Long Term debt cycle peaks) the allocation between various asset classes becomes quite skewed and needs attention.  This is because during such periods the Government becomes unusually active and unstable.  These are periods of over-extended government financing, economic support to the populace, devaluations of currencies, debt forgiveness, etc.  Assets classes such a precious metals play more of a role in these periods than in others. The typical 60% stocks/40% bonds asset allocation portfolio of the recovery and rising stages of the Long Term Debt Cycle, switches to a 20%/20%/20%/20%/20% portfolio upon entry into the Long Term Debt Cycle decline/fall.

Investing Guideline #3: Asset Allocation and Reallocation/Rebalancing Consistent with a Country’s Inflation and Economic Activity Indicators

The next level of detail to think about when investing is at the country scale.  Financial asset allocation and reallocation rebalancing should be done as the macroscopic economic conditions change.  The best model I use is the Gavekal framework for linking the macro environment to the investment landscape, namely the Four Quadrants.

Four Quadrants Model

The key finding here is that within any country it’s important to look at both the economic activity and the price inflation rate when determining which asset class to invest in. It’s also important to note that economies move through these 4 quadrants in cycle times from a few to a half-dozen years. This makes the timeframe for re-balancing investment portfolios on an annual basis a good idea. From approximately 1990 to 2020, the world has basically alternated between disinflationary booms and busts, which make inherent sense as the dominant force of capitalism is deflation. This is because every entrepreneur, everywhere around the world, is always trying to produce more with less (being more productive). And in a disinflationary world, asset allocation is a breeze: one needs to own government bonds (to hedge the risk of a deflationary bust) and equities (to participate in any deflationary boom). And best yet: in a disinflationary world, not only do bonds and equities both have the wind at their back, but the two main asset classes have in bad times been negatively correlated. So, happiness all around if you have a portfolio diversified in these two asset classes.

To put this model into practice, it if fortunate that knowing both the economic activity and price inflation rate is fairly easy to do real time. Good sources to find the data needed to plug into the above matrix are:

For economic activity:

US Economic Activity

For National Economic Accounts:

US National Economic Account

For inflation Rate:

US Inflation Rate History

Extract Example of Available Monthly US Inflation Rates
US Inflation Rate by Decade

To get the annual rate have to divide the above 10 years Cumulative values by 10.  Thus, above we see the Average annual inflation rate is 3.22%. That doesn’t sound too bad until you realize that at that rate prices will double every 20 years.

Reference is:,since%20they%20began%20keeping%20records.

The trick of course is that in order to make good investment decisions its best to be a little ahead of the market which means having the ability to forecast where economic activity and prices will be a little bit in the future. How to do this is covered in the sections below.

Rebalancing Bucket #2 Consistent with Financial Growth & Risk Factors

Because the time horizon of bucket #2 is relatively short, rebalancing is not as important as it is for bucket #3. However there are times when the economy really shifts and as that happens rebalancing is important. In this sense rebalancing is probably only done annually, or when the stock market or interest rate changes on the order of 40 or 50%. Upon such dramatic changes in the economic environment the bucket #2 investments, that can be moved around without penalty, should be evaluated for better opportunities in the new environment.

In three different interest rate environments the distribution of assets in bucket #2 might be:

Asset TypeHistoric High Interest / Inflation Rate & Low Economic Activity EnvironmentHistoric Low Interest / Inflation Rate & Historic Low Economic Activity EnvironmentHistoric High Interest / Inflation Rate & Growing Economic Activity EnvironmentHistoric Low Interest / Inflation Rate & Growing Economic Activity EnvironmentHistoric Low Interest / Inflation Rate & High Economic Activity EnvironmentHistoric High Interest / Inflation Rate & High Economic Activity EnvironmentHistoric High Interest / Inflation Rate & Declining Economic Activity EnvironmentHistoric Low Interest / Inflation Rate & Declining Economic Activity Environment
Treasury Bonds & Funds75%0%50%0%0%75%70%0%
Money Market Funds15%0%  0%0%  
CD’s     10%20% 
Variable Annuities0%60%  60%0%  
Fixed Annuities0%20% pre-retirement  20% pre-retirement0%  
Tax Deferred Fixed Annuities0%20% post-retirement  20% post-retirement0%  
Corporate Bonds & Bond Funds40%0%, Hold to maturity existing bonds 60%0%, Hold to maturity existing bonds15%, Hold to maturity existing bonds0%, Hold to maturity existing bonds 
Episodic #3 Stock Index Funds0%30% if market down too0%30% if market in early stages of recovery10%0%0%0%
Episodic #3 Gold, Real Estate Funds 20%     20%
Rebalancing Bucket #3 Consistent with Financial Growth & Risk Factors

Rebalancing among stocks, bonds, real estate, and cash keeps future portfolio’s risk level under control. In addition, rebalancing within a stock portfolio (for example: adjusting to a level of 50% blue-chip, 25% small, and 25% international stocks) also could reduce risk of an over weighted sector suffering a setback.

Asset TypeHistoric High Interest / Inflation Rate & Low Economic Activity EnvironmentHistoric Low Interest / Inflation Rate & Historic Low Economic Activity EnvironmentHistoric High Interest / Inflation Rate & Growing Economic Activity EnvironmentHistoric Low Interest / Inflation Rate & Growing Economic Activity EnvironmentHistoric Low Interest / Inflation Rate & High Economic Activity EnvironmentHistoric High Interest / Inflation Rate & High Economic Activity EnvironmentHistoric High Interest / Inflation Rate & Declining Economic Activity Environment
Stock ETFs25%25%90%90%75%75%5%
Managed Mutual Funds0%0%5%5%15%15% 
Individual Stocks60%60%25%25%0%0%15%
REITs40% pre-retirement40% pre-retirement10%10%30%30%20%
Rebalancing between Bucket #2 and #3 Investments

Now, the problem is that financial planners have done a lot of actuarial science around the average return you should expect on your investments so you can best prepare for retirement.  What they find is “8% return on your investments” is a common number used to plan for retirement. However, depending upon in which decade investments are made, there is a good chance that you might not hit that 8% number for a bunch of reasons, not the least of which is politics. It may turn out that actual returns are lower, and people may find they should have saved a lot more. That is almost always the case—people’s realized returns are lower than theoretical returns because they can’t help but engage in market timing.

To fix this, instead of a 60/40 stock/bond or bucket #3/bucket #2 portfolio, try a 65/35 stock/bond or bucket#3 / bucket #2 portfolio during your working lifetime. But the 65/35 portfolio doesn’t protect you against situations where stocks and bonds both decline. In that case, try the 20/20/20/20/20 portfolio: 20% stocks, 20% bonds, 20% commodities, 20% real estate, 20% cash.  This is best for very frenzied bull stock market runs close to the top of their cycle.

Thus, rebalancing means taking some money out of other assets and putting it into stocks if stocks are beaten down to bargain prices. For example, if bonds have been on a tear in the recent past while stocks are mostly in the doldrums. Reallocating some money to stocks from bonds or vice versa is a profitable strategy over the longer term. This can be fairly simple and painless in a tax-deferred retirement account, such as a 401(k). But be very careful as you approach retirement that you don’t underfund your bucket #2.  Only rebalance with the excess investment monies you have over what your bucket #2 requirements are.


If your stocks are in a taxable account and/or if you pay commissions when you buy and sell, rebalancing can be costly and involve paying attention to tax accounting. One way to avoid these problems is to direct new investment dollars to those investments that become under weighted. If stocks and bonds are outstripping your cash, for example, divert the money that you normally add to stocks and bonds into cash equivalents. Or you could take the dividends, interest, and mutual fund distributions that are produced by your stocks and bonds and add them to your cash allocation. The purpose of rebalancing is to get your model back to its original proportions. This may seem to like selling some in your winners and buying your losers, and that’s what it is! But, that may be a very good thing to do. If you don’t balance, eventually you’ll own almost all stocks and will have abandoned the concept of diversification. The “Rebalancing” figure shows this concept.

How often should you reallocate or rebalance? Some people do it on a timeframe of every quarter or every year or two. Others do it when, for example, one asset class varies by some percentage from its initial weighting. I tend to do it on a “whichever comes first basis”. I do it annually or whenever an asset class exceeds 10% of its allotted weighting.

“Trading” Guidelines to maximize the Financial Portfolio’s Risk Adjusted Growth

To maximize a Financial Portfolio’s Risk Adjusted Growth it is strongly recommended that an investor also think a little like a trader.  That is, to think about how the financial environment might be about to change and therefore get a little ahead of the trend by reallocating the financial portfolio proactively ahead of major market changes (i.e. governmental, geopolitical, social, technical, business, financial events) that will mark the onset of a significant shift in inflation or economic activity. 

Governmental Shifts affecting a Financial Portfolio’s Risk Adjusted Growth

US Interest Rates and Money Supply

This brings up the question “does a government cause inflation and economic activity or does it merely react to it?” The answer is a little of both. It is because the government lags in its decision-making processes, as well as its taking action once a decision is made, the government policy as it’s being enacted can get out of phase with what’s needed and therefore instead a dampening the economy to a stable growth level in fact what happens is a government accentuates the natural variation in the economy and in so doing makes the cycles magnitudes much larger. Thus for investing it’s important to know both where the economy is from an inflation and economic activity standpoint as well as being able to project what a government’s next move will be with interest rates and monetary base (the amount of printed money in the economy). This is because the government is such a large part of the economy, and can control its interest rate and monetary supply, that its actions outweigh almost everything else.

In 2020, after a few years of the monetary base falling as a percentage of GDP, markets were hit by a perfect storm that decimated Dalio’s thesis. Not only had the denominator (GDP) fallen dramatically, the numerator (money supply) exploded higher by trillions.  The result was that central banks had to halt their stimulative monetary policies because they would have diminishing utility if continued.  The only option left was for the Federal Reserve to cap yields, as in Japan, and thus there was a continuation of a “reflation” paradigm.

How the FED “controls” inflation

Since which asset class to invest in is very dependent on the inflation rate it’s important to understand how the Fed tries to control this rate. Even more important to understand is when the Fed mandates that the rate he changed to a certain level what are some of the unintended consequences of those changes and how might observing those unintended consequences provide insight is to how the Fed might change the interest rate in the future. Knowing such information allows one to rebalance the portfolio at the appropriate time.

How the FED “controls” economic activity by controlling the availability of Debt Financing for Companies’ growth

The key question is “what is that government’s policy with respect to making money available for that country’s companies to borrow, invest, and grow?” Whether or not the businesses and the economy grows, is dependent upon companies and individuals being able to obtain debt financing. When people are able to obtain financing to purchase goods and services that they need to build their business and can do so at rates less than the rate of return that they’re going to get for their hard work, that business in countries can grow and prosper. When borrowing rates are low companies can invest in much more risky endeavors and when the cost of money is high the only thing available to invest in his incremental low hanging fruit. Thus a key adage in investing is “don’t fight the Fed”. What this means is that if the Fed is lowering interest rates economy is likely to grow and when they raise rates high, the economy will contract.

Thus a key point in investing is to understand how the Fed works, and what they are doing. These Key Points follow.

The unintended consequence of the FED lowering the interest rate to spur economic growth is that amount of money in the system for borrowing also affects whether or not such a change in interest rates will really spur growth or not

If the Fed decides to lower the interest rate this spur economic activity, and that does not happen, the next likely step for the Fed is to lower the interest rates even more. Depending upon the amount of money circulating in a country’s economy one can predict whether or not the Fed’s actions will be effective or not, and thus you’re also able to predict what the next change in interest rates might be.

The amount of financing available depends upon how much money the FED and private entities make available.  This amount is thus driven by the total amount of money the FED has printed, how much in circulation, and how fast it moves from one transaction to another (or how many hands it passes through from the original loan to back in the bank).

Monetary stimulus works only when banks and their customers can reach agreement that a new loan will be profitable for both.

The increase in the monetary base and total reserves in the four weeks ended March 25 exceeded any four-week period in history and even larger increases can be expected over the next several months.

US Monetary Base and Reserves

Two critical equations define the U.S. monetary structure. First, M2 = MB x m where MB stands for the monetary base and m stands for the money multiplier (known as little m). Second, GDP equals M2 multiplied by the velocity of money, or GDP = M2 x V and V is GDP divided by M2. It is important to note that both m and V are complex variables and their operation in determining economic activity is opaque. Our understanding is that the essence of m is that the banks and their customers must reach an agreement that a new loan will be profitable to both. Prior to reducing reserve requirements to zero, swings in currency and time deposits could change m, but that is no longer the case. As long as the required reserve ratio remains zero, total reserves and excess reserves are identical. Swings in Treasury deposits still have a role, albeit minimal. It appears that the key to V is whether a new loan is productive in the sense that it generates an income stream to pay principle and interest.

Borrowers must have a use for the loan proceeds and ability to repay. The Fed has no direct role in this process.

Stimulus funds are being used to stabilize finances, not to fund new growth. This means money velocity will fall.

The main effect of current programs is to reduce the average maturity of privately-held federal debt.

Growing government deficits will likely push the net national saving rate below zero for the first time since the Great Depression.

Growth of US Debt vs GDP
US Saving vs Gross National Income

With debt productivity falling and unfavorable demographics, Hoisington and Hunt expect GDP growth to decline further.

Weak energy prices will keep inflation threat low.

In 2020, the US faces a deflationary recession far more severe than the previous worst post-war downturns (1973-75, 1981-82, 2008-09).

Bottom Line: “The economy will stagger, not march forward.  Five to seven years will likely elapse before the output gap returns to the peak “boom” level.  This suggests that once the cyclical decline and inflation has occurred, the economy will be mired in a protracted period of mild deflation and that firms with the weakest pricing power will need to try to lower nominal wages, something for which modern business managers have no experience… the Treasury yield curve will be anchored close to the zero bound for a very lengthy period.”


1. Over my Shoulder, Patrick Waltson, Hoisington Quarterly Review, Q1 2020, April 27, 2020

The Employment Cycle’s effect on the FED’s interest rates and monetary policy.

Now in order to predict what type of monetary policy the Fed will undertake it is important to understand that the Fed is responsible for 2 things. These are the level of inflation and the level of employment. Thus their policy is driven by the inflation rate and the employment rate.

By way of background on the employment rate, the stable service sector employment rose from some 25% of the workforce in 1910 to 86% today. This development caused an 85% drop in economic volatility during the 20th century, but suddenly triggered an explosion in volatility.

US Unemployment Rate

Employment Rate (Unemployment Rate):

In 2020 this was caused by a pandemic that caused consumers to stay inside and thus caused service sector interactions to cease. As this occurred, the most stable sector of the economy became the most unstable. In this environment, prospects for both GDP growth and inflation will primarily depend upon the unemployment rate. This is because, as workers lose their jobs, consumer spending can nosedive – as it did. This decline in consumer spending has immediate feedback effects on manufacturing which declines as well. A collapse in consumer confidence and spending, accompanied by a decline in manufacturing, implies a very sharp drop in GDP—allowing for lags.  Note the great irony here: For decades, consumer spending (the bulk of GDP) has been remarkably stable, mirroring the stability of employment in the service sector which generates 86% of all incomes. But this time, it was the implosion of the service sector that caused the first recession in history to be generated by a collapse in consumer spending. And what a collapse: Purchases of restaurant services did not fall by a recessionary 9%, but rather by some 75% — and it did so right out of left field. This was because people were suddenly told to stay home and not go out.

To get people working and spending again the Government has Two Kinds of Fiscal Stimulus: Direct spending by government, and indirect spending.

The effect of Direct Spending Levels by the FED on Economic Activity

Direct spending occurs when government itself initiates expenditures that result in the hiring of unemployed workers to generate income which they spend. Just think of those WPA projects of the Great Depression when the government built dams, bridges, and many other kinds of infrastructure. In 2020, the government will be able to sponsor trillions of dollars of infrastructure investments which virtually all members of Congress agree should be made. It can now do so because there is a growing army of unemployed that did not exist only two months ago. However, the workers out of work are trained for service sector jobs, not manufacturing or construction jobs.

The economic impact of the employment cycle is the inertia it contains, thereby creating a large time lag into any recovery efforts the Government may wish to employ.  This is because, in order for new Government reserve spending to cause increased employment, workers must be retrained for the jobs being funded. 

On the banking side of the coin, consumer spending, consumers must first take out new loans (use credit cards) made possible by increases in reserves to banks. Next they must spend the proceeds of these loans on Main Street. But in times of crisis and wealth loss, consumers do not wish to take on more debt.


1. Three Root Questions about Today’s Crisis, Strategic Economic Decisions, April 2020, #172

The effect of the FED’s  Money Creation Policies on economic activity

Indirect Spending: The second way to fund a deficit is for the Treasury to order the Fed to electronically “create” say $3 trillion within the Treasury’s checking account. It can do so, assuming the Treasury can oblige the Fed to do so. In exchange for this “loan” from the Fed, the Treasury sends an IOU note to the Fed saying: “The US Treasury hereby promises to repay the Fed $3 trillion via a loan that is perpetual and that carries a coupon rate of 0%.” In effect, the Treasury need never pay back the Fed. As we have explained in past issues, in this case, unlike in the case of traditional debt financing, the Treasury incurs neither any interest expense nor any repayment of principal to the Fed. In effect, the funds raised are “free” in these two senses. Additionally, the official “debt” of the US does not increase at all as no new debt securities are ever issued. This is convenient since there are times when the Treasury may not wish to increase the Debt/GDP ratio because a higher ratio could lower the US credit rating and drive up US interest rates. This is less likely to happen when the deficit is funded by money creation. What about the risks posed by that new asset of the Fed, namely the $3 trillion IOU from the Treasury? Intuitively, most observers believe this debt to be “bad.” But as we argued back in 2010 when QE began, the composition of the Fed’s balance sheet assets is quite unimportant. Under this money creation scheme, the Treasury has taken on an obligation (its IOU to the Fed) that will cost it nothing. The Fed for its part can perfectly well rip this IOU into pieces in five or ten years, or else it could hold it forever. Yet whether it remains on the balance sheet or is torn up matters to no one. Why? Because in ripping up the IOU, the Fed would not be defaulting on anyone. No one would notice the difference.

Because these points are not well understood, most of us remain suspicious of the money creation option. Indeed most people believe that the combination of huge deficits and money printing cause an ever-rising inflation rate that will ultimately bring down the economic system as it did in Weimar Germany in 1922. But for reasons discussed in Part 3, these beliefs are incorrect. Hyperinflation can indeed result, but so can outright deflation. Just as the quintupling of the balance sheet of the Fed that occurred during 2009-2012 never mattered to either inflation or growth, the same will be the case this time around provided that proper steps are taken to forestall inflation. [These same steps will be required if debt-financing were used.] Analogously, the contraction of the Fed’s balance sheet from $5 trillion to $2.9 trillion that occurred during the past five years did not matter. Nor did the more recent re-expansion of its balance sheet matter. Recall how gold bugs back in 2010 were sure that the introduction of QE would cause massive inflation? They were proven dead wrong for the counter-intuitive reasons we have cited. Keeping all this in mind, what will happen to inflation and GDP growth as a result of the current mega-stimulus? We speak of inflation AND growth here because, as we have shown in recent reports, the two are co-determined when the behavior of GDP is properly analyzed in both supply and demand terms – something that is rarely attempted to the shame of the macroeconomics profession.

If a significant changes in the “stock” of assets of the Fed did not matter to inflation and growth, then what will matter? The answer is changes in “flow” variables such as annual consumer spending, government spending, and investment spending. And it is here that today’s huge fiscal stimulus will matter. For the stimulus will directly impact the behavior of these flow variables that in turn will drive the course of inflation and growth. A Useful Model: How can we think about and indeed model the adjustment processes now afoot? The best way is to go back to fundamentals and realize that annual changes in both GDP growth and inflation depend only upon changes in the location of the supply and demand curves for goods and services. These curve shifts axiomatically define changes in both GDP and inflation. To see this, consult Figure 1.A below and recall that GDP in any year is nothing more that the shaded area defined by the price X quantity equilibrium as shown. Changes in both GDP and prices (i.e., the rate of inflation) are due to shifts in either or both curves, as indicated in Figure 1.B. Note importantly that the change in price (the inflation rate) is co-determined with the change in GDP growth since both are determined by the changes in the same supply and demand curves. This is an extremely important point that is rarely if ever pointed out.

Example Demand Curves

The “Example Demand Curves” figures show what happens when today’s collapse in employment and spending occurs: there is a sharp backward shift in the demand curve for products. Formally, at any given price, demand drops, and thus the entire curve shifts backwards. Suppose for the moment that the supply curve does not shift at all. The resulting price/quantity equilibrium is such as to lower both prices and GDP. Since sudden deflation and loss of output are not desirable, government must step in with a huge stimulus package, just as it has. Will this be inflationary as is commonly supposed? That depends. Suppose that the effect of the stimulus is to shift the demand curve back out to where it was before the slump. If the supply curve does not move, then the net impact of the stimulus will be to leave both GDP growth and prices at the same level as before. If, due to supply chain problems and to a large reduction in the workforce, the supply of goods and services falls sharply – and thus the supply curve shifts backwards – the outcome will be very different. Given the slopes portrayed, if the backward shift of the original supply curve is of the same magnitude as the backward shift in demand, then prices will not change (no impact on inflation). But GDP (the size of the dark area) will be much smaller. We see here how very useful the S/D framework is.

2020’s Demand Curve: It is not too difficult to determine what the net change will be in the location of the demand curve before and after the stimulus. This is because a proxy for the magnitude of the demand shift is available. We simply assess the dollar reduction in consumer and corporate spending due to the crisis – before any stimulus. Viewed as a fraction of GDP, this is a proxy for the backward shift in demand. Now suppose this reduction is $3 trillion or about one seventh of GDP over the entire calendar year 2020. Much more than half of this reduced consumption will take place before September, whereas the remainder of the reduction will occur from September to December. The current $3 trillion stimulus (including both Trump’s original deficit and the new stimulus) will offset some of the decline in demand until September, but not all. For only about $1.8 trillion will go directly to income support. Another $3 trillion stimulus will be needed and will in our view be appropriated in September before the autumn elections. All in all, a calendar year stimulus (deficit) of $6 trillion should restore a significant portion of the fall in final demand occurring during the first half of 2020.

To restate all this, the current stimulus package is barely half of what will be needed to restore demand to its pre-crisis level. Trillions more will be needed and will be granted by government, especially during this election year. Please understand this is a very crude analysis. For example, it ignores the need for the Fed to inject massive new liquidity to prevent the bankruptcies of many companies whose record-high debt loads will be crushing by September. If leverage causes a huge number of bankruptcies later in the year, unemployment will keep rising, and the demand curve for products and services will move backwards even further. The case for greater stimulus would then be overwhelming.

2020’s Supply Curve – and Inflation: It is more difficult to assess the shifts in the supply curve. We can find no estimate of the degree to which manufacturers and service providers will be forced to reduce output. Whatever the details, this curve will certainly shift backwards, but not as much as the demand curve does. This of course implies very significant deflation, at least in the service sector. Just consider the give-away prices of airline tickets today. One reason it will not shift as far backwards as demand lies in the role of “fixed capacity” (existing if empty airline seats and hotel rooms) that will not disappear – barring bankruptcy. Additionally, government subsidies to businesses of all sorts will mitigate the supply-side disaster. If the 2020 supply curve shifts backwards by half as far as the demand curve would shift backwards without any stimulus, then clearly there would be significant deflation. Moreover GDP would contract very sharply. Just adjust our S/D graph to see what happens in this case. Using rough estimates, nominal GDP in this case could drop by up to 20%.

However, with the demand curve shifting back out later in the year due to $6 trillion in fiscal stimulus, and with the supply curve shifting back out by $3 trillion to where it was pre-crisis, then there could in principle be zero inflation by the end of the year – following a couple of quarters of negative inflation. But will the supply curve shift back out? Yes it will because the unprecedented stimulus to consumption will cause businesses to rehire workers and ramp production back up. Additionally, the new subsidies to business will come into play.


1. Three Root Questions about Today’s Crisis, Strategic Economic Decisions, April 2020, #172

The results of the FED’s actions creates economic cycles that can be used to time investment and reallocation/rebalancing activities

Dalio Growth Cycle

At an even higher plane of abstraction, Ray Dalio looks at the above FED behavior as creating cycles between the four quadrants.  He feels that overall, for example, the cycles have a long term upward slope because living standards rise because we learn more, which leads to higher productivity, but we have cycles (ups and downs) in the long term rise in the economy because we have debt cycles (short and long term) that drive actual economic activity up and down around that uptrend.    

The Short Term Debt Cycle

Dalio’s Three Cycles

In fact, there are actually three cycles that make up the shape of the overall upward moving corkscrew plot.  These are shown in the “Dalio’s Three Cycles” figure and are (1) Productivity Growth which accounts for the underlying upward trend. This is driven by human learning and ingenuity.  Those that are hard-working and inventive increase their productivity faster than those who are not. 

Next is the Short Term Debt Cycle that accounts for all the little ups and downs in the economy and is driven mostly by individuals and corporations.  Finally, there is the Long Term Debt Cycle that accounts for the major ups and downs in the economy and is driven mainly by Government’s policies like being on a Gold Standard or setting artificial “FED” interest rates.

These curves more accurately combine to produce a set of upward sloping waves versus the first corkscrew diagram as shown for one long term debt cycle in the “Combined Dalio Curves” figure.

Combined Dalio Curves

Dalio believes that the reason people typically miss the big moments of evolution coming at them in life is that we each experience only tiny pieces of what’s happening in the Combined Curves. 

The economy is driven by transactions of all the people, companies, and government.  In each individual transaction money or credit is traded for goods, services or financial assets.  The government is most important because it has two parts, one that collects taxes and spends money, and the other, the Central Bank, that controls the amount of money and credit available.  It does this by controlling interest rates and printing new money.  Credit is the most important part of the economy because it is the biggest and most volatile part. In 2020 there was about $50 trillion in credit in the US economy and only $3 trillion in money.  Credit is important for investing because investors are one source of credit to others who want to buy something that they don’t have enough money for.  All our investments are credit instruments of one sort or another. They are each created and we by these financial assets (credit instruments) so others can spend money they do not have.  So credit is important because when credit is created it allows a buyer to spend money, and this increases spending is allows another transaction to be done in the economy, creating income for yet more people.  In good times a given amount of credit can cycle through four or more transactions before someone “saves” it by putting it into a financial asset of their own, stopping that one cycle. Since credit creates more income for many people these people become more “creditworthy”, which is they have more income and more collateral (financial assets), so banks consider they have a better “ability to repay”.  They ability to repay is just the difference between our income and expenses (debt interest included) as in the first part of this book.

Why economic growth

This multiplier effect, shown in the “Why Economic Growth” figure, is where one person’s spending and productivity becomes another’s income or borrowing, causes economic growth and increasing cycles.

Individual Variations in Productivity

Going back to why cycles occur, for the Productivity Cycle Growth is driven by “Individual Variations in Productivity” (a long term phenomena) and shown in the figure, but these are typically swamped out by “Changes in the Credit Cycle” (a short term cycle) as shown in the following figure. 

Changes in the Credit Cycle
Debt’s effect on Growth

Adding this all together we get see the real effect debt has on our ability to grow (seen in the “Debt’s Effect on Growth” figure.

Phases of the Short Term Debt Cycle

When credit is available we can consume and grow more than our underlying Productivity growth, and when that cycle tightens because we’ve borrowed too much and aren’t credit worthy any longer, we grow less than the underlying Productivity growth.  JP Morgan shows in a little more detail the scenario for a short term Credit Cycle in the “Phases of the Short Term Debt Cycle” figure.

As an example, for the U.S. this happened in 2008, and was triggered by the sub-prime mortgage crisis.  Note that the problem was the underlying overabundance of debt, the sub-prime mortgage crisis was just a trigger that caused the unwinding as seen in the “U.S. Debt Burden” figure.

U.S. Debt Burden

Debt cycles are both long term and short term.  The short term debt cycles last 5-8 years and the long term debt cycles last 75-100 years. Most people can’t see these cycles because we look at them too closely.  Note: It is because we borrow that we have cycles!  And we borrow because of human nature. Borrowing is simply pulling future spending forward. If your borrowing increases your productivity more than the debt service expenses, you come out ahead.  If not you are in a slow decline.  Debt sets into motion a predictable series of events in the future.  Taking advantage of this knowledge of the future allows one to invest and rebalance investments wisely.

In concert with the debt cycle is the price cycle.  When credit grows we have more money to spend on goods, services, and financial assets.  But when credit increases faster than the growth in goods, services, and financial assets, their price rises as people bid them up because they are scarce.  This creates price inflation. Now one predictable future effect is that when the Central Bank sees price inflation it raises interest rates, which starts to eliminate the less credit worthy people, as well as increases the interest payments for everyone having debt, and thus demand for goods, services, and financial assets slows down.  If done right, this causes the inflation to lessen, and the prices to decrease (deflation).  If the decrease continues too long we have a recession, and seeing this the Central Bank lowers interest rates, starting the cycle all over again.  Thus watching the FED set the interest rates tells us what the future economy will be.  And to get a little ahead of the game, watching the “Bid Price for the 10 Year Treasury Bond”, tells you what the future FED action will be.  Thus we should know how to reallocate ahead of others who are not watching such signals.

Short Term Debt Cycle Pattern within an Increasing Long Term Debt Cycle

Thus the Short Term Debt Cycle is controlled by the Central Bank and typically lasts 5-8 years.  But when this is superimposed on an increasing Long Term Debt Cycle, the Short Term Debt Cycle will peak higher than the one just past, and the low in the Short Term Debt Cycle will not fall as far down. The “Short Term Debt Cycle Pattern within an Increasing Long Term Debt Cycle” figure shows this graphically.

US Yield Curve Inversions

One way to see the downturn coming in Short Term Debt Cycles is to look at the “US Yield Curve Inversions” figure.  The global yield curve is created by comparing the US Fed Funds rates to 30 year yields across 25 different countries. And what we see when a downturn is eminent, within 1-2 years, is an unprecedented number of countries that have 30 year yields below the US overnight rate. The trigger signal is when the number gets over 70%, it is called a global yield curve inversion.

Short Term Debt Cycle Pattern within the Entire Long Term Debt Cycle

Now looking at the “Short Term Debt Cycle Pattern within the Entire Long Term Debt Cycle” figure we see that the number of downward Short Term Cycles in the decreasing part of the Long Term Debt Cycle is relatively few.

One way to see the Long Term Debt Cycle a somewhat easier is to plot things on a log scale as done in “The S&P on a log scale vs. time” figure.

The S&P on a log scale vs. time

The Long Term Debt Cycle

The long term debt cycle has as its underpinning the Four Turnings caused by the way each generation raises their children. The theory around this is by Strauss and Howe who define a social generation as the aggregate of all people born over a span of roughly twenty years or about the length of one phase of life: childhood, young adulthood, midlife, and old age. Generations are identified (from first birth year to last) by looking for cohort groups of this length that share three criteria. First, members of a generation share what the authors call an age location in history: they encounter key historical events and social trends while occupying the same phase of life. In this view, members of a generation are shaped in lasting ways by the eras they encounter as children and young adults and they share certain common beliefs and behaviors. Aware of the experiences and traits that they share with their peers, members of a generation would also share a sense of common perceived membership in that generation.

The Four Turnings Cycle

The Four Turnings theory uses the pattern in historical generations which revolve around generational events called turnings. The turnings are: “The High”, “The Awakening”, “The Unraveling” and “The Crisis”.

High: According to Strauss and Howe, the First Turning is a High, which occurs after a Crisis. During The High, institutions are strong and individualism is weak. Society is confident about where it wants to go collectively, though those outside the majoritarian center often feel stifled by the conformity. The most recent First Turning in the US was the post–World War II American High, beginning in 1946 and ending with the assassination of John F. Kennedy on November 22, 1963.

Awakening:  According to the theory, the Second Turning is an Awakening. This is an era when institutions are attacked in the name of personal and spiritual autonomy. Just when society is reaching its high tide of public progress, people suddenly tire of social discipline and want to recapture a sense of “self-awareness”, “spirituality” and “personal authenticity”. Young activists look back at the previous High as an era of cultural and spiritual poverty. The US’s most recent Awakening was the “Consciousness Revolution,” which spanned from the campus and inner-city revolts of the mid-1960s to the tax revolts of the early 1980s.

Unraveling:  According to Strauss and Howe, the Third Turning is an Unraveling. The mood of this era they say is in many ways the opposite of a High: Institutions are weak and distrusted, while individualism is strong and flourishing. The authors say Highs come after Crises, when society wants to coalesce and build and avoid the death and destruction of the previous crisis. Unraveling comes after Awakenings, when society wants to atomize and enjoy. They say the most recent Unraveling in the US began in the 1980s and includes the Long Boom and Culture War.

Crisis:  The Fourth Turning is a Crisis. This is an era of destruction, often involving war or revolution, in which institutional life is destroyed and rebuilt in response to a perceived threat to the nation’s survival. After the crisis, civic authority revives, cultural expression redirects towards community purpose, and people begin to locate themselves as members of a larger group. The authors say the previous Fourth Turning in the US began with the Wall Street Crash of 1929 and climaxed with the end of World War II. The G.I. Generation (which they call a Hero archetype, born 1901 to 1924) came of age during this era. They say their confidence, optimism, and collective outlook epitomized the mood of that era. The authors assert the Millennial Generation (which they also describe as a Hero archetype, born 1982 to 2004) show many similar traits to those of the G.I. youth, which they describe as including: rising civic engagement, improving behavior, and collective confidence.

Four Turning Cycles

The Four Turnings Cycle then drives how people live their life and manage their finances, i.e. expectations on income vs. expenses, assets vs. liabilities. Since each turning lasts about 20–22 years, the Four turnings makes a full cycle about every 80 to 90 years, which the authors term a saeculum, after the Latin word meaning both “a long human life” and “a natural century”. These cycles, as shown in the “Four Turning Cycles” figure, correspond to the long term debt cycle Ray Dalio researched. 

Generational changes described in the Four Turning Cycle, drives the cycle of turnings and determines its periodicity. As each generation ages into the next life phase (and a new social role) society’s mood and behavior fundamentally changes, giving rise to a new turning. Therefore, a symbiotic relationship exists between historical events and generational personas. Historical events shape generations in childhood and young adulthood; then, as parents and leaders in midlife and old age, generations in turn shape history.

Thus, back to financial planning, the long term debt cycle is caused by the cumulative effects of people’s view of the world and from a practical standpoint, taking on more debt (credit) than they (or society) have income to support.  The long term debt cycle makes its large downward reset transition during each Crisis Generation.  It is a human, societal and government policy problem.  The amount of debt to income is called the debt burden. When the ratio over long periods of time gets to a point that the amount of interest on the debt is more than people, or governments, can raise in income or credit, they go into a downward Long Term Debt Cycle.  This typically causes a major adjustment as so much debt has to be paid back or forgiven (bankruptcy or currency revaluation).

Ray Dalio has looked at a similar historical pattern and finds that when one looks at the rise and fall of empires, they also go through cycles of wealth and power.  These cycles are even longer than the generational Four Turning cycles.  These cycles are driven by productivity gains due primarily to improvements in broad learning and converting that faster learning into faster increases in productivity. The large-scale cycles Dalia looks at where the European Renaissance, the scientific revolution, the Enlightenment, and the 1st Industrial Revolution Britain. The broader base learning shifted wealth and power away from (1) an uncle cultural-based economy in which the agricultural land was the primary source of wealth and power that supported monarchies, nobles, and the church, who own the land and work together to maintain the power system that allow them to have the wealth and power to (2) an industrial-based economy in which the inventive S created and own the means production and industrial goods and work together with those in government to maintain the power system that allow them to have the wealth and power. This recently wealth and power of come primarily from a combination of education, inventiveness, and capitalism, with those who run governments working with those who control most of the wealth and education. Underneath the relatively smooth upward trajectory of productivity of the turbulent times that include booms, bus, revolutions, and wars (the 4 turning cycles). However because these turbulent times are small in relation to the evolutionary uptrend, they show up in a chart is relatively minor wiggles.

In the “Rough Estimates of Relative Standing of Great Empires“ figure the single measure of wealth and power for each country is made up of relatively equal average weights of 8 measures of strength. They are (1) education, (2) competitiveness, (3) technology, (4) economic output, (5) share world trade, (6) military strength, (7) financial center strength, and (8) reserve currency. “The Archetypical Rise and Decline by Factor” figure shows the average of each of these measures the strength, with most of the weight on the most recent 3 reserve countries (the US, UK, and the Dutch).

The Archetypical Rise and Decline by Factor

Broadly speaking, one could look at these rises and declines is happening in 3 phases: (1) the ascent phase, which is characterized by the gaining of competitive advantages, (2) the top phase, which scare guys for sustaining the strength but eventually sowing the seeds for losing competitive advantages they were behind you sent, and 3 (3) the decline phase, which is characterized by the self reinforcing declines in all these strengths.

In a nutshell the ascent phase comes about when there is strong enough and capable enough leadership provide the essential ingredients for success which includes… Strong education. By strong education don’t mean just teachings knowledge and skills, I also mean teaching… Strong character, civility, and a strong worth fact that, which are typically taught in the family as well as in school. These lead to an improved civility that is reflected in other factors such as… Local corruption and high respect rules, such as rule of law. This is where the concept of the 4th turnings cycle interweaves into Ray Dalia cycles. In the ascent phase people being able to work well together, united be timed a common view of how they should be together in a common purpose, is also important. Can people have knowledge, skills, good character in the civility to behave and work well together, and there is… A good system for allocating resources, which is significantly improved by… Being open to the best global thinking, the country has a most important ingredients in order to succeed. That leads to them gaining… Greater competitiveness in the global market, which brings in revenues that are greater than expenses, which leads them to have… Strong income growth, which allows them to make… Increased investments to improve their infrastructures, educational systems in research and development, which leads him to have… Higher productivity (more valuable output per hour work). Increasing productivity is what increases wealth and productive capabilities. When they achieve higher productivity levels thinking become productive inventors of… You technologies. These new technologies are valuable for both commerce in the military. As these countries become more competitive in these ways, actually they gain… A significant share of world trade, which requires them to have… A strong military to protect her trade routes and to influence those who are important to it outside its borders. In becoming economically preeminent they developed the world’s leading… Financial centers for attracting and distributing capital. (For example, Amsterdam was the world’s financial center when the Dutch empire was preeminent, London was it when the British Empire was on top, and New York is now it because the USS is on top. The China is beginning to develop its own financial center in Shanghai.) Expanding their tray globally these growing empires bring there… Strong equity, currency, and credit markets. Naturally lose dominant in trading capital flows other currency used much more that as a preferred global medium of exchange and the preferred store of hold of wealth, which leads their currency becoming a reserve currency. This is how the Dutch guilder became the world’s reserve currency when the Dutch empire was preeminent, the British pound became the world’s reserve currency when the British Empire was preeminent, and the US dollar became the world’s reserve currency in 1944 when the US was about to win World War II to it was clearly preeminent economically, financially, and militarily. Having once currency be a reserve currency naturally gives a country greater borrowing in purchasing power. A shown in the previous chart gaining and losing reserve currency status have is with a significant lead to the other fundamentals.

The top phase typically occurs because within the successes behind the ascent lie the seeds of decline. More specifically as a rule: prosperous periods lead to people earning more, which naturally leads them to become more expensive, which naturally leads them to be less competitive relative to those in countries were people are willing to work for less. Also, those were most successful typically have their ways of being more successful copied by emerging competitors, which also contributes a leading car becoming less competitive. For example, British shipbuilders, who had less expensive workers in Dutch shipbuilders, higher debt shipbuilding architects to design ships or more cost-effectively build the Dutch ships. Because it takes less money and time to copy that invent, all else being equal, emerging empires tend to gain more on mature empires through copying. Those who become richer naturally tend to work less hard, engage in more leisurely and less productive activities, and if the extreme, become decadent and unproductive. That is especially true as generation change from those who had to be strong and work hard to achieve success to those of inherited wealth, he’s younger generations tend to be less strong and battle hardened, which states the more vulnerable challenges. Over time people and prosperous society tend to want any more luxuries and more leisure intend to get weaker and more overextended in order to get them, which makes him more vulnerable. The currencies that are richest and most powerful become the world’s reserve currencies, which gives him the exorbitant privilege of being able to borrow more money, which gets them deeper into debt. This boots the leading Empire spending power over the short term and we can sit over the longer run. In other words when the borrowing and spending are strong leading Empire appears strong while its finances are in fact being we can. That borrowing typically sustains his power beyond its fundamentals by financing both domestic overconsumption in the military and wars that are required to maintain its empire. This over borrowing can go on for quite a while and even be self reinforcing, because it strengthens reserve currency which raises returns the foreign lenders who lend in it. When the richest get into debt by borrowing from the pores, it is a very early sign of relative wealth shift. For example in the 1980s when the US had per a per capita income that was 40 times that of China’s, it started borrowing from the Chinese wanted to save in US dollars because the dollar was the world’s reserve currency. This was an early sign that the dynamic was beginning. Similarly the British Bartolotta money from its much poorer colonies, particularly during World War II, and the Dutch did the same before their top, which contribute to the reversals in their currencies and economies when the willingness to hold their currency in depth suddenly fell. US certainly has done a lot of borrowing a monetization of its that, although this hasn’t yet caused to reduce demand for the US currency in debt. The leading country extends the empire to the point that the Empire has begun on economical to support and defend. As a cost of maintaining it become greater than the revenue it brings in, then profitability of the Empire further weakens the leading country financially. That is certainly the case for the US. Economics a success naturally leads to larger wealth gaps because those who produce a lot of wealth disproportionately benefit. Those with wealth and power (those who are commercially benefiting and those who run the government) naturally work and mutually supportive ways to maintain the existing system that benefits them while other segments of the population leg, until the split become so large that is perceived as an tar lovably unfair. This is an issue for the US.

The decline phase typically happens as the excesses of the top phase are reversed in a mutually reinforcing set of declines and because a competitive power gains relative strength in the previously described areas. When gaps become very large, when central blanks loser abilities to stimulate And economic growth, and when there is an economic downturn that leads to deck and economic problems and more printing of money, that it eventually devalues money. When wealth and value gaps get large and there’s a lot of economic strengths (wherever that stress comes from), their high probabilities of greater conflict between the rich and the poor, at 1st gradually and then increasing the intense. That combination of circumstances typically leads to increase political extremism, population of both the left (those who seek to redistribute wealth such as socialists and communists) and the right (those who seek to maintain the wealth in the hands of the rich such as the capitalists). That happens in both democratically and autocratic labor run countries. For example in the 1930s increasing leave extreme populace of the left became communists and those from the right became fascist. Populace tend to be more autocratic, more inclined to fight, the more inclined to respect power the law. In the rich further their money will be taken away and or that they will be treated with hostility, that leads them to move their money in themselves to places, assets, and/or currencies they feel are safer. If allowed to continue, these movements reduce the tax and spending revenue in the locations experiencing these conflicts, which leads to a classic self reinforcing hollowing out process in the places that the money is leaving. That’s because less tax money worsens conditions, which raises tensions and taxes, which causes more immigration of the rich and even worse conditions etc. For example we are now seeing some of that happening via the rich leaving higher tax states where there is financial stress large wealth gaps. When he gets bad enough, governments the longer allowed to happen, they outlaw the flows of money out of the places that are losing it and into the places, assets, and currencies that are getting it, which causes further panic by those seeking to protect themselves. When these sorts of disruptive conditions exist, they undermine productivity; Patrick’s economic pie and causes more conflict about how to divide the shrinking resources well, which leads even more internal conflict that increasingly needs to fighting between the populace leaders from both sides who want to take control to bring about order. That is when democracy is most challenged by autocracy. This is why in the 1920s and 1930s Germany, Japan, Italy and Spain (and a number smaller countries) altered away from democracy to autocratic leadership, and the major democracies (the US, UK and France) became more autocratic. It is widely believed that, during periods of chaos, or centralized in autocratic decision-making is preferable to less centralized and more democratic, debate-based decision-making, so this move it is not without merit where there is unruly, violent crowd fighting. My country gains economic political and military power that is large enough to challenge the existing dominant power, there are many areas of potential conflict between Israel world powers. Since there’s no system for peacefully adjudicating such disputes, these conflicts typically are resolved through tests of power. When a leading countries Casa maintaining its empire brought become greater than the revenue that the Empire brings in, that economically weakens country. When that happens at same time as other countries are merging his rival powers, the leading power feels compelled to defend its interests periods this is since especially threatening to the leading country both economically and militarily because greater military spending is required to maintain the empire, which comes when worsening domestic economic conditions are making it more difficult for the government leaders to tax and making it more necessary for them to spend on domestic supports. Seeing this dilemma, enemy countries are more inclined to challenge the leading power when that leading power is showing signs of weakness. Then the leading power space with difficult economic and military choice of fighting a retreating. When other exotic as shocks, such as acts of nature (plagues, droughts, floods) occur during the times of vulnerability such as those mentioned above, the increased the risks of a self reinforcing dollar word spiral. When the leadership of the country is too weak to provide what the country needs to be successful it stage in the cycle, that is also a problem. Of course, because each leaders responsible for leading during only a tiny portion of the cycle, they have to deal with, and can’t change, the condition of the country that they inherit. This means that destiny, more than the leader, is in control.

To summarize, around the upper trend of productivity gains producing wealth in living standards, there are cycles to produce (1). Some building which a country is fundamentally strong because there are (A) relatively low levels of indebtedness, (B) relatively small wealth, values, and political gaps, (C) people working effectively together to produce prosperity within the countries, (D) good education and infrastructure, I strong and capable leadership, and (F) a peaceful world order that is guided by one or more dominant world powers. These are the prosperous and enjoyable periods. When their taken excess, which they always are, that excess leads to (2) periods of destroying and restructuring in which the countries find the mental weakness of (A) high levels of indebtedness, (B) large wealth, values, and political gaps, (C) different factions of people unable to work well together, (D) poor education of poor infrastructure, and I the struggle to maintain an overextended empire under the challenge of an emerging powerful rivals lead to a painful period of fighting, destroying, and restructuring that establishes a new order that sets the stage for a new building.

The 17 Main Forces That Drive Rises and Declines of Countries

In the “The 17 Main Forces That Drive Rises and Declines of Countries” figure the 17 main forces that drive the above cycle are listed. For any country, the more items it has on the left, the more likely it will ascend, and the more items it has on the right, the more likely it is to decline. Does it make it to the top acquire more the characteristics on the left but with time they moved to the right, which makes them more prone to decline, while new competitive countries acquires the ones on the left until they are stronger, it which time the shift occurs as looking at the long-term debt and business cycles. The timeframe of these rise and fall’s seems to be on the order of 120 years, or 1 to 2 per turning cycle.

US Interest Rates

During this long term debt cycle decline, people deleverage, that is they allocate more of their income to pay off debts (causing an economic recession or depression as their spending (income to others’) decreases), and shed assets (causing their price to fall) to raise money to pay their debts.  At this time, the overabundance of fear and assets drives all asset prices down.  But, this is different from a recession because interest rates can’t be lowered by the Central Bank.  The Central Bank already has the interest rates at zero and can’t go any lower. The “US Interest Rates” figure shows this for the U.S. in the 1930’s and in 2008.

So since the Central Bank can’t fix a Deleveraging (Depression) it has to use other tools.  There are four ways it can do this as shown in the “Tools for Deleveraging” figure.

Tools for Deleveraging

The first way, Cut Spending is when people and governments cut spending.  People, Companies, and Governments have a hard time doing this because of their ratio of fixed versus variable expenses. People have to eat and have a place to live, i.e. a fixed expense. They can cut down on entertainment, a variable expense.  For governments, social security is a fixed expense, and freeway infrastructure a variable expense.  The problem is that in a deflationary environment most fixed expenses stay the same and there aren’t enough variable expenses to make ends meet. 

Thus onto the second way to reduce debts. Through Defaults and Restructurings.  Bankruptcy happens for people, corporations and governments.  Restructuring is mostly a corporate activity, but the value of the corporation falls dramatically during that semi-bankruptcy process. 

The third method is to Redistribute Wealth.  The governments can do this by taxes.  They can tax wealthy people and corporations, and provide assistance to poorer people and “vital industries”.

The last method, of last resort, is the Central Bank Prints New Money.  This devalues the currency versus other currencies, so over time this action results in an increase in prices (since much of the goods and services today comes from places outside the U.S.; food; clothing; construction materials; semi-conductors; IT; communications; entertainment).

These four ways have occurred in all historical deleveraging.  Cutting Spending really doesn’t work at the societal level because one person’s spending is another’s income.  Bankruptcy and Defaults cause Banks and other credit institutions to fail or restructure (paying only a fraction of what was owed or over a longer period of time), and when this happens at a large scale a Depression sets in. Income and credit is disappearing faster than the underlying productivity growth rate.  What people thought was their wealth (assets) isn’t really there. Government then takes in fewer taxes and has to support more unemployed people.  They also increase their spending as they try stimulus programs.  But these centrally managed programs are rarely well managed and effective and stimulating wide spread growth.

Since governments need money in this economic environment, they have to increase taxes on the rich or borrow more money. This tends to create social unrest as rich people resent having their money taken away and poorer people resent having to be put in the situation of needing to take money versus being able to earn it.  This social unrest in the past has led to leadership changes in countries and lead to war as a means to obtain more assets for the government (from conquered people) to distribute to its citizens.

U.S. Printing Money history

This leaves the Central Bank with Printing Money, a stimulating strategy for growth, but inflationary. As the “U.S. Printing Money history” figure shows, this has happened during U.S. depressions.

The problem with this strategy is that the FED can print money, but it can only buy financial assets!  Thus it drives up the price of financial assets, helping the rich as the expense of the poorer citizens.  This makes the social tensions even worse. The Central Government however can tax and spend money putting goods and services in the hands of poorer people, but it can’t print money.  Thus on only way for the Government to work is to have the Central Government and Central Bank work in cooperation with each other.  In this case the Central Bank prints money, and uses that money to buy government bonds (which it can legally do).  In buying those bonds of the Central Government, the Central Government can use the money to pay for goods and services given to poorer people. 

The trick is to match the (first three) deflationary ways to stimulate the economy with the (fourth) inflationary way to stimulate the economy.  This is very tricky and requires wise government officials and politicians.  If done correctly there can be a “Beautiful Deleveraging”.  This allows economic and social stability.

To keep inflation in check the Central Bank has to exactly match the disappearance of credit with the amount of money it supplies.  Since this total amount can be spent on good and services, prices will stay the same.  But again, the total amount of money and credit has to stay constant over time for this to work.  The government has a hard time at the macroeconomic  scale to know the true amount of money and credit available for spending at any point in time, and even if they knew it they have a hard time reacting in real time to keep the amount constant.  What really counts is that the level of debt has to stay less than the level of income growth. Thus the metric to watch at the FED level is the interest rate and the rate of income growth.  The rate of income growth (GDP – Gross National Product) of the country has to be more than the interest rate on the debt (economic activity or health).  Since both are public (yet trailing) numbers, and we know the inflation rate too, we can track for our investment purposes which of the Four Quadrants we are in, and thus our investment or rebalancing strategy.

The main thing to watch during a Deleveraging environment is the amount of money printed. If too much we’ll look like Germany in the 1930s, or Argentina more recently.  In that case the best strategy is to move countries.

Lost Decade

The time period for Deleveraging events is about a decade.  As the “Lost Decade” figure shows, this is comprised of about 2-3 years of a depression and 7-10 years of reflation, before things get back to normal.

Why do these cycles keep repeating themselves, it’s because we are like ants preoccupied with our jobs of carrying crumbs in our minuscule lifetimes instead of having a broader perspective of the big-picture patterns and cycles, the important interrelated things driving them, and where we are within the cycles and what’s likely to transpire. From gaining this perspective, Dalio came to believe that there are only a limited number of personality types going down a limited number of paths that lead them to encounter a limited number of situations to produce only a limited number of stories that repeat over time.

Ray Dalio believes that knowing which cycles are small and which cycles are macro aids greatly in knowing how to rebalance investments.

Using the FEDs activities to guide timing for reallocation/rebalancing