Transcription
If we cut the deficit to 3% of GDP, if you don't do that, we're going to have a supply demand problem. And this is a heart attack, like an economic heart attack.
Our fiscal situation is a 350 lb, two pack a day smoker on the ICU table. US federal debt is on an unsustainable path.
I can understand the mainstream ignoring people like me because who likes to be hear from a critic when you're part of the establishment? But this is the Bank of England and they ignored that statement. If you take a look at Bernanke's Nobel Prize speech, which I have, you'll find he doesn't even reference this article. In this case, Ray Deli is completely correct to be adding credit to the demand for the overall economy.
So, what I've done here in a very simple model in my Ravel software, I've just shown the absolute basics of the model that the textbooks teach and that Bananki believes that banks are simply intermediaries who enable savers to lend to borrowers. So, incredibly simple model. Savers lend credit dollars per year to borrowers. Borrowers then spend on savers and savers spend on borrowers. I've left interest out just to make things extremely simple. That's the vision of what banks actually do. And if that's the case, if I now run this model and see what happens when there's lending going on here, we start off first of all with no lending taking place and GDP is constant as you can see. What happens if we have a fraction of GDP lent every year? So I go 1% 2% 3% 4% etc etc. You can see there are small jumps in GDP because the borrowers spend more rapidly than the savers do. If we go in the opposite direction so the the debtors the borrowers pay off their debt so they go down to negative and therefore they're repaying their debt. So the debt ratio falls. So you get a fall in GDP as well coming out of that but it's fairly minor. We've gone from 500 to 460. And if I go back to the point where there's no borrowing going on, we're pretty much at the same level. What was the equilibrium beforehand? Was 480 there. Lo and behold, it's 480 here. So there's been no real impact by a dramatic increase in the level of private debt. Went from 0% of GDP to 200, back down to 50 again. Nah, nothing happens. You can forget about credit in the economy.
But as the Bank of England said, it's not true that banks are intermediary. Banks create loans and that creates money in the process. And it's very easy for me to correct this mistake in the model because as you can see here, if the savers are the ones doing the lending, then the debt is their asset. It's not the bank's asset. That's why debt didn't appear up in the bank's table up here. So I can simply delete that and say it's not true. The savers is not savers who are lending to borrowers. It banks who are lending to borrowers. So let's take the savers out of the equation here. I can bring up the table here and delete debt as an operation as an asset of the savers and the borrowing doesn't occur through them. So I've just got borrowers spending and savers spending as the action that takes place on the savers account. And now I can bring up the banks table. Let's make room for an extra asset here. The asset being debt. And now debt is something that is owned by the banking sector. So let's see what happens now having made that incredibly simple change. Go back to the publication tab. reset the whole thing. Start with zero and again you get the same basic level of GDP coming out of it. What happens if there's some lending? GDP rises as you can see there dramatically. Keep it going up more rises. Credit being 5% of GDP, you get a dramatic increase in GDP itself. If credit falls back down to zero, you're still at a far higher level of GDP. If you start having negative credit, that brings the economy down. Now, that's exactly what Ray Dallio was talking about in that model. So, he's right and the mainstream is wrong.
Let's see a few more elements from Dalio's arguments here. Because he's saying, why is credit so important? Let's see what his argument is.
So, why is credit so important? Because when a borrower receives credit, he is able to increase his spending. And remember, spending drives the economy. This is because one person's spending is another person's income. When someone's income rises, it makes lenders more willing to lend him money because now he's more worthy of credit. So increased income allows increased borrowing which allows increased spending. And since one person's spending is another person's income, this leads to more increased borrowing and so on. This self-reinforcing pattern leads to economic growth and is why we have cycles.
Now even that word is a radical word in mainstream economics because Rey is quite happily talking about the economy having cycles. But if you do mainstream economics, you learn that the economy is fundamentally in equilibrium and only shocks from the outside can cause cycles. Now that's completely wrong description of how the world actually operates. But Ray is also slightly wrong because he's left out one other potential cause of cycles and I want to show that another element of my Ravvel software. This is a model of a cyclical economy. I'll just go through the various bits and pieces of it. So you have a certain amount of capital and capital generates GDP. You have an output to labor ratio that tells you how many workers you need given that level of GDP. With that amount of labor and the population, you get an employment rate. That gives you a wage determination. If there's high employment, workers can get wage rises. If it's low, they take wage cuts. That then gives you the wage rate. and you multiply that by number of workers, you've got wages. Subtract wages from GDP and you've got gross profit. Subtract interest from that and I'll come back to that in a moment and you have net profit. Net profit gives you a rate of profit. Firms have a target for the level of profit they want to have. If they get more than that profit, they're willing to borrow money to invest. They invest that adds to the capital stock, but it also adds to their debt level. And then you have the cycle completed.
Now I've in this model I can turn off debt just by this little switch here. So I don't have any borrowing going on. I've just got the workers getting wage rises if employment's high, firms investing more, but I'm not explaining where the investment funds are coming from. So what I've got I've got there is a cycle in the distribution of income between workers and capitalists and that cycle goes on indefinitely. You don't have the breakdown. So there's an additional source of in of cycles to the one that Dre talked about which is the cycle struggles over the distribution of income.
What happens when we add debt to this picture? So it's exactly the same cycle. All that I've got now that if the desire to invest exceeds retained earnings then firms are willing to borrow money to finance that investment and then they have to pay interest on that and that interest payment gets deducted from gross profit to give you net profit. What happens then? And I think Ry might find this fascinating. I hope so. Because you no longer have that closed cycle. The cycle is now open. And if you're a neocclassical, you might look at this and say, "It's heading to equilibrium. Give it a while and it'll hit that little center spot there and it'll all stabilize down and cycles will be gone." Raise right. The cycles continue. And not only do they continue, they do something extremely strange. They get smaller. For a while, the growth rate is converging on what appears again to be an equilibrium. But it doesn't last. cycles start to get larger after a while. What you've got going on, and this is quite complicated in the internal mathematics of the system, is that the rising level of income going to bankers actually comes at the expense of workers, not at the expense of capitalists. So, capitalists continue investing whenever they get back to their target rate of profit. But the system gets crazier and crazier. As you can see, the cycles are getting more and more extreme. And at some point, we're going to have the system completely crashing. If I ran it for long enough, it would just fold. There'd be an infinite level of private debt compared to GDP, zero employment, and zero wages. That's what's called a debt deflation, and that's what you want to avoid. You do not want to end up in that situation.
This is reaffirming Ray Dio's focus on cycles as an essential element of a capitalist economy. It's naturally cyclical. There's nothing evil about saying capitalism is cyclical. But because mainstream economists have become obsessed with the idea of capitalism reaching equilibrium, they ignore the dynamics I'm talking about here, and they ignore credit, which is the essential thing that Ray Dallio adds to the argument, which has made him such a successful speculator over time. He's used these ideas, as he said, to avoid the global financial crisis, to profit out of booms in credit, to get out of the way when credit falls down. Understanding credit is why Ray Dallio understands the economy far better than most mainstream economists. But unfortunately, he is making a mistake in the arguments he's making there. That's probably too much for one video, so I'll cover that in the next video.
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