Your spending is someone else's income, and that drives booms and busts
Borrowing lets people spend more than they earn, which lifts someone else's pay, until the chain runs in reverse.
Principles by Ray Dalio · How The Economic Machine Works by Ray DalioThe economy looks complicated, but Ray Dalio's model rests on a simple idea, which Ray Dalio puts as "one person's spending is another person's income."
That is the starting point for Dalio, the author of Principles who lays out his model of the economy in a 30-minute video. A transaction, in his telling, is simply a buyer paying a seller for something, using cash or borrowed funds. Add up all the money spent plus all the credit spent, and you get total spending. That total, he says, drives the economy. Over the long run, he adds, learning to produce more, which he calls productivity growth, matters most for living standards, but it moves slowly.
What moves quickly is credit. Dalio describes credit as the most volatile part of the economy, and the part that counts the most over the next few years. Borrowed money spends just like cash, so when someone borrows, he can spend more than he earns. And because his spending is someone else's income, that other person now earns more, too.
Dalio walks through the math. Imagine a worker who makes $100,000 a year and then borrows $10,000 on a credit card. He can now spend $110,000. Whoever receives that $110,000 in income can then borrow $11,000 and spend $121,000, even though he earned only $110,000. Follow the chain, and each round of spending funds the next round of income, which funds more borrowing and spending.
The lesson is that booms and busts in spending can lift incomes up or drag them down in the short run. Productivity still determines how well people live over the long run, but credit explains much of the swing around that slower path. When credit expands, incomes, spending, and prices can all climb together in a self-reinforcing loop. When borrowing stops, the same loop runs in reverse.
Questions people ask
If your spending becomes someone else's pay, how can the economy grow at all?
It grows in two ways. In the long run, people learn to make more with the same effort, which economists call productivity growth. In the short run, credit lets total spending temporarily rise faster than current incomes, which pulls incomes up with it.
Is all borrowing bad for the economy?
No. Borrowing that pays for something that earns more later, like equipment that increases farm output, can help the borrower repay and live better. Borrowing for something that holds no future value, like a television bought on credit, adds debt without adding future income.
Why do prices rise when spending rises?
In this model, price equals total spending divided by quantity sold. If shoppers spend more dollars chasing the same number of goods, sellers can charge more. If spending falls while goods stay plentiful, prices tend to fall.