Summary of Ray Dalio’s “Template for Understanding Big Debt Crises” between 1928-1937 with a comparison of 2020

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by aemus001

“Those who do not learn history are doomed to repeat it.” – Some Autist


This summary of Ray Dalio’s “Template for Understanding Big Debt Crises” was copy-pasta’d from my FB notes on 5/11/2020. It focuses on the events between 1928-1937, which includes the events leading up the US Great Depression and after, and is contrasted to the events leading up to and happening now. I chose this particular time period as Ray Dalio has explicitly stated in modern interviews that we are entering a New World which resembles the era in which that last one occurred. After reading his amazing book “Principles” and seeing how he is pretty much the Steve Jobs of economics, I wanted to learn more about his thoughts and opinions about the effects of the Corona Virus on the economy.

What follows is my belief about the future, drawing on the wisdom of Ray Ralio. [\My personal side comments are written as such and reflect on the parallels between then and now in 2020\**] I will continue to monitor the news and markets with my primitive tools, relying mostly on my mind and ability to think critically. I will offer a few suggestions and thoughts at the end for how to prepare for what may come.

Thank you, and God Speed.

1927-1929: The Bubble || [\2017-2019\**]

The charts above show the explosion in margin debt through the bubble between 1927-1930 and the accompanying rise in prices.

After WWI [\The economic equivalent of our 2008-2009 Financial Crisis\] the economy experienced rapid technological growth with radio and automobile growth [\Internet-Of-Things growth****] leading the charge. Technological innovations happened across many other sectors as well. Technological breakthroughs filled the newspapers, driving wide-spread optimism about the economy.

Debt growth was approximately in line with income growth because it was being used to finance activities that produce fast income growth.

Then a bubble began to emerge. As is classic, the bubble had its roots in the dizzying productivity and technological gains of the period and people making leveraged bets that they would continue.

New buyers flooded the market, many of them were unsophisticated investors with no prior experience with stocks, one of the classic signs of a bubble. [\Recall that brokerages have been competing for household investors by lowering commission fees since 2012, and now most, if not all, brokerages offer zero dollar commission; such as Robin Hood\] Household margin debt was fueling the bubble. [\Recall that the 2008-2009 Financial Crisis bubble was fueled by housing market debt, and the 2020 bubble is being fueled by corporate debt.****]

1929 (late): The Top and the Crash || [\2019 – 2020 (early)\**]

The Federal Reserve started to tighten monetary policy, hoping to slow the growth of speculative credit without crippling the economy, it raised the interest rate to 6%.

25 year chart of the federal interest rate. You can see the FED tightening at a rate of 0.25% to try and reign in the economic growth starting in 2016.

[\Before the Crash of 2020, the Fed was tightening the economy by increments of 0.25% over the course of 4 years starting around late 2015. After the Financial Crisis of 2008, rates were held near 0% to stimulate economic growth. The interest rate was 1.75% prior to the Crash of 2020, the only place to go now is negative interest rates, should the Fed decide on that\**] As loans became more costly and holding cash became more attractive than holding longer duration and/or riskier financial assets (such as bonds, equities, and real estate), money moved out of financial assets causing them to fall in value. Declining asset prices created a negative wealth effect, which fed on itself in the financial markets and fed back into the economy through declining spending and incomes.

The Bubble reversed into a bust. [\February 20, 2020: The top of 2020 crash, only this time slightly different as it was in response to the COVID-19 pandemic and an oil price war between Russia and the OPEC, and the Federal interest rate was only at 1.75% instead of 6%\**]

The Federal Reserve attempted to counter the collapse in credit by providing liquidity to the markets. The Fed announced it would inject $100M to ease the credit crunch by purchasing government securities. [\April 16, 2020: Federal Reserve Announces Municipal Liquidity Facility *(the "MLF”) and Under the MLF, a Federal Reserve Bank will commit to lend funds to a special purpose vehicle (the "SPV”), on a full-recourse basis and secured by all assets of the SPV. The SPV will also be funded by the Treasury Department, which will make an initial equity investment of $35B to provide the market’s with liquidity\***]

1 year chart of DJIA showing peak on September 3, 1929

Stocks snapped back, rising 12.3% in one of those sharp bear market rallies that classically occur repeatedly during the depression phases of big debt cycles. [\We experienced a 21.3% snap back between March 23-26, 2020.\]

Chart of Dow Jones Industrial Average from Jan 1929 to 1937. Recession are shown in highlighted regions. Dark blue line on left shows the one year chart seen in the previous chart above.

By New Year’s Day of 1930 it was widely believed that the stock market’s 50% fall was over, which helped drive a strong rebound over the next four months. [\This is where I believe we are\**]

Stocks seemed cheap because there wasn’t much evidence that company earnings would fall much [\Recall that companies are not currently offering guidance on earnings for next quarter due to the uncertainty over Corona Virus impact\**]d investors were biased about their memories of the most recent downturn and subsequent recovery; most assumed that events would play out similarly this time.

In the early stages of deleveraging, it’s very common for investors and policy makers to underestimate how much the real economy will weaken, leading to small rallies that quickly reverse, and initial policy responses that aren’t enough.

Chart showing %YTD (day 90, May 11th) Performace of DJIA and those of 2018 and 2019.

[\It is here that history diverges from current events, because what transpires here hasn’t happened for us yet\**]

The future cyclical events are as follows:

1930-1932: Depression

1933-1936: The Beautiful Deleveraging

1936-1938: The Tightening Causes Recession

1938-1939: The Path to War

[\I think this should be enough for now. This took a really long time to do and I didn’t get nearly as much done as I wanted. I don’t know when I’ll update this. Ray Dalio’s advice, "Cash is trash; hold some gold”. But before you do that, I think it will be extremely important to become as self sufficient as possible; whatever that means for you. The Great Depression was no joke. At the end of the day, food and water are the most important resource.*

Macro view of a drop of water ejected after collapse

Huge holes are beginning to appear in the economic and financial structure that need to be filled. When small vacuums appear in water, they can be filled without disrupting the body too much, but when large vacuums appear, the water that rushes in to fill the hole is much more disruptive, causing the system to fluctuate more wildly\*]

You can learn more by reading the complete book “Principles for Navigating Big Debt Crises” by Ray Dalio by clicking here.

TLDR: NTM GLD Calls with time (the more time the better)


Disclaimer: This information is only for educational purposes. Do not make any investment decisions based on the information in this article. Do you own due diligence.


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