The economic machine
Ray Dalio’s “How the Economic Machine Works” presentation is a treasure trove of information and logic, especially for macroeconomics enthusiasts. In his presentation, Dalio explains three important factors that hold true for any economy (IVV) (VOO):
- spending drives the economy
- productivity growth matters the most in the long run
- debt (TLT) is an important driver of economic swings
The economy is “the aggregate of the markets”
Ray Dalio believes that the economy is “the aggregate of the markets” (IWD) (IWF). Therefore, it is possible to derive and determine the equilibrium price that would prevail in the market. The total amount spent is a function of how much money or credit buyers of goods and services will spend. Similarly, the total quantity sold depends on what quantities major sellers estimate they could sell.
Price can be determined
Therefore, price is a function that can be derived from the total amount spent divided by the total quantity sold. For an economy to be in equilibrium, it should be operating at the equilibrium price level.
Central bankers strive to keep spending at levels where it is consistent with the equilibrium price level. To do this, they need to consider the three forces that drive all economies, as we’ll discuss next.