Ray Dalio re Debt Crises (originally posted 9/11/18, now repeated 9/17/20)

This is a slightly-revised repeat of a Post of 9/11/18.  It remains relevant to Mr. Dalio’s thinking.

The final paragraph of this Post is as follows: We hope that Mr. Dalio will study Bernard Lonergan’s Macroeconomic Dynamics: An Essay in Circulation Analysis (CWL 15) to advance his present considerable understanding even further so as to understand the real grounds that might make his predictions successful .  We hope that, as a person of influence, Mr. Dalio will convey a more advanced, explanatory understanding of the economic process to the nation and the world.

On 9/11/18 Ray Dalio, Co-Chairman and Founder of Bridgewater Associates, appeared on TV and reviewed some highlights of his new book, A Template for Understanding Big Debt Crises.  The book is presently available as a free PDF (with some strings attached).  An alternative, no-strings-attached, introduction to Mr. Dalio’s thinking is available on the Bridgewater website’s home page under the title The Economy, How the Economic Machine Works.

Mr. Dalio’s comments were cogent; they were somewhat aligned with much of what Lonergan has provided in his scientific systematics of the economic process.  Both would agree that the repetition of crises is not inevitable; crises are caused by repeated mismanagement. But what Dalio loosely describes Lonergan precisely explains

Note the words “debt crises.”  Steven Gjerstad and Vernon J. Smith connected the crises following both 1929 and 2006 to excess lending and borrowing for housing.

Before Dalio, countless others, notably Hyman Minsky and Joseph Schumpeter, pointed out that careless and excess lending is a root cause of major financial problems.

Banks are not there to “force their money upon people,”4 nor “do they congratulate themselves if they are loaned up.”5  A banking committee is not “an automaton” but understanding and attentive to purpose and situation, “ judging chances of success of each purpose and, as means to this end, the kind of man the borrower is, watching him as he proceeds …”6 “It should be observed how important it is for the system of which we are trying to construct a model, that the banker should know, and be able to judge, what his credit is for and that he should be an independent agent.  To realize this is to understand what banking means.”7  “the banker’s function is essentially a critical, checking, admonitory one.  Alike in this respect to economists, bankers are worth their salt only if they make themselves thoroughly unpopular with governments, politicians and the public. This does not matter in times of intact capitalism.  In the times of decadent capitalism, this piece of machinery is likely to be put out of gear by legislation.”8  McShane, Philip (quoting Joseph Schumpeter’s Business Cycles I and II) Implementing Lonergan’s Economics, in The Lonergan Review, Culture Science and Economics, Vol. III, No 1, Spring 2011, Seton Hall University, pp. 196-204

Lonergan points out that the lack of a scientific understanding of the economic process results in an inability to distinguish between the significance of a relative and an absolute rise or fall of monetary prices.  The associated misinterpretations of rising prices generate excessive optimism and excess investment.

Previously I have suggested a lack of adaptation in the free economies to the requirements of the pure cycle.  What that lack is can now be stated. It is an inability to distinguish between the significance of a relative and an absolute rise or fall of monetary prices.   This, I believe, is the fundamental lack of adaptation to the productive cycle that our economies have to overcome. … [CWL 15, 139]

Now in any expansion it is inevitable that quantities under production run ahead of quantities sold.  Current production is with reference to future sales, and if there is an expansion, then future sales are going to be greater than current sales. But in the free economies the acceleration factors are not held down to the minimum that results from this consideration.  During the surplus expansion the basic price-spread ratio will increase from an increase of R, of a”, and also of a’.  The advance of the price-spread ratio will work out through a rise of the basic price level, and selling prices generally will mount. Now, when prices are rising and due to rise further, the thing to be done is to buy now when prices are low and sell later when they are high.  There results a large amount of liquid investment.  Each producer orders more materials, more semifinished goods, more finished goods, tan he would otherwise.  Moreover, he makes this speculative addition to a future demand estimated upon current orders received, so that the further back in the production series any producer is, the greater [will be] the speculative element contained in the objective evidence of current orders received, the more rosy the estimate of future demand, and the greater the speculative element he adds to this estimate when he places orders with a producer still further back in the series. Thus an initial rise in prices sets going a speculative expansion that makes the acceleration factors quite notable, expands the price spread still more, and stimulates a pace of further acceleration that it will be quite impossible to maintain.  …. [CWL 15, 160]

The phenomena of our depressions can be explained by our lack of any mechanism that will reduce net aggregate savings smoothly and equitably.  There results the distorted equilibrium conditioned by a rate of losses.  This rate of losses forces a series of contractions and liquidations that characterize the depression. [CWL 15, 156]

until the position of the strong1is undermined by the general and prolonged contracting, the requirement2for the rate of losses continues, and with it the depression. … [CWL 15, 155-56]

And Lonergan provides the systematics of crises in CWL 15, 156-62:

This boom suffers no restrictions from a limited potential for short-term acceleration since both stages are now expanding in long-term style.  Both acceleration factors can mount to maxima and remain at the summits with da’ and da” both zero.  Further variations of the price spread thus depend exclusively upon dR, and this becomes negative as the surplus expansion gives place to a basic expansion.  When the prices begin to fall to effect the continual reduction of the price spread, there follows sooner or later the final crash.  Speculative embarrassment makes both da’ and da” negative, to augment the rate of contraction of the price spread and intensify the embarrassment. Assets are frozen and then liquidated in a great drop of prices.  Worse, there is no recovery; for the remainder of the cycle should be a basic expansion which our ill-adapted economies transform into a depression. [CWL 15, 161]

Ray Dalio’s use of the word template reminds us of the word framework.  Lonergan provides a double-circuited, credit-centered image of interdependent rates of flow – an imagic framework– leading us to an insight yielding a scientific understanding of the relations among current, interdependent, mutually conditioning rates of flows – dynamic framework.  In particular, our framework indicates precisely the dealings of borrowing and lending about which Dalio also has much to say.

Diagram of Rates of Flow 2

Diagram of Rates of Flow

A systematic explanation, then, requires a normative theoretical framework.  The basic terms and relations of such a framework would specify the distinctions and correlations that articulate the causes, which are not necessarily visible, of events that are apparent to all.  The framework would thus stand to the ordinary apprehension of the booms and slumps of the trade cycle in much the same way that the explanatory grasp of acceleration as the second derivative of a continuous function of distance and time stands to the ordinary, commonsense grasp of what it is to be going faster. [CWL 15, Editors’ Introduction  lv]

Lonergan agreed with Schumpeter on the importance of systematic or analytic framework in order to explain, rather than merely record or describe, the aggregate phenomena of macroeconomics; he agreed with Schumpeter that to be able to explain the booms, slumps, and crashes of the trade or business cycles the economist’s analysis had to be as dynamic as the subject matter under investigation; and he agreed that the economist had to know what are the significant variables in the light of which price changes are to be interpreted.  According to Lonergan, standard economic theory had successfully achieved none of these desiderata. [CWL 15, Editors’ Introduction liii]

Lonergan’s distinction between basic and surplus production and circulation enables him to envisage clearly those ‘further equilibria that have to be maintained’ in the normative framework of a pure theory of economic expansion and growth…. An explanatory account of the intrinsically evolutionary processes of any industrial exchange economy’s cycles of surplus (i.e. producer-goods) and basic (i.e. consumer-goods) production and exchange has to reveal how the different phases in the distinct cycles intermesh and coordinate in an intelligible sequence, by means of differential rates of crossover payments from basic to surplus and from surplus to basic, depending on what phase of aggregate expansion or leveling of the economy happens to be in at any given time.  [CWL 15, Editors’ Introduction lxiii]

the set of terms and relations capable of explaining the phenomena of the business or trade cycle would not be the same as any given pricing system that automatically coordinates a vast coincidental manifold of decisions of demand and decisions of supply.  Such a system comes to sight as bookkeeper’s entities that form the basis of the preliminary descriptive classifications that need to be explained: they are the similarities “first-for-us.”  The relevant set of explanatory terms and relations would have to expose similarities that reside in the relations of things to one another or what is “first-in-itself”: namely both the dynamic elements and the differentials of the economic mechanism which reveal the significance of aggregate changes in prices that by themselves are in need of interpretation.  To repeat, then, Lonergan holds that prices as a concern for the bookkeepers or accountants are known- first-to-us by description and commonsense classification; and that his own functional analysis of production and circulation reveals an explanatory system known-first-in-itself.  Only such an explanatory framework will enable the all-important discrimination either of the causes and the variations in prices (CWL 15, 75-80, 113-20) or of a relative and an absolute rise or fall of monetary prices, only such an explanatory framework will make possible a correct interpretation of their significance. [CWL 15, Editors’ Introduction lvi]

We hope that Mr. Dalio will study Bernard Lonergan’s Macroeconomic Dynamics: An Essay in Circulation Analysis (CWL 15) to advance his present considerable understanding even further so as to understand the real grounds that might make his predictions successful .  We hope that, as a person of influence, Mr. Dalio will convey a more advanced, explanatory understanding of the economic process to the nation and the world.

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