How The Economic Machine Works – Learn from Ray Dalio_US 1928-1937

80 years ago, the famous “great depression” occurred in the U.S. It took ten full years to recover, however, the stages it went through is same as the crisis in 2008. The early signal displayed in 1927 is :rising debt

Then in 1928,  Ray Dalio wrote that “the Fed started to tighten monetary policy. From February to July, rates had risen by 1.5 percent to five percent. The Fed was hoping to slow the growth of speculative credit, without crippling the economy. A year later, in August 1929, it raised rates again, to six percent. As short-term interest rates rose, the yield curve flattened and inverted, liquidity declined, and the return on holding short duration assets such as cash increased as their yields rose. 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.

inverse rate

Early attempts by the Hoover government failed, as was acutely pointed out by Ray that “It is classic in a big debt crisis: Policy makers play around with deflationary levers to bring down debt for a couple of years but eventually wake up to the fact that the depressing effects of debt reduction and austerity are both too painful and inadequate to produce the effects that are needed. So more aggressive policies are undertaken.”  He called out Hoover’s very actions to crunch the credits, cut expenditure, raise interest rate as rookie move, and “Policymakers’ reliance on the deflationary levers of debt reduction had pushed the US into a severe depression/“ugly deleveraging.”.

Then in 1933, Roosevelt came to power, he took actions such as unpegging the gold anchoring,  printing money,  providing guarantees, and differently than his predecessor Hoover’s attempt to tighten the expense, when, Federal spending had fallen by more than $1billion, FDR issued policies that ended up increasing annual spending by $2.7 billion (5 percent of GDP) by 1934. According to Ray, this is a “beautiful deleveraging”, in which “deflation turned into acceptable rather than horrible inflation”.

Even there is a bit of reversal in 1936, then the government resorted to a ease policy again after quick identification of the situation, in 1938, the stock market began to recover, credit, the whole economy all waded through the darkest era and back to the upward trajectory.

out of depression



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