How the Economy Works

By James Cox

In order to help us consider ‘How the Economy Works’, we can turn to the views of one of my favourite hedge fund managers in the world – Ray Dalio. Having founded Bridgewater Associates in his apartment in 1975, he developed a set of rules and an understanding of how the world works. He was so successful that Bridgewater became the world’s largest hedge fund with approximately USD $120 Bn in assets under management.

In 2007, Ray Dalio predicted the global financial crisis and in 2008 published an essay, “How the Economic Machine Works; A Template for Understanding What is Happening Now.”

This was later made in to a fantastic video:

Whilst this is extremely helpful, the video does not cover the subject of money entirely. Simply put, the vast majority paper currencies eventually fail because so much is printed that people start to reject it as being the ‘credit’ of a bankrupt government.

Ray Dalio is fully aware of this possibility and that is why he holds a sensible amount of his wealth in bullion:

“Gold is a currency. Throughout the history, I won’t tell you in length, money was like a check in a checkbook and what you would do was get your gold and gold was like a medium. So gold is one of the currencies– We have dollars, we have euros, we have yen and we have gold… But if you don’t own, I don’t know 10%, if you don’t have that and that depends on the world, then there’s no sensible reason other than you don’t know history and you don’t know the economics of it.” – Ray Dalio

The two questions to ask are:

1) “Why is that only a minority amount of gold (or silver)  in your portfolio help protect your wealth?”

2) “How is it that we can decide whether our portfolio should include more or less than 10% if it “depends on the world?” What does that mean?

We can help answer these questions by understanding “The Liquidity Pyramid.”



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