In article 9 I wrote about “Economic Cycles” but I need to clarify some points.

Life, economy, business.

The economy follows a cyclical pattern, the same is true for human life and business life but we will dig deeper into business life when we will talk about valuation. Economic cycles are mainly defined by the relation between credits and debts. The best explanation on this matter was published by Ray Dalio, founder of Bridgewater Hedge Fund.
If you want a more comprehensive description I invite you to watch his video lesson on youtube How the economic machine works.
I think  is important to understand the basics of how the economic machine works in order to be a good investor.

Time Value.

Basically a debt is an agreement between two parts that money given today (principal) will be repaid in the future with a premium (interest). It’s obvious that if I give you a sum of money I expect to be paid for the time that my money is in your hand.
In other words, with this money I can do various things that give me a return, then if I decide to give you this money, I lose the opportunity to invest in other things that could have a return. This is called the time value of money and it is one of the most fundamental notions in finance.

The power of debt.

Meanwhile, you have my money, you can use this money to generate a profit greater than the interests you will pay to me. Typically banks are the main lenders in our system but individuals, too. They can lend money to other individuals (households debt) or corporations (corporate bonds). Government and state also are in debt.  The principle doesn’t change.
All those entities ideally borrow money with the goal to create more wealth in the future in order to repay the principal plus interest and make the gain. The best example to describe those dynamics is a simple business like a farm. Imagine that a farmer has already a land, paid with his own money. Now he wants to sow wheat but he doesn’t have a tractor, the farmer has 2 choices: saving for months until he can buy the tractor or take a loan and buying the tractor now, this means earn already now. An obvious part of future gains will be utilized to repay the principal and to pay interest, but if he does the math he can earn more and he will develop his business.
I have deliberately left out debts related to private consumption like a new TV, new car, new tablet because is not a matter of this blog and I think is a stupid use of this instrument.
Instead of getting into debt to buy useless stuff, learn the art of saving.

“Do not save what is left after spending; instead spend what is left after saving.”

Warren Buffett

This mechanism creates the economic cycle, the time where we get into debts and we grow and time where we have to pay back this debt then our spending capacity decreases. When we get into debt, usually because central banks adopt expansionary policies, productivity explodes boosted by low-interest rates.

Long term horizon.

This can’t last forever then there will be the reverse process. However, in a healthy economy, the productivity line will grow in the long term.

This is an extreme synthesis that gives you a broad idea about the whole credits-debts economy.

“I spend about fifteen minutes a year on economic analysis.””

Peter Lynch

Following the suggestion of Peter Lynch, I think the argument doesn’t worth more time.
For a more comprehensive explanation, I refer you to the clip realized by Ray Dalio.

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