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Bumble

The lifecycle of a sovereign country

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I came across this really helpful account of the stages of the lifecycle of a sovereign country. It is from Bridgewater, which is a highly successful hedge fund run by Ray Dalio. It's well worth taking a few minutes to read.

1) In the first stage countries are poor and think that they are poor.

In this stage they have very low incomes and most people have subsistence lifestyles, they don’t waste money because they value it a lot and they don’t have any debt to speak of because savings are short and nobody wants to lend to them. They are undeveloped.

2) In the second stage countries are getting rich quickly but still think they are poor.
 
At this stage they behave pretty much the same as they did when they were in the prior stage but, because they have more money and still want to save, the amount of this saving and investment rises rapidly. Because they are typically the same people who experienced the more deprived conditions in the first stage, and because people who grew up with financial insecurity typically don’t lose their financial cautiousness, they still a) work hard, (b) have export-led economies, c) have pegged exchange rates, d) save a lot, and e) invest efficiently in their means of production, in real assets like gold and apartments, and in bonds of the reserve countries. (This is where China is today.)

3) In the third stage countries are rich and think of themselves as rich.
 
At this stage, their per capita incomes approach the highest in the world as their prior investments in infrastructure, capital goods and R&D are paying off by producing productivity gains. At the same time, the prevailing psychology changes from putting the emphasis on working and saving to protect oneself from the bad times to easing up in order to savor the fruits of life. This change in the prevailing psychology occurs primarily because a new generation of people who did not experience the bad times replaces those who lived through them. Signs of this change in mindset are reflected in statistics that show reduced work hours (e.g., typically there is a reduction in the average workweek from six days to five) and big increases in expenditures on leisure and luxury goods relative to necessities. (This is where the UK was in the latter half of the 19th century, and where the USA was in the latter half of the 20th century.)

4) In the fourth stage countries become poorer and still think of themselves as rich.
 
This is the leveraging up phase – i.e., debts rise relative to incomes until they can’t any more. The psychological shift behind this leveraging up occurs because the people who lived through the first two stages have died off and those whose behavior matters most are used to living well and not worrying about the pain of not having enough money. Because the people in these countries earn and spend a lot, they become expensive, and because they are expensive they experience slower real income growth rates. Since they are reluctant to constrain their spending in line with their reduced income growth rate, they lower their savings rates, increase their debts and cut corners. Because their spending continues to be strong, they continue to appear rich, even though their balance sheets deteriorate. The reduced level of efficient investments in infrastructure, capital goods and R&D slow their productivity gains. Their cities and infrastructures become older and less efficient than those in the two earlier stages. Their balance of payments positions deteriorate, reflecting their reduced competitiveness. They increasingly rely on their reputations rather than on their competitiveness to fund their deficits. They typically spend a lot of money on the military at this stage, sometimes very large amounts because of wars, in order to protect their global interests. Often, though not always, at the advanced stages of this phase, countries run “twin deficits” – i.e., both balance of payments and government deficits.

5) In the last stage of the cycle they typically go through deleveraging and relative decline, which they are slow to accept.
 
After bubbles burst and when deleveragings occur, private debt growth, private sector spending, asset values and net worths decline in a self-reinforcing negative cycle. To compensate, government debt growth, government deficits and central bank “printing” of money typically increase. In this way, their central banks and central governments cut real interest rates and increase nominal GDP growth so that it is comfortably above nominal interest rates in order to ease debt burdens. As a result of these low real interest rates, weak currencies and poor economic conditions, their debt and equity assets are poor performing and increasingly these countries have to compete with less expensive countries that are in the earlier stages of development. Their currencies depreciate and they like it. As an extension of these economic and financial trends, countries in this stage see their power in the world decline.

Edited by Bumble

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The thing that always amazes me is how long insanity can carry on without repercussions.

The biggest mistakes I've made in trading markets in my life have always been because I was too early to the trade, usually too early to trade against obvious insanity.  I've become much better at it over the years because of the very fact that I now have total respect for how long insanity can continue.

Edit, perfect example ... U.S. debt to GDP, which currently stands at about 105, only 13 points below what it was at the height of world war 2, 40 points above where it was just 10 years ago.  Can't go on forever ... but it can go on for a long, long time.

Edited by Lowlow

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I think UK debt to GDP is even worse too. 

On another note. World debt stands at $72Trillion. Only 5 countries in the world have no debt apparently. So who are all these countries in debt too? I think the answer is banks.

Once some sort of re-set happens those holding physical PMs should do pretty well.

The big question is how long can the insanity continue. How long is a piece of string.

Only some big financial crisis, bigger than last time could trigger the sanity I believe.

Interesting timesww live in!

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We're in late stage 4. In the next downturn I see us moving into stage 5.

 

I would add that this life cycle reflect the political cycle of a country, as it becomes more prosperous on the ingenuity and productivity of its individuals, the have nots of society vote themselves ever increasing claims on wealth they didn't earn, while the politicians play a game of increasing promises of everything to everyone and expecting someone else to pay for it, firstly with tax claims on other members of society, and then debt claims on the unborn.

Edited by vand

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I think we are already in stage five and wish we were in stage four!

A fantastic read, factor in the impact of the world wars and it all makes sense over the past 200 or so years in the UK context.

The only unresolved issue is what does stage six have in store?

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On 20/04/2018 at 18:46, KDave said:

article-2118152-124602BE000005DC-0_964x528.jpg.1840d93848914887b4ab6165c842ddf8.jpg

Look at all that lending. Looks like we still have a fair bit left to borrow from China, Japan and Ireland. They can borrow a bit more from the US, Germany and France to cover it :P

Does anyone else find this picture disturbing.

Where did it originate from? I’d love to read the article but it looks like a right mess.

Who is the £10 in my pocket owed to? 

Who does the gram of gold belong to? Oh yeah, me!

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Yes it is disturbing and this is an old map I had it saved in a dusty research folder from a few years back. :P

Someone said they wonder who we borrow from and I remembered this picture, the answer appears to be we borrow from each other. It's perpetual debt lending between nations, all of their currencies linked to the dollar.

How many unborn generations can we borrow from? It can't go on forever..  can it? 

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13 hours ago, 8phwt said:

 

A more light-hearted look at the same graph... Oldie but a goodie :)

 

Ca .. can ..can't .. st-o-p .. wa..wa-tch-ing Clarke .. a .an.and Dawe ..on Youtube ..

Can't ..lo.look ..a..away

lol, I've never seen these guys before, they are freaking hysterical... thank you for posting that link, an hour of my life .. gone forever.

Edited by Lowlow

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The stages are interesting. 

But they are open very much to interpretation of the observers bias and use of selective evidence that can be made to fit if you ignore stuff and highlight other bits.. For example, who is to say China is not stage 4 given its government borrowing and lending via the shadow banking sector. Not an action a stage 2 sovereign nation, more poor trying to be rich. 

Where does Iceland fit in following the debt default a few years back, was that stage 5? If so they have skipped a few stages since.

The issue is a global monetary one now in my view. The issue of sovereign action is a distant second as to future prospects. Everyone has been playing the fiat lending scratchy back borrowing game since the 1970's. We all rose together, we will all sink together. I call that stage 6 :P

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48 minutes ago, KDave said:

The issue is a global monetary one now in my view. The issue of sovereign action is a distant second as to future prospects. Everyone has been playing the fiat lending scratchy back borrowing game since the 1970's. We all rose together, we will all sink together. I call that stage 6 :P

This plays itself out visually in the markets.  When I was young, markets around the world didn't move together, but now the markets follow each other around the globe on nothing but sentiment.  Not only are markets moving in tandem against their local currency (a bad sign in itself), now all of the markets in the world are moving in tandem with each other and a basket of currencies.  This has been going on for so long many people don't even notice anymore, it now seems natural that Japan would follow the U.S., EU follow Japan, etc, but it shouldn't do that since they're trading unique securities with different fundamentals.  It's all just debt now, sloshing around like tits on a tilt-a-whirl.

Edited by Lowlow

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