The Economic Machine and Global Money Flow

You don’t need a degree in economics to trade the forex market, some say it is a disadvantage. However if you truly want to understand the forex market and not just trade daily using indicators and the like which at best are random, you should take the time to understand what is causing the forex market to be so dynamic. Whilst we trade intraday at a micro level using economic data releases as they come out, it is useful to understand how this data fits into the bigger picture at the macro level.

The Forex Market

Just to recap exactly what the forex market is. It is a marketplace for people to convert their home currency ie the currency that they earn their money, into another currency to enable them to buy or sell products or services in another countries currency. This can be anything from the consumer exchanging their currency to travel to another country to enable them to make transactions in another country, to a bank facilitating large purchases for a client in another currency, to a hedge fund selling European assets to buy US assets. If an economy such as the US is doing well and Europe is not doing so well money flows from EUR to USD to facilitate the purchase of such assets like US Treasury Bonds or US Equities. If these economies continue to have a difference in relative strength over time then a trend is formed in our example with the EURUSD continuing in a downward trend.

As with everything there is always a Cause and Effect. In forex the cause is the changing fortunes of the economies and the effect is the interpretation of the trader to take advantage of the information provided.

Whilst economic theory is subjective and taught by theorists which makes it difficult to apply to reality. There is a new approach to the subject which has been based on actual real life business and works from the ground up.

Ray Dalio has turned the economic theorists on their head with his interpretation of the economics of a country, that he describes as an ‘Economic Machine‘. Ray Dalio is the CIO & Founder of Bridgewater Associates, one of the largest hedge fund in the world. His concept is that the world is simply a boiling pot of trillions of ‘money’ transactions occurring continuously. Money isnt just cash but the combination of cash and credit and it is credit that is often missed out in traditional economics because it can be created out of thin air between two parties.

Money and Credit

Money is cash that you use to buy from a seller, once the transfer of money and goods has occurred the transaction is over. Credit on the other hand is an agreement (that is created out of thin air) between the buyer and the seller for the buyer to settle the agreement at a later date creating a debt for the buyer and a credit for the seller. Currently in the US the total amount of debt created by credit is about USD$50 Trillion and the total amount of money or cash is about USD$3 Trillion. So there is no where near enough cash available to repay the credit debt.

Now that we have the notion of ‘Cash and Credit’ and that Credit is actually the dominant metric in the whole equation, Dalio suggests that the Economic Machine as he calls it is actually based around ‘Short Term’ and ‘Long Term’ Credit Cycles.

Watch his video and get an insight into how the Global Economies work. Let us know what you think.