Jonathan Burton’s Life Savings: Ray Dalio: Rising debt, income inequality and political polarization are a recipe for a nasty downturn
Let’s make one thing perfectly clear: Ray Dalio sees parallels between the U.S. today and during the unstable 1930s, but the billionaire hedge-fund manager does not expect the next financial crisis to rival the one that knee-capped Americans in 2008 and nearly triggered another Great Depression.
That said, the founder of Bridgewater Associates, the world’s largest hedge-fund firm, is concerned that when the downturn hits — likely within the next couple of years, by his reckoning — investors, companies, politicians and policy makers will be blindsided, or worse. Capitalism and democracy, our system of government, will be under heavier fire than it is already.
“I worry about the next downturn, which isn’t imminent but also isn’t many years away,” Dalio said in a telephone interview this week. “If you go out two or three years from now, there is significant risk of a downturn at a time that we have a political and social polarization. That is very similar to the late-1930s period.”
As someone who is obsessive about being completely prepared, Dalio knows that unwelcome surprises can spark panic, self-preservation and other fearful reactions even among normally rational people.
So he wrote a book to help them. “A Template for Understanding Big Debt Crises” is a free PDF, timed to the 10 years since major U.S. investment bank Lehman Brothers collapsed and the painful deluge that followed.
Read: 10 years after Lehman’s bankruptcy, these are the big lessons for investors
“I see significant other problems ahead in two or three years,” Dalio said, “because of the combined effects of debt, pension and health-care burdens, the wealth and opportunity gap that create polarity and populism, and less effectiveness of central-bank policies that makes it more difficult to reverse a downturn.”
Moreover, he adds, “The ability to ease monetary policy by lowering interest rates is limited in the United States and nonexistent in Europe and Japan, and quantitative easing will be a lot less effective in the future than it was in the past.”
In his book, Dalio teaches about debt by historical example and his own experience, namely what Westport, Conn.-based Bridgewater knew more than a decade ago about the shaky debt and shady derivatives that would trigger the 2008 crisis, and how it came by this knowledge.
Dalio tells readers that after poking for weaknesses in the then-ballooning mortgage and derivatives market, the hedge-fund firm concluded that creditors, investors and even the Federal Reserve were being too optimistic. So, with help from the firm’s “Depression gauge” and other proprietary algorithms developed from Dalio’s trademark principles, Bridgewater battened down the hatches and along with its investors rode out the world’s worst financial market upheaval since 1929.
Dalio’s narrative of Bridgewater’s thinking in the runup to, during and after the 2008 crisis gives a fascinating inside look at what it takes as an investor to go against the herd, and to have enough fortitude to be wrong until you’re proven right.
Opinion: Ray Dalio’s new tips to survive the next market meltdown are grounded in these career secrets
Polarization and paralysis
Debt, left unattended, can mutate from benevolent builder to malevolent destroyer. Dalio’s book details the stages of a debt cycle and discusses effective and ineffective responses when borrowing becomes dangerous. In this manual, Dalio describes how to defuse a ticking debt bomb (spoiler alert: quickly and carefully), and hands a prescription to current and future central bankers for diagnosing and treating a major financial crisis with skill. If policy makers know to pull the proper levers, they can temper the wrath and get an economy growing faster.
Ideally, a country mired in a debt crisis recognizes that its people must swim or sink together. This happened to a large degree in the U.S. in 2008 after the financial markets imploded; government and business, Republicans and Democrats, essentially agreed that all hands were needed on deck — even if those hands couldn’t agree on a solution.
But the U.S. in 2018 is more disunited, socially and politically, in large part because the decade since 2008 has been far more lucrative for some Americans, especially stock owners, while too many others still bear open scars. Widening wealth disparity also shows up in countries suffering under excessive debt and economic austerity.
Economy for the few
Rising income inequality is a stark reminder that just as debt can devour, so can an economic system. When that system works well for a select few but sputters for the rest, resentment and anger swells. Dalio is a self-described “professional capitalist” — a winner many times over from the American Way. He respects capitalism and defends it. But Dalio is also a student of history, so the cavernous gap between the haves and the have-nots in the richest country on earth alarms him.
“We have growing populism around the world because capitalism isn’t working for a lot of people who feel disenfranchised,” Dalio said. “When there is a downturn, conflicts within countries and between countries will probably increase.”
‘If we don’t get capitalism to work for the majority of people, both capitalism and democracy will be at risk.’
Consequently, Dalio expects the next major downturn to deepen these wounds — unless the political will is found now to protect more people from the coming storm.
“If we don’t get capitalism to work for the majority of people, both capitalism and democracy will be at risk,” Dalio said.
To address this, at least in the U.S., he adds, “a national emergency should be declared to create the right mixture of people to identify various ways of dealing with what I will call the ‘opportunity gap.’”
Says Dalio: “Capitalism has got to work for the majority of people to survive. You have to give them good, quality opportunities for education and work. For example, improved public education that lowers crime and incarceration rates, microlending that provides opportunities for borrowers with profitable repayments for lenders, public-private partnerships that bring both capital and skills to bear, are a few examples. There are many ways that I don’t know that others know about that could be fleshed out.”
Back to a 1930s future
The price of inaction is high. Dalio has been saying for several years that the U.S. economy and society nowadays echoes the 1930s in troubling ways. For example, after the October 1929 stock-market crash, the Fed slashed interest rates and began printing money, engineering what Dalio calls a “beautiful deleveraging” — the perfect balance of inflationary and deflationary forces that reins in a big debt crisis. This also happened in the U.S. after 2008.
The mid-1930s saw the Fed-built recovery ignite a rally in stocks and riskier assets, just as the Fed’s moves after 2008 have enriched today’s stock investors. But since most Americans didn’t own stocks in the 1930s — and still don’t — a wealth gap erupted to where the top one-10th of 1% of the population was worth as much as the bottom 90% combined. About the same level of income inequality exists in the U.S. currently.
So it’s not surprising that now, like then, many people see populism and its autocratic, authoritarian underpinnings to deliver them from financial insecurity and bring back the “good old days.”
“The period in the past that is most analogous with today is 1935-1940,” Dalio said. Specifically, for him, the current economic cycle mirrors 1937. America 80 years ago had low unemployment and rising inflation; in response the Fed tightened interest rates. And the U.S. stock market’s response? Let Dalio tell you:
“That led to a big falloff in the stock market.” (The Dow Jones Industrial Average DJIA, +0.57% peaked in March 1937 and a year later had given back almost 50%.) More ominously, Dalio observes, this disruption “led to more social and political conflicts, which ended up leading to war. I’m not saying that the future will be the same. But I am saying that the linkages are the same and that we have to watch out for something similar.”
Added Dalio: “How well we navigate the next downturn will depend on how we are with each other. Laws and the system can take you so far. It all depends on whether we view those issues we face as common problems and we remain calm and work ourselves through that, or we become emotional and fight with each other.”
History is written by the victors, Winston Churchill famously said. As the next financial crisis will make plain, it is also hardest on them.
Check out: Here’s how to spot the next financial crisis
Related: If Ray Dalio’s 1937 comparison continues tracking, the market is in big trouble
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