The transcript from this week’s MIB: Ray Dalio, Bridgewater Associates, is below.
You can stream/download the full conversation, including the podcast extras on iTunes, Bloomberg, Overcast, and Stitcher. Our earlier podcasts can all be found at iTunes, Stitcher, Overcast, and Bloomberg.
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This is Masters in Business with Barry Ritholtz on Bloomberg Radio.
BARRY RITHOLTZ, HOST, MASTERS IN BUSINESS: Dear Lord, I have an extra special guest, his name is Ray Dalio, I could’ve sat and chat with Ray for hours and hours, his newest book is “Principles for Navigating Big Debt Crisis” and it is a masterful three-volume set on what the debt crisis around the world looked like throughout history, he does detailed case stories about three the biggest ones, the great financial crisis of ’08 – ’09, the Great Depression, and then what took place in Germany. And then there are 48 case studies or 46 case studies about other debt crises.
He really provides an education for central banks, going forward, as to what they need to do to avoid these sorts of problems in the future, and when they happen, how to make them less painful. It’s a masterwork and I expect it’s going to be on our central bank bookshelves for decades and decades to come.
This would also be a good time to mention we have coming up, Masters in Business Live with Ray Dalio, and keep your ears open for that. We are going to do a live broadcast going over the book, you could get the PDF of the book for free, the Kindle version is $15 and this behemoth is about 50 bucks, so a free PDF, it’s hard to argue with that. With no further ado, my conversation with Ray Dalio.
My extra special guest this week is Ray Dalio, founder of Bridgewater Associates. Out of his apartment over 40 years ago he is presently co-chairman and co-CIO of the firm which manages $160 billion in assets. Bridgewater perhaps has made more money for clients than any other hedge fund in history. Rather than waste a lot of time with the introduction, I just want to say Ray Dalio, welcome back to Bloomberg.
RAY DALIO, FOUNDER, BRIDGEWATER ASSOCIATES: Thanks for having me back.
RITHOLTZ: Before we get to the new book, last year you were here right after “Principles” came out and knowing how you look at the world as a giant experimental learning opportunity, what did you learn on the tour to promote the book?
DALIO: I was I was surprised at how curious and interactive people were. I went on social media and that’s a place that I thought I’d never go on and I’ve thought probably was a snarky place.
RITHOLTZ: A little, tacky.
DALIO: It hasn’t been for me, you know, there are a lot of curious people out there who you get to learn and good people, I’m having great conversations with them back and forth, take a little bit of time to do it and so I was most surprised about those things.
RITHOLTZ: You embraced this part of your process both radical transparency and a pure meritocracy, if someone has a good idea, it doesn’t matter where comes from.
DALIO: Well, the markets teach you humility, you know, you are never 100 percent sure of being right in any way and so that what that taught me is that I love to have my views challenged. And so to learn the art of thoughtful disagreement, that’s not a fight, it’s a curiosity experience.
RITHOLTZ: That’s a great phrase, the art of thoughtful disagreement. So now you write a second book, I have to ask, you go 60 years without ever writing a book and you put out two really, this is a really substantive book in three years, what is the hurry? What’s the rush to get all this writing done so quickly?
DALIO: Well like my other book a lot of principles that I had in this book were written over a long period of time, a lot of the research and then I was asked by a number of policymakers and others to write this book on — for the 10th anniversary of the financial crisis because they said that there is no book that you can go to that really gives the lessons that happen over and over again.
In other words, we are going to focus a lot on the 2008 financial crisis and that’s good, but it’s like looking at one case of a disease. If you really want to understand that how the disease transpires, you have to see much pretty much them all and then understand how they work on average and how they deviate and that was the purpose of the book. So the timing was a big thing and then a shove from other people.
RITHOLTZ: You don’t want to get too lost in the weeds on any one particular financial disaster, what we’re trying to find is the consistent thread, the best ways to respond to them, the best ways to manage them and even heaven forbid, possibly avoiding them in the future. A fair statement?
DALIO: Yes, well, let me give you an example, in this particular financial crisis, a lot hinged on bank capital. In other words, how do you rectify bank capital.
RITHOLTZ: Liquidity and how much capital…
DALIO: Liquidity is different from capital but some of the words basically capital is on your income statement, what your balance sheet look like, okay? Are you out of money? Then you get shut down.
RITHOLTZ: Okay.
DALIO: Liquidity is the money that comes in, you can have no bank capital and plenty of liquidity and be fine. If they don’t have mark-to-market accounting. So like my going through the 1982 crisis, which and by most measures was up severe or comparable severity in terms of that, one of the big differences was they didn’t have mark-to-market accounting. So because they didn’t have mark-to-market accounting, the solvency issue wasn’t as big a deal because they didn’t account for it as being insolvent, where the liquidity issue was.
So my point is that when you go from one to the other, you start to understand what levers and what patches, so the whole notion is look at the one on average, what’s the typical one? And then look at the deviations and see what causes them and then you understand how these things work and that’s what the book’s about.
RITHOLTZ: So when we look at the ’08 – ’09 crisis, we see most of the banks had a lot of capital but they also had a ton of assets leveraged on top of that capital, how significant is that leverage ratio of capital to additional leveraged assets?
DALIO: Well, it tells you how much of a downward movement in the assets you can tag, right? If it’s a bank, it’s leveraged 10 to 1 and the average assets go down 10%, you’re out of money.
RITHOLTZ: Right.
DALIO: That is the accounting. And if you don’t account for that like in 1982, that period of time, you don’t count for that exactly that way you treat them differently, then you’re really dealing with a liquidity case.
But these things happen over and over again, the same basic structure happens over and over again, and I thought it was really, really important to have a book that shows what that classic disease is like, how it works, one thing leads to another in a certain way and then to show all of the cases, so it shows all 48 cases of bad debt crises over the last 100 years and you can go into them, see them one by one, and that it takes you through three classic ones in detail. It takes you through them pretty much almost day by day so you can viscerally feel what they were like and you could almost imagine what you would do on that day.
It starts with – and does it in a sequential order, so in the 1920s, the inflationary depression of Germany’s Weimar Republic, and the reason I put that in is because depressions can be inflationary or deflationary and in order to understand what makes the difference, what makes them inflationary versus deflationary, wanted to put that in, the sequence is similar, then we go that’s the end of World War I and the period in between, that’s interesting, and then we go to at the after World War I, we have the 20s and with that we had the set up for the 1930s Great Depression.
RITHOLTZ: I love the way you structured this. Three segments, one is the arch typical debt cycle, the next is some detailed case studies and you look to the Great Depression, you look to the Weimar Republic, you look at ’08 – ’09 and then you come up with 48 additional case studies, each of these are a different volume in what effectively is a three volume set.
Tell us the thinking about this in and tell us about the feedback you’ve gotten from people who had to manage the ’08 – ’09 crisis?
DALIO: Well I believe the same things happen over and over again and it’s like a disease, if you don’t watch all the cases, you won’t understand them.
RITHOLTZ: It’s kind of like doctors in emergency room, they do a 24 hour shift just so they can see the disease run its full course over and over again.
DALIO: Over and over again, right? And then you make the connections, you know how these things work. Because they are classic, they all happen basically in the same way. So that’s what, that’s why I put all of those case studies in there as a backdrop and then I put the template, the template is just 60 pages, you read it and you get the template.
People, Ben Bernanke said “Ray Dalio’s book is a must read for anyone who aspires to prevent or manage the next financial crisis.” Larry Summers said “A terrific piece of work by one of the world’s top investors who has devoted his life to understanding markets and demonstrating that understanding by navigating the 2008 financial crisis.” Tim Geithner said “It’s an outstanding history of the financial crisis including the devastating crisis of 2008.”
RITHOLTZ: That is an amazing list of people who were actually, actually there and running this and Hank Paulson is another person who had some comments.
(Crosstalk)
DALIO: I think it’s – think it’s accurate and the most important thing isn’t the book, the most important thing that I’m really trying to get at is the mechanics of the disease as described here because if we can just understand and agree on the mechanics of these things, we make a giant leap forward. A lot of the mechanics are not agreed to, and they are not studied, they don’t look at cases. For example, at the time, there was a lot of argument that printing money would bring back a wave if inflation.
RITHOLTZ: Hyperinflation, yes.
DALIO: Right, but…
RITHOLTZ: Which showed a fundamental misunderstanding of what …
(Crosstalk)
DALIO: Showed a fundamental misunderstanding because when more money comes into the system at the same time as credit is contracting, the of actual amount of purchasing power is not rising, and so what causes inflation is when more money is spent than goods and services are produced, okay? And what’s happening at these times is that money creation is making up for the contraction in credit.
RITHOLTZ: So you’re jumping ahead to the beautiful deleveraging, let’s go through the six steps as you outlined in the book and just a quick overview, the early part of the cycle, the bubble, the top, the depression, the beautiful deleveraging, the pushing on a string and then normalization, did I get that more or less right?
DALIO: That’s right and in basically most cycles work the same way but there’s when you hit a zero interest rate, then you have the big one.
RITHOLTZ: Right.
DALIO: Okay, so what happens is in the early part of the cycle, the amount of lending that takes place produces a cash flow which is greater than the debt service payments on that, so that’s a virtuous lending because credit gives buying power.
RITHOLTZ: Sure.
DALIO: And depending on how you’re using that buying power for using it to create income that’s greater than the debt service payments is a self reinforcing positive cycle, that normally happens in the early part of the cycle.
Then it pushes asset prices up and what happens is that people start to extrapolate those things going forward. So as the debts continue to rise and they believe this is going to go higher and higher…
RITHOLTZ: Forever.
DALIO: In other words, the belief in the miracle of the new thing.
RITHOLTZ: Right.
DALIO: It may be the miracle of the new Amazon or the Tesla or – it’s the nifty 50 another years in other words, that other world, and that there is not a careful calculation in terms of what could be paid back, we start to get into the bubble stage. The bubble stage is also accompanied by the development of shadow banking.
RITHOLTZ: Is that consistent always?
DALIO: Always.
RITHOLTZ: We saw shadow banking very much in ’08 – ’09, I was not aware until I plowed through this that there was a shadow banking system in the Great Depression, there was a shadow banking system repeatedly throughout history.
DALIO: Repeatedly throughout history. The way it works is the banks are regulated and they are controlled and they are safe and they are overseen, but there are innovations that come outside of the banking system. There’s a shadow banking system now, you know, in other words it – private lending that takes place outside of the banking system in various ways and it’s not regulated. And there is an incentive to go outside the banking system because the banking system being regulated and being controlled can’t make as much money as going outside the banking system.
RITHOLTZ: Safer, but capped.
DALIO: Safer but capped. Right. Watched over, but not necessarily totally safe.
But you always have the going out to that and you always have the development of new vehicles, always new vehicles, and they grow in a very fast way, it doesn’t mean they’re not healthy, but they grow in a very fast way and you see a growth in that in lending that becomes an unsustainable growth rate that feeds on itself because the middlemen make money on making these kinds of loans.
RITHOLTZ: Sure.
DALIO: Those who are buying them have them go up and in value and everybody is happy. At that point, what we always try to do is do the pro forma financial statements, in other words, how much cash is going to come in and come and you don’t have – you have a problem. And so you see…
(Crosstalk)
RITHOLTZ: And so the lending exceed the ability to service the debt.
DALIO: That is right.
And in addition, you come to the late part of the cycle, you know, when there’s not much capacity to grow as fast but the markets continue to discount a fast growth rate. The funny thing about markets is that they discount what they’ve experienced more than what’s likely. Like you would imagine when an economy is really depressed that by and large that they would discount that it would pick up because it’s at the low part of cycle or when you’re running into the late part of the cycle they would say it can’t sustain that particular growth rate and they certainly can’t sustain that growth rate on a lot of debt, but yet, they are priced to discount that.
And so the irony is asset prices are higher, there’s much more leverage in the system, and so why would asset prices be higher or credit spreads be lower when there’s a lot more leverage and the price of everything is higher? It doesn’t make sense but that’s where the bubble is. These are the good times, these are the great times it seems. Right?
RITHOLTZ: So then you get the top and then bang the next stop is depression.
DALIO: Well most typically then the top, the top usually comes through a combination of a tightening of monetary policy because you’re later in the cycle.
RITHOLTZ: Are the central bankers historically always late to the party, is there anything they could do to sort of slow it down in real-time or as history shown they always are out of step?
DALIO: History has shown that they are pretty much always allowing the rate of growth to be faster than the rate of capacity to produce, and so we see a shrinking labor force, excess labor, we see a shrinking utilization of excess utilization capacity, you see those types of things, that the put on the brakes enough – ahead of the capacity limitations, you know, hardly ever takes place. They can’t – they don’t get it right and that’s partially related to this economy but it’s also partially related to the asset prices.
The asset prices go first before the economy goes.
RITHOLTZ: Right.
DALIO: So private equity competes with public equity and everything and so like in this cycle, you have seen those asset prices go down and projected returns of all those asset prices go lower. You see the duration of the asset’s length and duration means also price sensitivity placing. More sensitive than the…
(Crosstalk)
RITHOLTZ: To the removing of…
(Crosstalk)
DALIO: The interest rates.
RITHOLTZ: Okay.
DALIO: So the interest rate, so (LLS) become more sensitive and then what happens is classically you have enough of a tightening to create the crack that usually also happens when the cash flow is not in – not positioned because there is too much debt relative to the cash flow and it starts in the periphery of the credit markets, and then it works itself down through that. So…
(Crosstalk)
RITHOLTZ: Are you suggesting it starts in the shadow banking market in and works its way into the mainstream? So you get to…
(Crosstalk)
RITHOLTZ: So what we saw in ’08 – ’09 these non-bank lenders, the model was underwrite mortgages to sell to securitizers, they started going belly up in pretty big numbers in ’06 – ’07 long before you saw any problems with the big banks.
DALIO: That’s typical of all these cycles because at the periphery, there’s more aggressive lending, it’s unregulated, the leverage – think about the investment banks being more leveraged than the traditional banks by way of example, traditional banks are all part of the party, I mean it’s the same thing.
RITHOLTZ: Post Glass-Steagall now, everybody’s in the same hot tub together.
DALIO: Yes, all of these cycles, the upward cycle is self reinforcing…
RITHOLTZ: So let’s get to the – I want to jump to the beautiful deleveraging which is your phrase which I’ve always found to be somewhat of a romantic phrase about something that’s a fairly dry economic process. Tell us about the beautiful deleveraging post ’08 – ’09 and in previous cycles?
DALIO: Well in a normal cycle, when you have the downward move to get it moving on the positive side to get the good cycle going, you lower interest rates enough so that the present value discount rate for asset prices goes up, you make it cheaper to have new borrowing because the monthly payments are less because the interest rate is less, you and you make everybody richer and that is how the cycle goes.
RITHOLTZ: And that seem to have happened post ’08 – ’09.
DALIO: Yes it happens in all these cycles, that is the normal way to happen, the – what’s different of about the ’08 – ’09 which is the same as the 1929 to ’32 period is interest rates at zero, when interest rates hit zero, the game changes, okay? Because monetary policy cannot operate that way.
And so two times that century, that happened, and that’s when…
RITHOLTZ: 20th-century or…
DALIO: 20th century, that’s the time it happened. And then what that means is that the game changes and the game then has to be that you print money and you buy financial assets, central banks got to do.
RITHOLTZ: ZIRP and Q.E.
DALIO: Yes, and they do that all over the world and in that since then they built – they bought about $16 trillion – central banks have bought about $16 trillion, put about $16 trillion of liquidity out in the system in financial markets and that causes financial markets to go up and produces plenty of liquidity. In that crisis, they also guaranteed about two thirds of all of the debt in the United States.
RITHOLTZ: That’s just an astonishing figure. You have been using 1937 as the parallel for today, 19 37 was kind of scary time in history, it was before the rise of Nazism, it was before World War II, a lot of bad things were going on in 1937, why do you draw that parallel?
DALIO: Well I think things happening, there is a list of things happening. In 1932 — 1929 to 1932, as in 2008 and to 2009, there was a debt crisis and that when interest rates hit zero and central banks had to print a lot of money to buy a lot of financial assets which produced big rallies in the stock market and a big pickup in economic activity. And in 1937, the Federal Reserve started to tighten monetary policy a lot and there was an interest rate sensitivity associated with that.
RITHOLTZ: Was it premature in 1937?
DALIO: It’s not so much premature as much as highly impactful, in my opinion, maybe a bit of both, but the point at that time is that in doing that, that contributed to the wealth gap because financial assets are owned by people who held financial…
RITHOLTZ: Wealthier people, sure.
DALIO: And poor people don’t have that and it produced a wealth gap in which like now the top 1/10th of one percent of the population, net wealth is equal to the bottom 90% combined. So there is a giant wealth gap. And at that time, there’s tension between the left and the right and this is true in all countries around the world, and so we have the emergence of populism.
Now four countries decided to go from democracies to dictatorships, that happened in Italy first and then it happened in Germany, it happened in Japan, and happen in Spain, and that that tension produce tension inside the country and tension outside the country and it produced a certain type of leader which was a populist leader. So we have populism, in other words a gap there that I think is a very important to understand. Politics now is more important than at any time in my lifetime and I’ve been doing this for 50 years.
RITHOLTZ: So what are we seeing in today’s world of politics between the rise of Trumpism and what we’ve seen in the Philippines and Britain and Brexit, are you saying hey world post crisis is now dealing with a very similar 1937 form of populism and leading to dictatorship?
DALIO: Yes, populism is when a strong individual is brought in by a segment — a disenfranchised segment of the population, partially because of economics, partially because of sense that their culture is being threatened. And that they are – it’s anti-elites and it is nationalistic, it is protectionistic, and is militaristic and the populist has a fighter mentality. So that’s what populism is.
RITHOLTZ: That’s every financial crisis, it’s the same thing.
DALIO: Well in the big ones, in the big ones, you tend to get that polarity. So we have a situation that’s like that, I think everybody would agree that the nature of the situation is like that. It is producing more domestic conflict around that, the right becomes more right and the left becomes more left and then also more international conflict.
Another key element here in the 30s which we’re not used to is that all you have a rise of a country to existing power to have challenged the exist – the existing power, rise of a new country, China…
RITHOLTZ: So that was Japan versus the Europeans of Japan versus the US in the 30s?
DALIO: Japan versus the European powers that had colonies in the Pacific area, a lot of them had colonies then and the United States had interest there where they were competing for natural resources.
And so when Japan then had its economic problems and wanted to grow it needed resources beyond Japan because Japan had very limited resources. And so it goes into takes over Manchuria in northern China, there is that competition, so now we’re worried about resources and we start to put in you know blockades and things.
And then when World War II begins to break out really 1939 so we have the same phenomena happening in Europe where the rising power was Germany, that it was hobbled at the end of World War I, hobbled and humiliated and as a result of that, it became stronger and became strong relative to the existing powers and that was particularly the UK and France. And as a result, we had that conflict, that type of conflict. And over the period of time, it first started economically, like in Japan, they – we would put sanctions in place and eventually when it go more serious, then Japan took advantage of that because they couldn’t – those colonies couldn’t defend themselves in Asia.
RITHOLTZ: Right.
DALIO: And so they invaded those areas and so expanding to also get materials, rubbers and things like that, and then we had then embargo their assets and then eventually we embargo their oil and that led to Pearl Harbor in1941. So ’39 was war in Europe and ’41 was Pearl Harbor and the beginning of that.
I’m not saying we’re going down that path along those lines but I’m saying it’s a key points, okay, first you’re later in a short-term debt cycle, so there are two debt cycles I’m referring to, one is a short-term debt cycle, I think we are acquainted with that, that is a business cycle, you have recessions, economy grows because the stimulations, you run out of capacity, central bank tightens monetary policy, markets start to decline and the economy declines and then you have recession and you do that over and over again, those things are usually maybe 10 years in that vicinity, a little less.
Then you have a long-term debt cycle and the long-term debt cycle is the accumulation of those short-term debt cycle but it kind of reaches its end when first interest rates hit zero because you can’t puff things up with interest rate declines anymore.
And then you have Q.E. which is then the purchase of those assets to cause those apps at prices to rise a lot and with those asset prices rising a lot, you can from that point have the same impact.
I want to emphasize…
RITHOLTZ: That’s the pushing on the string..
DALIO: That is the pushing on a string phase.
RITHOLTZ: Which is a wonderful metaphor you try and do something and nothing happens, you push on, it doesn’t…
(Crosstalk)
DALIO: Go into the system.
RITHOLTZ: Right.
DALIO: Yes. And so on just let’s take a moment here and realize that we have a system in which demand is produced by credit and that most people are long. In other words, and they are leverage long.
RITHOLTZ: So the balance that you’re looking for a healthy economy to obtain is sufficient credit consumption so that consumers are out buying, businesses are expanding, but not such reckless issuance of credit that things go haywire when you get the bubble and then debt cycle that leads to a giant collapse.
DALIO: Yes.
RITHOLTZ: How do you get that balance?
DALIO: Well, is debt rising faster than the income to service? That’s a bad sign. Maybe a lead lad but at the end of the day, it has to rise there. So that you have debt being – debt service payments growing faster than the actual, excuse me, the income growing faster than the debt service payments, so you are going to need that.
RITHOLTZ: Income growing faster than you could service that…
(Crosstalk)
DALIO: That is a viable. That’s good…
(Crosstalk)
RITHOLTZ: That’s a growth economy.
DALIO: That is good economy. That’s the way the capital markets should work, so when you have that growing faster than the debt service payments that’s unsustainable and at some point that stops and you lose that demand, so that’s point one. Point two is what is the power of the central bank to keep that thing going to – in other words, repair that situation, by lowering interest rates or buying assets to produce liquidity in the system to build it up because a debt is a promise to deliver cash. And when they put money into the system, it makes it easier to service that debt and lowers interest rates, causes asset prices, so what is the capacity of the central bank?
When we get into serious problems, really serious problems, we have a situation in which we can’t service that debt and we are in a situation where the central bank policies aren’t – are not as powerful because either interest rates are close to zero or the power of quantitative easing has largely been used up because that balloon has been expanded and also what you can buy is limited.
So that’s when you’re out more at the end of the longer-term that cycle.
RITHOLTZ: I want to ask you about the current circumstances, can you stick around a little bit?
DALIO: Sure.
RITHOLTZ: We have a ton more questions.
We’ve been speaking with Ray Dalio. If you enjoyed this conversation, be sure and check out the podcast extras where we keep the tape rolling and continue discussing all things debt crisis. You can find that at Apple iTunes, Bloomberg.com, Stitcher, Overcast, wherever your finer podcasts are sold. We love your comments, feedback and suggestions, write to us at MIBPodcast@Bloomberg.net. Check out my daily column at Bloomberg.com/opinion, you could follow me on Twitter @Ritholtz.
You could follow Ray on Twitter @RayDalio. I’m Barry Ritholtz, you’re listening to Masters in Business on Bloomberg Radio.
Welcome to the podcast. Ray, thank you so much for doing this, I’ve been looking forward to following up with you since our last conversation and I have so many questions we did not get to before we move away from big debt crises. I just have to ask you here it is, it’s 2018, has anybody learned anything about financial crises? Do you think we’re better prepared next time or are we going to continue to make the exact same mistakes over and over again?
We’ve learned some things but not enough things, I think people are more cautious, the cash is higher on the lending is different I think the banks have more capital, those things are good, I think we also, I think may put some regulations in place that limit the policymakers’ flexibilities to be able to deal with things. I think every crisis is a bit different and you can’t write the rules so precisely that you can deal with it. Anyway I don’t think we’ve materially changed those things. If I’m looking forward, I would say when we do our financial numbers pro forma, generally speaking, there is much less of a bubble around back in 2007 when we did those numbers, we could see that a lot of that problems and a debt crisis was going to come.
RITHOLTZ: So how do you contextualize something like the student debt crisis which is at all-time highs or is that not the sort of bubble that leads to a systemic issue?
DALIO: Well, what we do is we look at each of the different types, there are parts here that look like bubbles to us and the question is what is the – how big are they and what are the contagions?
And so you put..
RITHOLTZ: You are so methodical, you really you bring an engineer’s approach to this, it’s the economic machine what you’ve described previously, but even when looking at a specific type of debt, you want to know exactly how problematic it is and is it something that’s contained within its own silo, or does it have the ability to infect the whole system?
DALIO: Well, you need to do that, and not just the you know you have to be granular as well as big picture, so yeah, that’s what we do. And so when we go there, I think the biggest risks that we see are on the corporate debt market has increased a lot, there has been a lot of funding to private equity firms and so on.
RITHOLTZ: Is that a good thing or a bad thing?
DALIO: Well funding is good, it depends on whether that debt is producing the cash flows and so on. If you have a decline in earnings which would come from the next recession, a fair amount of that debt will be stress-tested and there will be issues pertaining to that. And then the other particular imbalance that we see is the amount of sales that the US treasury is going to have to make and so when we look about what those numbers will be, particularly after the stimulus starts to taper off, we have a big one time stimulus particularly…
RITHOLTZ: The tax cuts.
DALIO: And particularly the corporate tax cuts and that will have a fading impact at the same time as the budget deficit hence the sales of bonds will increase at the same time as the balance sheet is being contracted. When I do the calculations of who are the buyers of that and what are their quantities? I see an imbalance in that. And so that is a form of problems that are existing.
RITHOLTZ: So three types of debt, you have household, you have corporate and you have government, where is the biggest problem?
DALIO: Government and — the government debt and the corporate debt are the biggest problems.
RITHOLTZ: So let me push back on you on that.
DALIO: And please do. And what I’m saying is not in total, okay, but government by and large in total, but corporates not in total but existing in certain pockets.
RITHOLTZ: Okay, that was going to be the pushback because there seems to be a whole lot of corporate debt, some of which seems to be with good companies with good cash flows and a strong ability to service that debt, A rated, and then, I don’t know, let’s call it the bottom 30 percent who are issuing a lot of debt that’s kind of junkie and of dubious serviceability in the future, or am I just being too negative?
DALIO: No, I think you’re pretty accurate on that. In other words if you did triple B or double B debt, and if you look that leverage loans and…
RITHOLTZ: Which has become huge the past five years.
DALIO: That’s right, and to finance also acquisitions, a lot of private equity acquisitions and so on, and you looked at the collateralized loan obligation mark, the CLO mark in terms of those things, there are some vulnerabilities that exist there in terms of if incomes go down and they are fairly covenant like, they’re very covenant like.
And so and the big growth in debt in this cycle has been the corporate debt to because when interest rates were lowered to a level that was below the return on equity, it paid to have buybacks or to make acquisitions or them to go out there and have a private equity because I get a higher return on my equity so it’s a great financial.
RITHOLTZ: That’s what you do with free money, you take it and you put it to where it’s going to generate the highest return.
DALIO: That’s right.
And so on a lot of that, that’s where the big growth is. Two things about that is that can’t continue, first of all, at that pace.
RITHOLTZ: Right.
DALIO: Okay? So on that that prop under the market will be disappearing and then you get leverage up to certain point, you can’t extrapolate that, but then in addition to that, you know through experiences that there are some that you could see are going to be problems when earnings get hurt, and then there were some that you can’t see because you haven’t stress tested whether that was done well with good asset liability matches. you know for example number of multinational companies bought companies in other countries, and they finance that with dollar-denominated debt.
RITHOLTZ: Right.
DALIO: And when the dollar goes up and the incomes that they’re receiving is in local currency, you have an asset liability mismatch.
RITHOLTZ: Right.
DALIO: So there are a lot of asset liability mismatches that are out there that we sort of worry about, those are the particular spots I would say that look vulnerable, nothing like it looked to us back in 2007, but then if you go a little bit longer and you take the movement, we also have non-funded — non-debt liabilities in the form of pension liabilities and healthcare liabilities.
RITHOLTZ: Both of which wildly underfunded.
DALIO: That are going to come, I mean we’re going to – a lot of promises, promises either would be paid back in the form of debt or promises to have money to pay pensions and all and then Medicare, that that all becomes limited, not all that produces a greater squeeze.
So it doesn’t look as big like a big bang type of thing. My concern has to do with the fact that it is coming at the same time as there is populism and the political because we’re really right now at each other’s throats, the left, the right, the have…
RITHOLTZ: I want to push back on that also but before I do that, I just have to come back to the corporate debt. What you’re describing is sort of an echo boom following the original bubble and crash. Is that echo boom historically consistent? Does that always seem to happen after a debt crisis and collapsed, do you always get – hey, things start to repair and he we go again or is this kind a unique to…
DALIO: Well, you always go through the cycle and so when you’re – when we are in a position where we’re nine years into the expansion and central banks have bought $15 trillion, $16 trillion worth of assets and made that cheap, you then mechanistically have what you are calling an echo boom, you have that big boom that has taken place.
RITHOLTZ: And that always happens.
DALIO: That always happens. So that’s why you always have cycles, you know?
RITHOLTZ: And that’s why you come back to 1937 between the politics, it’s 10 years after, that’s 20 years – almost 10 years that it’s been going on…
(Crosstalk)
DALIO: So we’re late in the short-term cycle, relatively late, although I would say we got – we’re probably in the seventh-inning of the short-term cycle, the business cycle, we’re late in the long term cycle meaning the amount of ammunition is less. These are facts, in other words, the interest rate, the Q.E. thing…
RITHOLTZ: Right.
DALIO: And we do have a lot of populism and clashes about wealth and culture and those things internally much more than we did and we’re at the top or right near the top of the cycle and the markets and so on. So you can imagine that things would turn down and when things turn down, my big worry about that following these cycles is that political conflict, social conflict worsens because times get worse for everybody. And that’s an issue so how do the politics play out, how are we with each other? Can we approach that together or not and then of course then there’s the power of the central bank to be helping us which is less.
RITHOLTZ: So let me do the little bit of pushback and you know we kind of all exist in a media world, in a social network world, but when we see the studies that talk to Americans about a lot of hot button issues, once you get away from the crazy rhetoric and the divisiveness, we kind of all more or less have 60 percent, 70 percent, 80 percent agreement on some big issues.
We all agree that there should be less abortions if there’s a way to make that happen, we could disagree about whether or not it should be mandatory but there is some agreement there, there is some agreement about some pretty common sense gun control laws. There is some agreement about pollution and climate change. There’s a small group of people who don’t believe it’s man-made and there is a small group of people who don’t believe in smallpox vaccination, but by and large, most of America thinks it’s a bad idea to spew chemical exhaust into the atmosphere that we all have breath.
So taking what you’ve learned when you put these principles of debt crisis together, how can we get people outside of Twitter and Facebook to focus on what we have in common, hey we’re all Americans, we all share a certain common belief system, how come we don’t focus on what brings us together as opposed to what divides us?
DALIO: Well, first of all I would disagree with – I think we have a higher level of conflict that created a conflict gauge, the conflict gauge consist of a lot of different measures of conflicts…
(Crosstalk)
RITHOLTZ: Go over that, I was kind of leaning in that direction.
DALIO: Okay but it would be the polarity within the two political systems, the percentage of those who are adamantly in favor of their candidate versus adamantly opposed to the other candidate.
RITHOLTZ: Locker up. That sort of craziness.
DALIO: It would be that there’s a whole bunch of political things like compromises in the bills that are there, a whole bunch of those types of political things. There are social value measures and in other words, lots of indicators of what the parties think of the other side which is antagonistic, almost to the port point of being violent in terms of measuring what one side is listening to the other side.
And if you use, if you Google the word, the Google cap the word war as distinct from the word peace or compromise and so on, all of those measures, I could rattle on a lot. Big differences in beliefs. Okay? Big difference – one of the things that used to bind us more together was certain – religious produced certain common beliefs, the Judeo-Christian kind of system, the appreciation for the immigrant, these were things in other words where diversity was really the main sort of takes – anyway, I could rattle off those, so we created an index and the index of conflict which is just these measures bottled up shows that the conflict gauge is both within the country and within most countries is greater than it was a since the 30s and also between countries.
(Crosstalk)
RITHOLTZ: Where do you attribute that to? Is it just the nature of the debt cycle? Can we blame – can you blame, I don’t know, social media, Fox News, Nancy Pelosi, Donald Trump? Who gets the blame for that? Or is this just what happens when you have a big debt crisis.
DALIO: I think it happens over and over again because of that disenfranchised and also I don’t think they have much contact, I mean it’s totally understandable I think in the sense that capitalism right now is not working for the majority of Americans and I’m a hard-core capitalist I wish I could, but if you take the bottom 60%, I did a study of carving out what is it like the bottom 60% because I want to look at the majority.
Those conditions are bad, there hasn’t been income growth there…
RITHOLTZ: 30 years, right? On the real basis.
DALIO: That’s right. There’s rising debt, there’s rising death rates, there are death rates from opiates, death rates by — from suicide…
RITHOLTZ: Suicide.
DALIO: And so on and those conditions.
RITHOLTZ: Less economic mobility, there is a whole gamut.
DALIO: We used to have a middle class that was on the assembly line and the kind of work so we have a greater economic polarity, you have, so there’s a disenfranchised group out there that’s important. We’re also – we don’t have that same sort of contact with each other. You know, I live in Greenwich Connecticut in Greenwich so I think so exemplifies this. And I – we live in Fairfield County, Greenwich, Connecticut, it’s I think, still the wealthiest state in the United States, anyway, right up there. In that state there is one County that is rich and the rest of the state pretty much is poor and it’s going in terrible situation. My wife…
RITHOLTZ: She does the work with the disengaged kids, the students who basically they are just kind of coasting through school and not doing anything.
DALIO: Yes, thank you for remembering, yes, it’s – theirs is disengaged and there is disconnected. And the disengaged are the kids who attend school but he doesn’t study, doesn’t take tests, or he fails and that kind, he is sort of getting through.
And then there’s disconnected which means they don’t know where they are, they are no longer coming to the schools district, 22 percent of the high school students are one of those, those kids are going to be — 22 percent, those kids are going to be on the street, they are going to be, there’s a uselessness, they have to share books literally, I mean in some cases sharing pencils, they literally …
RITHOLTZ: What can you do to change that sounds like a broken system both on the educational level and the family level. How can you possibly fix that?
DALIO: Well these are – I’m still answering the last question on the division.
RITHOLTZ: Right.
DALIO: And that division and most people don’t even have contact with it like I wouldn’t have contact if it wasn’t for my wife taking me there and the – and they are 25 miles up the road…
(Crosstalk)
DALIO: …get and then you go to Bridgeport, or you go to Hartford and you look at what the daily shootings are, killings in this place, Hartford, Connecticut, used to be the…
RITHOLTZ: Insurance capital.
DALIO: Yes, and a very fine place to be. So there is this polarity, we’re talking about the reasons for the polarity, there’s a lot of reasons, I think to answer your question, what you need is to recognize that that’s a national emergency. In other words, the capitalism is going to work for the majority of the people first of all, let’s recognize that, let’s — and let’s establish what that polar metrics around that.
RITHOLTZ: You have always been such a private individual most of you career, you’re not a big, in the past, when the books came out, you started doing a little more media, this sounds like politics, I can’t imagine any interest in running for office or are you the…
DALIO: I can’t imagine it…
(Crosstalk)
RITHOLTZ: Right?
(Crosstalk)
RITHOLTZ: Now, some guy who sits about 40 feet from where we’re having a conversation has been talking about running in 2020, do you think the sort of technocratic approach, the engineered approach that Bridgewater uses or Mike Bloomberg who is the owner of Bloomberg LP where we’re sitting right now, do you think that approach can help solve some of these issues? And I was not planning on making a political commercial, I’m sincerely asking a question, these have been very, very challenging problems for generations, nobody seems to have figured out how to fix that.
DALIO: Well I think big progress can be made first, let’s acknowledge it, let’s measure it, put the statistics, let’s use those measurements as metrics, in other words to own it. So that now you say if I change that number, I’m doing a good job of I’m not changing that number, and then let’s bring about the various peoples and parties — on various parties of people most importantly who are experts, who deal in those communities and understand them and make changes because I think there are a lot of things that can be done.
In my philanthropic efforts and I think probably in Mike’s philanthropic efforts.
RITHOLTZ: You guys just did something with the Ocean X, it’s a $200 million investment to help focus on keeping the oceans cleaner and resolving some issues there.
DALIO: That is right. And I think people we’re also dealing with that population and we see all the time, great return on investment type of things that could be done and you just cannot imagine how the payoff can’t be great on those types of things.
RITHOLTZ: Right.
DALIO: I think you could put together public-private partnerships and that could be corporations or philanthropists together with the government to do high return on investment. I could rattle off a bunch of these types of things that would help to eliminate. In other words things that pay for themselves.
DALIO: Right.
RITHOLTZ: Think about you know the cost of getting — not getting through high school and not getting a job in the individuals lifetime…
DALIO: It’s going to be a societal drag forever…
(Crosstalk)
DALIO: It’s about $1 million per person.
RITHOLTZ: Really? Wow. That means everything from police to courts to jails and beyond.
DALIO: That’s right. Incarceration is between $80,000 and $120,000 a year is what happens and if you don’t have jobs and you’re in a community that way and like I support micro finance and for every dollar that I give to micro-finance, $12 is lent out to people in the first five years and it keeps on going…
(Crosstalk)
DALIO: Because they get paid back and so on…
(Crosstalk)
DALIO: If you look at the – I could go on and on in listing little those things, but somebody’s got to take it on, right? In other words and then the other thing is I think the important – most important thing is to believe that we’re – there is a country that we are in it together, okay? That we need to not fight about things but to debate, argue and then move on to compromises and to run the country for the whole.
We need to have thoughtful disagreement and principles for dealing with it. So you got me on a hot streak.
RITHOLTZ: Ray, you got my vote, so I’ll tell you that much, I wish…
(Crosstalk)
RITHOLTZ: I know you have to head out, promise me you will come back, I have a thousand more questions for you, I can talk to you for hours and hours. This is been absolutely delightful. Thank you for being so generous with your time.
DALIO: Thank you for having me. It’s always a delight.
RITHOLTZ: We have been speaking with Ray Dalio, cofounder of Bridgewater Associates.
If you enjoyed this conversation, well be sure and look up an inch or down an inch on Apple iTunes, Overcast, Stitcher, SoundCloud, Bloomberg.com, wherever your finer podcasts are sold.
I would be remiss if I did not thank the crack staff that puts this together each week. Madena Parwana is my audio engineer and producer extraordinaire Atika Valbrun is our project manager, Taylor Riggs is our Booker/Producer, Michael Batnick is my head of research.
I’m Barry Ritholtz, you’ve been listening to Masters in Business on Bloomberg Radio.
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