Just a Great Article

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rci2145's picture
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Just a Great Article

This is just a great interview of Ray Dalio who has made himself one of the richest men in the world through investing.  He called the economic meltdown in 2007 and unlike Peter Schiff, made a profit last year.  He rarely puts himself in the limelight so I hadn't heard of him until this interview but I think there is some really great stuff in it. He does not call our economic situation a recession, he says it will be a long D-process.


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Re: Just a Great Article

The link doesn't work anymore for non-subscribers so here is a link and paste.

Barron's Online  

Saturday, February 7, 2009


Recession? No, It's a D-process, and It Will Be Long

Ray Dalio, Chief Investment Officer, Bridgewater Associates

AN INTERVIEW WITH RAY DALIO: This pro sees a long and painful depression.

market crash than clients of Ray Dalio's Bridgewater Associates and
subscribers to its Daily Observations. Dalio, the chief investment
officer and all-around guiding light of the global money-management
company he founded more than 30 years ago, began sounding alarms in Barron's
in the spring of 2007 about the dangers of excessive financial
leverage. He counts among his clients world governments and central
banks, as well as pension funds and endowments.

Matthew Furman for Barron's
"The regulators have to decide how banks will operate. That means they are going to have to nationalize some in some form." -- Ray Dalio

No wonder. The Westport,
Conn.-based firm, whose analyses of world markets focus on credit and
currencies, has produced long-term annual returns, net of fees,
averaging 15%. In the turmoil of 2008, Bridgewater's Pure Alpha 1 fund
gained 8.7% net of fees and Pure Alpha 2 delivered 9.4%.

Here's what's on his mind now.

Barron's: I can't think of anyone who was
earlier in describing the deleveraging and deflationary process that
has been happening around the world.

Dalio: Let's call it a "D-process," which is
different than a recession, and the only reason that people really
don't understand this process is because it happens rarely. Everybody
should, at this point, try to understand the depression process by
reading about the Great Depression or the Latin American debt crisis or
the Japanese experience so that it becomes part of their frame of
reference. Most people didn't live through any of those experiences,
and what they have gotten used to is the recession dynamic, and so they
are quick to presume the recession dynamic. It is very clear to me that
we are in a D-process.

Why are you hesitant to emphasize either the words depression or deflation? Why call it a D-process?

Both of those words have connotations associated
with them that can confuse the fact that it is a process that people
should try to understand.

You can describe a recession as an economic
retraction which occurs when the Federal Reserve tightens monetary
policy normally to fight inflation. The cycle continues until the
economy weakens enough to bring down the inflation rate, at which time
the Federal Reserve eases monetary policy and produces an expansion. We
can make it more complicated, but that is a basic simple description of
what recessions are and what we have experienced through the post-World
War II period. What you also need is a comparable understanding of what
a D-process is and why it is different.

You have made the point that only by
understanding the process can you combat the problem. Are you confident
that we are doing what's essential to combat deflation and a depression?

The D-process is a disease of sorts that is going to run its course.

When I first started seeing the D-process and
describing it, it was before it actually started to play out this way.
But now you can ask yourself, OK, when was the last time bank stocks
went down so much? When was the last time the balance sheet of the
Federal Reserve, or any central bank, exploded like it has? When was
the last time interest rates went to zero, essentially, making monetary
policy as we know it ineffective? When was the last time we had

The answers to those questions all point to times
other than the U.S. post-World War II experience. This was the dynamic
that occurred in Japan in the '90s, that occurred in Latin America in
the '80s, and that occurred in the Great Depression in the '30s.

Basically what happens is that after a period of
time, economies go through a long-term debt cycle -- a dynamic that is
self-reinforcing, in which people finance their spending by borrowing
and debts rise relative to incomes and, more accurately, debt-service
payments rise relative to incomes. At cycle peaks, assets are bought on
leverage at high-enough prices that the cash flows they produce aren't
adequate to service the debt. The incomes aren't adequate to service
the debt. Then begins the reversal process, and that becomes
self-reinforcing, too. In the simplest sense, the country reaches the
point when it needs a debt restructuring. General Motors
is a metaphor for the United States.

As goes GM, so goes the nation?

The process of bankruptcy or restructuring is
necessary to its viability. One way or another, General Motors has to
be restructured so that it is a self-sustaining, economically viable
entity that people want to lend to again.

This has happened in Latin America regularly.
Emerging countries default, and then restructure. It is an essential
process to get them economically healthy.

We will go through a giant debt-restructuring,
because we either have to bring debt-service payments down so they are
low relative to incomes -- the cash flows that are being produced to
service them -- or we are going to have to raise incomes by printing a
lot of money.

It isn't complicated. It is the same as all
bankruptcies, but when it happens pervasively to a country, and the
country has a lot of foreign debt denominated in its own currency, it
is preferable to print money and devalue.

Isn't the process of restructuring under way in households and at corporations?

They are cutting costs to service the debt. But they
haven't yet done much restructuring. Last year, 2008, was the year of
price declines; 2009 and 2010 will be the years of bankruptcies and
restructurings. Loans will be written down and assets will be sold. It
will be a very difficult time. It is going to surprise a lot of people
because many people figure it is bad but still expect, as in all past
post-World War II periods, we will come out of it OK. A lot of
difficult questions will be asked of policy makers. The government
decision-making mechanism is going to be tested, because different
people will have different points of view about what should be done.

What are you suggesting?

An example is the Federal Reserve, which has always
been an autonomous institution with the freedom to act as it sees fit.
Rep. Barney Frank [a Massachusetts Democrat and chairman of the House
Financial Services Committee] is talking about examining the authority
of the Federal Reserve, and that raises the specter of the government
and Congress trying to run the Federal Reserve. Everybody will be
second-guessing everybody else.

So where do things stand in the process of restructuring?

What the Federal Reserve has done and what the
Treasury has done, by and large, is to take an existing debt and say
they will own it or lend against it. But they haven't said they are
going to write down the debt and cut debt payments each month. There
has been little in the way of debt relief yet. Very, very few actual
mortgages have been restructured. Very little corporate debt has been

The Federal Reserve, in particular, has done a
number of successful things. The Federal Reserve went out and bought or
lent against a lot of the debt. That has had the effect of reducing the
risk of that debt defaulting, so that is good in a sense. And because
the risk of default has gone down, it has forced the interest rate on
the debt to go down, and that is good, too.

However, the reason it hasn't actually produced
increased credit activity is because the debtors are still too indebted
and not able to properly service the debt. Only when those debts are
actually written down will we get to the point where we will have
credit growth. There is a mortgage debt piece that will need to be
restructured. There is a giant financial-sector piece -- banks and
investment banks and whatever is left of the financial sector -- that
will need to be restructured. There is a corporate piece that will need
to be restructured, and then there is a commercial-real-estate piece
that will need to be restructured.

Is a restructuring of the banks a starting point?

If you think that restructuring the banks is going
to get lending going again and you don't restructure the other pieces
-- the mortgage piece, the corporate piece, the real-estate piece --
you are wrong, because they need financially sound entities to lend to,
and that won't happen until there are restructurings.

On the issue of the banks, ultimately we need banks
because to produce credit we have to have banks. A lot of the banks
aren't going to have money, and yet we can't just let them go to
nothing; we have got to do something.

But the future of banking is going to be very, very
different. The regulators have to decide how banks will operate. That
means they will have to nationalize some in some form, but they are
going to also have to decide who they protect: the bondholders or the

Nationalization is the most likely outcome?

There will be substantial nationalization of banks.
It is going on now and it will continue. But the same question will be
asked even after nationalization: What will happen to the pile of bad

Let's say we are going to end up with the
good-bank/bad-bank concept. The government is going to put a lot of
money in -- say $100 billion -- and going to get all the garbage at a
leverage of, let's say, 10 to 1. They will have a trillion dollars, but
a trillion dollars' worth of garbage. They still aren't marking it
down. Does this give you comfort?

Then we have the remaining banks, many of which will
be broke. The government will have to recapitalize them. The government
will try to seek private money to go in with them, but I don't think
they are going to come up with a lot of private money, not nearly the
amount needed.

To the extent we are going to
have nationalized banks, we will still have the question of how those
banks behave. Does Congress say what they should do? Does Congress
demand they lend to bad borrowers? There is a reason they aren't
lending. So whose money is it, and who is protecting that money?

The biggest issue is that if you look at the
borrowers, you don't want to lend to them. The basic problem is that
the borrowers had too much debt when their incomes were higher and
their asset values were higher. Now net worths have gone down.


me give you an example. Roughly speaking, most of commercial real
estate and a good deal of private equity was bought on leverage of
3-to-1. Most of it is down by more than one-third, so therefore they
have negative net worth. Most of them couldn't service their debt when
the cash flows were up, and now the cash flows are a lot lower. If you
shouldn't have lent to them before, how can you possibly lend to them

I guess I'm thinking of the examples of people and businesses with solid credit records who can't get banks to lend to them.

Those examples exist, but they aren't, by and large,
the big picture. There are too many nonviable entities. Big pieces of
the economy have to become somehow more viable. This isn't primarily
about a lack of liquidity. There are certainly elements of that, but
this is basically a structural issue. The '30s were very similar to

By the way, in the bear market from 1929 to the
bottom, stocks declined 89%, with six rallies of returns of more than
20% -- and most of them produced renewed optimism. But what happened
was that the economy continued to weaken with the debt problem. The
Hoover administration had the equivalent of today's TARP [Troubled
Asset Relief Program] in the Reconstruction Finance Corp. The stimulus
program and tax cuts created more spending, and the budget deficit

At the same time, countries around the world
encountered a similar kind of thing. England went through then exactly
what it is going through now. Just as now, countries couldn't get
dollars because of the slowdown in exports, and there was a dollar
shortage, as there is now. Efforts were directed at rekindling lending.
But they did not rekindle lending. Eventually there were a lot of
bankruptcies, which extinguished debt.

In the U.S., a Democratic administration replaced a
Republican one and there was a major devaluation and reflation that
marked the bottom of the Depression in March 1933.

Where is the U.S. and the rest of the world going to keep getting money to pay for these stimulus packages?

The Federal Reserve is going to have to print money.
The deficits will be greater than the savings. So you will see the
Federal Reserve buy long-term Treasury bonds, as it did in the Great
Depression. We are in a position where that will eventually create a
problem for currencies and drive assets to gold.

Are you a fan of gold?


Have you always been?

No. Gold is horrible sometimes and great other
times. But like any other asset class, everybody always should have a
piece of it in their portfolio.

What about bonds? The conventional wisdom has it that bonds are the most overbought and most dangerous asset class right now.

Everything is timing. You print a lot of money, and
then you have currency devaluation. The currency devaluation happens
before bonds fall. Not much in the way of inflation is produced,
because what you are doing actually is negating deflation. So, the
first wave of currency depreciation will be very much like England in
1992, with its currency realignment, or the United States during the
Great Depression, when they printed money and devalued the dollar a
lot. Gold went up a whole lot and the bond market had a hiccup, and
then long-term rates continued to decline because people still needed
safety and liquidity. While the dollar is bad, it doesn't mean
necessarily that the bond market is bad.

I can easily imagine at some point I'm going to hate
bonds and want to be short bonds, but, for now, a portfolio that is a
mixture of Treasury bonds and gold is going to be a very good
portfolio, because I imagine gold could go up a whole lot and Treasury
bonds won't go down a whole lot, at first.

Ideally, creditor countries that don't have
dollar-debt problems are the place you want to be, like Japan. The
Japanese economy will do horribly, too, but they don't have the
problems that we have -- and they have surpluses. They can pull in
their assets from abroad, which will support their currency, because
they will want to become defensive. Other currencies will decline in
relationship to the yen and in relationship to gold.

And China?

Now we have the delicate China question. That is a complicated, touchy question.

The reasons for China to hold dollar-denominated
assets no longer exist, for the most part. However, the desire to have
a weaker currency is everybody's desire in terms of stimulus. China
recognizes that the exchange-rate peg is not as important as it was
before, because the idea was to make its goods competitive in the
world. Ultimately, they are going to have to go to a domestic-based
economy. But they own too much in the way of dollar-denominated assets
to get out, and it isn't clear exactly where they would go if they did
get out. But they don't have to buy more. They are not going to
continue to want to double down.

From the U.S. point of view, we want a devaluation.
A devaluation gets your pricing in line. When there is a deflationary
environment, you want your currency to go down. When you have a lot of
foreign debt denominated in your currency, you want to create relief by
having your currency go down. All major currency devaluations have
triggered stock-market rallies throughout the world; one of the best
ways to trigger a stock-market rally is to devalue your currency.

But there is a basic structural problem with China.
Its per capita income is less than 10% of ours. We have to get our
prices in line, and we are not going to do it by cutting our incomes to
a level of Chinese incomes.

And they are not going to do it by having their per
capita incomes coming in line with our per capita incomes. But they
have to come closer together. The Chinese currency and assets are too
cheap in dollar terms, so a devaluation of the dollar in relation to
China's currency is likely, and will be an important step to our
reflation and will make investments in China attractive.

You mentioned, too, that inflation is not as big a worry for you as it is for some. Could you elaborate?

A wave of currency devaluations and strong gold will
serve to negate deflationary pressures, bringing inflation to a low,
positive number rather than producing unacceptably high inflation --
and that will last for as far as I can see out, roughly about two years.

Given this outlook, what is your view on stocks?

Buying equities and taking on those risks in late
2009, or more likely 2010, will be a great move because equities will
be much cheaper than now. It is going to be a buying opportunity of the

Thanks, Ray.


Farmer Brown's picture
Farmer Brown
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Re: Just a Great Article

Thanks for the link - great article!

caroline_culbert's picture
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Re: Just a Great Article

Thank you.

ccpetersmd's picture
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Re: Just a Great Article

Great article post, thank you.  Much to digest, and now, I have to look up more about Ray Dalio!

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Re: Just a Great Article

And, to think I just played the children's version of Monopoly with my boys last night!


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Re: Just a Great Article

This excerpt is from page 5 of Ray Dalio's letter to his investors:

Along these lines, I am very pleased to say that I think that the top people on the Obama economic team are stars, and I have the utmost admiration for the way the Fed is now being managed.  So, I believe that the country has a team of great doctors working on a very serious disease that will eventually end and will inevitably leave the markets, the economy, and us on a more sound footing. Of course, that doesn’t mean that all people will eventually be OK.   As part of this evolutionary process, there will be great risks and opportunities that will  lead to the survival of the fttest.   As with all such evolutionary processes, this will eventually be great for the whole, though it will certainly be deadly for some.

It is intriguing, to say the least, as every other "guru" that I have read has nothing but negative things to say about what our government is currently doing.

I'm not sure what to make of this - what do you think?

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Re: Just a Great Article

He also does not see hyperinflation down the line with all the money printing either, just moderate inflation.  So I think his point of view is that this whole thing is just a process that was invevitable, not necessarily the government's fault. 

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Re: Just a Great Article



I wonder if he doesn't see hyperinflation down the line for the same reasons discussed in this article...


Steve Keen: "The Roving Cavaliers of Credit" (or Why Ben's Helicopter Will Fail)


He argues that,


To make a serious dent in debt levels, and thus enable the increase in base money to affect the aggregate money stock and hence cause inflation, Bernanke would need to not merely double M0, but to increase it by a factor of, say, 25 from pre-intervention levels.


Keen upends the argument that the FED's quant easing will eventually cause (very significant) inflation, and more
fundamentally, the belief that the seed money of fractional reserve banking is
what multiplies the money supply. He argues it is
credit that leads money supply, not the reverse. And that given debt
demand has fallen off a cliff, no amount of money printing will reflate
the credit bubble (this latter reasoning has of course has been
discussed elsewhere).



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Ray Dalio's Missing Coda

Ray Dalio is a great macro analyst. The examples he cites, such as
the UK's 1992 devaluation, are very pertinent. One can also examine the
Argentine devaluation of 2001-2 and the Russian devaluation of 2008-9.
After a sharp devaluation -- say, by one-third or more -- the devalued
currency suddenly looks cheap, and so do asset prices ... such as
stocks and property. Stocks get a double-barrelled kick because the
multinationals and exporters are suddenly earning much more than
before, thanks to more favorable currency conversion on foreign
incomes. Plus, their sales volumes go up.

However, classical
macroeconomics also teaches that the benefits of devaluing are
temporary. Import prices rise, plus the flood of incoming capital
drives up asset prices. Later, wages and other domestic prices follow.
After a few years of higher inflation, the post-devaluation price
advantage versus the rest-of-world disappears, and the country is back
where it started.

Dalio's description of incomes not being
adequate to service debt is something that I've talked about for years,
as has Dr. Martenson. Is the global surplus -- that is, corporate
profits plus individuals' disposable income -- sufficient to service
the global debt total? Economists can't tell us. They do know -- as
Dalio explicitly states -- that devaluing the currency cuts the real
debt burden, by expropriating purchasing power from creditors. Of
course, creditors catch on soon enough, and begin to mark up their
interest rates accordingly. An ugly aspect of high nominal interest
rates, such as the double-digit rates of the late 1970s, is that they
front-load the real interest payments of a loan. It becomes very
difficult for borrowers and capital projects to qualify for loans, as
their income is rarely sufficient to service the initial debt payments.

a professional macroeconomist, Dalio's role is to discuss what is
likely to be -- not what should be. The scenario he describes is one of
gross uncertainty. Few new, promising investments and technologies will
be funded while a mass restructuring of earlier malinvestments is
underway. And the uncertain macroeconomic environment means that many
new investments will be off target as well. If you wanted to build a
new manufacturing plant today, where would you put it? In China, whose
export competitiveness is likely to decline? In the U.S., where the
future value of the dollar and interest rates are a huge question mark?

coda to Dalio's comments is this -- fiat currencies are a human
tragedy. They systematically depress investment and living standards;
systematically blight childrens' future. The need to restructure debt
with a currency devaluation follows directly from the fact that fiat
currency is created from excessive debt. A stiff 'hair of the dog' shot
of debt is not going to cure our debt addiction. It's only going to set
off a new, more reckless and spectacular, binge of borrowing. BOTTOMS UP.


investorzzo's picture
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Re: Just a Great Article

I've heard of this guy before. Like Gerald Celente and others he seems to have a good grasp of coming events. Here's another way to look at it, from history.


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Re: Just a Great Article

There is historical sense, and there is historical nonsense.

Ray Dalio makes sense. So does the commentary of Edward Harrison, on Dalio's interview, which appears at http://www.creditwritedowns.com/2009/02/a-conversation-with-bridgewater-associates-ray-dalio.htm

Another article at financialsense.com
seems to me to be a far superior complement to (it is not a commentary
on) the Dalio interview than is the Cooke ramble; that is Brian
Pretti's Friday Market Wrapup, at http://www.financialsense.com/Market/daily/friday.htm


provides excellent detail and very telling charts describing the status
and prospects of the systematic deleveraging process we seem to be
beginning. Just (what seems to me at least) descriptive, reality
based information and estimates based on credible interpretations of
current trends.

We have needed a devaluation of our
currency for a long time. Our large trade and payments deficits have
demonstrated that fact, amply. I had hoped it would happen far more
subtly, and under better circumstances. But it has to happen, and we
will know when it is sufficient when the deficits have been
substantially eliminated. The increase in consumer prices, especially
petroleum based product prices which results will look, sound, and feel
like price inflation. Actually we will only be losing the ability to
rip of the rest of the world by using an artificially overvalued
currency to pay for our imports of their production. "Inflation" in the
traditional sense is not the right concept in this case.

Gold may do very well, as a stand in for the average values of
currencies against which the dollar has to be deprecated. Personally
I'd rather invest in productive real assets in the countries having
currencies which are currently undervalued relative to the dollar. If
well managed, they will benefit from the change in relative exchange
valuation, and still be able to compete successfully with newly
competitive US exports.

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