http://dealbook.nytimes.com/2011/03/03/ray-dalio-under-the-microscope/
Interview | SATURDAY, MARCH 12, 2011
Observing a Bipolar World
By SANDRA WARD | MORE ARTICLES BY AUTHOR
Interview with Ray Dalio, founder and chief investment officer, Bridgewater Associates
Pre-crisis, crisis, post-crisis, it always pays handsomely to heed Ray Dalio and his team at Bridgewater Associates, a global money manager based in Westport, Conn., specializing in credit and currency markets. With nearly $90 billion under management, Dalio delivered gains of about 40% in 2010 to a coterie of clients that includes governments, central banks, endowments and pension funds. That performance adds to an impressive winning streak and brings Bridgewater's 10-year average annual return to about 18%. Subscribers to the firm's Daily Observations market report are treated to detailed analysis of important global financial events, with keen attention paid to historical precedents. When Dalio speaks, we listen.
Barron's: How do you view the world at this point?
Dalio: This is a bipolar world in which there are emerging countries, which don't have debt problems, which are saving a lot and growing at fast paces. Those include China and Brazil. Then there are the developed countries, which are the U.S., most of Europe and Japan, and they have too much debt. Each group can be broken into two other groups, those that have independent monetary policies and those that don't.
For developed debtor countries, the ability to print money is what differentiates them. The U.S. can print money. England can print money. If you are a debtor, you ordinarily like to print money to get out of debt. But if you can't print money, whether you are the state of Wisconsin or Spain, you are a debtor with one path: a decade of hell. It's a period of restructuring that lasts a very, very long time in which there is debtor-creditor tension. Whether it was Brazil or Argentina in the 1980s, or Japan in the late '80s, it amounts to a lost decade.
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Matthew Furman for Barron's
"If you can't print money, whether you are the state of Wisconsin or Spain, you are a debtor with one path: a decade of hell." —Ray Dalio
Let's talk about the creditors.
There are those creditor countries that have independent monetary policies and those that don't. The irony of China is that it doesn't have an independent monetary policy. It would like to tighten monetary policy, because it is in an inflationary bubble, but it can't. They have about a 5½% inflation rate—actually, if you look at it month by month, it is 13% annualized—but let's call it 5½%, year over year. They also have nearly a 10% economic growth rate. And interest rates are at about 5%. So China's gross domestic product is growing at about 15% a year. When you have an economy that is growing at a 15% nominal rate, and you have a 5% interest rate, you would be nuts not to borrow and buy things with a higher return and you would be nuts to save in bank-deposit accounts.
The countries whose economies are booming are buying the things that are inflating. They have low labor costs, so they are very competitive in the world and are earning all sorts of money and at the same time creating all sorts of credit in response to the demand for goods and hard investment assets. They are running out of capacity, and they are overheated, and they can't tighten monetary policy.
In the U.S., quantitative easing is coming to an end. What happens then?
The Federal Reserve's printing of money will continue through June and the fiscal stimulus will carry through the third quarter. We are also seeing a modest pickup in private-credit creation. Later this year, the economy's two major sources of stimulation, monetary and fiscal policy, will be declining significantly. Most likely, growth will slow significantly going into year end, unless the pace of private-credit growth picks up.
How does Europe factor into all this?
The European debtor countries—Spain, Ireland, Portugal and Greece—don't have independent monetary policies and can't print money. Therefore, they are in the early stages of decade-long debt and economic problems in which there will be constant tensions between them and their creditors. They got into this mess because the banks leveraged their balance sheets to lend money, and borrowers leveraged their balance sheets. Everybody had a great time. Then they reached their debt limits. When the private sector couldn't borrow more and the government wanted to provide fiscal stimulus to make up for the shortfall in spending, these governments borrowed a lot of money because they couldn't print money [because they are part of the euro zone]. These governments took on too much debt, so all sources of credit growth have largely shut down. As a result, they will have miserable economic growth and chronic debt problems, which will cause political and social instability. All countries can ultimately pay their debt if they impose taxes or cut spending. But there is only so much citizens can take, and then they throw those governments out and elect ones that promise not to cut spending or raise taxes.
So the European debt crisis is far from over?
It is likely we are going to have another phase of the European debt crisis, in which events will get ahead of the policy makers. Conditions in Germany are very different from those in the other countries. It is getting very delicate, because Germany is experiencing inflation, and Germans don't want inflation, and they will get to a point where they want to tighten monetary policy, probably next month. As the year progresses, the tension between Germany and the debtor countries will intensify, and so this issue of debtor and creditor countries with different economic conditions being linked by the same monetary policy is going to come to a head.
What does all this mean for emerging countries?
China and Brazil and some other emerging countries are in the opposite situation. They should be tightening monetary policy, but they can't have a tighter monetary policy because their policy is linked to the U.S. As time progresses, their inflation and their bubbles will become more severe.
Through 2011, and into 2012, these links are going to cause intolerable conditions. I believe that sometime in the next 18 months, we will probably have a seismic shift, very similar to the Bretton Woods breakup in 1971, in which linked monetary policies and linked exchange-rate policies come undone. The pain of holding them together is going to be terrible, and that's going to create the seismic shift.
What is the likely outcome?
The likely outcome is a big exchange-rate shift between those two groups. Generally, creditor countries that are running surpluses, whose growth is too strong and whose inflation pressure is too high, and that have linked exchange rates, will revalue their currencies in order to have independent monetary policies. Debtor countries that can't print money will restructure their debts, and those that can print money will devalue their currencies.
What does that mean for their bond markets?
Debtor countries' bonds will be unattractive for the creditor countries' lenders. What they want to buy are the assets they know they'll need. They want to buy commodities. Commodities are considered safe. That's why they, particularly the Chinese, are on a commodity-buying spree.
The commodity bubble continues?
It continues until China and those countries become too tight, and that's probably not until late 2012. Not only are they going to buy commodities, they are going to buy the commodity manufacturers, because there is only a certain amount of inventory of actual commodities they can hold. They are also going to buy other kinds of companies, instead of being exposed to bonds denominated in our depreciating money.
You are going to see China and other creditor countries buy more assets in the U.S.And, this time around, politicians will have to be more favorably inclined?
It will become a political issue in the 2012 elections. By the way, 2012 is an election year in both the U.S. and China.
What about the threat of capital controls?
The Chinese are trying to keep their exchange rate stable. In the year ahead, you are going to hear a lot more about capital controls. But the talk won't be material. I don't believe China will pursue capital controls because it would be against their interest for two reasons. First, capital controls aren't effective for any country with a lot of international trade and investment. Second, China would like to internationalize their currency. Every great power, throughout history, always has had a reserve currency. They want the yuan to be a reserve currency. Imposing capital controls would set back the internationalization of their currency by 10 years.
Where does Japan fit into this equation?
Japan's situation is interesting, more for Japan than for its impact on the rest of the world. It is coming to the end of a period in which the government can run large deficits and borrow from its people without printing money. As the population gets older, they want to draw on their savings. As they draw on their savings, they switch from lending to the government to running deficits. It's a touchy situation. The central bank is going to have to print money, and that won't be something the older population will be happy about.
What about the earthquake?
It won't have a material effect on this picture.
Let's talk about how you're positioned. Given your outlook, would you recommend U.S. bonds at this point?
No. We got out of the bond market about seven months ago, and we are slightly shorting the bond market.
Just U.S. bonds?
No, bonds in developed countries and bonds in most places. Interest rates will have to rise in Germany. Interest rates will have to rise in China. But the currency will rise, too. Rising interest rates are good for currencies, but not bonds.
And gold?
We are still long gold. We are also long commodities, and currencies of emerging countries with surpluses, versus the currencies of developed countries with deficits. Gold is a very underowned asset, even though gold has become much more popular. If you ask any central bank, any sovereign wealth fund, any individual what percentage of their portfolio is in gold in relationship to financial assets, you'll find it to be a very small percentage. It's an imprudently small percentage, particularly at a time when we're losing a currency regime.
Safe used to mean U.S. Treasury bills, safe meant cash in dollars, European currency and yen. Now it is an ugly contest between those three currencies. So where is safe? Where is the least risk? It isn't going to be in those countries that have too much debt, too many obligations to pay.
All debtor countries are going to print more money and will depreciate their money. Creditor countries know that. Historically, in times like this, they will increase their gold reserves.What does this mean for stocks?
I was a clerk on the floor of the New York Stock Exchange in August 1971, when the U.S. devalued. President Richard Nixon spoke to the nation on a Sunday night. Monday morning, the stock market went through the roof. In August 1982, the Latin American debt crisis occurred. More than 200% of American bank capital was lent to Latin America, and those countries defaulted. That marked the bottom 4 of the stock market at 777 on the Dow and that is because the U.S. started printing money. Those two instances were telling in terms of what currency devaluations do.
Currency devaluations are good for stocks, good for commodities and good for gold. They are not good for bonds.
Thanks, Ray.
