Fresh on the heels of publishing his latest book, “Big Debt Crises”, Bridgewater Associates founder Ray Dalio appeared on CNBC Tuesday morning to share what he learned while researching the book, and explain its central theme: That while debt crises are an inevitable feature of our capitalist system, there are steps that can be taken to better manage them.
While Dalio doesn’t see a crisis exploding in the coming months, the next downturn isn’t far away, he argued. And one straightforward step that could be taken to help control it lies with central banks which, through their easy money policies, have helped aggravate the debt problem in both the developed and emerging world.
Because of this, Dalio believes that lawmakers should modify the mandate of the Federal Reserve and other major major central banks to enable them to step in when aggregate debt levels begin to appear unmanageable.
Dalio: Of all of them, there’s the debt growth that finances the bubbles that happen before it that create the busts. You know, there’s basically six stages to it. There’s the normal debt growth that finances growth that pays for itself. Then you get into the bubble stage, when everybody’s extrapolating what happened in the past. So asset prices are going up and everybody is borrowing a lot of money to extrapolate what’s happened. And that bubble stage, central banks don’t pay much attention to because it doesn’t affect inflation and growth. And so I think at that stage is when the central banks should be looking at “are those debts going to be able to be paid back from the financial?” that would be the biggest.
This shouldn’t be too much of a leap: After all, though it’s not part of the Fed’s “official” purview, the Fed and the “plunge protection team” step in to defend stocks whenever a selloff starts to become self-reinforcing.
Before moving on to Dalio’s next point, it’s probably worth revisiting the Bridgewater Founder’s now-famous “1937” thesis (where he posited that the US market was nearing a “1937”-style top that would soon give way to another retrenchment). Dalio first introduced the concept three years ago, then modified it following President Trump’s upset victory in the presidential election:
- Debt Limits Reached at Bubble Top, Causing the Economy and Markets to Peak (1929 & 2007)
- Interest Rates Hit Zero amid Depression (1932 & 2008)
- Money Printing Starts, Kicking off a Beautiful Deleveraging (1933 & 2009)
- The Stock Market and “Risky Assets” Rally (1933-1936 & 2009-2017)
- The Economy Improves during a Cyclical Recovery (1933-1936 & 2009-2017)
- The Central Bank Tightens a Bit, Resulting in a Self-Reinforcing Downturn (1937)
And with the release of his new book, Dalio has adapted these priniciples to serve as a general guide to the business-debt cycle.
- The Early Part of the Cycle
- The Bubble
- The Top
- The Depression
- The Beautiful Deleveraging
- Pushing on a String/Normalization
* * *
Today, Dalio argues, the cycle hasn’t arrived at its climax just yet – rather, we’re closer to the seventh inning. Because while debt levels have surpassed their levels from before the crisis, companies aren’t yet being choked by their debt payments (well, at least not in the US).
Dalio: Corporate debt of course — but if you look at the corporate cash and you look the maturity of the debt. When we run the pro forma financial business calculations, it’s nothing like 2007 looked like to 2008. There’s a squeeze that will be emerging. But generally speaking, we’re in, I would say, the seventh inning of the cycle. I think that we’re at the stage in the cycle where interest rates are being raised. We’re in the later stage. Probably, maybe we have two more years into the cycle, something like that. And then the issues of this debt crisis are very different than the last debt crisis. Each one’s a little bit unique. This one look very much more like the 1935 to ’36 — 1935 to ’40 period.
But once interest rates rise high enough to choke the expansion into submission, the economy will be heading into a downturn at a time when wealth inequality is so profound – and populism is so ascendant – that political factors will complicate the next turnaround. Because with governments tapped out on the fiscal side, and monetary policy already at its most accommodative level, markets will be forced to grapple with issues that they have never before seen as pension funds collapse and problems of unfunded benefits – like health-care, for example – will provoke an even more incendiary reaction from the public.
Dalio: Because I think the parallels are really important to understand. Okay. 1929 to ’32 and 2008 to 2009, we have a debt crisis. And interest rates hit zero. Both of those cases, interest rates hit zero. Only two times this century. There’s only one thing to do next. And that is to print money and buy financial assets. So in both of those cases, that’s what the central bank did, and they pushed asset prices up. As a result we had an expansion, we had the markets rising. And we particularly had an increase in the wealth gap. Because if you owned financial assets, you got richer. And if you didn’t, you didn’t. And so what today we have is a wealth gap that’s the largest since that period. The top 0.1 of the 1% of the population’s net worth is equal to the bottom 90% combined. You have to go back to 1935-40. As a result we have populism, okay. Populism is the disenchanted – capitalism not working for the majority of people. So we have that particular gap. So we have a political gap, a social gap in terms of the economics, and we’re coming into the phase where we’re beginning the tightening cycle. 1937, we begin a tightening cycle. We begin a tightening cycle at this point. No tightening cycle ever works out perfectly. That’s why we have recessions. We can’t get it perfectly. So as we’re going into this particular cycle, we have to start to think, “well, what will the next downturn be like?” we’re nine years into this. As you have a downturn, I believe that there’s a political and social implication to that related to populism. And less effective monetary policy. There’s less effective monetary policy because so far there are two types of monetary policy used: lowering interest rates, we can’t lower interest rates, and the second is quantitative easing. And it’s maximized its effect. So I think the next downturn is going to be a different type of downturn. I think pension problems, health care problems in terms of obligations that are not funded that are not debt —
The result will be a slower, more grinding crisis.
Sorkin: More severe next time?
Dalio: I think it’ll be more severe in terms of the social/political problems. And I think it will be more difficult to handle –
Quick: What you’re saying –
Dalio: It won’t be like the — it won’t be the same in terms of the big bang debt crisis. It’ll be a slower growing, more constricting sort of debt crisis. But I think it’ll have bigger social implications and a bigger international implication.
And while we don’t have the tools to prevent the next crisis, taking a good hard look at the people who have been left behind by the present expansion – and doing more to help them – could be one way to mitigate the the fallout from the next debt implosion.
Dalio: I think there should be a national initiative to look at the parts of the population that are not benefitting from the cycle. And I think that then, you know, education in many ways is just terrible.
Kernen: You’re not talking about pure redistribution, you’re not talking about universal basic income, you’re not talking about anything like — you want to keep things going in terms of the private sector.
Dalio: I think the most important thing is the ways to create opportunity and productivity in that group.
It’s worth noting that Dalio’s doomsaying forecasts in recent years have proven premature. But with the 10th anniversary of the Lehman Bankruptcy on Saturday, and the tenth anniversary of the bull market looming in March, he isn’t the only major investor who’s questioning how much longer the good times can possible last.
Watch the full interview below:
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