The man who predicted the Great Recession says we’re not ready to handle the next downturn

David Brancaccio Apr 7, 2016
Ray Dalio says that the U.S. won't be able to easily deal with its next recession — whenever it comes. Thos Robinson/Getty Images for New York Times

The man who predicted the Great Recession says we’re not ready to handle the next downturn

David Brancaccio Apr 7, 2016
Ray Dalio says that the U.S. won't be able to easily deal with its next recession — whenever it comes. Thos Robinson/Getty Images for New York Times

Who would you want to sit next to on plane if you wanted to know where the economy is going? Fed chair Janet Yellen is a good answer. So is Ray Dalio, a legendarily successful investor. Dalio is founder and CEO of Bridgewater Associates, the largest hedge fund manager in the world. Dalio bases his investment decisions less on abstract financial data, and more on his reading of the macro economy. He’s very focused on how central bank interest rates are running close to zero these days. Dalio joined Marketplace Morning Report host David Brancaccio to talk about the future of the economy when central banks run out of firepower.

Dalio: Europe is there, in Japan it’s there, and the U.S. is very close.

Brancaccio: But maybe we, in the U.S., don’t need it anymore. Maybe the vitality of the economy will drive us forward and we don’t need the help from those folks in Washington at the central bank?

Dalio: We hope we don’t, but we live in this world that we’re affected by, and also, we’re pretty sure that one day we are going to need it. There’s always downturns. There’s upturns and there’s downturns — that’s the business cycle, the short-term debt cycle. We see that all the time. 

Brancaccio: But you also see superimposed over the shorter-term gyrations, these cycles, a big set of long ones? 

Dalio: Yeah, people don’t know much about the long-term debt cycle because they only come around once in one’s lifetime, but they’ve existed throughout history. You can go back to the Old Testament and they talk about the year of Jubilee, the relief of that debt. The short-term debt cycles add up to a long-term debt cycle because we prefer stimulation over restraint, and so debts rise relative to incomes for a long time. And because we want to perpetuate that, central banks do, they lower interest rates until they hit zero. And when they hit zero, and there’s high debt relative to GDP, they are in a bind. And last time that happened was 1930. In other words, we had the stock market crash, then they lowered interest rates, and so on.

Brancaccio: And what happened in 2007-2008 wasn’t the resolution of a long-term debt cycle, you’re saying that we’re still working on the current one. 

Dalio: Just like what happened in 1930 to 1932, it’s not the resolution of the long-term debt cycle. It continued on because still the debts are high in relation to the income, and still you’re close to a zero interest rate. So what the Federal Reserve is doing by putting more money into the economy is it’s having that money allow more spending without raising debts —  so that’s been a good thing. But when we start to imagine the next downturn, which I don’t think it’s going to happen this year or next year – I’m not sure when it’s going to happen. 

Brancaccio: Which is fabulous news on its own, that a recession is not around the corner according to Ray Dalio. But at some point –

Dalio: It will come and it won’t be easily dealt with. In the meantime, because we don’t know exactly when it’s going to come. There’s an asymmetric risk for the Federal Reserve because the downside is more difficult to deal with than the upside. We know that they can tighten monetary policy, slow the economy and reduce inflation. We know they have the power —

Brancaccio: But what are they going to do if it goes down, especially if the quantitative easing strategy is getting long in the tooth and is less effective?

Dalio: If they raise interest rates too quickly, you will see that affected in stock and bond prices. Then that not only affects psychology, it affects wealth and it adversely affects spending. And so it’s a delicate thing there, so they’ll have to tread lightly. 

Brancaccio: Tread lightly. So if there’s a closed-circuit message from your microphone to the ear of Janet Yellen, the chair of the Federal Reserve, at this moment, what’s the practical takeaway right now?

Dalio: First, go study the long-term debt cycle — make sure you understand the economics of that. And then realize that the risks are more on the downside than the upside. So it pays to see the whites of the eyes of inflation before you shoot at it. 

Brancaccio: Be careful on these further interest rate increases. If you have to, you have to, but be careful.

Dalio: That’s right.

Brancaccio: Now, you have been a fan of what has affectionately been referred to by economists as “helicopter money” — central banks pouring money over the economy as if dumping it from a helicopter. Tell me more about that.

Dalio: Well, let me be clear regarding me being a fan of it. What I’m saying is that the existing way of running monetary policy, of having the central bank buy bonds from investors and putting cash in the hands of investors, has the effect of keeping it in the hands of investors and buying other financial assets that are not going as easily to the spenders — that the system doesn’t get the money as effectively to the spenders because it’s putting it in the hands of investors and they keep it in investments.

Brancaccio: Yeah, we see all these companies using these low interest rates to do stock buybacks, which is awesome if you’re that company and a shareholder in that company, but my friends on Main Street don’t see that.

Dalio: Right, and because that process becomes less efficient, the objective is going to have to become increasingly how to put money in the hands of spenders. Now, normally, that could be done in a couple of ways. If there is a coordination of fiscal and monetary policy so the government is the spender of money or the government reduces your taxes leaving you with more money, and the central bank then buys the debt of the government, so it provides the cash to do that, that’s one way of achieving that goal. Quite often at politically fractious times like now, it’s not easy for that coordination to exist. And so central banks also, in varying degrees, have ways of getting the money into the hands of people directly. So “helicopter money” is the more extreme version of that. But it means literally, like is done in Finland, you can receive a check in the mail that actually is for a certain amount of money, and you can use it to spend that money. Or it might even be targeted for a particular group. For example, people in poor areas could use it for school books or medical or in the war it was given to veterans – money was sent to veterans to spend. So you can send money directly to spenders. And you know, the wealthy or investors are less likely to spend money because they didn’t need the money to spend, but there are parts of the economy that really could use the money. But there are technical legal questions in terms of exactly how that’s done.

Brancaccio: And the hope would be if it works, that the economy would be stimulated, tax revenues would go up and that for the government sending out these checks or dumping the money from the helicopter, that ultimately the system would be in balance, it wouldn’t cost the Treasury a fortune?

Dalio: That’s right. You have to get people to spend. Now this sounds like a very scary thing to a lot of people because they say, ‘Jesus, you’re just going to print money and give it to people and isn’t that going to be inflationary?’  The important thing I think to understand is that money plus credit equals spending, and the amount of money spent is what’s going to determine inflation. So if there’s less credit in the economy for spending and it’s made up by more money, that doesn’t make it more inflationary. For example, when you go into a store and you buy with a credit card or you buy with cash, it’s the same amount of buying. And so if you put more cash, it’s not inflationary. At the end of the day, our living standards are going to be determined by how productive we are. So producing money or producing credit is not going to raise our living standards over the long run. At the end of the day, it has to be productive. But there’s a balance between being able to demand goods and services, and to produce them – a symbiotic relationship between those two things that’s essential. 

Brancaccio: I also see Ray, that you’re a hit filmmaker. Your 30-minute animation featuring the voice-over of Ray Dalio has been viewed, I just checked it before you came in, 2,749,388 times. I want to ask you about this: why did you spend the time to make this, what is essentially a tutorial about the economy?

Dalio: The economy is a really simple thing. In other words, basically almost everything I know is covered in that 30 minutes, and it’s just not appreciated as a simple thing. If you look at that template and understand that template, you can see where you are at any time. In other words, right now we are a little bit past the midpoint of that business cycle, at the end of a long-term debt cycle

Brancaccio: But as to the notion that the economy is relatively simple, you liken it to being a kind of machine. Is that fair? 

Dalio: Let me establish what I mean when I say a machine — everything that happens has causes. There are cause-effect relationships; that’s what I mean by a machine. 

Brancaccio: Cause and effect, mechanical relationships, but it could be a fairly complex machine?

Dalio: You know, the problem I think is that people don’t step back and they are so into the particulars and the details. There was a saying, I’m not sure who said it, but: ‘Any damn fool can make it complex; it takes a genius to make it simple.’

Brancaccio: It’s pretty straightforward stuff. For instance, there’s a moment where you explain that when we get better at doing our jobs, productivity growth, that’s a long-term thing. But that’s not the force that matters most in the short term. According to your animated video, “Debt is — because it allows us to consume more than we produce when we acquire it, and it forces us to consume less than we produce when we have to pay it back.” OK, the film makes economics seem easy. We worry about productivity growth, the short- and the long-term cycles, but c’mon, it’s not that easy. The Fed struggles with this. They are up at night struggling with this, and there are other factors besides those cycles.

Dalio: The most important other factor is politics. During difficult times, people get emotional — particularly when there’s a wealth gap and there’s social gaps and so on. And the great problem of our wonderful democracy is when emotional people, who may not be all that well-informed, select leaders who are not responsible handling economics in a calm, thoughtful way, and that we could handle it badly. 

Brancaccio: But when you raise this issue of politics, do you think this issue of the gap between rich and poor which can lead to these tensions is something that has to be addressed specifically as a matter of policy?

Dalio: Yeah, I think it has to be addressed as a matter of policy. I’m worried about what the next downturn would be like emotionally, socially, because we have tensions now and they are reflected in our current politics – anger. If you have another downturn, especially a downturn that can’t be effectively managed because monetary policy is a problem and fiscal policy has people at odds, there’s going to be a lot of emotionalism. That has to be well managed; people have to be calm. We have to have a country in which people are together. And the fractured nature of that scares me.

Brancaccio: Yeah, our politics at the moment in 2016 doesn’t seem to be set up for that.

Dalio: No. 

Brancaccio: As we’ve learned in the course of this discussion, your approach is to look at the macro economy then try to figure out the directions of things, perhaps before others. But there is an alternative approach to investing – the quants, who see the truth in the numbers that are streaming live from the markets, not the macro economy. What do you think of the quants, Ray?

Dalio: A lot of concepts can be expressed in numbers, but that doesn’t; there has to be understanding. There has to be deep understanding of cause-and-effect relationships.

Brancaccio: Data is not wisdom, is that sort of what you’re telling me?

Dalio: Great way to put it. I’m worried about a lot of quants and yet, quantitatively expressing understanding is a wonderful thing. If you just look at the data and you assume the future will be exactly the same as the past, you don’t get at those simple fundamental cause-effect relationships. You have data mining and it can be very dangerous. As we come into this new world with much more artificial intelligence, it’s a fabulous thing and it’s a very dangerous thing. The key is whether there is deep understanding, and deep understanding can be lost by putting a lot of numbers into computers and betting on them. 

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