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Divided Decade

Ray Dalio discusses the anatomy of the debt cycle

David Brancaccio and Daniel Shin Sep 25, 2018
Thos Robinson/Getty Images for New York Times
Divided Decade

Ray Dalio discusses the anatomy of the debt cycle

David Brancaccio and Daniel Shin Sep 25, 2018
Thos Robinson/Getty Images for New York Times

Ray Dalio is the founder of Bridgewater Associates, the world’s largest hedge fund. He predicted the 2008 financial crisis a year earlier and Bridgewater can be counted as one of the survivors of that crisis. He recently released a new book, titled “A Template for Understanding Big Debt Crises,” in which he touches upon the symptomatic and historic nature of debt cycles and explains how a better understanding of how these cycles function can work in our favor. He spoke to Marketplace Morning Report host David Brancaccio about these cycles, as well as the state of the economy today.

Below is an edited transcript of the conversation.

David Brancaccio: This template that you’re offering, this book, this is about noticing that we go through these cycles – they’re not every 18 months, they’re long cycles of “lending is easy, borrowing gets crazy, things start to go bust, policymakers respond, [and] credit gets tight.” And you think you could really understand that if you have any hope of prospering?

Ray Dalio: It’s my job. I live and die on that. There are six stages of those, OK? There’s healthy debt growth and then healthy debt growth leads to extrapolating past trends and thinking those things that went up are going to continue to go up and then they borrow money to do that and that is called a bubble. You can anticipate whether those debts can be paid off. Then there is a top, and that top is usually because central banks then need to tighten, slow things down or because those debts can’t be paid. And so the bubble bursts, and then there is a contraction. And the worst ones are the ones when we hit zero interest rates, and those are called depressions. And because you hit zero interest rates, monetary policy can’t be the same, and they inevitably print money to buy financial assets, push those financial assets up in value. And that is what we’ve been through. 

Brancaccio: So where are we on the cycle now, the cycle of history, the cycle of economics?

Dalio: I think the most analogous period is 1935 to 1940. When you have a big debt crisis and you hit zero in interest rates when they’re trying to relieve that debt crisis, that hitting zero produces a big debt crisis. That’s why 1929 to 1932 and 2007 to 2009 are analogous. [They were] big debt crises, hit zero [interest rates]. In both of those cases, the Federal Reserve has to print money and buy a lot of financial assets. That causes financial asset prices to rise, and it also causes the economy to improve, but it also widens the wealth gap. And as a result, we have a wealth gap today that is quite similar to the wealth gap that existed then. Big wealth gaps produce populism [and] produce conflict between the left and the right or the haves and the have nots. We are also in a period of time – very much like the 1935 to 1940 period – in which the conflict is not only domestic, internal conflict among countries, it’s between countries.

Because when we elect populist leaders, they are strong nationalist leaders who tend to have conflict. So we’re in a position in which there is a rising power in the form of China and an existing power in the form of the United States. Through history, there’s a pattern in when that rivalry happens of conflict. At first, that’s economic conflict and then later it can become even military conflict. I think the situation in China is quite similar to the situation with Japan in the post World War II period.

Brancaccio: That’s starting to be scary, if you’re drawing that analogy.

Dalio: I don’t mean to scare anybody, but I do think that it’s important to realize that we do have a competitive situation with China. That means conflict of some form, and how that conflict is handled should be considered in light of history. In other words, there are good ways of doing that and there are bad ways of doing that. More dangerous. And it’s a delicate situation. So yes, there are economic conflicts internally. It may sound scary that we have the left and the right at odds or that we may have a wealth gap but we should recognize those things, and we should deal with them.

Brancaccio: So is it your view that the way that we’re pursuing our trade policy and this burgeoning trade war that the U.S. has with China, are we doing it, in your view, in a prudent fashion? 

Dalio: I think there are two ways that negotiations take place. Do we have a negotiation, a hard, strong negotiation in which there’s mutual respect in that negotiation? Or do you have a war? Just using the term “trade war” is something that’s significant. If the game is, “I’m going to hurt you more than you’re going to hurt me” and you play that game, that’s a dangerous game. 

Brancaccio: I know you see these cycles in history, but there’s that line about “history doesn’t repeat, it rhymes.” If we are in a position now that’s similar to the late 1930s — 1940, it doesn’t mean the outcome has to be what we saw in the middle of the 20th century.

Dalio: Not at all. There’s a concept called the Thucydides Trap, and basically it means when there’s a rising power during an existing world power, there is a probability of war. Over the last 500 years that’s happened 16 times. In 12 of those times there were wars, and in four of those times, there were not wars. It’s one of those situations in which there can be ways of dealing with this in a way that brings around mutual prosperity. But if you’re going to hurt the other and you’re exchanging hurts to the other, it’s a risky situation. 

Brancaccio: So we should be careful, is what you’re saying. 

Dalio: We should be careful, I think. 

Brancaccio: Given all that, you still don’t see a recession looming in the U.S. economy? 

Dalio: No. In the business cycle, that happens when capacity is constrained and inflation is accelerating and tightness of monetary policy … those conditions I don’t see any time soon. I think we’re in the sixth or seventh inning of the game in terms of that cycle. In terms of the long-term debt cycle, in other words, where debt levels are still high and other benefits like pension benefits and health care benefits, they’re large. And we have zero interest rates and we’ve then had quantitative easing which has pushed up asset prices … we’ve stretched that cycle pretty far. So the long term debt cycle I think is pretty stretched. The wealth gap is pretty large. But the business cycle that we’re in has probably a few more innings. No, I’m more worried about what will happen when that cycle runs its course in maybe two, three years. I can’t say when exactly. 

Brancaccio: And is it your sense that a little wealth redistribution might be in order at this stage in the current debt cycle?

Dalio: I think the biggest issue is our wealth and opportunity gap. And I would say it should be made as a national priority to deal with that, with metrics. You have to redistribute opportunity to create productivity. That segment has got to be productive. It’s not good for them psychologically as well as economically. Capitalism has got to be made to work for the majority of the people. Otherwise, it’s not safe and it’s not fair.

Brancaccio: What’s redistributing opportunity? It’s training, it’s education …

Dalio: I think you could create public-private partnerships in which there is productive uses of money to do programs like education, quality education, job education and microfinance and the like in which there’s payoffs. The private sector would be able to evaluate whether there’s going to be payoffs. When you think about what it costs to get a student through high school and then you look at the cost of the incarceration rates, it’s between $85,000 a year to $125,000 a year – 22 percent of the high school students in Connecticut, which is the richest state in the country, are either disengaged or disconnected. That means they’re participating in school but they don’t study or they don’t even know where they are. When you think of the costs of that on our society in terms of all its cost — the crime rates, the incarceration rates — there are many ways. But in any case, let’s at least define it as a national emergency, establish metrics and bring in private-public partnership to view that as a national agenda in much the same way as there’s a space program.

Brancaccio: Since we’re talking about debt cycles, I have to ask you this. The other day I sat down with the people who brought us the Dodd-Frank financial reform law. Former Congressman Barney Frank says there will be no more government bailouts of companies that are allowed then to live on. If there is a future bailout under the law, those companies will have to be forced out of business. Barney Frank and [former] Sen. Chris Dodd are proud of that. Is that how you see it? There’ll be no more bailouts of the sort in which the institution lives on?

Dalio: While they have made, in many cases, the system safe, they’ve also created such rigid rules, that rigidity is in and of itself a threat. Every cycle is different than the one before in certain ways in terms of its applications. And when you say, “thou shalt not” and you don’t make room for exceptions, you are exposing yourself to a great vulnerability. I will say that there will come a day that you will need to make those moves. I think that there should be a Special Economic Emergency Powers Act, when the president of the United States and the head of the Federal Reserve and representatives of both houses of Congress say that “this is one of those cases in which the rules are not exactly right for the circumstances,” that those rules can allow exceptions to those rules in order to get us through it. That was one of the things that got us through it last time. We were almost toast. So the notion of trying to do it perfectly with written rules that are going to be followed [and] adhered to perfectly is risky to me. 

Brancaccio: You seem to be assuming that you have grownups on the left and the right in power in Washington if the next disaster befalls us. 

Dalio: I’m saying I’m setting the bar high enough. I could easily imagine that you could have a crisis in which those people don’t agree. The greater crisis is not getting through it rather than getting through it perfectly. Look, we got through this one. If you want to make a big deal of whether one company got the loan and another company didn’t and you expect that that’s going to be examined perfectly at that time in the middle of the whole mess, you’re being naive. It won’t happen that way. It’ll be a lot of companies going down and then all of a sudden you’re going to stigmatize one company and not stigmatize another and you’re going to bankrupt them. And even just the bankruptcy procedures and the nationalization, all of that is incredibly difficult, incredibly cumbersome. The important thing is to get through it well. Consider it like an automobile accident. Don’t worry about being precise. Get the adrenaline into that patient and get their heart going again and then try to handle it. When you look at most of how this was handled and you look at the economics of this, the government made money on all of this in terms of the assistance. 

Brancaccio: In the fullness of time. 

Dalio: In the fullness of time. Get us through it. That’s the main thing. 

Brancaccio: All right, there’s one little detail here about this new book of yours. You can download it for free?

Dalio: Yeah, I wanted to make it free for everybody … on PDF if you go to Principles.com

Brancaccio: The idea is you wanted these ideas out there for people. Why is that debt crisis cycle so important for people to understand? 

Dalio: We do this thing over and over again for the same reasons. And it’s like having a disease in which somebody hasn’t taken the time and understand the progression of that disease. I’m at a stage in my life where I want to pass along the things that have been helpful to me. This has been helpful to me over these last four or five decades and I want to pass it along and hopefully reduce the chances of it happening again or help people handle it better. 

This interview is part of Divided Decade, a yearlong series examining how the financial crisis changed America.

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