Ray Dalio on the D-Process in Europe

Ray Dalio, the founder of the macro hedge fund Bridgewater Associates, gives his take on the European sovereign debt crisis, investing and the global economy in the video below. Although Dalio doesn’t talk about this directly, when I have highlighted Dalio’s commentary in the past, I noted in particular what he calls the D-process. I think this is central to his macro view.

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 deflation?

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.

A conversation with Bridgewater Associates’ Ray Dalio, February 2009

The D-Process played out with greater initial force in the US private sector. Now Europe is playing catch-up, but more via the public sector due to the restrictions imposed by the Euro.

Dalio’s macro view is very much aligned with mine. Here’s how I would describe it: The doom loop of greater private sector debt and larger financial crises was attenuated time and again via lower interest interest rates. This allowed for greater levels of debt for the same debt service cost to reach its apex when rates effectively hit zero percent. The D-process and the deleveraging of this secular debt cycle then reach a terminal stage (‘terminal debt’) at this point and a depression ensues (see “The origins of the next crisis” for a detailed discussion on this macro view).

For me, I see credit writedowns in the financial sector as the central element linking financial system fragility with the underlying economy. and will have more on this in an upcoming post.

In the meantime, the Ray Dalio video is below. Definitely watch it.

P.S. – Dalio is a superb fund manager based on a multi-decade track record that is second to none. He invests based on some cultural principles that guide Bridgewater Associates which see self-reflection and understanding as key to investing, personal relationships, and the economy as a whole. If you want to learn more about this approach, read Dalio’s Principles here.

  1. Tom Hickey says

    Dalio’s D-Process sounds reminiscent of Hyman Minsky and Irving Fisher. Hyman Minsky described this in terms of financial instability and the long financial cycles, contrasting financial cycles with business cycles. The US, UK, and EZ are all in the process of unwinding third and final phase, which he called Ponzi finance. This is where Irving Fisher’s debt deflation theory of depression kicks in. So I would say that Dalio’s intuition is right on target here if he knew nothing of Minsky and Fisher and was not influenced by them.

    1. Edward Harrison says

      Hi Tom, agree 100% that it is very Minsky. I am also surprised at how much it sounds like what I have been saying independently. The political economy element in terms of apportioning losses is where the I think a lot of the outcome for ‘D-process’ becomes important.

      1. David Lazarus says

        It also is clear what the long term solutions are. Minsky said to avoid the pain of the fallout you have to avoid the bubble in the first place. Though no government wants to stop the party.

        In future to avoid such problems governments need to bring in such changes. Though that is the problem, governments will not bring in legislation that stops booms especially those using other peoples money, and especially if the fall out will occur in another governments term of office possibly many years away. Then the banks will lobby against it because it limits their earnings over the cycle. Add in the additional problem in that governments and central banks are still stuck in the old model where they rely on credit growth to boost the economy, when they will not use fiscal measures to help the economy. Any de-leveragiing now will only make them less electable even if it is the only option long term.

        1. TC says

          A while back I wrote a post about how certain sectors of the economy demand a bubble by their growth rates relative to the widespread interest rate in the economy.

          If this demand isn’t met through equity finance in this area, it will be met through debt financing.

          This causes part of the dynamic that Minsky talks about, but I think Minsky misses part of the dynamic – that these bubbles are (or at least can be) “demanded” by the bubble sector.

          Of course the Dalio idea is very similar to Minsky and others. I think what traders can also catch are the areas where these bubbles are demanded and then unwound.

          It’s similar to Soro’s “reflexivity” – I think Soros was talking about how these situations unfold on both the upside and downside. Dalio is describing an economy-wide reflexive debt reduction program.


          I am totally with you. This blog has one of the greatest names of all time. I remember many of your early posts were around the theme: “This isn’t going away until we writedown this debt, and the process will be as political as it is financial.”

          It’s funny to see these writedowns being debated even today. In the end, it’s only a few billion bucks one way or the other.

          Imagine you have Greece defaulting vs. Greece bailout. What’s the net difference in cost between these two for Germany? Under $100bn for sure. Peanuts over 20 years. I am not saying the political frames aren’t important, or that who pays for what is meaningless. But we’ve traded 10-20% of GDP for an multi-year argument over a few hudred billion more or less.

          I really think it’s the bastards that don’t want to take the writedowns or face even a whiff of inflation that are really going to get crushed at some point.

          This country is far closer to riots than people think. I’d start a blog on it, but I don’t want to be the one yelling “fire”

          1. David Lazarus says

            Minksy, Dalio, Soros and even Keynes called for counter cyclical policy. Yet few governments actually use it. I agree that the costs either way are minimal for bailout or write off but at the moment the efforts are to stop the creditors losing a cent. That is the nature of credit risk, that you lose money if you make the wrong choice. Yet banks seem to have lost this knowledge. So they want the tax payers to bail them out. That is wrong. We need massive writedowns of debt and if the banks are too systemically important then they should be rescued from creditors and nationalised. With all creditors apart from small depositors suffering losses. Then the banks should be nationalised and split up, so that they are no longer systemically important.

  2. [email protected] says

    So what do you think the chances of the US going into a Great Depression II? Since the Eurozone is so shaky would they be most likely to lead us into it?

    The US got out of the Great Depression via a war; is that the only way out of a GD? Hopefully not. Has any country gotten out of a deep depression another way?

    1. Edward Harrison says

      At this point, it’s pure speculation about the likely policy responses in Europe and the US. So much of what happens in the global economy is now tied to the existential crisis of the euro and the continuing soft depression in the US that a single important policy response could make the difference. What is clear now, however, is that the muddle through approach creates voter fatigue and the draw of a politician promising bold action becomes that much greater.

      1. [email protected] says

        Well said. Voter frustration is likely to grow no matter which course the US takes as there are no good outcomes for the near-term future that I can see. If anyone can thread the needle to find a democratic way to keep things stable (and dare we hope, slowly improving) in the economy it will be one for the history books.

  3. Dave Holden says

    What I’d like to see articulated are the consequences of *real* private sector debt write down and how government could aid/alleviate this. Almost all government efforts seem to be aimed at avoiding this, when to me it seems like the only solution.

  4. Jim says


    Great video…thanks for “insisting” that your readers watch it.

    Excuse my ignorance as I’m not familiar with the terms used in the world of hedge funds…but what exactly does he mean by 15 uncorrelated return streams?

    1. Edward Harrison says

      Hi Jim,

      supposedly different markets in the financial world are not correlated. The concept that diversifying assets by putting money behind uncorrelated return streams is central to modern portfolio theory. So, without seeing what Dalio is referencing, I can say that he means 15 different uncorrelated investments in an overall portfolio that one can view as separate return streams. That is supposed to be a good thing.

      In crisis, however, correlation rises in a parabolic way and then hedge funds find that they weren’t truly hedged at all by being diversified if they are net long too many markets. Suddenly all markets are falling together and the funds suffer massive losses. That’s what happened to Long-Term Capital Management

      1. David Lazarus says

        LTCM aslo ignored long tail risks which was their ultimate undoing. The events that killed them were supposed to be impossible. The problem was that their data model was too short and so they left out data that did not fit their quants model, but was to be their ultimate undoing.

        1. Edward Harrison says

          The tail risk you speak of is that correlations in uncorrelated markets would increase so dramatically. LTCM was net long markets (i.e. net short long-term S&P volatility). That position went bust with Russia’s default (that’s the increase in correlation). They thought they were hedged in uncorrelated markets but, alas they were not.

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