Ray Dalio on Deleveraging
Ray Dalio was featured in Barron’s at the weekend. He spoke about the various options available to effect a private sector deleveraging. He sees three ways which he calls austerity, restructuring, and money printing.
Below is an excerpt of his commentary:
Barron’s: You’ve called the current phase of the U.S. deleveraging experience "beautiful." Explain that, please.
Dalio: Deleveragings occur in a mechanical way that is important to understand. There are three ways to deleverage. We hear a lot about austerity. In other words, pull in your belt, spend less, and reduce debt. But austerity causes less spending and, because when you spend less, somebody earns less, it causes the contraction to feed on itself. Austerity causes more problems. It is deflationary and it is negative for growth.
Restructuring the debt means creditors get paid less or get paid over a longer time frame or at a lower interest rate; somehow a contract is broken in a way that reduces debt. But debt restructurings also are deflationary and negative for growth. One man’s debts are another man’s assets, and when debts are written down to relieve the debtor of the burden, it has a negative effect on wealth. That causes credit to decline.
Printing money typically happens when interest rates are close to zero, because you can’t lower interest rates any more. Central banks create money, essentially, and buy the assets that put money in the system for a quantitative easing or debt monetization. Unlike the first two options, this is an inflationary action and stimulative to the economy.
How is any of this "beautiful?"
A beautiful deleveraging balances the three options. In other words, there is a certain amount of austerity, there is a certain amount of debt restructuring, and there is a certain amount of printing of money. When done in the right mix, it isn’t dramatic. It doesn’t produce too much deflation or too much depression. There is slow growth, but it is positive slow growth. At the same time, ratios of debt-to-incomes go down. That’s a beautiful deleveraging.
We’re in a phase now in the U.S. which is very much like the 1933-37 period, in which there is positive growth around a slow-growth trend. The Federal Reserve will do another quantitative easing if the economy turns down again, for the purpose of alleviating debt and putting money into the hands of people.
We will also need fiscal stimulation by the government, which of course, is very classic. Governments have to spend more when sales and tax revenue go down and as unemployment and other social benefits kick in and there is a redistribution of wealth. That’s why there is going to be more taxation on the wealthy and more social tension. A deleveraging is not an easy time. But when you are approaching balance again, that’s a good thing.
What makes all the difference between the ugly and the beautiful?
The key is to keep nominal interest rates below the nominal growth rate in the economy, without printing so much money that they cause an inflationary spiral. The way to do that is to be printing money at the same time there is austerity and debt restructurings going on.
Personally, I’m not so sure the ‘money printing’ is inflationary in the sense of embedding consumer price inflation. What I have seen is transitory price rises from portfolio preference shifts to commodities and other risk assets. In the absence of real wage gains, food and commodity price inflation during a period of deleveraging destroys demand and is reversed.
It is interesting that Dalio sees financial repression as a staple of deleveraging. It certainly was in Britain’s great deleveraging.
Also see Dalio’s views on Europe and his comparisons to the United States during the Revolutionary War. I recommend reading this one.
Source: Dalio’s World, Barron’s
I agree there will be an “optimal” combination of these three mechanisms for private sector deleveraging but as adjectives go “beautiful” wouldn’t be my first port of call.
I have a clear knowledge gap on the mechanisms behind inflation. The QE triggered distortion in portfolio preferences has clearly been one mechanism behind price inflation of the things people *need*, but as you suggest unless this is matched by wage gains it’s counterproductive. It seems some think there just hasn’t been enough price inflation to trigger wage inflation but does that thinking factor in the enormous pool of relatively cheap labour available in Asia. Wasn’t the accumulation in private sector debt partly in response to the stagnating of wages resulting from this new source of labour. Has anything changed there?
Wages may be sticky but you are not going to get wage gains in a deleveraging situation. That’s the real story here; this environment is fundamentally deflationary unless it is countered by government propping up demand for employment and wages. until the deleveraging has happened, none of the money printing is going to feed through into embedded inflation. That’s the big contrast between the inflationary depression of the 1970s and the episodes now and in the 1930s.
Yes, my thinking though is not only are wages held down by deleveraging but the increased pool of Labour. Therefore both QE and fiscal type operations will struggle to make it through to wages in developed economies.
Agree 100%.
I would have said tolerable would be a far better description of this combination. Though that does depend on external factors. The UK in the post WWII situation had a rapidly growing world market to export to. That is not so clear now, and its manufacturing has been decimated by decades of policy mismanagement. The UK is now in a mild recession because of the minimal austerity already. The rampant money printing has lead to commodity inflation which has also taken any steam out of the fragile economy and financial repression now is far more severe than any measures taken in the post war period. Don’t forget that interest rates had never been below 2% until this crisis. All of these and permanently high unemployment have eliminated the power of workers to maintain living standards, which are being eroded by inflation, fiscal drag and high asset prices that again drain the family purse, via higher rents or property prices.
The impacts of the zero interest policy have yet to be felt, but when they are it will bring down governments. It has pushed investors of all sizes to risky assets and these are clearly over valued. When they collapse because returns are unrealistic this will lead to a major crash. The poor returns coupled with a permanent squeeze on family incomes is depressing essential savings like pensions. Also with companies increasing prices to allow for the commodity increases that will have an impact on final sales. Few companies are price setters, the vast majority are price takers, and with squeezed incomes that does not look good longer term.
My main criticism of most analysts is that they might compare the productivity of one nation or company against another but only use head counts for comparison. It ignores the impact of high asset prices. Greek hotels are not expensive because of the staff but the real estate values. That is ignored by everyone. Greek wages have fallen yet hotel rates are still very high.
Nice analysis and you bring up a critical point. Too much of the analysis is for the aggregates – Hey, GDP is back up, wonderful!!! But it ignores that there are 8 million fewer people in the US labor force. More income distributed too fewer hands.
And yes, the bonuses at JPM easily offset inflation. But we can’t mention the 99% whose income doesn’t keep up with inflation…