Another conversation with Bridgewater Associates’ Ray Dalio

The last time Ray Dalio conducted a major interview, the global economy seemed to be headed toward a major depression. This was in February 2009 when Barron’s had a conversation with Bridgewater Associates’ Ray Dalio. For his part, Dalio saw the episode as part of a necessary restructuring process. He called it the D-Process.

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.

Dalio went on to say:

"The Federal Reserve is going to have to print money. The deficits will be greater than the savings. So you will see the Federal Reserve buy long-term Treasury bonds, as it did in the Great Depression. We are in a position where that will eventually create a problem for currencies and drive assets to gold."

This is exactly what has occurred. A month after Dalio spoke to Barron’s , the S&P hit rock bottom and has doubled in the intervening time. So, what’s next? Well Dalio was on CNBC this morning to tell us exactly where he thinks we are in this cycle and what to expect going forward.

Below is the 25-minute video plus a few bullet points crystallising the essence of Dalio’s main points. I have also linked to my posts on the same subject which are more or less in line with his commentary.

Ray Dalio’s ideas

Dalio on independent thinking:

In order to make money in the market you have to be an independent thinker. And i think also creative, you have to be willing to make mistakes. And so the process is that anybody in the company, if anything doesn’t make sense to them, that they can bring up what doesn’t make sense to them in a nonhierarchal way and look at whether it’s true or not and what we should do about it. We particularly like looking at mistakes or weaknesses that we have in order to get stronger.

[See The psychology of economic forecasting]

Dalio on the dollar’s diminishing role as a reserve currency:

I think it’s inevitable that the dollar’s role as a world currency diminish from the dominant world currency to one of a few and it will happen over a gradual time. We’ve been very lucky, because the dollar is the world’s currency and considered the place that’s safe so foreign countries will save there and we’ve been able to borrow at cheaper rates than we could have otherwise. And so that is diminishing.

[See How To Reduce Government Budget Deficits and Wait for the next crisis for reform of the monetary system]

Dalio on the two-speed global economic recovery:

The world is broken into two parts now. We have the debtor-developed world. So the United States, Europe and Japan basically are countries which are overly in debt and expensive. Then we have the emerging world. Basically, it’s 50-50. Emerging world now accounts for 53% of GDP. The developed world is 47% of GDP.

[See Gross: ‘The global economy is suffering from a lack of aggregate demand’]

Dalio on emerging markets:

The one world is booming. The emerging market. Inflation rates and strong growth rate and tied through this currency link to the U.S., Europe and Japan. And as a result, they have totally inappropriate monetary policies because if you have a currency that’s linked, you have interest rates that are linked. And it’s created totally uneconomic behaviour in those countries. This is going to be the big next seismic shift, I believe. I think that probably something in 2012 it will become intolerable to maintain those currency links and we’ll probably have a big shift.

[See Win Thin’s Korean Rate Hike Needed As Inflation Accelerates and Russia Widens RUB Trading Band, Signaling Comfort With Further Strength as well as my Is Brazil Overheating?]

Dalio on US shares:

U.S. Equities first are still comparatively cheap. But more importantly, the flows are beneficial to them because U.S. Equities benefit from currency depreciations. I think, as I say in 2012, the developed countries’ currencies will devalue in relationship to the emerging countries’ currencies.

[See Is this Nasdaq Chart Bullish? and On Printing Money and Debasing The Currency]

Dalio also believes that gold remains an underappreciated asset and that the de-leveraging is far from over, both views that I agree with (see The recession is over but the depression has just begun). Dalio also says the Fed saved us from an almost certain major depression. I agree here again – but reluctantly. QE1 was a necessary injection of liquidity to take on the role of the collapsed shadow banking system. That is the Fed acting as lender of last resort, its principal role. But I object to the easy terms it has provided and to QE2, which has not served a liquidity function but has stoked animal spirits and created a Bernanke put. Eventually, economic weakness will return – probably in the second half of 2011 (see Cautiously Optimistic Into 2011). 2012 will be weaker than 2011 and then we’ll have to see where the deleveraging gets us in an environment where the Fed has been prodding punters into reaching for yield and taking on risk.