Ray Dalio spoke to Barron’s in an interview that appeared in the weekly this past weekend. The themes of the conversation were the following:
- The world is on a dual track with emerging markets doing much better than developed economies.
- China is growing at a fantastic rate (15% nominal per year) while interest rates are 5%. That is a sure-fire recipe for increased credit growth.
- When QE comes to an end in June, US growth will slow markedly, just as it did when QE1 came to an end.
- The European debtors can’t print money. A deflationary outcome and default is inevitable.
- This confluence of factors makes developed economy debtor sovereign bonds unattractive and is a principal reason the Chinese are diversifying into commodities.
But commodities are also a volatile asset class. If demand falls for whatever reason, prices could also fall fairly dramatically. Barron’s asks Dalio "The commodity bubble continues?" And Dalio answers yes, as if he thinks there is a bubble in commodities. He sees this bubble ending in late 2012 as a result of Chinese tightening monetary policy.
All of this should be reconsidered after the Japan earthquake and tsunami because Japan is the third largest economy in the world. The demand destruction the earthquake wrought and the demand surge rebuilding will create will have far-reaching implications for commodity prices and global markets over the medium-term. Longer-term, Dalio is sanguine though:
As the population gets older, they want to draw on their savings. As they draw on their savings, they switch from lending to the government to running deficits. It’s a touchy situation. The central bank is going to have to print money, and that won’t be something the older population will be happy about.
What about the earthquake?
It won’t have a material effect on this picture.
Right now, Dalio is out of developed economy bonds – and has been for seven months. He is still long gold, commodities, and EM currencies. As for stocks, he says, "Currency devaluations are good for stocks, good for commodities and good for gold. They are not good for bonds."
Here is the beginning excerpt from that conversation.
Barron’s: How do you view the world at this point?
Dalio: This is a bipolar world in which there are emerging countries, which don’t have debt problems, which are saving a lot and growing at fast paces. Those include China and Brazil. Then there are the developed countries, which are the U.S., most of Europe and Japan, and they have too much debt. Each group can be broken into two other groups, those that have independent monetary policies and those that don’t.
For developed debtor countries, the ability to print money is what differentiates them. The U.S. can print money. England can print money. If you are a debtor, you ordinarily like to print money to get out of debt. But if you can’t print money, whether you are the state of Wisconsin or Spain, you are a debtor with one path: a decade of hell. It’s a period of restructuring that lasts a very, very long time in which there is debtor-creditor tension. Whether it was Brazil or Argentina in the 1980s, or Japan in the late ’80s, it amounts to a lost decade.
[Barron’s:] Let’s talk about the creditors.
[Dalio:] There are those creditor countries that have independent monetary policies and those that don’t. The irony of China is that it doesn’t have an independent monetary policy. It would like to tighten monetary policy, because it is in an inflationary bubble, but it can’t. They have about a 5½% inflation rate—actually, if you look at it month by month, it is 13% annualized—but let’s call it 5½%, year over year. They also have nearly a 10% economic growth rate. And interest rates are at about 5%. So China’s gross domestic product is growing at about 15% a year. When you have an economy that is growing at a 15% nominal rate, and you have a 5% interest rate, you would be nuts not to borrow and buy things with a higher return and you would be nuts to save in bank-deposit accounts.
The countries whose economies are booming are buying the things that are inflating. They have low labor costs, so they are very competitive in the world and are earning all sorts of money and at the same time creating all sorts of credit in response to the demand for goods and hard investment assets. They are running out of capacity, and they are overheated, and they can’t tighten monetary policy.
[Barron’s:] In the U.S., quantitative easing is coming to an end. What happens then?
[Dalio:] The Federal Reserve’s printing of money will continue through June and the fiscal stimulus will carry through the third quarter. We are also seeing a modest pickup in private-credit creation. Later this year, the economy’s two major sources of stimulation, monetary and fiscal policy, will be declining significantly. Most likely, growth will slow significantly going into year end, unless the pace of private-credit growth picks up.
[Barron’s:] How does Europe factor into all this?
[Dalio:] The European debtor countries—Spain, Ireland, Portugal and Greece—don’t have independent monetary policies and can’t print money. Therefore, they are in the early stages of decade-long debt and economic problems in which there will be constant tensions between them and their creditors. They got into this mess because the banks leveraged their balance sheets to lend money, and borrowers leveraged their balance sheets. Everybody had a great time. Then they reached their debt limits. When the private sector couldn’t borrow more and the government wanted to provide fiscal stimulus to make up for the shortfall in spending, these governments borrowed a lot of money because they couldn’t print money [because they are part of the euro zone]. These governments took on too much debt, so all sources of credit growth have largely shut down. As a result, they will have miserable economic growth and chronic debt problems, which will cause political and social instability. All countries can ultimately pay their debt if they impose taxes or cut spending. But there is only so much citizens can take, and then they throw those governments out and elect ones that promise not to cut spending or raise taxes.
[Barron’s:] So the European debt crisis is far from over?
It is likely we are going to have another phase of the European debt crisis, in which events will get ahead of the policy makers. Conditions in Germany are very different from those in the other countries. It is getting very delicate, because Germany is experiencing inflation, and Germans don’t want inflation, and they will get to a point where they want to tighten monetary policy, probably next month. As the year progresses, the tension between Germany and the debtor countries will intensify, and so this issue of debtor and creditor countries with different economic conditions being linked by the same monetary policy is going to come to a head.
Source: Observing a Bipolar World – Barron’s ($)