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Circulation by region, state and printing plan

Saturday, February 7, 2009


Interview With Ray Dalio: This pro sees a long and painful depression.
Chief Investment Officer, Bridgewater Associates

Naperville

Recession? No, It’s a D-process, and It Will Be Long


WA
5,561
MT
545
ND
267
Des Moines
10,272
22,754
Highland
7,537
Seattle
MN
10,000
By Sandra Ward SD
3,979

WI
Bowling Green
14,825
OR 353 5,165
2,714 ID
705 WY MI
297 IA 8,020 NY
Nobody was better prepared for sion, and the only reason that 1,674 43,240
NE
the global market crash than people really don’t understand 1,098 PA
IL OH 13,327
clients of Ray Dalio’s BridgewaterNV this process is because it hap- 18,616
IN 9,048
UT CO
Associates and subscribers to its 2,166 pens 1,143rarely. Everybody
4,901 should, KS MO
3,290
WV
DC
1,449
1,717
Daily Observations. Dalio, CA the at this point, try to understand 3,557 KY
1,540
502
VA
Palo Alto 39,176 8,222
chief investment
18,069officer and all- the depression process by read- M
TN NC 7,
around guiding light of the global ing about the Great Depression or OK
1,350 AR
2,488 5,456
AZ NM
money-management company he the Latin
5,313 American
1,024 debt crisis or
813
GA
SC
Riverside 2,181
founded more than23,915 30 years ago, the Japanese experience so that MS
679
AL
1,772
5,652

began sounding alarms in Barron’s it becomes part of their frame TX of LA


La Grange C
Denver 14,405 9,397
in the spring of 2007 AK about the reference. Most people didn’t live
12,443 1,424
185
dangers of excessive financial through any of those experiences, FL
Beaumont
leverage. He counts among his and what they have gotten Dallas used 7,716
20,239

clients world governments and to is HIthe recession dynamic,


10,822 and Orlando
19,864
central banks, as well as pension so they are quick to presume the
474

funds and endowments. recession dynamic. It is very clear Matthew Furman for Barron’s
to me that we are in a D-process.
Western:
No wonder.64,427 The Westport, Conn.- Southwestern: 18,538 Midwestern:
al Reserve 75,127
eases monetary policyEastern: 1
based firm, Colorado,
Alaska, California, whose Hawaii, analyses of Why are you hesitant to empha- and produces anIowa,
Arizona, Louisiana, Mississippi, New Mexico, Alabama, llinois, Indiana, Kansas,
expansion. WeConnectic
Idaho, Montana, Nevada, Oregon, Utah, Oklahoma, Texas. Kentucky, Michigan, Minnesota, Mississippi, Florida, Ge
world markets
Washington, Wyoming. focus on credit and size either the words depres- Missouri, can make it more
Nebraska, complicated,
New York (Buffalo), NorthbutMassachu
currencies, has produced long- sion or deflation? Why call it a Dakota, that Ohio,
is a Pennsylvania
basic simple (Erie, description
Harrisburg, New York,
term annual returns, net of fees, D-process? Pittsburgh,
of whatWilkes-Barre),
recessions South
areDakota,
and whatRhode Isla
Geographic Distribution represented in Tennessee, Wisconsin. Virginia, W
averaging 15%.
ABC Statement. (May In the
26, 2008 issue) turmoil of we have experienced through the
2008, Bridgewater’s Pure Alpha 1 Both of those words have conno- post-World War II period. What
fund gained
© 2008 Dow 8.7%Inc.net
Jones & Company, of Reserved.
All Rights fees and tations associated with them that you also need is a comparable
revisedun-
December 29, 2008

Pure Alpha 2 delivered 9.4%. can confuse the fact that it is a derstanding of what a D-process
process that people should try to is and why it is different.
Here’s what’s on his mind now. understand.
You have made the point that
Barron’s: I can’t think of anyone You can describe a recession as an only by understanding the pro-
who was earlier in describing economic retraction which occurs cess can you combat the prob-
the deleveraging and deflation- when the Federal Reserve tight- lem. Are you confident that we
ary process that has been hap- ens monetary policy normally to are doing what’s essential to
pening around the world. fight inflation. The cycle contin- combat deflation and a depres-
ues until the economy weakens sion?
Dalio: Let’s call it a “D-process,” enough to bring down the infla-
which is different than a reces- tion rate, at which time the Feder-
The D-process is a disease of sorts Basically what happens is that The process of bankruptcy or re-
that is going to run its course. after a period of time, econo- structuring is necessary to its via-
mies go through a long-term bility. One way or another, Gener-
When I first started seeing the D- debt cycle—a dynamic that is al Motors has to be restructured
process and describing it, it was self-reinforcing, in which peo- so that it is a self-sustaining, eco-
before it actually started to play ple finance their spending by nomically viable entity that peo-
out this way. But now you can ask borrowing and debts rise rela- ple want to lend to again.
yourself, OK, when was the last tive to incomes and, more accu-
time bank stocks went down so rately, debt-service payments This has happened in Latin Amer-
much? When was the last time rise relative to incomes. At cy- ica regularly. Emerging countries
the balance sheet of the Federal cle peaks, assets are bought on default, and then restructure. It is
Reserve, or any central bank, ex- leverage at high-enough prices an essential process to get them
ploded like it has? When was the that the cash f lows they pro- economically healthy.
last time interest rates went to duce aren’t adequate to service
zero, essentially, making mone- the debt. The incomes aren’t We will go through a giant debt-
tary policy as we know it ineffec- adequate to service the debt. restructuring, because we either
tive? When was the last time we Then begins the reversal pro- have to bring debt-service pay-
had deflation? cess, and that becomes self-re- ments down so they are low rela-
inforcing, too. In the simplest tive to incomes—the cash flows
The answers to those questions sense, the country reaches the that are being produced to service
all point to times other than the point when it needs a debt re- them—or we are going to have to
U.S. post-World War II experi- structuring. General Motors raise incomes by printing a lot of
ence. This was the dynamic that is a metaphor for the United money.
occurred in Japan in the ‘90s, States.
that occurred in Latin America in It isn’t complicated. It is the same
the ‘80s, and that occurred in the As goes GM, so goes the nation? as all bankruptcies, but when it
Great Depression in the ‘30s. happens pervasively to a country,
and the country has a lot of for-
eign debt denominated in its own
The Top of a Cycle currency, it is preferable to print
Debt service is at its highest since the Great Depression, Dalio says, so restructuring is needed. money and devalue.

Household Debt Service (as % of Disposable Income) Isn’t the process of restructuring
Total Debt Service Interest Payments Principal Payments
15% under way in households and at
corporations?

12 They are cutting costs to service


the debt. But they haven’t yet
done much restructuring. Last
9 year, 2008, was the year of price
declines; 2009 and 2010 will be
the years of bankruptcies and re-
6 structurings. Loans will be writ-
ten down and assets will be sold.
It will be a very difficult time. It
3 is going to surprise a lot of people
because many people figure it is
bad but still expect, as in all past
0 post-World War II periods, we
1925 1935 1945 1955 1965 1975 1985 1995 2005
Source: Bridgewater Associates
will come out of it OK. A lot of dif-
ficult questions will be asked of risk of default has gone down, it banks will operate. That means
policy makers. The government has forced the interest rate on the they will have to nationalize
decision-making mechanism is debt to go down, and that is good, some in some form, but they are
going to be tested, because dif- too. going to also have to decide who
ferent people will have different they protect: the bondholders or
points of view about what should However, the reason it hasn’t ac- the depositors?
be done. tually produced increased credit
activity is because the debtors are Nationalization is the most
What are you suggesting? still too indebted and not able to likely outcome?
properly service the debt. Only
An example is the Federal Re- when those debts are actually There will be substantial nation-
serve, which has always been an written down will we get to the alization of banks. It is going on
autonomous institution with the point where we will have credit now and it will continue. But the
freedom to act as it sees fit. Rep. growth. There is a mortgage debt same question will be asked even
Barney Frank [a Massachusetts piece that will need to be restruc- after nationalization: What will
Democrat and chairman of the tured. There is a giant financial- happen to the pile of bad stuff?
House Financial Services Com- sector piece—banks and invest-
mittee] is talking about examining ment banks and whatever is left Let’s say we are going to end up
the authority of the Federal Re- of the financial sector—that will with the good-bank/bad-bank
serve, and that raises the specter need to be restructured. There is concept. The government is go-
of the government and Congress a corporate piece that will need to
ing to put a lot of money in—say
trying to run the Federal Reserve. be restructured, and then there is$100 billion—and going to get all
Everybody will be second-guess- a commercial-real-estate piece the garbage at a leverage of, let’s
ing everybody else. that will need to be restructured.say, 10 to 1. They will have a tril-
lion dollars, but a trillion dollars’
So where do things stand in the Is a restructuring of the banks a worth of garbage. They still aren’t
process of restructuring? starting point? marking it down. Does this give
you comfort?
What the Federal Reserve has If you think that restructuring
done and what the Treasury has the banks is going to get lend- Then we have the remaining
done, by and large, is to take an ing going again and you don’t re- banks, many of which will be
existing debt and say they will structure the other pieces—the broke. The government will have
own it or lend against it. But they mortgage piece, the corporate to recapitalize them. The govern-
haven’t said they are going to piece, the real-estate piece—you ment will try to seek private mon-
write down the debt and cut debt are wrong, because they need fi- ey to go in with them, but I don’t
payments each month. There has nancially sound entities to lend think they are going to come up
been little in the way of debt relief to, and that won’t happen until with a lot of private money, not
yet. Very, very few actual mort- there are restructurings. nearly the amount needed.
gages have been restructured.
Very little corporate debt has On the issue of the banks, ulti- To the extent we are going to have
been restructured. mately we need banks because to nationalized banks, we will still
produce credit we have to have have the question of how those
The Federal Reserve, in particu- banks. A lot of the banks aren’t banks behave. Does Congress say
lar, has done a number of suc- going to have money, and yet we what they should do? Does Con-
cessful things. The Federal Re- can’t just let them go to nothing; gress demand they lend to bad
serve went out and bought or lent we have got to do something. borrowers? There is a reason they
against a lot of the debt. That has aren’t lending. So whose money
had the effect of reducing the risk But the future of banking is go- is it, and who is protecting that
of that debt defaulting, so that is ing to be very, very different. The money?
good in a sense. And because the regulators have to decide how
The biggest issue is that if you The Hoover administration had Have you always been?
look at the borrowers, you don’t the equivalent of today’s TARP
want to lend to them. The basic [Troubled Asset Relief Program] No. Gold is horrible sometimes
problem is that the borrowers in the Reconstruction Finance and great other times. But like
had too much debt when their in- Corp. The stimulus program and any other asset class, everybody
comes were higher and their as- tax cuts created more spending, always should have a piece of it in
set values were higher. Now net and the budget deficit increased. their portfolio.
worths have gone down.
At the same time, countries What about bonds? The
Let me give you an example. around the world encountered conventional wisdom has it that
Roughly speaking, most of com- a similar kind of thing. England bonds are the most overbought
mercial real estate and a good went through then exactly what and most dangerous asset class
deal of private equity was bought it is going through now. Just as right now.
on leverage of 3-to-1. Most of it now, countries couldn’t get dol-
is down by more than one-third, lars because of the slowdown Everything is timing. You print a
so therefore they have negative in exports, and there was a dol- lot of money, and then you have
net worth. Most of them couldn’t lar shortage, as there is now. Ef- currency devaluation. The cur-
service their debt when the cash forts were directed at rekindling rency devaluation happens before
flows were up, and now the lending. But they did not rekindle bonds fall. Not much in the way
cash flows are a lot lower. If you lending. Eventually there were a of inflation is produced, because
shouldn’t have lent to them be- lot of bankruptcies, which extin- what you are doing actually is ne-
fore, how can you possibly lend to guished debt. gating deflation. So, the first wave
them now? of currency depreciation will be
In the U.S., a Democratic admin- very much like England in 1992,
I guess I’m thinking of the istration replaced a Republican with its currency realignment, or
examples of people and one and there was a major deval- the United States during the Great
businesses with solid credit uation and reflation that marked Depression, when they printed
records who can’t get banks to the bottom of the Depression in money and devalued the dollar a
lend to them. March 1933. lot. Gold went up a whole lot and
the bond market had a hiccup,
Those examples exist, but they Where is the U.S. and the rest of and then long-term rates contin-
aren’t, by and large, the big pic- the world going to keep getting ued to decline because people still
ture. There are too many non- money to pay for these stimulus needed safety and liquidity. While
viable entities. Big pieces of the packages? the dollar is bad, it doesn’t mean
economy have to become some- necessarily that the bond market
how more viable. This isn’t pri- The Federal Reserve is going to is bad.
marily about a lack of liquidity. have to print money. The defi-
There are certainly elements of cits will be greater than the sav- I can easily imagine at some point
that, but this is basically a struc- ings. So you will see the Federal I’m going to hate bonds and want
tural issue. The ‘30s were very Reserve buy long-term Treasury to be short bonds, but, for now, a
similar to this. bonds, as it did in the Great De- portfolio that is a mixture of Trea-
pression. We are in a position sury bonds and gold is going to be
By the way, in the bear market where that will eventually cre- a very good portfolio, because I
from 1929 to the bottom, stocks ate a problem for currencies and imagine gold could go up a whole
declined 89%, with six rallies of drive assets to gold. lot and Treasury bonds won’t go
returns of more than 20%—and down a whole lot, at first.
most of them produced renewed Are you a fan of gold?
optimism. But what happened Ideally, creditor countries that
was that the economy continued Yes. don’t have dollar-debt problems
to weaken with the debt problem. are the place you want to be, like
Japan. The Japanese economy ket rallies throughout the world; Thanks, Ray.
will do horribly, too, but they one of the best ways to trigger a
don’t have the problems that we stock-market rally is to devalue
have—and they have surpluses. your currency.
They can pull in their assets from
abroad, which will support their But there is a basic structural
currency, because they will want problem with China. Its per capi-
to become defensive. Other cur- ta income is less than 10% of ours.
rencies will decline in relation- We have to get our prices in line,
ship to the yen and in relationship and we are not going to do it by
to gold. cutting our incomes to a level of
Chinese incomes.
And China?
And they are not going to do it by
Now we have the delicate China having their per capita incomes
question. That is a complicated, coming in line with our per capita
touchy question. incomes. But they have to come
closer together. The Chinese cur-
The reasons for China to hold dol- rency and assets are too cheap in
lar-denominated assets no longer dollar terms, so a devaluation of
exist, for the most part. How- the dollar in relation to China’s
ever, the desire to have a weaker currency is likely, and will be an
currency is everybody’s desire important step to our reflation
in terms of stimulus. China rec- and will make investments in
ognizes that the exchange-rate China attractive.
peg is not as important as it was
before, because the idea was to You mentioned, too, that
make its goods competitive in the inflation is not as big a worry for
world. Ultimately, they are going you as it is for some. Could you
to have to go to a domestic-based elaborate?
economy. But they own too much
in the way of dollar-denominated A wave of currency devalua-
assets to get out, and it isn’t clear tions and strong gold will serve
exactly where they would go if to negate deflationary pressures,
they did get out. But they don’t bringing inflation to a low, posi-
have to buy more. They are not tive number rather than produc-
going to continue to want to dou- ing unacceptably high inflation—
ble down. and that will last for as far as I can
see out, roughly about two years.
From the U.S. point of view, we
want a devaluation. A devaluation Given this outlook, what is your
gets your pricing in line. When view on stocks?
there is a deflationary environ-
ment, you want your currency to Buying equities and taking on
go down. When you have a lot of those risks in late 2009, or more
foreign debt denominated in your likely 2010, will be a great move
currency, you want to create re- because equities will be much
lief by having your currency go cheaper than now. It is going to
down. All major currency devalu- be a buying opportunity of the
ations have triggered stock-mar- century.

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