If you don’t know who Ray Dalio is, he is one of our time’s greatest minds in macroeconomics and he also happens to be the Founder, Chairman and co-CIO of the world’s largest hedge fund, Bridgewater Associates.
If you haven’t already, I highly recommend checking-out his short film on How The Economic Machine Works - at the end of this article.
On October 27th 2020 (yesterday), Bloomberg released a podcast in which Ray provided his updated views on the world, how they have changed his thinking about portfolio allocation (i.e. his famous All Weather Portfolio), the rise of China and how it challenges the status quo, and how the upcoming elections in the USA will impact our life going further.
I highly recommend listening to the episode as it is full of interesting insight and certainly a solid introduction to his upcoming book: The Changing World Order: Why Nations Succeed and Fail, coming out January 2021.
I’ll summarize a few of his thoughts below, links at the end;
1/ We are at an important inflexion point in History
The current macroeconomic situation is at the confluence of 3 strong trends:
- We are at record high debt levels;
- There is extreme social inequalities and a huge (and widening) wealth gap;
- We are witnessing an undeniable and unstoppable rise of a super power (hint: China);
This was true before the pandemic hit, which has become an important stress test for our economies and has certainly accelerated the above three trends. Now, of course we can’t predict the future, but Ray says our situation is not unprecedented: history is repeating itself!
So what can be learned from the past?
2/ This happened 16 times in the past 500 years...
...12 of which resulted in a military war.
Which isn’t to say we’re going straight for WW3. There are other, non-military, types of wars that may or may not come our way:
- Trade war - sounds familiar?
- Technology war - Huawei & 5G, anyone?
- Geopolitical war - look at the situation in the South China Sea, look at Taiwan and Hong Kong… look at who exercises more world influence (see World Health Organisation).
- Capital war - history has shown that in times of war, belligerent countries get cut-off of other economies (oil, rubber, capital). China owns about a trillion worth of US bonds - the US could decide not to repay that debt;
- Finally, military war - because of nuclear bombs and how devastating they are, the military component nowadays is mostly a test of power. And there is no world court to arbitrate. China has developed a clear superiority in their region. Again, look at what is going on in the South China Sea.
3/ Are we doomed? (fair question)
No - Ray says “this should not completely change the world…” but we will witness over the next 5 years an increase in decoupling with China (both countries are working on getting more independent from each other, not only on supply chain).
This will create inefficiencies (2 systems, will they operate in harmony or otherwise?). We need to read between the lines here, but what inefficiencies means is usually opportunities for investment/innovation/arbitrage.
It’s important to note that all civilizations in the past have risen and fallen. All of them. Death is just part of life.
4/ What does this mean concretely?
Let’s look closer at the current situation:
- Contrary to what some say, trade deficits are not a bad thing fro th US: it’s what protects USD’s status as the world reserve currency - but Ray says the value of the USD is at risk because there is little chance the federal government will stop printing money;
- Nominal interest rates are close to zero, real interest rates are negative. It's important to understand the difference and the impacts on your returns;
- Time is on China’s side (they are growing much faster, getting more and more independent, and have a much larger population than the US - or any other country);
- Ray talks about 3 different monetary policies:
- Monetary policy 1: lowering interest rates
- MP2: money printing & buying of assets (which provides no trickling down)
- MP3: the government borrows to the FED for specific distribution/spending/stimulation
⇒ USA has gone through all 3
- No matter who will be the next President of the US, the debt level will rise and the money printing will continue, because the alternative is either lowering interest rates further (and remember real rates are already negative...) or raise taxes and cut spending… The easiest political decision is clearly to increase debt and print money.
It's important to note however that only the Federal Government can print money whereas the states can’t, which means they may have to resolve to spending cuts and that has historically proven to have huge impacts on communities (downwards spiral).
5/ What can the US government do about this situation?
This goes back to what the role of the government should be. For Ray, governments should focus on the basics (the engine of the american dream):
- Education (as a fundamental right)
- Basic healthcare
- Equal opportunities
Unfortunately, what the government should do contrasts with what it can do: Education for example is a state issue or responsibility. But as mentioned above, states don’t have enough money, some are on the verge of bankruptcy.
Ray did provide some advice for the USA’s next president under two categories, internal politics and external politics:
Internally, the next administration should :
- Focus on the education level of the population
- Make sure people can be productive
- Strengthen the country’s balance sheet (somehow)
- Unify the country
Externally, they should:
- Build a strategic plan which needs to address the elephant in the room;
- They need to work with China to agree on mutually protective measures, find a win-win situation;
- Do it sooner rather than later, again, time is on China’s side.
5/ What could be the differences between a Biden and Trump presidency?
It’s important to note that Ray’s thinking is not ideological but a mechanical view of the world - he’s about economics, not politics. Here are his thoughts:
- The “right” is usually better at increasing the size of the pie but the “left” is usually better at distributing it;
- Ray dreams of a government that is able to do both but it will be hard: the state of the US’s balance sheet is not ideal and may not allow for it;
- What is truly important is how people will treat each other (he recommends having a philanthropic spirit, seek to emulate “heroes” and role models);
- People should come together as one to take on the challenges ahead - which, as I understand it, probably means finding a way to reduce the wealth gap and social inequalities...
7/ Why is there such an important wealth gap in the US?
The wealth gap is self perpetuating because:
- Some government stimulus played disproportionately in favor of the wealthier segment of the population: only 50% of Americans own stocks and 50% of the equities owned by Americans are owned by the 10% richest Americans, so when the stimulus helped the stock market, it mostly made the rich richer. Note that the top 0.1% has more than bottom 90% combined.
- As Ray noted, the top 40% of the population spends about 5 times more on education than the other 60%. Less money spent on education means less financial literacy, lower paying jobs and it all clearly widens the gap;
- Technology is replacing people with machines. Workers are on the losing end of this equation while shareholders are on the winning end;
- Globalization is narrowing the wealth gap in between countries but as labour is being transferred from rich countries to rising countries, the low-wealth population within the rich countries are, again, on the losing end of the equation.
Ray notes that this situation has grim political consequences in the rise of populism (as history has also shown - and has led humanity into very dark times).
8/ Could Universal Basic Income be a solution?
Ray does not seem to be a proponent and explains why:
- Governments should focus on providing the basics: healthcare and education;
- People need to be productive (i.e. not be paid for doing nothing);
- UBI is expensive;
- People need to be financially literate for it to be useful or efficient and there is clearly a financial literacy problem;
- It’s more efficient to provide programs to funnel the money in the right direction (education, provide equal opportunities).
9/ A word of advice for retail investors?
- Don’t mix emotion with investment.
- Remember that history repeats itself (booms come after depressions and wars, there are cycles: debt, etc).
- Understand market mechanics, for example how long term certainty drives short term volatility (in bond pricing for example);
10/ How could we increase our return without increasing risk?
Ray is famous for his hedge fund returns and for this asset allocation strategy. Here are two asset classes he cautions against:
- Bonds: avoid them right now, "don’t look for yield but for price change";
- Cash: think about the value of money. Because of low interest rates there is a huge risk in holding cash.
Ray has long been ruling against holding cash (as opposed to Buffet for example) but the Bond part is new. His “All Weather Portfolio” for example did account for 40% of long-term bonds and 15% of intermediate-term bonds.
Here are the assets classes he did recommend:
- Gold: Early in the debt cycle (low debt), it pays to hold cash instead of gold. But late in a debt cycle (like now), gold becomes more interesting (it performed well in the past 10 years). So Ray says it should be in your portfolio (approximately 10-15%, up from 7.5% in the All Weather Portfolio);
- Other gold-like assets also worth considering but make sure they are liquid (i.e. not real estate);
He then recommended making sure you diversify as much as possible (true to his philosophy), in terms of:
- Asset classes;
He said “If you balance well, you don’t give up any return in order to reduce risk because assets compete with each other”.
He is not a proponent of Cryptocurrencies, sees 3 big problems with them:
- Hard to exchange (can’t buy stuff with credit card);
- Not a good store of wealth (volatility);
- Could be objectionable by the government (i.e. the government could outlaw it);
It is possible that Ray’s understanding of cryptocurrencies may not be as deep as it is for other asset classes. I say that because these three points are... false. There are a number of credit cards that plug directly to crypto-wallets, some cryptocurrencies have less volatility than stocks, and governments have little say on who and what can be done with cryptocurrencies, which is one of the main reasons it exists (decentralization). Maybe Ray juste doesn't like crypto or has other motives not to publicly vouch for them. Who knows.
Ray did however speak favorably about digital currencies, which are basically cryptocurrencies controlled by central banks. An important example is of course the Chinese digital currency which seems to be ahead of any other country in the matter.
11/ Some other insights and advice
Finally, here is some sensible advice Ray provided that can be applied by anyone, anywhere:
- Be humble and learn your lessons, from your experience extract principles to live by (pain + reflection = progress);
- Continue to learn even if and when you become the head of the largest hedge fund in the world;
- Be kind to others, open minded and curious;
12/ Closing and references
A great big thank you to Ray Dalio for sharing his wisdom and to Bloomberg for the great podcast episode.
Here is the link to the episode: https://ritholtz.com/2020/10/mib-ray-dalio-bridgewater-associates-3/
Also check-out Ray's authored and recommended books at the end of that page.
Finally, watch Ray Dalio’s excellent video on How The Economic Machine Works: