Ray Dalio, the Founder of the world,s largest hedge fund Bridgewater Associates, is one of the most important voices in global financial markets. TIME magazine lists him among the 100 most influential people on the planet, and he is widely known as the Steve Jobs of investing, such is the inventiveness he brought to fund management. In an exclusive interview with Business Today,s Global Business Editor Udayan Mukherjee, Dalio talks about the burning issues in the global economy today and warns of dire days ahead. Edited excerpts:
Q: Ray, they call you the Steve Jobs of investing—does that annoy you? Or do you take it as a compliment?
A: I was an admirer of Steve. He was an independent thinker who came up with great and different ways of doing things that contributed a lot to what our world is like today. Wow! To be compared to Steve Jobs is an honour that I really don’t deserve, but I’m happy to get.
Q: Okay, let us take it from the top; over the last few days, all the chatter in global financial markets has been about what the US Federal Reserve Governor told us. Was he signalling that rates will not go up a lot, that they’re almost done? Perhaps it all boils down to the genesis of the problem, which is the sheer amount of debt and liquidity pumped into the global system over the last decade. Do you think the US Federal Reserve and central banks across the world can successfully dial back these excesses?
A: I think in answering that question, we have to look at three factors. The normal economic factors, which had been anything but normal, particularly the enormous creation of debt. And then the monetisation of that—in other words, the central bank printing money and buying the debt. And so, we’re facing that big problem today. But at the same time, we are going through two other factors that are disruptive and related. One, a great internal conflict due to large wealth gaps that is producing populism of the left and populism of the right—at war with each other—which we can see in elections all around and particularly in the way the United States is fragmenting. They’re not just money issues, but ballot politics. And second, we have, internationally, this great power conflict. No longer is the United States the sole dominant power. We have a great rivalry, bordering on war, between China and the United States. And that is having disruptive effects, economically disruptive effects, for example, in how it makes supply chains more difficult and so on. And that adds to inflation. Of course, it creates other worries as well. So, it’s the interaction of those three things that is creating a much bigger problem.
So as far as your question goes, on monetary policy... how high will interest rates go and what is the Fed looking to do? First, let’s go back to basics. I think we’re going to have an inflation rate that is probably in the vicinity of 5 per cent. But it’s a very uncertain inflation rate because of all the shocks that we have around it. But let’s say 4.5-5 per cent is probably what it settles down at, after all this tightening. The real interest rate, in other words, the rate above inflation is in the vicinity of 1.5 per cent. So that would mean that they would eventually need to be approaching a 6 per cent risk-free rate. And the Federal Reserve will put the short-term rate up towards that level, which is very harmful, very damaging to the economy. But what the Federal Reserve is trying to do is balance those, having an interest rate that’s high enough for the creditor, but not so high for the debtor. And so, what you’re going to see is a slowing of the pace of the rise, but still approaching over 5 per cent, probably in the vicinity of 5.5 per cent. This will still have an effect on all markets, particularly on stocks. And we are talking about the government rate here; if you have low-grade credit, you can safely add five percentage points to that. So, you’re talking about 10-11 per cent, which will have a very severe negative effect, particularly on companies that have so far relied on receiving funding on an ongoing basis. In other words, they don’t have enough profits to carry themselves.
Q: Just to pick on the last bit of what you said, if short rates indeed approach 5.5-6 per cent, is that baked into stock prices already? Has the market factored it in fully?
A: No, it’s not priced in. What’s priced in rather is that there will be a sharp fall in inflation rates. We do know that there will be a fall in inflation rates as some of the exogenous factors like the oil price won’t stay up where it is, and some commodity prices and even housing prices will ease off, and so on. So that’ll bring inflation down some, but that brings it down from a very high level of 8 per cent to something that’s lower than that, and not sustaining. The wage sector, the employment sector is going along relatively well, because [the] unemployment rate is low. So, there’s still demand. And the inflation that we’re seeing there is also coming from compensation inflation. So, we’re going to see those rates rise. So, what you see built into the curve today is a fall-off in rates and a fall-off in inflation. But I believe that you’ll see it staying higher than those levels that are built into market expectations now.
Q: For how long though, Ray? Pessimists are warning of a 1970s-like situation where inflation surprises us and lingers on at a very high level for many years. What are the risks of that?
A: Those risks are very high. We’re at a paradigm shift. We know that we’re going to spend a lot more money than we are taking in. In the United States, we will have a budget deficit in the vicinity of 5 per cent of GDP. As is now planned, the Federal Reserve will also sell its bonds, and short-term debt to the tune of about 5 per cent of GDP. That’s 10 per cent of GDP. And that’s going to create a very tight set of circumstances, which are bad for growth.
You know, there are so many demands on money. We need money for poverty alleviation, building infrastructure, repairing the Ukraine, spending money for climate change. An individual might ask—‘How much money do we have? And what should we spend it on?’—but the big difference between individuals and governments is that governments don’t have that constraint because they can print money. So, we have this trade-off. Whenever in history, you have a lot of debt and a lot of financial assets, it becomes very, very difficult for those to be balanced. And we’re now in a shift. The prior decade, we had falling interest rates, cash was very cheap, free, almost. And so, the whole investment landscape was very much built around that. Now we’re having this adjustment away from that. So central banks try to balance growth and inflation. But it will be a very difficult balance, which creates an environment of stagflation, I’m afraid.
Q: Now, the question for any investor, of course, is how do you preserve, or at least conserve, your wealth at a time like this? You’re famous for maintaining that cash is trash for most of your investing career. Would you say that even today?
A: Interest rates have now risen to a level where it’s not as trashy. When I say cash is trash, I’m looking at it in relation to the inflation rate. When we had zero interest rates almost, cash was terrible, of course. As we now approach this level of 1.5-2 per cent above inflation, it is less bad. I would call it neutral, no longer trashy. It is harmful to other asset prices though. I think what you’re going to see is a classic sequence of events, where the interest rate rise is high enough that it is good for the creditor, but bad for the economy. And when economic conditions again become a bigger worry than inflation, you will see them [central banks] come in and print more money. So, I think it’s very important for investors over the long term to not hold debt instruments. Over the short term, I would say fixed income is neutral to slightly attractive. Over the long run, always look at your returns relative to inflation. Too many people look at just the level of returns, and they don’t pay enough attention to inflation. Generally stay away from debt assets, debt-denominated assets. Third, have a well-diversified portfolio. Diversification reduces risk without reducing expected returns, if you do it well. Also, don’t be too tactical. I think you have to realise that the markets are a zero-sum game. And to compete in the markets is more difficult than competing in the Olympics, because many more people are trying to do it and take money away from others.
Q: Ray, I want to touch upon the third point that you mentioned about the changing political power axis. We’ve lived 75 years without any kind of major war globally. Do you think that era is about to change?
A: I am a student of cycles and their mechanical cause, effect, linkages. If we take the financial issues we just talked about and the measures—size of the wealth gap, size of political gaps, amount of populism and the like; and if you look at the external factors—the conflicts between countries, the military build-up, and such; they are all, each one of those, at the highest levels since the tumultuous 1930-45 period. And that’s a period we’re in again.
What we’re seeing is no longer the minor country confrontations—like the United States against Afghanistan or Iraq. It is now Russia and China. And there are five kinds of wars. There is a trade war, a technology war, a geopolitical influence war, a capital and economic war, and a military war—five of those. We are already in the first four of those. Even if we never go to a major military war, we still have damage happening. Globalisation, as we know it, is declining. Because of fears of those looming wars, there is the desire for self-sufficiency. It used to be that the world would come closer to producing items wherever it was most efficient. That is now changing. Now, it’s wherever it’s most secure.
We have to assess investment destinations keeping this in mind. Neutrality is important. The three things that I look at while assessing countries is first the financials: Do they earn more than they are spending financially? Do they have a good income statement and good balance sheet? Second, do people within the country operate in a harmonious way? Healthy competition, yes, but not destructive political, dysfunctional behaviour. And three, are they at risk of an international war? Or are they more neutral and staying out of the international war? If they tick these three boxes, I favour those countries.
Q: And using those three parameters, how would you compare India and China today?
A: I think India has great potential. I use indicators, like the next 10 years’ expected growth rate, the cost of an educated person, barriers to trade and capital flows, levels of corruption, etc. And on balance, India should have the highest growth rate of any country. It’s opening up to the global capital markets. And it is largely taking a neutral position in these global conflicts. Of course, it needs to develop a very strong economy hinging on technology. As it stands, a number of indicators suggest that it should do very well over the next 10 years. So, it’s at an earlier stage of development, but should be a good investing environment.
Q: Finally, what kind of a cycle do you foresee over the next few years? Will these difficulties that you outline get resolved or does it look really tricky?
A: I predict the cycle like this. We have a political election now in the United States, [the] mid-terms. I think that we also have an economic cycle. Both are going to get worse, in the United States and elsewhere. You’re going to have more internal conflict, and you’re going to have at the same time, more economic problems like stagflation and that’ll take us into—in the United States—the 2024 election. Similar patterns are visible around the world. I think all this is going to be very difficult. Not least because the situation with international conflicts is not going to improve substantially. So, as we go into the 2024 period, you’re going to encounter more of those problems.
So if I was to pick a period of time that I think will be particularly challenging, it’ll have to be in the vicinity of ’24-25, perhaps. The main thing is that we don’t get into an all-out war. In other words, if this just becomes an evolutionary struggle, we’ll get through this. Even in depressions most people remain employed; even in wars, most people don’t get killed. It takes a while, but we get through it. The main thing is, you know, avoiding the wars.
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