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Remarks at the 40th Annual Central

Banking Seminar
Published on October 5, 2016 | Featured in: Banking & Finance, Economy, Editor's Picks

Ray Dalio

Following
Chairman & Chief Investment Oicer at Bridgewater Ass

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ThefollowingspeechwasdeliveredattheFederalReserveBankofNewYork's
40thAnnualCentralBankingSeminaronWednesday,October5,2016.

Itisbothanhonorandaveryspecialopportunityformetobeabletoaddresssucha
largeandesteemedgroupofcentralbankersatsuchaninterestingtimeforcentral
bankers.IespeciallywanttothankPresidentDudleyandVicePresidentSchetzelfor
invitingmetoforthrightlysharemyperspectiveasaninvestorandmyunconventional
templatethatIbelieveshedssomelightontheveryunconventionalcircumstancesthat
weface.
Itisnolongercontroversialtosaythat:
thisisntanormalbusinesscycleandwearelikelyinanenvironmentofabnormally
slowgrowth
thecurrenttoolsofmonetarypolicywillbealotlesseffectivegoingforward
therisksareasymmetrictothedownside
investmentreturnswillbeverylowgoingforward,and
theimpatiencewitheconomicstagnation,especiallyamongmiddleandlower
incomeearners,isleadingtodangerouspopulismandnationalism.

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Whilethesethingsarenowwidelyagreed,therestillisntagreementonwhythese
thingsaretrueorwhattodoaboutthem.Whiletherearemanyfactorsatplay,Ibelieve
thatthemostimportantonesarecoveredbyasimpletemplatethatIusetoguidemy
globalmacroinvesting.
Tomeaneconomyisnothingmorethantheaggregateofthemarketsthatmakeitup,
andthattounderstandwhatisgoingon,weneedtolookatwhoisdoingwhatbuying
andsellingofgoods,servicesandfinancialassets,andwhy.Thatunderstandingis
essentialforustounderstandmarketpricesandvolumes.Wetrytoputourselvesinthe
shoesofthemajorbuyersandsellerstounderstandwhattheyaredoingandwhy,and
thenprojectwhattheywilldo.Bylookingatthemajorbuyerstoestimatehowmuch
moneyandcredittheywillspendandthemajorsellerstoestimatewhatquantitiesthey
willsell,wedividethetotalamountspentbythetotalquantitytodeterminetheprice.

Fromwatchingthesetransactionsfromboththemicrolevelupandthemacrolevel
down,weseethemadduptothreemainforcesthatalldrivealleconomies:
1)Productivitygrowth
2)Theshorttermdebtcycle,alsoknownasthebusinesscycle,whichtypicallytakes5
to10years,and
3)Thelongtermdebtcycle,whichtypicallytakes50to75years.
Ibelievethatthemostimportantforcethatisnowdrivingwhatishappeningandisnt
wellunderstoodisthelongtermdebtcycle.Longtermdebtcyclesarenotwell
understoodbecausetheycomealongonlyonceinalifetime.
Therearealsothreeimportantequilibriumsthateconomiesandmarketsgravitate
towards:
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1)Debtgrowthhastobeinlinewiththeincomegrowththatservicesthosedebts
2)Economicoperatingratesandinflationratescantbetoohighortoolowforlong,
becauseifaneconomyisdepressedortoohotforlong,thatwillleadtochangesto
reverseit,and
3)Theprojectedreturnsofequitieshavetobeabovetheprojectedreturnsofbonds
whichhavetobeabovetheprojectedreturnsofcashbyappropriateriskpremiums.
Themostimportantdifferencesthatwillexistinthefuturethatdidnotexistinthepast
arethatdebtwillnotbeabletoriseasfastandthecapitalmarketstransmission
mechanismwontworkaswell,asinterestratescantbeloweredandriskpremiumsof
otherinvestmentsarelowandshrinking.Ifappropriateriskpremiumsdontexist,the
transmissionmechanismofcapitalwontworkaswellandtheeconomywillgrindtoa
halt.Forthesereasonsmajorcentralbanksarefacingapushingonastringsituation.
Thelasttimethishappenedwasinthelate1930s.
Therearetwoleversthatpolicymakersusetobringabouttheseequilibriums:
1)Monetarypolicy,whichoperatesviainterestratechangesandquantitativeeasings,
whichdependonsignificantcentralbankpurchasesandappropriatecapitalmarketrisk
premiums,and
2)Fiscalpolicy,whichdependsonpoliticalcoordinationbothwithinthecentral
governmentandwiththecentralbanksmonetarypolicy.
Economicandmarketmovementsarelikeaperpetualmotionmachineofinteractionsof
these.Themostprofounddifferencesthatnowexistaretherelativeimpotenceof
monetarypolicyandpoliticalfragmentationthatmakescoordinationoffiscaland
monetarypolicieshardtoimagine.

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Wheredoesthatleaveusnow?
Byandlarge:
1)Productivitygrowthisslow,thoughproperlyaccountingforithasneverbeenmore
difficult
2)Theshorttermdebt/businesscyclesasmeasuredbyGDPgapsareclosertotheir
midpointsthantotheirextremes,and
3)Thelongtermdebtcyclesareapproachingtheirverylatestagesasdebtscantbe
raisedmuchandcentralbanksareapproachingpushingonastringlimitationstotheir
effectiveness.
Thebiggestissueisthatthereisonlysomuchonecansqueezeoutofadebtcycleand
mostcountriesareapproachingthoselimits.Inotherwords,theyaresimultaneously
approachingboththeirdebtlimitsandcentralbankspushingonastringlimits.
Centralbanksareapproachingtheirpushingonastringlimitsbothbecauseinterest
ratesareapproachingtheirmaximumlows,andbecausetheeffectivenessofQEis
approachingitslimitsastheriskpremiumsandspreadsarecompressing.Also,the
wealthgapandnumerousotherfactorsmakelendingtospendersmorechallenging.
Thisisaglobalproblem.Japanisclosesttoitslimits,Europeisastepbehindit,theUS
isasteportwobehindEurope,andChinaisafewstepsbehindtheUnitedStates.
Unlikein2007whenthistemplatesignaledthatwewereinabubbleandadebtcrisis
layahead,Idontseesuchanabruptcrisisintheimmediatefuturebecausea)most
economiesarenearthemidpointsoftheshorttermdebtcyclesandtheirgrowthrates
areneitherdangerouslyrapidnordangerouslyslowi.e.thecyclicalinfluencesare
closetobeinginequilibriumandb)debtgrowthratesinthedevelopedcountrieshave
beenroughlyinlinewithincomegrowthrateswithdebtslargelyinthehandsofcentral
bankerswhocanrollthemforward.
However,whenwedoourprojectionsweseeanintensifyingfinancingsqueeze
emergingfromacombinationofslowincomegrowth,lowinvestmentreturnsandan
accelerationinliabilitiescomingduebothbecauseoftherelativelyhighlevelsofdebt
andbecauseoflargepensionandhealthcareliabilities.Thepensionandhealthcare
liabilitiesthatarecomingduearemuchlargerthanthedebtliabilitiesinmostcountries
becauseofdemographicsi.e.,duetothebabyboomgenerationmovingfromworking
andpayingtaxestogettingtheirretirementandhealthcarebenefits.
Ithinkofthegapbetweenprojectedliabilitiesandprojectedincomesinthefollowing
way.Holdersofdebtbelievethattheyareholdinganassetthattheycansellformoney
tousetobuythings,sotheybelievethattheywillhavethatspendingpowerwithout
havingtowork.Similarly,retireesexpectthattheywillgettheretirementandhealth
carebenefitsthattheywerepromisedwithoutworking.So,allofthesepeopleexpectto
getahugeamountofspendingpowerwithoutproducinganything.Atthesametime,
workersexpecttogetspendingpowerthatisequalinvaluetowhattheyaregiving.
Theyallcantbesatisfied.
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Asaresultofthisconfluenceofconditions,wearenowseeingmostcentralbankers
pushinginterestratesdowntomakethemextremelyunattractiveforsaversandweare
seeingthemmonetizingdebtandbuyingriskierassetstomakedebtandotherliabilities
lessburdensomeandtostimulatetheireconomies.Rarelydoweinvestorsgetamarket
thatweknowisovervaluedandthatapproachessuchclearlydefinedlimitsasthebond
marketnow.Thatisbecausethereisalimitastohownegativebondyieldscango.
Theirexpectedreturnsrelativetotheirrisksareespeciallybad.Ifinterestratesrisejust
alittlebitmorethanisdiscountedinthecurveitwillhaveabignegativeeffecton
bondsandallassetprices,astheyareallverysensitivetothediscountrateusedto
calculatethepresentvalueoftheirfuturecashflows.Thatisbecausewithinterestrates
havingdeclined,theeffectivedurationsofallassetshavelengthened,sotheyaremore
pricesensitive.Forexample,itwouldonlytakea100basispointriseinTreasurybond
yieldstotriggertheworstpricedeclineinbondssincethe1981bondmarketcrash.And
sincethoseinterestratesareembeddedinthepricingofallinvestmentassets,that
wouldsendthemallmuchlower.
Atthesametime,asbondsbecomeaverybaddealandcentralbankstrytopushmore
moneyintothemarketandyieldsgoevenlowerandpricerisksincreasefurther,savers
mightdecidetogoelsewhere.AtexistingratesofcentralbankbuyingwhichIbelieve
willberequiredfortheforeseeablefuturecentralbanksaregoingtostarttohitthe
limitsoftheirexistingconstraints.Thoselimitswereputintoplacebecausethey
originallythoughtthattheywereprudentbuttheyaregoingtohavetogobuyother
things.Rightnow,anumberoftheriskierassetslookattractiveinrelationshiptobonds
andcash,butnotcheapinrelationshiptotheirrisks.Ifthiscontinues,holdingnon
financialstoreholdsofwealthlikegoldcouldbecomemoreattractivethanholdinglong
durationfiatcurrencyflowswithnegativeyields(whichiswhatbondsare),especiallyif
currencyvolatilitypicksup.
Concerningwhatpolicieswilllikelyberequiredofcentralbankersgiventhereduced
effectivenessofinterestratecutsandquantitativeeasing,andassumingthatpolitical
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limitationsonfiscalpoliciesandstructuralreformsremainstringent,itappearstome
thattherewillhavetobegreaterpurchasesofriskierassetsandmoredirectplacements
ofpurchasingpowerinthehandsofspenders,especiallyasthepreviouslydescribed
squeezeintensifies.

Whilenoperiodisentirelyanalogous,themostrecentsimilarperiodfortheworld
economyasawholewas193545.Afterthedebtfinancedbubbleofthelate1920s
(whichwasanalogoustothedebtfinancedbubblesofthe200507period),andafterthe
192932stockmarketandeconomicdives(likethosein2008),andfollowingthegreat
quantitativeeasingsthatcausedstockpricesandeconomicactivitytorebound(like
thosewesawsince2008),camepushingonastringin1935,foranalogousreasons
i.e.interestratesandriskpremiumsapproached0%.

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Similarly,thelast20yearsinJapanareanalogousinthattherehasbeenasimilar
combinationofhighlevelsofindebtedness,interestrateshitting0%,riskpremiumsand
assetreturnsshrinking,growthandinflationbeinglow,andpushingonastringbeing
aproblem.

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Appendix:

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BureauofStatistics,AssetInternational,Inc.,BarclaysCapitalInc.,BloombergFinance
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Ray Dalio

Chairman & Chief Investment Oicer at Bridgewater Associates, L.P.

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Adriana Niazi

9h

Senior Business Intelligence Analyst at Holistic Solution Systems

This entire piece was written as seen through the lens of Wall Street with complete disregard for Main
Street.
It is true that interest rates are so low and risk rates so compressed that adding money via the tools
ordinarily used by the Fed would do no more good than "pushing on a string." This string theory
reminds me of a quote by the famous American hermit, Henry Davi See more
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Michael Vail F Fin FCPA

2h

Principal - Agriculture, Agribusiness, and Pastoral, at TRE PONTE capital

Great counter-point
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Michael
Vail F Fin FCPA
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Well said.
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Philip Bower

1d

Marketing & Development Manager at Sutton Winson Risk Managers & Insurance Brokers. Helping

How the economic machine works..simple and eective video - thank you Ray
https://youtu.be/PHe0bXAIuk0
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