A Conversation with Ray Dalio

Wednesday, September 12, 2012

Ray Dalio, founder and co-chief investment officer of Bridgewater Associates, L.P., discusses global economics.

This meeting is part of the Corporate Program's CEO Speaker Series, which provides a forum for leading global CEOs to share their priorities and insights before a high-level audience of CFR members. The series aims to educate the CFR membership on the private sector's important role in the policy debate by engaging the global business community's top leadership.

MODERATOR: Good morning, everyone. Thank you so much for joining us bright and early this morning. We appreciate it.

Just want to say a few specific (sic) here in terms of our members. Please turn off your cellphones because it does interrupt the microphones. And we will talk for 30 minutes and then open it up to questions from all of you.

We hope that you do have questions for Ray Dalio. We're thrilled to have Ray here with us today from Bridgewater Associates. Ray, thank you for spending the time with us.

RAY DALIO: I'm looking forward to it. Thanks for having me.

MODERATOR: Great. It's great to see you. We'll get right into it.

Ray, you have a specific way of looking at the world and putting capital to work in the world based on your template and your approach to things. Want to start off with that approach, your macro look at the world, and how you use the things in that template to actually allocate capital. Tell us how you do that. First let's talk about how you approach investing today.

DALIO: OK. So I'm just, like, a guy who has, you know, been in a lot of battles over a long period of time, and I've then seen these battles repeatedly occur, right? So we look at today's financial crisis, and I think of the 1980-82 period, and I think of -- well, and many people here who might -- Latin American debt crisis or very many crisises (sic) through periods. And these things keep happening over and over again, and there's a series of experiences. And so I think it's very important to realize that most everything has happened repeatedly through history. And when we look --

MODERATOR: Even this huge financial crisis that we all suffered in 2008 -- in some sense, you were expecting some disrupter to the market.

DALIO: So I don't -- yeah. I'm just saying that if you understand how the economic machine works, it just works like a machine. There are cause-effect relationships. And through these experiences, there's such a thing as a deleveraging. There's a deleveraging. How do deleveragings work? And I think the problem of most people is that they encounter their experiences for the first time. First time it happens to them in their life, their -- that's their frame of reference. But those same things have happened many, many times throughout history, right?

So the issue of a deleveraging -- there's a bubble, and you know a bubble when you see a bubble. OK, how do you define a bubble? So maybe I should explain a little bit, what I think of --

MODERATOR: I love it.

DALIO: I could just take a few minutes and take -- to describe what a deleveraging -- what -- you know, what a cycle works like, OK? And it's -- and it's very basic. So --

MODERATOR: Did you know we were in a bubble in the housing market in 2008, 2007? You saw things that sort of disrupted your model. We're talking to one of the most successful hedge fund managers on the planet, if not the most successful. You have been able to navigate hugely difficult waters. Take us back to 2007. What did you see -- tell us about your model and your approach to investing when things really started to turn ugly.

DALIO: Well, so I'd like to take -- yeah, not just 2007. I'd just to take a few minutes and just describe how the economic machine works and my frame of reference pertaining to it. And it's a just a very basic thing.

There's a transaction. An economy is not a complicated thing; it just has a lot of moving parts. But the basic is there's a transaction. And that transaction means somebody makes a purchase; they make a purchase of a good, a service or of financial assets. That purchase can be made with money or credit. If you -- if -- money -- when you make a purchase with money, you end the transaction; you don't owe anything. When you make it with credit, then there's a liability. You have to come up with the money because a credit, a debt, is an obligation to deliver money. So there's a basic transaction. There's spending -- in other words, the total amount of money and credit spent on a good or service -- and then there's the item that you're buying, a stock, a bond, a car, a bushel of wheat. There's that transaction.

Demand is best measured in terms of spending. You know, I think in traditional economics, it's a mistake to measure it in terms of the quantity of goods. What is given up in a purchase is money or credit. What we go through is we go through a cycle; we go through a credit cycle. Credit can be created. It's not created through the velocity, as is commonly believed. It can be created out of thin air. If I go into a store, you know, or I have somebody paint my house, and I say I'm going to pay you later, I've created credit. That'll count in GDP. It'll be an item of production.

So what we have is a credit cycle. If there's not much debt, if you don't have much debt, then you have the ability to borrow money. Let's say you earn a hundred thousand dollars a year and you don't have any debt. You can then borrow 10,000 dollars a year. You therefore can spend $110,000. Your spending of $110,000 is somebody else's income of $110,000. So it has a positive effect, and you go through a cycle, and through that cycle, you spend 110,000 (dollars), they earn 110,000 (dollars), and we -- and the cycle becomes self-reinforcing. Through that cycle, debt rises faster than income. Debt rises faster than income. Debt can't rise faster than income forever. So as debt rises faster than income, you have a debt cycle.

As you get -- what causes it to stop? Well, traditionally, as you lower interest rates it creates -- debt -- has three positive effects. If interest rates are too high, then you lower interest rates. Lowering interest rates has the effect of making it easier to service the debt. It has the effect of making items cheaper to buy on credit because the monthly payments are less. It has a present-value effect on assets. So if you lower interest rates and you have something that has a cash flow -- let's say a piece of real estate or something, that have a present-value effect, it causes those assets to go up. That produces wealth and that allows more borrowing. And so when you get to a situation where you can't lower interest rates anymore -- let's say you hit zero -- you hit -- that part of the cycle ends.

So then you go through a deleveraging. Now, a delevraging -- deleveraging means that you can't raise debt relative to income anymore. When you can't raise debt relative to income anymore, the cycle begins to work in reverse.

So I think the people, if -- they don't do a very good job of calculating incrementally what the effects are on demand, but let's say you're having debt growth at something like 10 percent and you go to a 5 percent debt growth instead. That has a negative effect on growth. The marginal change from that level produces a negative effect on growth. So traditionally in delevraging, that negative effect that happens for, let's say -- Europe is a very classic case, the Spanish banking system is a very classic case, the European banking system.

As banks leverage up at a certain rate and they can't leverage up more than that rate, and they lessen the rate at which they're leveraging it up, it has the effect of a deleveraging. Deleveraging means then the income, the spending all produce sort of a negative cycle. That produces the beginning of a depression.

A depression is the phase of the deleveraging in which there's a combination of austerity and debt restructuring, because if you have -- it's a basic thing If you have too much debt to service, you've got to do something about it. And when you have too much debt to service and you do something about it, there are a limited number of things that you can do. You can either transfer the debt, that you can transfer resources from the rich to the poor, so you can have it transferred, for example, from Germany to Spain. That's one way of dealing with it.

The other way is to -- you have a combination of austerity and debt restructurings. A debt restructuring means that you lower the debt in one fashion or another; you lower the debt burden to something that you can afford to service because of the income that you produce. Restructurings can take one of three ways. You can either actually write down the debt. If you write down the debt, let's say write it down in half because you can service half, you can service half, but the problem is, one man's debts are another man's assets. So when you write it down in half, you have a big negative wealth effect. So if you have a negative wealth effect, you can't borrow money and it has that problem.

So a restructuring becomes a problem. You could restructure it either in the form of writing it down or in one way or another you can lengthen the payments or you can forcibly lower the interest rate. But some way or another, you've got to get the payments in line for what the cash flows are producing so that you can service that kind of a debt. That's a very painful process.

So a depression is the phase of the deleveraging when there's a combination of austerity and writing down debts. So, classic, the Depression, 1930 to 1932, March of 1933 we print money. So the third way that you can deal with it is you can print money, essentially what we call "print money." The printing of money means that essentially a central bank -- debt is a commitment to deliver money. So if a central bank slips into the system a certain amount of money each year, it can make that easier.

Think about the debt writedown, that something maybe is a debt and you say, I'm going to write it down to a level that can be sustainable, and you write it down by 50 percent. That has a big negative wealth effect. Big deal. Bad. If it's a 10-year debt, maybe that's equivalent to 5 percent a year for 10 years. If you slip in 5 percent a year instead to that person, who then can pay that debt, they can service the debt -- it's 5 percent a year -- it's not that big a deal. And so in all deleveragings, in the end, they print money. It's part of the mix.

Now, the best deleveragings are ones in which you have a balance of those things. Ultimately, you have to bring down the debt-to-income ratio. So -- and the ways that -- ultimately, you'll have a balance of those three things. Those three things, again: You're going to have a certain amount of transfer of wealth; you're going to have a certain amount -- let's call them four things -- a certain amount of austerity, a certain amount of debt writedowns and a certain amount of printing of money.

The debt writedowns and the austerity are deflationary. The printing of money is inflationary. If you can get the balance right of those things, then you have what I call a beautiful deleveraging, a deleveraging -- (laughter) -- well, you -- when you look at the deleveraging, the debt-to-income ratios --

MODERATOR: (Off mic.)

DALIO: Thank you. I'm fine.

If you look at the debt-to-income ratios and say, how have they come down over time, England after World War II or the United States in the Great Depression, in all of these cases where the debt-to-income ratios came down, they came down. How did they come down? They came down with relatively good conditions by trying to get -- by that mix. There's a certain -- the number one reason is that there's enough of the printing of money that the nominal growth rate in GDP has to exceed the nominal interest rate. OK, if you're -- because think about it: You have a certain amount of debt, and there's a certain debt service cost, and if that interest rate on the debt is higher than the nominal GDP rate, then that means that it's going to compound unless you're -- you keep cutting. And that produces a negative consequence.

So the most important thing is -- in these deleveragings, as the United States is now doing, is that you can -- you have enough of a printing of money to produce a nominal growth rate that's above the nominal interest rate over a period of time. I'm oversimplifying, but that's the most important single thing.

So now when we then take 2007 -- and that's -- I'm just describing a little bit the template, these templates have happened repeatedly. They've happened -- you know the IMF restructurings -- you can go back and study them all -- they're all deleveragings, and they're all classic cases, and they're all pretty simple. So 2007, and also in the European case, what we had was rates of debt growth that were unsustainable rates of debt growth.

Now, the mistake of monetary policy -- I think, most common mistake of monetary policy is that it's targeting inflation and growth. And while inflation and growth are important, it -- really, what it does is it produces debt. And what it has to pay attention to is debt growth relative to income growth, debt growth relative to sustainability.

And so what happens is lots of times you have a lot of debt growth that goes into the purchase of financial assets. And that's a classic bubble. That's worse than -- that's a riskier situation than inflation. So you take 2007 or such periods, and you see that there's a lot of debt growth, which is accumulating for the purchase of financial assets. And then you look at the financial assets, and you say, they will not be able to service that debt. And so that produces a bubble. That's what produced the 1929 bubble. That's what produced, in Japan, the 1989 bubble, 1990 bubble. That's what produced the 2007 bubble.

MODERATOR: Are you always looking for this opportunity where, whether it be debt is growing faster than they can service it or -- in terms of your approach to investing, are you looking at it to get an edge?

DALIO: I'm just looking at what's happening and trying to stay one step ahead of it, you know. (Laughter.) You know, things are happening -- there are certain -- things happen for reasons. They're cause-effect -- I'm just trying to understand those reasons, and I'm saying the same things happen over and over again, and you -- if you see that that's happening, I know that in a bubble that that's not a healthy thing; that's not going to work. And I just therefore don't want to own the assets that are going to go down when the bubble's going to burst and move into the assets that'll be safer. That's what I do.

MODERATOR: So we want to hear, really, about what's going on in Europe and in the U.S., because it seems that what you're talking about in terms of this template is very familiar in terms of whether it's the U.S. or Europe. But in terms of your template, what did you see in 2007? Was it that debt on the banks' books that really made you realize there was a -- there was an opportunity here?

DALIO: Yeah, I saw a lot -- there was the debt, then there was the bubble. And then there was this behavior that was -- volatility went down. And there is this notion of VAR, value at risk. And there is not an understanding of volatility changes. So what happens is, as volatility is going down, the -- everybody thought that it was an easy thing: All you do is, if something has a lower interest rate than something else, you borrow the thing (that has ?) the lower interest rate, and you buy the asset that has the higher interest rate. And that's going to be OK; that was an investment strategy. And you do a lot of it because volatility is low. Well, volatility changes.

So you look at this, and you see that there is leveraging up, it seems leveraging up for absolutely crazy reasons that can't be sustained. That was -- I mean, (it started ?) 2007. You also know that -- you know, take the bank equity, and there is a certain amount of leveraging up that's taken. And that rate of leveraging can't be sustained. So when it's not sustained, when you have a lower rate of leveraging, it means it's going to pop, OK? So that became, I think -- that's what happened.

And then, as -- we have mark-to-market accounting. So it was -- it was fairly easy to see that -- what the bank's assets were. You go through 10K reports, you go through studying their various financial statements and so on you go through, on a mark-to-market accounting, we're going to have a big hit to equity. And you have a big hit to equity, you're going to have to contract balance sheets.

So, you know -- and then, you know, conversations -- I take conversations with policymakers or other people; there was a lack of awareness. And not only a -- it's very interesting; it's a lack of awareness because also, people think that the things that haven't happened recently are implausible. So you look at the leveraging, and they say, I don't -- you know, that's a crazy scenario because it's not within the range of expectations. In my life, through my whole range of expectations, everything's been surprises. You know, 1971, breakdown of the monetary system, that didn't happen before. It's the first time. Never happened in my lifetime. Most things just have not happened in our lifetimes that are big things, and there are a lot of them.

So I think it's an -- so when you -- when I look at this configuration of the leveraging up, the way people were dealing with it -- clients to us saying we should leverage up more because VAR is down, a crazy concept. So it's all that stuff.

MODERATOR: So what about Europe today? I mean, you know, you've got the ECB providing all of these programs in terms of liquidity, in terms of moving rates where they are. Tell us how you see Europe playing out.

DALIO: Well, Europe's interesting because most -- in most cases, you have one country, one fiscal policy and one monetary policy; that's the normal dynamic. What's -- in Europe, what you have is you have different countries. And so there is a different dynamic between the central bank and the fiscal. So let's take the three -- the three things.

They're -- first, there is -- I estimate that there'll be about 2 trillion euros' worth of losses on the debt that exists -- if I took the present value of those, something like $2 trillion worth of losses. So now we have to say, what are we going to do with those losses? Who's going to bear what in those losses?

There are three ways of dealing with them. You can either transfer wealth, and so that's a fiscal transfer from the Germans or the northern Europeans to the others. And that's, like -- and then who will transfer 2 trillion (dollars or euros)? The Germans don't want to obviously do that. And also, the way that they want to approach it -- I'll get to in a second. But basically, the transfer is going to fall short .

OK. The second way, which is austerity and debt write-downs, that is a depression. The -- 1933, in March of 1933, Roosevelt was inaugurated, gets in front of the television and he says, we're going to have a bank holiday. (Here ?) we're going to close the doors, and then you can come back and you can -- going to get your money. And then everybody could come get their money. And that was when there was a severing of the gold, the relationship of the gold. And that was the bottom in the Great Depression, March of 1933. So if you look at growth and you look at unemployment, you look at stock market, everything happened then. That was the point where they print money. So what we have -- but printing money is a transfer of wealth too. It is a subtle transfer of wealth.

But anyway, if you have -- from 1929, 1930 until March of 1933, we had that depression, so contraction, austerity and debt writedowns. That's what we were in, were going to. And then there's the negotiation between the Germans and the Southern Europeans regarding what should be done with monetary policy. So there's an interesting dynamic pertaining to that.

So the Bundesbank has a sense of responsibility. There's a mission and so on. There's a -- and there's the issue of the printing of money. There's the question of whether countries would leave the euro. There's a realization, I think -- Southern Europeans have the votes. They control monetary policy. So if -- it's a -- it's a voting organization. They -- you know, 17 votes. You got the -- you got the vote. If you let them vote, they'll vote, print money and give it to me. And so they have -- they have the votes. Germans, of course, essentially, it's a subtle tax.

So what we had was a standoff and a talk about whether the Southern Europeans would -- you know, would they be forced out? Why should they be forced out? They don't have to be forced out; they control it. If somebody's going to be forced out, it's more likely the Germans would be forced out because -- in other words, you've got the votes. You can maintain the euro. So you can -- so the question was -- we were at an inflection point, and the question was would monetary policy -- you need to print money.

The basic difference between -- let's be clear that the basic difference between Spain and Italy and the United States, to a large extent, is the ability to print money. So if you can print money -- Japan's numbers are much worse in terms of their debt numbers than Spain or Italy's. But if you've got the capacity to print money, then you don't have a credit spread.

So we were at that particular juncture, and now we're going into a dynamic where the ECB's policy is the natural extension, as in all deleveraging, the natural last phase because it's the least painful -- none of them are good -- none of them are good, but it's the least painful -- is the movement toward printing money. Now --

MODERATOR: But can you print money forever? I mean, this is the issue that we're talking about with the Federal Reserve. With rates where they are, I mean, you have to wonder what else they can do in terms of stimulating -- but I want to stay on Europe right now.


MODERATOR: Let me -- let me ask you first, specifically: Do you think the euro looks different in one year?

DALIO: How so? What do you mean?'

MODERATOR: Will Greece leave the euro?

DALIO: I think -- so I think that Greece -- probably, but I'd say it's 50-50.

MODERATOR: Does it matter?

DALIO: It matters in a manner that's tolerable. In other words, I think that -- maybe 60-40 in favor that they don't leave the euro, and I think that it is manageable.

MODERATOR: So what happens in terms of the eurozone in the next two years? Do you think things are getting better? Do you think things are, you know, sort of at a standstill? What's your take on Europe right now?

DALIO: I think it's going to be a -- it's going to be very similar to, the most part, Southern European countries, as a classic lost decade, very similar to the Latin American debt crisis for Latin America. It means -- I think that we're beginning a -- you know, we're at the early stages of a major deleveraging in those countries. So that will produce a depression kind of environment. What I mean by that is that we will have a -- go back to spending, spending is -- certain amount of money and credit. There's a limit to how much money. So now we take the credit.

Credit comes from private sector credit. Private sector credit typically comes through banks. There will be a bank deleveraging. There is going to be a bank deleveraging. We're in the early stages of a bank deleveraging. There will be some recapitalization of the banks, but we're coming into an environment that there will be lots of controls, and there will be a net deleveraging of the private sector through the banks.

And then in the public sector, there'll be a deleveraging because there has to be a deleveraging in terms of you can't continue to run the deficit. There will be the equivalent of the IMF type of program. It'll be equivalent of the troika. So we're going to go through -- if you look at Latin American type of deleveragings or different kinds of deleveragings the IMF has been through, the troika will manage those deleveragings. So they will take over the controls of the banking systems. We're in the early stages of that. And so if the -- the conditions will be very bad for those countries.

The marginal amount that it will be bad -- it will mingle in with monetary policy, a mix of, again, the deleveraging, debt restructurings and a certain amount of monetization. I think there's going to be that kind of mix. And then the question becomes really a social program, so how the tolerance for those types of conditions has been dealt with. If it's dealt with well socially, I mean, that becomes a test of the character of the people, all of the deleveragings. We have a capacity to get through these things if we have a capacity to not have such conflict that in itself becomes a terrible thing. You know, everybody's -- so I think we're going to have a bad set of economic conditions.

You're going to have market -- you'll go through cycles, 10 years of cycles, very much like Japan, in which you'll have bull markets and bear markets and everybody -- you know, you get a bull market -- like almost in the United States, to some extent. We have our deleveraging too. We're focusing on their deleveraging just because it didn't have the same monetary. We have our own deleveraging. But you will have the bull market, in which people -- there will be injections, there will be cycles, very similar to our quantitative easings and those particular things. They produce a bull market. Everybody says, OK, the problems are behind them. And then what happens is -- and you go through the cycles, and these things go on for quite a long time, for -- you know, we call them lost decades. They usually take maybe 15 years, something like that.

MODERATOR: So where are we in this cycle in the United States? And are you worried about the debt in this country? Tell us how you use the template to look at the happenings right now in the U.S., the fiscal position.

DALIO: So the most important thing about, I guess, the template is first it creates a framework for this deleveraging, but also it gets down to the nitty-gritty of who is the buyer and who's the seller. You have to know -- in our anticipation of the European debt problem, there was a lot of talk by policymakers and a lot of people that there was this -- if I can keep the markets having faith and confidence, everything would be fine. That was not correct. If you actually knew who the buyers of the financial assets were, their confidence had very little to do with the decisions of the amounts of money that were being provided. For example, the banks. The banks, you can give -- banks today in various places, you can give them all the confidence in the world; they can't expand their balance sheets. There are limitations and they have to contract their balance sheets.

So knowing who the buyers are and the motivations of the buyers is very key to making that decision. I give the example of Japan because when you're looking at the United States, the Japan example, I think, is a very good example. We have -- Japan has total debt-to-GDP of about 500 percent, and it has government debt-to-GDP of about 270 percent. So it is way, way, way more leveraged, in a sense, than the United States is. And so then the question is, as we go through this, the magnitude of monetization. You have to go back to say, who are the buyers of the debt and what are the motivations?

There is a "greater fool" theory. The "greater fool" theory can go on for a really long time. The timing of when that shift takes place is very much dependent on that. So as we look in terms of, let's say, the United Sates, certainly it's the case -- and in Japan -- certainly it's the case that we can't support these kinds of debt. Anybody with a sharp pencil will know that we're not going to be able to support that. That doesn't mean there won't be adequate buy, just like in Japan's case. You can have plenty of buy. You provide enough liquidity, and the question is, what are the choices?

So the big shift in terms of going to the notion of what do I do with my money -- let's say you have a lot of liquidity and you're looking -- the world has lots of liquidity. Today the world has lots of liquidity. The question is, what are its choices and what do those choices look like? And then you put your money. So you produce a lot of money around, a lot of liquidity, and then say, do you stop buying U.S. bonds when you have -- or do you stop buying Japanese bonds when you have no interest rate and a currency risk, so when do you stop buying?

Well, it's when you have confidence in some -- ultimately when it's driven to something else. At some point, you get a move toward inflation. If there's a move toward, like, I want to hold inflation assets, then you come into problems. Until you don't have that move to move toward inflation assets, you have a capacity for a lot of the buying there, and so the timing. So this could go on for quite a long time because you have to go back to the buyer, and you say, who is that big buyer? We know who the big buyers are of U.S. Treasurys, OK?


DALIO: We know who the big buyers are. And then you know there's -- look at their choices. Look at their -- you know, their preference, those --

MODERATOR: Not a lot of alternatives.

DALIO: Yeah. So there are all of those -- so these are the -- we're -- it's not sound finance. And when we talk about our budget, we're also not talking about, you know, the nonliability, the social, the pensions, the other liabilities that exist. We have a lot more promises than we can keep. But the timing of that very much depends -- that can go on for a long time. So there's a lot of dynamic between (now ?), and a problem, just like Japan, can go on for a very long time.

MODERATOR: So should we be worried about the $16 trillion debt in this country, knowing who the buyer is and knowing that this country has an ability to print money?

DALIO: I think we have to worry about getting the balances of dealing with these right, right? There's certain -- it's the same thing. There needs to be a certain amount of austerity. There needs to be -- but if that austerity is too much -- we have to worry as much also about the social consequences. We cannot have a downturn -- a bad downturn.

So in worrying about the debt, yes, we have to worry about that and we have to balance that correctly, but we have to balance that in a way that does not produce another 2008 because if you have a downturn, then you're going to have social consequences of the rich and the poor at each other and then also the possibility of doing crazy things, and then the political shifts become meaningful. You know, Hitler came to power in 1933 because it was the bottom of the Great Depression, and democracy -- democracies have a challenge in terms of making effective decision-making. So I think that you have to worry on -- about getting the balance right, right? So the fiscal cliff next year is also something to worry about. So we can't just worry about too much debt; we have to worry about too much austerity; we have to worry about getting that balance right.

And my biggest worry is that people are not -- policymakers and a lot of people are not doing that with a sharp pencil. In other words, they just talk -- they're -- it's just a calculation. You can do the calculations. There's a certain amount of spending. Nominal GDP and real GDP is a certain amount of spending. OK, who are the buyers of goods and services? Where did they get their money from? And then how much do they need? And so it's -- with a sharp pencil, you can deal with that. But it's more with slogans. And so I'm worried about balance.

MODERATOR: And the market has been trading up.

We're going to get to questions right after this, so I hope you have some questions for Ray.

The market has been trading up as if the world is good. I'm wondering, are the markets getting it right?

DALIO: Yeah, I -- well, it's -- for the most part, I think that that's -- that they are.

MODERATOR: Even though you've got this deleveraging going on and you've got this huge debt and we know who the buyer is, you're comfortable with that?

DALIO: So let me explain -- it's so interesting to me because it's such a reflection of the monetary policy -- the surprises I've had. Let me -- (inaudible) -- tell you about two surprises I had.

I was clerking on the -- graduated college in 1971. I was clerking on the floor of the New York Stock Exchange before I went to business school. And this was August 1971. And I was seeing that we had -- it was reported at the time, and I read in the newspapers -- (I traded markets ?) -- that we had too much debt and that the Europeans wouldn't accept dollars of the American tourists who were going over there. We had a link to the dollar. This was clearly an emerging crisis. The crisis burst. President Nixon gets on the television on Sunday night, tells the American people essentially that we're breaking the link with gold, and we're in the -- you know, and this was a crisis. So I walk on the floor of the New York Stock Exchange, and I'm expecting, oh, no, it's a crisis. The stock market was up 4 percent. And we began a major bull move, second time -- second instance I'll take you to.

MODERATOR: And this was surprising you?

DALIO: Of course. It was, you know, like, this shock. OK, and next analogous surprise, Mexico, the Latin American debt crisis in late 1970s. I -- do the numbers. I know Latin America can't pay its debts. I know American banks have a lot of money to Latin America. Two hundred and fifty percent of their equity was lent to Latin America. This crisis begins to build, comes down -- Mexico defaults, August 1982. That was the bottom of the stock market, 777 on the Dow. You can go right (to ?) there because of the printing of money, OK? The printing of money -- so March 1933 -- I refer -- March 1933, Roosevelt -- that's the bottom of the stock market -- says you can come get your money. Printing of money, OK?

So in various ways, the notion of when you're in a deleveraging -- we all go through this -- when we're in a deleveraging, and you have that austerity, and you realize you've got too much debt -- finally, it dawns on you, you got too much debt. It didn't dawn on you in 2007. The markets become -- 2007, everybody's got too much debt and they're not aware of it. Then you have the too much debt, and everybody's aware with -- and then everybody gets, you know, very depressed about it. And then we have a crisis. And then they print money, and then we go through our cycles. And these are the cycles that happens during these 10-year type of periods and so on.

So when I'm looking at that, I mean, I think that that's -- that becomes the nature of the dynamic. The money's got to find a home. Where is the home? Where is the better place for the home? And then you print money. The effect of printing money means that -- now, there is a dynamic, there is a mechanical part to printing money. So when I look at printing money, printing money isn't necessarily good enough. Printing money is an important thing, but let -- literally --

MODERATOR: Can the Fed continue printing money today?

DALIO: Yeah -- so the Fed can continue -- again, it's very important to track the transactions. So when the Fed makes a purchase and prints money, it can expand its balance sheet, and it makes a purchase. The key is, are you getting the money in the hands of the -- that person who's going to use it the way you want it to be used? So now if you go buy a mortgage-backed security or you go buy a Treasury bond and so on, it's not -- probably not going to good enough because it puts -- it now gives somebody, the owner of that Treasury bond -- they're going to want to buy something that's like a Treasury bond because that's what they had before, or something like a mortgage. And that particular problem means, how do you get that into spending. It's a long way between that person who's holding that financial asset and the guy who's going to buy a car or a house.

MODERATOR: Is that where we are right now?

DALIO: That's where you are now, right? So the traditional dynamic of that is that in order for that thing to work, that there is -- central banks can buy financial assets, but they can't buy goods and services. Central government, fiscal policy, can buy goods and services, but they can't print money. So the usual dynamic is to take money, make it purchase -- buy your bonds, Treasury, by the government, and you will take that money and get that in the hands of people.

So in order to be functional, if you hit an air pocket -- I think that we may -- there's a good chance for -- (here ?) that we don't hit an air pocket, but it's very much like hitting an air pocket. The economy can probably grow at about 2 percent, maybe a little bit less than 2 percent, because it can grow at a rate that doesn't raise the debt-to-income ratio.

So if you look at the feedback loops, basically somewhere in the vicinity of 1 1/2 (percent) or 2 percent anyway, so that could have -- and if we sort of coast along at 1 1/2 (percent) to 2 percent, OK, that becomes sort of a tolerable -- maybe it's tolerable, that's the kind of thing.

If you hit an air pocket, you have to have -- you have to have -- you have to have a stimulation. You can have monetary stimulation by the central bank doing that, but if they buy Treasury bonds for people (to ?) buy something similar, it's not going to stimulate the economy very much because it won't buy cars and houses. And so you need then the fiscal policy. And then the question is, how does fiscal policy, because of the circumstance of the politics of it, the ideologies of it, how does it respond to that kind of circumstance?

MODERATOR: I want to get back to this. I want to get some questions from the audience before. We have microphones.


QUESTIONER: Amy Barker (ph). I wonder if you can talk a little bit about deflation, whether you see that as a real risk and what the consequences of that might be.

DALIO: I -- so yeah, I think that the -- I think the natural -- the natural way of things right now is much more deflationary. And I -- and so I'm looking at the world as a whole. And so I'm looking at China, Europe, the United States, the nature of deleveraging and there's a natural move toward more deflationary pressures.

Then there is the response of monetary policy. And so we look at -- and I just offered those sort of comments. Certainly it's just -- it becomes a mix of those --

MODERATOR: It doesn't -- you're not worried about inflation. You think we're in a deflationary environment for the foreseeable future.

DALIO: So --

MODERATOR: Does inflation become a problem three years out?

DALIO: So I want to explain why -- rather than give you the answer, I want to explain the reasoning. There was a deflationary -- a natural deflationary move having to do with deleveragings. Even China as in a bubble and their bubble's bursting.

So they have a domestic demand problem that's emerging, they have an export problem because they're going into a world that is always a problem and they have an efficiency problem in terms of allocating capital and allocating spending. So they accounted for more than a third of the expansion since the low in 2008 -- the global expansion.

So they'll -- the world does not have a locomotive. We don't have a locomotive and we have these deflationary pressures. That's the natural course of things. It -- the purpose of monetary policy -- effective monetary policy and fiscal policy, if it's working, is to negate those things. And so, the responsiveness, if it's kept in an orderly way, means that you don't go to inflation, you negate deflation.

So in the Great Depression, there was a big expansion of monetary policy and we didn't produce an inflation. And so in various ways fiscal monetary policy can negate that. Those would be at odds -- and so how it's managed really will very much be dependent on how policy makers run policy.

So as we're dealing with that, those become the bigger questions -- how you're managing those two things. I think over the near term, there's more deflation risk than there is inflation risk globally. I think over the long term, there's more inflation risk than there is deflation risk.

MODERATOR: And the long term -- five years, 10 years?

DALIO: Five years.

MODERATOR: Five years.

DALIO: Yeah. Five years. And the key is in achieving balance -- this is again the one thing I want to emphasize -- is that balance is so important because there is a tendency to go extremes sometimes.

MODERATOR: Yes, sir.

QUESTIONER: Andrew Gunlach (sp) -- (inaudible). You suggest, in a way, that this -- these crises are a little bit different because we're in an all fiat currency world. But isn't a constraint on the Fed, to Maria's (sp) question, the price of gold in the sense that it's a shadow currency? It doesn't vote, doesn't enforce things, but it certainly is a signal of something. I'm just curious at what your thoughts are.

DALIO: Yes. So I do -- gold is very much -- gold is a currency. Throughout the history -- I won't go on in length -- but money was like a check in the checkbook and what you would do is you would get your gold. And gold was a medium. And so gold is one of the currencies. So we have dollars, we have euros, we have yen and we have gold.

And if you get into a situation where there's an alternative, and in this world where we're looking what are the alternatives, and the alternative -- best alternative becomes clearly one thing -- something like gold -- there becomes a risk of that. Now, it doesn't have a capacity -- the capacity of moving money into gold in a large number is extremely limited.

So the players in the world that I -- you know, that, I don't know, I have contact with, who are -- who've got money -- really don't view gold as an effective alternative. But we always -- but it could be a barometer, and it is an alternative for smaller amounts of money. And if --

MODERATOR: Do you want gold?

DALIO: Oh, yeah. (Laughter.) I do. I think -- well, I think anybody -- let's be clear that I think anybody who doesn't have any -- there's no sensible reason not to have some -- if you're going to own a currency, if you don't -- it's not sensible not to own gold. Now, it depends on the amount of gold, but if you don't own, I don't know, 10 percent in -- if you don't have that and then it depends on the world, then you -- then there's no sensible reason other than you don't know history and you don't know the economics of it. (Laughter.)

But I -- well, I mean, cash -- so cash is an -- view it in terms of an alternative form of cash and also view it as a hedge against what the other parts of your portfolio are, because it's traditional to hedge financial assets. And so in that context, as a diversifier, as a source of that, there should be a piece of that in gold, is all I'm saying.


DALIO: And -- but anyway, the -- what I'm talking about here in terms of your reflection is that, putting aside gold -- I don't want to draw an inordinate amount of attention to gold, but I would want to say that the -- in this world of liquidity and the world trying to find out what is the place, and in which also -- think about it. You know, for basically -- you get no interest rate --- you -- so the question is is cash under the bed better than treasuries? You're -- you could be quite close to cash under the bed being better than treasuries, right, because essentially you know you're going to get it back -- (chuckles) -- if it's under the bed and -- or in -- or in a bank. And you're not giving you any money on it anyway.

And so when you're looking at an international investor -- somebody like, I don't know, a Chinese investor or something -- and you say, what am I going to -- I'm going to give you this, and you're going to give me zero interest rate for that -- we are at one stage; we're at one level. And the question is is it -- does there become emerging some clear alternative? And if it becomes emerging a clear alternative, we have to worry about that because it will -- that will be the notion of -- let's say Japan. If we think in Japan, they -- there's all this -- Japanese save, and they buy their bonds. And that can go on for a very, very long time. And it can go on here for a long time.

MODERATOR: I guess what we're trying --

DALIO: So the question is what are the alternatives? And those create shifts.

MODERATOR: What we're trying to figure out is how worried are you about the current situation? And how much exposure do you want to have to gold versus equity versus real estate and other asset classes? Talk to us about that.

DALIO: So I think -- so I think I'm going to answer it in the following way that I think that is the right way for people to look at it; it's the way I look at it. I think that the first thing is you should have a strategic asset allocation mix that assumes that you don't know what the future is going to hold. And I think most people should because -- in other words, when I -- let's say -- I play the game of betting against others. So it's like going on the poker table, and if I'm smarter than the -- and I know how difficult that game is. So very few winners and, you know, like, I -- if I'm not engrossed in it, and we're not engrossed in it, I'd be worrying about it. And I do worry about it when I am engrossed in it.

So the average investor and most people should not be playing that game. They're going to lose at the poker table, and so they -- so what that means is they should have a properly balanced portfolio. Now, the most important thing about that is that they balance -- they make a mistake of balancing it in terms of dollars invested and with a bias to what's done well in the past. And they don't realize that risk -- they should balance it in terms of risk. Let's say stocks have twice the volatility of bonds -- more than twice the volatility of bonds. So when they own a portfolio and structure a portfolio that way, they tend to have concentrated risks. And I think that what they need to do is -- I would recommend read how to -- on the subject of risk parity. Read -- on our website we have explanation of how to balance risk.

But the key thing is that there are basically four economic environments. There are two main drivers of asset class returns: inflation and growth. Assets all price based on an -- you could look at the pricing of assets and calculate what the discounted growth rate is and what the discounted inflation rate is. And what causes assets to move is surprises to that. So when growth is faster than expected, stocks go up. When growth is slower than expected, stocks go down. When inflation is higher than expected, bonds go down. When inflation's lower than expected, bonds go up. OK? So if you can --

MODERATOR: But growth has not been faster than expected today, and equities have gone up.

DALIO: I -- what I'm trying to say is that for the average investor, what I would encourage them to do is to understand there's inflation and growth -- it can go higher and lower -- and to have four different portfolios essentially that make up your total portfolio that gets you balanced, because in every generation there is some period of time that will ruin -- there is a ruinous asset class -- and will destroy wealth. And you don't know which one that's going to be in your lifetime. So the best thing you can do is to have a portfolio that is immune, that is well-diversified, that is what we call an all-weather portfolio. That means that you don't have a concentration in that asset class that's going to annihilate you. And you don't know which one it is, OK?

MODERATOR: What does that portfolio look like today?

DALIO: No, well, I'm saying it should be based on the notion that you don't know which one it is, and therefore when you say, which should it be today, it should be balanced today like it is in the future, and it should have that mix of assets. And then how you get into it is a whole conversation. I would say -- you know, on our website, you can read about what we call our weather portfolio or risk parity. But you need to achieve balance.

That's why when you asked me something about gold, a certain limited amount, at least passably, should be in gold, just like you would hold a certain amount in cash. But you don't want to hold too much in cash, because it'll have a return. You want to hold a certain amount in equities, and then you -- and then you want to hold a certain amount in bonds, in long-duration bonds, so that it'll have an offsetting effect on the equities so that you're having a diversified portfolio that balances. And if I -- I fear that if I go deeper into the question, we will be going on quite awhile.

MODERATOR: (Laughs.) OK.

Dan, go ahead.

QUESTIONER: Daniel Arbess from Perella Weinberg.

DALIO: Hello.

QUESTIONER: How are you?

I'm thinking about your comment concerning circumstances that are hiding in plain sight that suddenly become the next crisis. Now, the major change that we've experienced in the last four or five years is a massive expansion of central bank balance sheets. You pointed out in your writings that that has not be inflationary as yet because it's been counterbalancing deflationary forces in the real economy. It's been good for risk assets, but you've also referred to this period as a beautiful deleveraging. I don't see the deleveraging or austerity side having been implemented at all in Europe or in the United States.

So my question is what happens if the fiscal response simply fails, as it has over the past three or four years? If there's no fiscal answer and all there is is a continuing expanson of central bank balance sheet where the Federal Reserve bank is buying 70 percent of all new issued Treasurys, how long can that go on before we see a really serious problem?

DALIO: So I'm -- there's a number of dimensions in your question, so I'm trying to let -- first of all, I think it's very important to realize -- in order to produce an inflation, it all comes down to a transaction. And so money, by the central bank producing money, has no different effect for a transaction than if credit was created, OK? I mean, it just doesn't have the liability against it. So I think that there's a mistaken tendency to believe that if the central bank is producing money and that number grows by a large number that that means that it's going to produce -- you know, you double it -- and we've more than doubled it -- that that means you're going to owe -- you'll have an explosive situation with inflation. And that's not correct because it's spending, and so how it passes through -- it's just making up for credit.

So now -- then let's take the deleveraging. The United States has, net, been going through a slow deleveraging. In other words, our debt to GDP -- I'm talking about total debt. In other words, there's government debt, and then there's the total debt, in other words, all of the sectors, the household, the business sector and so on. And so we have slowly been going through a gradual deleveraging while there has been positive growth. That's what's been happening.

QUESTIONER: Is there an absolute reduction in debt, or is there --

DALIO: There's an absolute -- there's an absolute reduction in the debt-to-GDP ratio, a slow, absolute reduction in the debt-to-GDP ratio, which has been occurring with positive growth, OK? Now, if we were to continue that, that's good. That's good. We don't have social -- you know, in 2008 people are at each other's throats practically. If you were to continue that process going through -- and we have nominal interest rates below the nominal growth rate, and so that process is progressing.

And now we are building up debts that are not good debts. I mean, the government -- how does the government eventually get its deficit -- receive enough tax revenue back to pay that off in real dollars? I mean, we can't do that.

But if you're asking when it comes home to roost and how it comes home to roost, on the -- on this website, I -- in there I set up a little website that you could go to that calls -- that's called, I think, "How the Economic Machine Works." Can you just go in there and -- on my bio, in the bottom of it, whatever it is -- I go through the other deleveragings that have taken place to show how debt -- debt-to-GDP ratios, debt-to-income ratios go down, and I've gone through various of those cases. And you could see how that happens. Britain after World War II, these kinds of cases -- they exist.

STAFF: It's howtheeconomicmachineworks.com.

DALIO: OK, "How the Economic Machine Works." So you could go to those cases and see how that's transpired.

Regarding our worries of that, I am worried about that, but almost look at the Japanese situation as almost an example of how -- you know, I think some people have imminently worried about that, that it'll explode. I'm not as worried that it'll imminently explode, because look -- we're -- look how long we would have to be to also get to where Japan is. I --

MODERATOR: And you always know -- (inaudible).

DALIO: My comments could be misconstrued as not worrying. They --- I do worry about it. But I do worry mostly that the balance gets out of line; that -- so that if, let's say, the fiscal cliff -- I worry equally, as I come into the fiscal cliff, that in the enthusiasm of that austerity, that the feedback loop works, and then you get a movement down and then that produces other reactionary moves that then can become destabilizing.

MODERATOR: Do you think we will see recession in 2013 as a result of this fiscal cliff issue?

DALIO: So I think -- I want to distinguish between a recession and a depression.


DALIO: OK. I think there's more of a risk of a depression than a recession. And a recession -- a recession is one of those cyclical movements that you can pull out of easily through monetary policy and so on. It is the -- it is the uncontrolled deleveraging -- if you have an air pocket -- we have an air pocket. If we go down and we do not have the right mix of fiscal and monetary policy globally, we could have another depression, another situation in which there is a significant economic downturn.

I don't think it's likely. I think it's -- but because it's so severe, it's the thing that I think we have to be very -- I don't think you're going to have a normal recession, but if you have a downturn and -- of these countries -- a downturn and you don't have -- look, recessions end because of monetary policy. They end -- traditionally, it used to mean that interest rates mattered. We're now in a world that interest rates don't matter. So it was that you lowered the interest rates, and that's how you got out of recessions.

MODERATOR: How do we get out of recession today, then, given that rates are so low?

DALIO: It's a mixture of the quantitative easing, the printing of money, and the fiscal policy and how those levers are worked.

MODERATOR: So you're expecting fiscal policy, then, to change things?

DALIO: Well, the risk -- so the risk of 2000 -- the next two years is a risk that you could have an -- that the world as a whole could slip, having to do with China, Europe and us, which is a -- practically, we're a little bit above stall speed in the economy, but those things could go down and that you can have something which is a tolerable set of circumstances, a slow -- the world is slow stall speed, kind of, mode -- that you could have that downturn. And if it goes down and then there is not a proper response to that, which is going to be a proper mix between monetary and fiscal policy -- if there's not a good response to that, then that could be bad.

MODERATOR: But you're not --

DALIO: I don't expect that. I don't think that's likely. But I do think it's like if you're flying, you know, from here to California and I say to you on the plane, I don't think it's likely we're going to hit an air pocket, but if we do -- (chuckles) --


DALIO: -- you're dead, you know, your reaction might be, OK, so should I not worry about that?


DALIO: You know, in other words, I do worry about that.

MODERATOR: We have a question right here. We want to keep you on time. I'm sorry. We are going over.

QUESTIONER: (Name and affiliation off mic.) Ray, oil has been a (surprise ?) since 1974. (Price of oil ?) --

DALIO: Oil, as the --


DALIO: Yes, yeah.

QUESTIONER: We had a recession in '73, '74, '75. We had another problem with oil in '79 when the shah was overthrown. We also had -- (inaudible) -- prices go up to $147 in 2007 due to a combination of Chinese demand and the war in Iraq. Today we have a growing crisis with Iran. If this crisis leads to a shooting war, would you see oil prices, and what would the impact be on places like Spain, Italy and, of course, the U.S.?

DALIO: So the question is about oil prices and politics and a shooting war in Iran. And I think I'd leave the geopolitics and what the associated risks are to others, because I'm not -- you know, I get what I can get, but I know not to comment on -- (inaudible) --

MODERATOR: Would you buy oil right now? (Laughter.)

DALIO: (Chuckles.) No, I wouldn't buy oil right now.

MODERATOR: You think it's going down?

DALIO: I have so many positions in so many markets. You know, like, I don't have a big --

MODERATOR: I was trying to catch the trace.

DALIO: I didn't have a big view on oil. I don't have a big view on oil.

MODERATOR: OK. Next question. We have just time for just one or two more questions. Right back there.

QUESTIONER: (Off mic.)

DALIO: Hi, Mike.

QUESTIONER: Just a little bit on China. Now, you hit on a -- can you comment a little bit on China? The economy seems to be slowing. They're a -- leadership transition, and is it a big worry for you or just a small worry?

DALIO: China's a big place, and it has a big impact. So it always -- and there are lots of things always to worry about. But let me describe it. I don't -- I -- if China is socially stable, then I think that it will have its undulations like we have, our contractions, and so on, and that we will feel the repercussions of that, because China is now, in terms of its impact on the rest of the world, a significant impact. And it has an effect in terms of exports and imports.

But -- and I would -- so I basically would expect that it will have a fluctuation that could take it down to a growth rate, temporarily, that might be 5 (percent) or 4 percent, which would be a big negative in China on that kind of a movement, and that I think that the controls are not smooth controls, because the capital markets do not work as smoothly as ours, so that when you change gears, there are lags, and it -- and it fluctuates.

But I think that the power exists to then create that kind of shift and to move things up, that the social and -- issues -- you know, it's a big place and a lot of moving parts. And it's a difficult place to manage. My understanding of the change in the leadership -- we're going to move from nine members of the Politburo to seven members of the Standing Committee of the Politburo, and the strength of leadership is going to be much better. The movement, I think, towards reforms is going to -- from everything I understand, is going to be much stronger. You're going to have stronger leadership, much more movement towards reforms, I think, which is good.

I think that because -- there will be tensions in leadership. Whenever there's a leadership change and there's a new group of people who represent different vested interests, there will be those kinds of changes. I don't think it'll be disruptive, and I think that they can manage those swings well. I don't think it's going to go into a tailspin, anything like that. I would be surprised. Possible, but I don't think so. And so I think that you'll -- it'll contribute to the volatility, but it won't be a bust.

MODERATOR: What is your view of the U.S. economy right now?

DALIO: That the U.S. economy is now doing what it can do sustainably for a very long time if taken in aggregate, that the -- that we have repaired; we -- that we were through a car crash, and we -- and we destroyed our -- large parts of the system; we were in the intensive care unit, and that we have largely created a healing, that the credit markets have largely healed, gotten from unhealthy in 2007, which everybody thinks that a boom -- all those were good old times; that was an unhealthy behavior -- to a -- paying a terrible consequence, to having readjusted and gotten healthy again. So we're healing, or we're largely healed, and we're now largely operating in a manner that for the most part is sustainable if we don't hit an air pocket and if we continue to have good monetary and fiscal policy.

MODERATOR: And what is your biggest worry right now?

DALIO: The biggest worry is the air pocket and the failure to achieve a balance of monetary and political policy due to, first of all, an imprecise understanding by policymakers of how to do the calculations of what the right mix of monetary policies is. I don't think there's an expertise, a broad expertise for how to do that mix. And then also the politicalization of that decision-making process that tends to produce one extreme rather than another -- rather than prudence. So that would be my biggest risk.

MODERATOR: Does that change after the election?

DALIO: The election -- the election affects it, and I hope that we'll have -- whoever it is -- open-minded decision-making and also more understanding of how to do the calculations to get that right mix.

MODERATOR: Ladies and gentlemen, thank you. We took you beyond our -- (applause). Ray Dalio, thank you so much.

DALIO: Thank you.

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