Ray Dalio on the Economy, Pandemic, China's Rise: Full Interview

[00:00:00] Speaker 1: Ray, let me begin with this. You've described the current environment in various ways as a non-market economy, as a political economy, as a new paradigm. Tell us more about the new paradigm. [00:00:19] Ray: - Well, I think there are three big forces that are at work that have not existed in our lifetimes before, and they are a long-term debt cycle, and we've reached the part of that cycle where interest rates are at zero, and monetary policy is a major driver, what this looks like in a world where we're going to print a lot of money, monetize debt, and so on. There are three stages, really, in monetary policy, and the cycle that we are in, the whole world cycle began in 1945, but that was the beginning of the New World Order. 1944, we established the dollar as the world's reserve currency. It was connected to gold, and then until 1971, that broke up, and so there was an arc in which central banks have the capacity to produce demand by producing credit. just sort of hit a button and poof, and demand rises because credit comes out. But when interest rates no longer are effective and hit zero, as they did in 2008, you go to a monetary policy, which I call monetary policy two, which is the printing of money and the buying of financial assets. And with that, there was the implications of that. Lots of liquidity in the world, bidding up asset prices. And we had an environment which was very good for capitalism, corporate tax cuts. All of that caused asset prices to rise. And then, of course, it also contributes to the wealth gap. So this first influence, monetary policy, which I hope we'll talk about, the long-term debt cycle and monetary policy, is an overarching influence, and it's important to understand where we are in that cycle. Related to that cycle is also the wealth gap cycle, periods of prosperity that occur after wars, during periods of peace. There are periods of peace because there's a dominant power that no one wants to fight and you have a prosperous period. And during those periods, there's a lot of development of credit, a lot of also expansion of prosperity and so on, technology development, and that creates wealth gaps. And those wealth gaps, and then along with those wealth gaps, values gaps and political gaps develop. So our wealth gap is now the largest since the 1930s, and the political gap is also very large. And so that influence is a giant influence. So that's number two. And then number three as the major influence is the rise of a great power to challenge the existing world leadership of the United States. And these cycles have happened over periods of time. That competition, that wars of various types, trade wars and the like, is another factor. So those factors are in place and were in place in place before we had the coronavirus. The coronavirus came along and is a knockback and it has big financial implications. But, so I think those are the three factors. And now when we look at monetary policy, I'd like to get into what that means, what the value of money is and how that affects the markets and the currencies that we're now dealing with. [00:04:25] Speaker 1: - Well, perhaps I could ask that question of you this way. I've heard you say, Ray, that central banks control the capital market now. What does that mean? [00:04:40] Ray: - In the normal world, at normal times, the way the system works is central banks put money on deposit. And banks come along and they borrow that money and lend it to those who they expect will pay back. And that then passes through the credit system. And then all financial assets compete with each other. And it spreads out. Credit gets expanded. And then there's the issue of payback. And then we have the cycles. Money's too loose. Inflation rises. Central banks put money on the tight money and it slows down and we go through our cycles. That's no longer the case for the most part. Today, the economy and the markets are driven by central banks and the coordination with the central government. What I mean by that is the purchases right now of financial assets by the Federal Reserve or the purchases by the Federal Reserve of government securities are the drivers of that market. So the production of the money, if you look at money and you look at who is in the market. And so the Federal Reserve, for example, will set an interest rate that for different types of creditors based on its economic objective. In the old days, let's say when we had the 2008 financial crisis, we needed to protect banks because they were systemically important. And then money, market funds and commercial paper and the like. Now it's much broader than that. The whole economy is systemically important. If they didn't go out and make lending to companies, including what we call fallen angels, those that were just above investment grade and fell into investment grade, we would lose large parts of our economy. And so we're in a situation now where they're the market makers. Take the market out, take the central banks out. And you have a different story, including the value of money. What is the value of money? I mean, think about it in Europe, for example. The central bank will lend to banks at a minus 1%. So that means you don't have interest payments. In fact, you have interest credits. And the central banks will take that debt on. They'll loan it. And they have a political agenda, not a economic agenda, in which they'll determine whether they'll be paid back or when they want to be paid back based on how the economy is doing and what will happen. So in that case, like example in Europe and the similar situations in the United States and Japan in varying degrees, they will make loans that will have interest credits almost, or let's say zero. You don't have to pay interest back. And you may not have to pay principal back. It depends on what the conditions are at the time. So those are markets which are driven by central banks, not only their actions, but their desire to be an owner of those assets and their priorities about that ownership when they buy and when they sell are not the same as the classic free market allocations. And as a result, the capital markets are not free markets allocating resources in the traditional ways. [00:08:26] Speaker 1: - One of the questions investors are wrestling with, Ray, is how far central banks are willing to go in their effort to reflate financial assets to begin with. And then of course they hope, you know, transmit something through to the real economy that would result in growth and jobs. How far are central banks willing to go with this power they've discovered they have? [00:08:53] Ray: Central banks are willing to go and need to go as far as it takes in order to keep the system afloat. And because we're in the late stages where we have a lot of debt, you are going to see central banks' balance sheets explode. They have to because the choice is the sinking ship. I've studied the rises and decline of reserve currencies because I think we're at a key moment. And I studied the rise and decline of the Dutch gilder, the rise and decline of the British pound, the rise and decline of currencies throughout history. And the track record is a perfect track record. When the time comes where you're faced with political disruptions, is there enough money, there will be enough money. The question will be what the value of the money is and how far they can go. What are the limits to that? And so when we look at the limits, we can discuss what the limits, but the, you know, what are the market limits or how does that become manifest? I can describe that, but what's their willingness to go? Their willingness to go is enough to keep order, which means acceptable economic conditions. [00:10:19] Speaker 1: - Well, before we get to limits, and that is a very important part of the conversation, let's stick to the intervening period, which is what we're at the beginning of right now. Ray, should investors stop worrying about things like PE ratios? Do traditional asset valuations apply in a capital market that, as you say, is effectively being run by central banks? [00:10:48] Ray: - Yeah, they don't apply. I think what, I think the important thing to understand is that there's a real economy, and then there, that has a supply-demand of stuff. There's a financial economy that has its supply-demand of money and credit, and that the price of an asset will equal the risk-free return, which you can see is something close to zero, and a risk premium. So, when you're looking at a bond, and let's say in the United States, a treasury bond less than 1%, or if you take a corporate bond, a good quality corporate bond, slightly more than 1%, and you look at that, or you go to other countries, and it's essentially zero, that is the return that investors are getting for the risk-free return. In terms of equities, you have to ask yourself, what will the premium be for equities? And the central bank has the capacity to put money in the system, and the money, excuse me, and the money, and the money competes for getting returns. And so, if you ask yourself, what could the risk premium be, or what would the expected excess return for equities be over cash? And they buy assets. That number could go from 4%, let's say, to 2%. The PE is just the inverse of that. So, just by way of example, you could make the PE go from 20 or 25 times up to 40 or 50 times by the demand. That may seem implausible. That's just because people have sticker shock. But it's no less implausible than the zero interest rates. So, the risk premium will be driven by the amount of liquidity put in, and multiples are not, shouldn't be used as, in the traditional way of a frame of reference. I think you have to understand that the capital markets drive the economy, and the PEs, and the risk premiums, more than the real economy drives the capital markets. So, if that's the case- - So, the question is the value of money. What we're seeing now, what we're seeing now, I'm sorry, go ahead. [00:13:46] Speaker 1: - No, that's fine. Continue your thought, Ray. Continue your thought. [00:13:54] Ray: - Think of it this way. You don't want cash because, and I don't think you want bonds. - Because, you get no interest rate. You get a negative real rate, so you get taxed at that negative real rate. And then, so, from a holding point of view, it's got no return. And then, the central bank's gonna print plenty more of it and produce its supply. So, there's a move to what is a storehold of wealth. You know, think about it. You know, like, all of us. What is a good storehold of wealth? And if you look at history through times, it's basically almost the reciprocal of the value of money. And we see that from financing. You know, when you think a company or an individual thinks I could borrow money at this level and I can lend it at that level or I could buy my stock back at that level, you see that kind of movement. And so, one, through history, sees that there are different storeholds of wealth that are basically almost the mirror image or the reciprocal of the value of money. And so, that storehold of wealth is equities. In other words, if you were to think about certain types of equities that are not, let's say, economically sensitive, but if you just buy a company and so on, and you think it's the reciprocal of that, and you think that the, and you realize that they have to put liquidity in the system, then it's equities, it's gold. It is what is the thing that is the reciprocal of the value of money that you have to hold your wealth in. And so, that's what we're seeing. And you see it, you've seen it through history at the, you could go to the dates it's happened. You know, March 1933. Same thing, August 15th, 1971. Nixon, same thing, the values. You could see it when Mario Draghi in 2012 said, we'll do whatever we, it takes. You produce liquidity and you produce money, and that creates the bottoms in those markets because really you're dealing with the liquidity issue. The same in 2008, in November of 2008, it was the TARP plan and quantitative easing. So, through history, I can take you back to the Dutch and so on. That decision that they're going to print money and buy financial assets and lend money to the government, which will also disperse money to the poor, to those who need money and the companies. That process has happened over and over and over again in history. And it means that, you know, what do you hold during such things? You hold reflation assets. Doesn't mean inflation assets. What I mean is, there's inflation in goods and services. Let's put that aside for a moment. But there's first the inflation in financial assets as those risk premiums are driven down and that liquidity is put into the system and there's the competition for trying to get returns. [00:17:56] Speaker 1: - So, let's talk then, Ray, about the limits of money printing. How long can this continue before central banks do run in to the limits of their capacity to explode, as you say, the balance sheet and print money? [00:18:14] Ray: - Well, the limiting factor has to do with the demand for that money in debt. In other words, what debt is, a bond, is a promise to receive a lot of currency. And so, when it gives no good return or a bad return, and there's a printing of a lot of currency, clearly, it's not desirable relative to other things for private investors. However, the central bank can buy it too. And so, the limit has to do with the limit of demand. And that limit of demand has to do with the central bank's purchases of that, because they can buy it, and hence there's no problem. So, you look at periods of time of where in history, where was the most of it that has ever taken place, and to try to define the limits. And the war years was an example. I think the most analogous period we're in now was 1930 to 1945. I'll explain the various ways it was analogous, but more importantly, I'd like to deal with the question of the limits. And so, you first had the depression. And in that depression, and when you hit zero interest rates, you had the printing of money and the buying of financial assets. And then you had a lot of fiscal policy, so programs that produce large deficits, which then were monetized by more of that. And then you went into the war years. And the war years, very similar to now, in terms of the need for a lot of money and credit, produced an enormous amount of money and credit. But it was managed by the central bank in a way where they were de facto taking that on. And it was a good example of testing the limits of that. Now, we went into periods where what is an alternative source of wealth? And as I say, it could be stocks, gold. It could be other assets. But those became the boundaries. What would happen in terms of this limit is if something transpired where the dollar as a reserve currency, the holders outside, made another market that was a better market. It could be gold. It could be stocks. Or it could be an alternative currency. Like, in the earlier session, which I listened into, China as a reserve currency, there will need to be an alternative process. When that happens, and I think it will happen, then it looks like a currency defense. What I mean by currency defense is if money leaves that asset, if those who are holding bonds don't want to hold the bonds because they have lousy returns and they're printing a lot of money and they want to go to something else, and that starts to accelerate, should that happen, then what that does is, as money leaves, it puts the central bank in the position of having to decide whether it buys more bonds in order to fill in that gap or it lets interest rates rise. Well, they can't let interest rates rise. There's too much debt, and then also interest rates rising means that the asset prices all go down and it's too vulnerable. So like all currency defenses, what it means is that they then have to accommodate that, and the act of accommodating that in and of itself is a big problem. Should that happen, that would be terrible for the United States. Earlier, I heard about the discussion of the privilege. That's right, the United States dollar is a tremendous privilege, and we are certainly pushing the limits of that. And if we were to think that the dollar was to be any other currency because of us pushing the limits, if that were to happen, it would be probably the biggest disruptor not only to the markets, but to the whole world geopolitical system. So we're in a fiat monetary system. What I mean is through history, throughout most history, there was gold. Let's say 1944, we create the Bretton Woods system linked to gold. The United States printed a lot of money and more claims on gold than there was gold, and in 1971, which wasn't very long ago, we couldn't meet those claims on gold because we had too many IOUs. So we had a devaluation. And the dollar as a world's monetary system or currency is critical. But it very much depends on the dollar of the United States competitiveness and so on. So it's a longer term risk. As Noriel was pointing out in the earlier session, one of the things that's been a prop for the dollar is the fact that there's a lot of dollar denominated debt. So what that means, it creates a demand for dollars. That debt will either be satisfied in some fashion or another, because there'll be the dollars to produce it, or that dollar debt will be defaulted on in one way or another. That's a whole other discussion we can get into if you want. But at that point, it'll reduce the desire, the short squeeze for dollars, which will serve to weaken the dollar at the same time. And also as we look longer term, as Noriel was pointing out, the squeeze, the politicalization of it changes the nature of the capital flows, because we are in a situation where you can be squeezed. And so when you start to think about, yes, if you're China, and you're holding a trillion dollars of treasuries, would you want to do that? Well, particularly, I mean, given the returns, given all that and given the conflict. So this China piece is a part and piece, I'd say there's three things. We're spending a lot of time discussing the monetary and debt cycle. The second is the, what I'll call the gap, the wealth gap and the values gap cycle, which, and then the third is China. So if we look at those things in combination, I think that's the best way to look at the whole picture. [00:25:35] Speaker 1: Ray, you've been fascinated and impressed by China for the past three decades. You started to go to China in 1984, and I'm sure it would be hard to count the number of times you've been there and the number of friends you've made there. As you well know, increasingly, the West views China as the enemy. Do you think you'll ever, as an American, come to think of China as the enemy? How should we understand the situation? [00:26:11] Ray: Well, I think we tend to think of sort of like good guys, bad guys, rather than systems that are operating. We have a system and they have a system and we're sharing the world. You can have an enemy. It depends what you mean by the word enemy. You can have somebody on the opposite side of the chessboard who was an enemy and you can approach that unemotionally. That's the party on the other side of the chessboard that's playing their hand the best way that they know and the United States has to play its hand the best way it's known. And so I just look at it very sort of matter-of-factly in terms of what the systems are like and what the cultures are like too, to affect that dynamic. And so it's true throughout history, you know, there's Graham Allison wrote the book, The Thucydides Trap, in which he referred to the fact that over the last 500 years, there have been 16 times that there have been rising power, challenging existing power, and in 12 of those, they got into shooting wars. But there's certainly competitions that are in the world that we live in are not like inside competitions and according to rules. They're brutal competitions in terms of playing the game. And so we have whatever you want to call that relationship, a relationship in which China is growing, becoming powerful, playing the game in the best way it knows how. We have a different system. We're playing the game the best way that we know how. And my main issue is, you know, how well are we playing the game? How well is the United States in that world? And then you go back to basics. And the basics are things like education, you know, the quality of education over a period of time, whether you are united in a common purpose. And you have a highly fragmented world, fragmented psychology, fragmented economics. Everybody's got an opinion of what should be done. But are we actually achieving those things? And you have those kinds of problems. I worry about that in terms of the competition. But it's a very impressive system and, you know, and they're very smart, wise people with great historical perspectives, but they're on the other side of the chessboard in that game. So that, you know, that's what it looks like to me. [00:29:10] Speaker 1: Ray, I want to thank you very much for joining us here at Bloomberg's Global Asset Owners Forum. Kind of you to share all this time with us.