- After the media obsession with Warren Buffett, it is time to turn our attention to noted billionaire investor Ray Dalio of Bridgewater Associates.
- Ray predicted the 2007 Credit Crunch and has earned the respect of both the public and private sector. His “beautiful deleveraging” theory helped in the subsequent economic recovery.
- Ray advanced his advice of humility when making financial decisions and also his opinion that the Fed should not rise interest rates this year.
Warren Buffett and his company, Berkshire Hathaway, are well-known icons in the world of investing and even to the general public. It is a newsworthy whenever Buffett gives his opinion. However we are at the stage where The Wall Street Journal finds it worthy to write a full article when Buffett plays ping-pong with an 11-year-old girl.
With all this Buffett saturation in the media, I would think it is advisable to look at another investment icon who is wise, accomplished and worthy of respect in the investment arena. So let me introduce you to Ray Dalio of Bridgewater Associates — the largest hedge fund in the world with $169 billion in assets under management. Ray Dalio first came to my attention when I was reading the memoirs of Timothy Geithner. Timothy Geithner was the 75th Treasury Secretary of the United States and he played a key role together with the 14th Chairman of the Federal Reserve to heal the US economy from the Great Recession in 2008.
Establishing Bona Fides
Timothy pushed his memoir, Stress Test in May 2014 on his experience during the tumultuous period of 2008. His memoir introduced me to the previously unknown (to me) investment legend, Ray Dalio, who commands the respect of both the private and public sector. This is how the former Treasury Secretary described Ray Dalio in his memoir:
“I walked into the Oval Office for the President’s daily economics briefing with a report from Bridgewater Associates, the world’s largest hedge fund firm. Many experts, including Larry, regarded Bridgewater’s Daily Observations as among the smartest and most credible sources of private-sector economic analysis— and among the darkest about the banks. In front of the economic team and the President’s political advisers, I handed that day’s Observations to the President. The headline was ‘We Agree!'”
Ray Dalio is the founder and Co-Chief Investment Officer of Bridgewater Associates based in Westport, Connecticut in the United States. Bridgewater manages $169 billion worth of funds. As its founder, Ray ranked #60 in the Forbes World Billionaire List with $15.4 billion in net worth which is eclipsed by Warren Buffet’s #3 Forbes ranking with a massive $69.8 billion in net worth. Both are self-made billionaires and you don’t become a billionaire without having impressive investment acumen. So while you might not have heard of Ray Dalio before this article, he is not someone to be dismissed.
Ray is relatively younger than Buffett at 65 years of age compared to Buffett’s 84. However he has seen enough of the world to make meaningful judgment that is worthy of our time. For example, Ray is one of the few investment professionals to accurately predict the 2007 credit crunch and went on to warn the Treasury Secretary Henry Paulson. He even went all the way to reach out to key members of the economics team in the White House. He was ignored by the government but he was ultimately right when he identified the key issue in the housing markets then was solvency and not just a liquidity problem.
Ray made his name after the events that unravelled proving that he was right. There were no lack of bright academics offering opinions but they were essentially wrong. However he remains a relative unknown to the general public because the world’s attention was on how the 74th Treasury Secretary Henry Paulson, 15th Fed Chairman Ben Bernanke, and 9th President of the New York Federal Reserve Timothy Geithner (before President Obama promoted him to Treasury Secretary) would do to save the world in early 2008. However if you are a serious financial professional, you would have heard of his name one way or the other. True talent always find ways to shine and emerge from the masses.
Ray Dalio’s Contribution to Economic Recovery
You may not know it but it is Ray Dalio’s theory of ‘beautiful deleveraging’ that influenced Ben Bernanke to start the printing presses with quantitative easing 1, 2 and 3 which lasted from March 2008 to October 2014. The Fed’s balance sheet shot up from $700 billion to end with a massive $4.5 trillion. It was controversial to say the least but the world was saved.
Ray posits that there are essentially four ways for an overburdened economy to deleverage on its debt. They can cut spending, find ways to reduce debt itself, transfer wealth, and lastly for the Central Bank to print more money. He pointed out that you can’t save an economy by forcing people to cut spending (also known as austerity) simply because that one man’s spending is another man’s income. It would be deflationary and the economy would shrink faster than the debt burden. It would not be possible for everyone to cut spending at the same time and for the economy to grow.
Debt burden can be reduced through outright default or restructuring for more lenient credit terms. However if you push it too far, depositors will start to doubt the ability of banks who lend the money to be solvent. This would result in a bank run like the UK’s Northern Rock in 2007.
The other way would be for wealth to be transferred from the rich to the poor. This can be done by the government through an increase in tax rates from the wealthy to fund increased social spending to the poor. However this will cause both the wealthy and the poor to resent each other and increase social tension. The wealthy will see the poor as free loaders especially at a time when their wealth is eroded by the recession in the form of lower stock valuations. The poor will resent the rich when they lose their jobs and might have to sell their houses, cars and valuables just to get by. They will only see the privileges enjoyed by the rich and not their higher tax contributions to fund their social spending. All these three methods are self-defeating and ultimately unlikely to work according to Dalio.
The last and best method would be for central banks to print more money to replace the credit lost in the system through the recession. It could be highly inflationary and every central bank rejected that idea in year 2008 except for the Federal Reserve. Everyone was reminded of the Weimar Republic example in the 1940s and other incidents of hyperinflation.
Dalio’s beautiful deleveraging theory persuaded Bernanke to create credit to replace the lost credit by buying mortgage back securities when everyone was dumping it. It placed a floor on the credit market, confidence returned and the economy recovered slowly and steadily even as the economy gradually reduced its debt burden. The key is not to print so much money to cause inflation but enough money to restore confidence. This was also done together with a Fed-administered bank stress test as ordered by Timothy Geithner. People were spending and income rose faster than the debt burden as the Fed kept interest rates low. This is the essence of Dalio’s beautiful deleveraging theory.
US Self-Defined Economic Recovery Path
It is also important to note that what the United States did not do was equally or even more important than what it did. For example, the United States did not impose austerity measures like those that were imposed on Greece. Greece is still an economic backwater today and has been dragging the Eurozone economy for six long years now ever since concerns over its sovereign debt emerged in 2009. Austerity reduced Greece’s ability to pay its debt as it income shrunk faster than its reduced spending which in turn reduced their ability to pay its existing debt and forced them to take on more debt.
The Obama administration rejected Europe’s advice for austerity and went in the other direction of increasing spending. A notable economic program would be the $3 billion Car Allowance Rebate System which encouraged car owners to scrap their old cars and purchase new ones. It was started during the depth of the recession on 1 July 2009 with a $1 billion budget which was quickly reached and subsequently increased to $3 billion. It is commonly known colloquially as the Cash for Clunkers program and it drove up automobile sales significantly and is still operational today.
It was the exact opposite of the European experience. South Korea’s economic re-emergence from the 1997 Asian Financial Crisis was hailed as a victory of austerity. However it was done during a period where the crisis only affected Asia and the rest of the world was doing well. This allowed South Korea to export its way to prosperity but this is not the case for the recent 2008 Great Recession. Even so, the IMF admitted later on hindsight that it imposed too much pain of austerity on South Korea than what was necessary.
Advice and Outlook
So after establishing the credibility of Ray Dalio, we can now move on to consider his advice seriously. There is limited scope for this article so I would just focus on one rather unique piece of investment advice from him and one investment outlook from this macro fund manager.
Ray’s first investment advice is one of humility. He made an important point about market efficiency where prices reflect all available information in the market. In order to make money, the investor has to think independently and find out where the market’s assumption is wrong in this uncertain world. The most important point to note is that he must be right to make money.
Ray Dalio generously shared with us his experience with a recent article written for The Institutional Investor on 6 March 2015. He predicted the stagflation experience in the US in the early 1980s and positioned himself accordingly in the market. His view was validated when Mexico defaulted on its debt in August 1982.
What Dalio did not expect is that Paul Volcker, then Chairman of the Federal Reserve, would then reduce interest rates in that environment thereafter. Volcker was the one who raised Fed rates to a peak of 20% (it is 0.25% today) in 1981 before allowing rates to come down. It would only be logical for the central bank to defend the USD with a rate hike after Mexico defaulted. It is also illogical for the Fed to cut rates before inflation was fully tamed. However Volcker had other considerations in mind.
This episode taught Dalio to consider all options carefully before making a decision. He would gather those experts who had different opinions and hear them out. After he understands the difference in opinions clearly, then he would make his decision.
“This episode taught me the importance of always fearing being wrong, no matter how confident I am that I’m right. As a result, I began seeking out the smartest people I could find who disagreed with me so that I could understand their reasoning. Only after I fully grasped their points of view could I decide to reject or accept them. By doing this again and again over the years, not only have I increased my chances of being right, but I have also learned a huge amount.”
As for his investment outlook, Dalio sees a parallel between 2015 and 1937 before the Great Depression. The Fed is on the verge of raising interest rates and he is of the opinion that the economy might sink as it occurs. His opinion is that the Fed should defer its rates lift off decision and allow for more inflation. The Fed’s opinion is that the monetary condition remains highly accommodative even with the increase in interest rates by historical standards.
It remains to be seen if he is correct this time round. Although Dalio is influential, he does not hold the key to monetary policy decisions. With this article, I hope that you have taken notice of this investment legend and benefit from his investment advice. Dalio also said that success is the ability to look and adapt to the facts as it is and not how you want it to be in his ‘Principles’ philosophy. It is 123 pages long and it is a good read for both personal and investment progress.