Dalio is the founder and co-chief investment officer of Bridgewater Associates LP, which manages about $160 billion in assets, more than any other hedge fund company. He gave me an interview to promote his new book, A Template for Understanding Big Debt Crises. Its purpose, he said, is to share Bridgewater’s ideas for how to prevent more debt crises and to help investors and policymakers deal with them if they occur.
Dalio timed the book’s release for the 10th anniversary of the fall of Lehman Brothers, which kicked off the most severe phase of the global financial crisis. In a video released on YouTube in conjunction with the book’s publication, he describes going to the White House and Treasury Department, without much success, to warn officials about the unsustainable buildup of debt.
Ramsen Betfarhad, a senior domestic policy adviser at the time to then-Vice President Dick Cheney and now a senior research associate at Bridgewater, says in the video that Dalio told federal officials the banking system could suffer $5 trillion or more in losses. Says Dalio: “It was initially perceived as something that’s pretty kooky.”
Washington gradually paid more attention to the Bridgewater founder. Dalio communicated with Timothy Geithner when Geithner was president of the Federal Reserve Bank of New York and, later, when he became President Obama’s Treasury secretary. On May 7, 2009, a Bridgewater publication endorsed Treasury’s newly released results of stress tests on banks. In his own book, Stress Test: Reflections on Financial Crises, Geithner described bringing a copy of the Bridgewater publication into the Oval Office to show Obama and the president’s economic and political advisers. “I wasn’t dancing in the end zone, but that was a good day for the home team,” Geithner wrote.
Knowing history is the key to predicting financial crises, because history repeats itself, Dalio writes in his book: “In my life, from the beginning, every time I was surprised by what happened in the markets, it was because it hadn’t happened to me in my lifetime.” Most of the book consists of studies of past financial crises, including Germany’s hyperinflation after World War I and the Great Depression of the 1930s. Last decade’s crisis merits a chapter of its own.
In 2008, Dalio explained in the interview, “we did a lot of pro forma financial numbers of each different financial and corporate entity and household borrowers. We could see that there was going to be a debt service problem that would cascade. When we do the same calculations now we don’t see the same things.” He added: “I don’t think something as systemically threatening as that which occurred in 2008 is at our doorstep.”
That doesn’t mean he’s blithe, however. “I’m significantly concerned for the next economic downturn for two reasons,” he said. “The first is that we have right now a higher level of populism and a worse wealth gap, so that when we have a downturn, the rich and the poor, the left and the right, will be more at each other’s throats.” Second, he said, monetary policy will be less effective because there’s not much room to cut interest rates, and because quantitative easing—the Federal Reserve’s purchase of long-term bonds to lower interest rates—“has much less marginal effectiveness.”
When a financial crisis does hit, as it inevitably will, regulators may not be well-equipped to fight it, Dalio said. “There’s a cycle here. What they did was to write regulations that reduced the chance of a financial crisis but significantly limited the flexibility in dealing with it. History has shown that all financial crises don’t work out exactly as they are anticipated.”
He added: “The debt crises themselves are less of a risk than the inabilities to deal with them, due to either lack of understanding of how to deal with them or political and legal constraints.”
Dalio proposes some kind of mechanism that would allow the president, together with a handful of other officials, perhaps from the Fed and Congress, to abrogate regulations “if they unanimously agreed that the regulations are standing in the way of needed action” to rescue failing firms and prevent a systemic crisis. That idea would certainly stir opposition from lawmakers and others who oppose bailouts.
There’s an understandable tendency when a crisis hits to make sure that the people who caused the problems aren’t inadvertently rewarded. But, Dalio writes in the book, that can be a mistake. “At such times, above all else, the most important thing is to provide life-blood (i.e., stimulants) to keep the systemically important parts of the system alive. It is dangerous to try to be overly precise in getting the right balance between a) letting those who borrowed and lent badly experience the consequences of their actions and b) providing judicious amounts of liquidity/lending to help rectify the severity of the contraction.”
For the record, Dalio's seven indicators of a bubble are:
1. Prices are high relative to traditional measures
2. Prices are discounting future rapid price appreciation from these high levels
3. There is broad bullish sentiment
4. Purchases are being financed with high leverage
5. Buyers have made exceptionally extended forward purchases, such as of inventories, to speculate or to protect against price appreciation
6. New buyers have entered the market
7. Stimulative monetary policy threatens to inflate the bubble even more.
So far, the indicators aren't telling him we're in a bubble.