Billionaire hedge fund manager Ray Dalio spoke exclusively to ET Now's Tanvir Gill & Nikunj Dalmia on his new book Principles to Navigating Big Debt Crisis, sharing his insights on where world markets stand 10 years post the global financial meltdown & how India can manage its debt problem.
Edited excerpts:
What do you think about Indias debt problems and what policy makers can do to manage the risk?
What I say will be equally true for India and China now. The key to achieve a balance is how you are dealing with debt to produce a beautiful deleveraging because there are basically four ways to reduce debt burdens.
The first way is austerity. The problem with austerity is when you have too much that, they think one should spend less but when they spend less, one person is spending anothers income and it compounds. But anyway, that is the usual reaction, but it does not work for the system as a whole.
Sometimes it is done by bankruptcy and debt restructuring. Debt restructuring and austerity are both deflationary forces and are negative on the economy. That is because when you have debt write-downs, you are reducing somebodys net worth because that one persons asset being written down is another persons debt and so you create debt relief but you also reduced the value of the asset and that is a deflationary force.
The third way of doing it is to print financial assets and have the central bank buy financial assets, quantitative easing it is commonly called now.
The fourth way of doing it is to find some way of transferring wealth from those who have more assets to service those who do not. So, in some form or other, transfer of wealth is taking place. The key is to balance these well.
All these efforts are made so that debt is not defaulted on to systemically important institutions.
In other words, you are not going to do this with everybody. Everybody who get into debt, need to have consequences and you need to have those problems dealt with. Otherwise, you will have to do it repeatedly. But it is important to not let that threaten the system and by identifying those systemically important entities, provide the support that is needed for them and to spread out that debt crisis in a way that is balanced is how you produce a beautiful deleveraging.
When we speak to classic investors on Wall Street, they say do not focus on macros, do not talk about cycles, focus on human behaviour and valuations. What is the importance of cycles for genuine long-term investors who want to value a good business and wants to sit on it for years?
First of all, what is a good business? Over time, most businesses that are Dow Jones Industrials or any of the top businesses that existed 10-20-30 years ago, are no longer good businesses. The world changes and I do not think one can just sit on a good business and be comfortable doing that.
In India, you know about cycles and how things work and they are just cause-effect relationships. One thing leads to another, which leads another and if you are saying that it is okay to ignore the cycles, it just does not make sense to me. Think about that. Why do businesses in India now have a problem and do you not use debt? The impact of the cycle on everybody like was terrible in 2008. Just hold your business and ignore that? I just cannot understand how ignoring cycles and holding your business is going to be a sensible path?
My dad raised me and taught me about debt and told me not to get too much into debt and pointed out their consequences. I cannot imagine how one could operate by just saying I am just going to hold the business and I will be good.
In the book, you have talked about inflationary debt cycles which is largely derived from countries with high foreign debt to GDP ratio, something that recently spooked markets vis-a-vis Turkey, leading to a risk of a contagion in EMs. Do you think emerging markets are at greater risk at the turn of this cycle than developed?
I think it is such a good example. The same things happen over and over again. How many times have I been doing this in last 50 years? I cannot tell you how many cycles I have been through and it is the same basic dynamic and that is why I wrote the book.
It is a situation where you borrow in foreign currency, you have the balance of payment, you have the bubble and then what happens is as you get into the debt problem phase in the cycle. You have foreign debts and your currency goes down, then your foreign debt service payments rise because you have to pay in a currency that has gone up a lot. If it goes up 10-20%, that is like interest rates being 10-20%. You get squeezed and as some get squeezed, others also get squeezed and you have contagion because of losses and worries and then the cycle feeds on itself. Then the cycle works through a process of self correction.
The big thing is why we are asking questions when the same things happens over and over again? Do we learn our lessons about the mechanics of that? Do the policymakers learn any lesson about how much foreign debt they should have relative to their cash flows and so another investor? They all sell at the bottom.
The biggest problem is that most investors think the assets that went down are bad and the assets that go up are good, rather than the fact that assets that go down are cheaper and the assets that went up are more expensive. Investors need to understand the calculations which I tried to put out in that book.
By the way, that book is free online. If you go to principles.com, you can download the PDF of the book and it is free so that people can navigate that but it is just another one of those of cases, another one of those cycles.
A year ago when we spoke to you, you said the world is not taking cognizance of risk. You said you were long on equities and indicated that gold should be part of everyones portfolio. What according to you should be a preferred asset allocation?
Yes, I said so. A year earlier, there was a lot of cash on the sidelines and we were into the cycle and I am glad we were long equities and so on. I would say, generally speaking, we are now later in the cycle and I do not feel the same way about equities. The circumstances are different, prices are higher, there has been more debt and the circumstances are different as they pertain to equities.
Generally speaking, if one is timing those moves and which I caution everybody to do, I would say we are in a different spot and I do not feel the same way about equities.
In terms of gold, what I am saying is that between 5% and 10% of a portfolio should be in gold. Our choices are money and there is a lot of debt. If you take a look at debt and money, bonds are a promise to deliver currency and there is a lot of debt around. If you look at the US borrowing, the US financial position which is the main reserve currency, not only do we have a lot of debt, we are going to need to borrow a lot more money because the fiscal policies that existed created a lot of corporate tax cuts which is are stimulative for the economy, we are experiencing those now.
At the same time, it means that there has got to be a lot more borrowing to finance the deficits which are happening and so they have to sell a lot more bonds. As they sell a lot more bonds, for a buyer from around the world it means they are going to get a lot more promises to get a lot of dollars, There is a supply demand imbalance there and bonds are riskier assets and dollars are riskier assets.
Look at the world reserve currencies, the dollar in a sense is risky, the euro is risky. We are dealing with a whole set of things that makes the euro risky. The Japanese yen is risky in terms of that money. There is a lot of debt around and there is a challenge in terms of that money. And you could be in a situation where that kind of money is not as appreciated and also the nature of assets means that equities and bonds in a sense are tied to that same financial structure. So, gold is a diversifying asset and should make for 5-10% of a persons portfolio. This share could go up later into the cycle. I cannot tell you exactly where it is but I can say I think we are pretty late.
You said that 2019 is setting up to be a dangerous period for the US economy. What could indicate when things may turn for the worse?
What I mean by danger is that we are on the later stages of the short-term debt cycle and the later stages of the long-term debt cycle. Short-term debt cycle means we are in that phase of the cycle where you are having a combination of the tightening of monetary policy and interest rates sensitivity to asset prices and that creates short-term volatility. You are in the later part of the long-term debt cycle because you are closer to zero interest rates.
A lot of the power of the monetary easing through quantitative easing and buying financial assets is behind us than in front of us. There is not as much power to reverse it. You are also in a world in which there is much more populism.
In other words, the rich and the poor are more at odds and the political leaders are more populist and it is a little bit more difficult to run government in a harmonious way as there is more conflict. These are realities of where we are and as we go forward into 2019, 2020, we have to realise that these are riskier periods for these very reasons.
You initially indicated a similarity between the current cycle and that in 1930s. But after 1930s, we had World War II. Do you think somewhere markets are underestimating the importance of trade war because in the last 15-20 years the world has opened up for trade and now the reversal has started?
Right, the reversal has started and certainly we will have a change in trade related to what you call a trade war. I do think it goes beyond the trade war, I hope not and I do not think that it goes to a military war. But a competition exists now. United States, particularly under the new leadership, is competing with China in ways that extend from different systems operating differently. China has a much more top down plan for the economy. They want to organise the plan of 2025 and be competitive in the world. They are going to be very effective and tough competitors.
The United States has a much more of a bottom-up society and culture — having things to dispute, questions about changing supply lines, for example, in this competition. And also I think that it occurs to both sides that there could be military conflict in various ways and so on. So, everybody wonders where are my supply lines and how does that work for whatever reasons? We are in a situation where there is that element of competition. For example, administration wants some of the manufacturing that is taking place to China getting imported into United States instead get produced in the United States itself. What pressures will exist to bring that about and what are the implications of that? I think, there will be more pressures for that in various ways and it serves a purpose in the administrations eyes to bring production back to the United States and makes the country more self sufficient. This is because in case of a conflict, supply lines could be disrupted!
We are in a new world which has quite profound disruptions because we built this world in a globalist way, where you could produce wherever it was most cost effective and ship it. Now, that is being disrupted.
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