Interview with Ray Dalio (Part 1)

Transcript of an exclusive interview given by Ray Dalio, founder of investment firm Bridgewater AssociatesCNBC

Ray, you are the founder and chairman of the boardthe world's largest hedge fund. Financial volatility is not new to you. But, when you look at the markets today, you are not surprised at how quickly the general narrative changed from global synchronous recovery to global synchronous slowdown?

Over the years, the paradigm always somehow changes. People get used to a certain type of economic environment, and then they have to adapt to a completely different economic situation. For example, the 1930s. were the exact opposite of the 1920s. For most people, this transition was a shock. 1950s markedly different from the 1940s, etc. And each of these periods was somewhat different from all the others. There are times when something has been happening for a long time - such as a weakening of monetary policy, not only through lowering interest rates to negative ones, but also through quantitative easing. This paradigm, such a buildup of debt, can no longer continue. The fact is that people are inclined to extrapolate to the future the events of the past - hence such a surprise when entering into another cycle. I think that such paradigm shifts occur regularly. It is very useful to step back and look at events in the long run.

But this time, you were surprised at the speed with which everything changed?

I am never surprised at the fact that something unexpected is happening. I rather think about what underlies these changes - in my opinion, this is much more important.

What about the Fed's sudden refusal to raise rates and return to soft monetary policy and lower rates?

I find nothing surprising in this. In my opinion, the Fed made a mistake by assuming that what is happening is part of a normal cycle, and itself is aware of this mistake. They thought that accelerating growth and lowering unemployment should increase inflation, but the world has already changed. It can be called in different ways - the world of excess capacity, the world of total digitalization, etc. - but we already exist in another economic reality, where it does not matter so much. It is important that the possibilities of central banks and their incentive measures to have a real impact on the economy are practically exhausted, and this puts us in a situation of a very large asymmetric risk: in the event of an economic downturn, if we do not have time to reorganize in time, central banks will no longer be able to stimulate the economy and reverse the situation. And this happens against the backdrop of tremendous inequality in the distribution of wealth. So, if the left and right, capitalists and socialists, rich and poor, are so ready to cling to each other's throats today, in relatively prosperous times, imagine what will happen when the global recession begins and the central banks are powerless to oppose it. Returning to the Federal Reserve, the change in their policies that occurred at the end was dictated by precisely these factors observed around the world. The current period is very reminiscent of the end of the 1930s, and there are several ways to explain this, but this is too voluminous for an interview.

After 18 consecutive profitable years, in the first half of this year, your flagship Pure Alpha Fund has fallen 4.9%. Do you expect that in the second half of the year he will be able to improve his performance?

In fact, such differences occuralmost every year. Everyone closes big deals in a particular quarter or half a year, and you need to understand that you can’t always go into profit even every year. Some changes will always happen, and the main thing here is to maintain control over the situation and adequately respond to the changes.

You recently talked about a paradigm shift andrecommended to consider investing in gold. Why do you think gold is a good bet today? Do you think a recession is inevitable?

Well, first of all, I believe that every portfolioshould be sufficiently diversified. And if so, then I approach the issue of including gold in the investment portfolio from the point of view of strategic asset allocation - I believe that gold should always occupy some share in the portfolio, because it is a good diversifying asset, and, in addition, the economic situation today, indeed, inspires some concern. I assess the recent economic situation as very risky. In such circumstances, it becomes very difficult to stimulate the economy and there is a strong incentive to artificially weaken currencies. Think of the fact that bonds are actually currency too. Holders of bonds or other debt instruments must pay money within a certain period of time. If we have a large number of such bonds, a huge debt, or even unsecured obligations (such as pension or in the field of healthcare) and we do not have an effective monetary policy to lower interest rates and stimulate the economy, then we will have to cover the growing budget deficit using a printing press, and I think that we are clearly approaching this moment. Given the depreciation of currencies, cheaper money is the easiest way to pay off accumulated debt.

So you expect a worsening situation?

In an evolutionary sense, next year, two orthree position noticeably worsen, yes. I think that we will deal with an aggravated situation in which surplus capacities, debt restructuring, and political problems arising against this background converge. The next election in the United States, in my opinion, will be of great importance. First of all, I mean the growing contrast and conflict between capitalists and socialists. I think that this kind of disagreement will intensify. The current situation carries potential risks for capitalism, and we need to closely monitor its development.

Is a US recession inevitable?

Recessions, of course, are inevitable. The only question is when the following happens.

In your opinion, is the next recession on the way?

Yes, I think that in the next two years - say, until the next election - the probability of a recession is forty percent. And I think that signs of this can be seen all over the world.

In late July, the Fed lowered rates - for the first time since 2008. How do you feel about this decision? Do you think higher rates are needed today?

I think yes. As the global economy slows down, there will be many more reasons for a more serious reduction in interest rates. I think you see what is happening now under the influence of government bond rates. Interest rates on long-term debt are reduced faster than on short-term, which leads to the inversion of the yield curve. This suggests that storing money in cash is becoming more profitable than in bonds, and usually this leads to a redistribution of cash flows in favor of cash and a slowdown in lending. So now we have significant pressure in favor of lowering rates in a situation of relatively high economic activity so far.

Do you think that the Federal Reserve can prevent a sharp slowdown in the economy, or is it now more likely to opt for fiscal stimulus?

I think that political factors have a role todayбольший вес. Так что я бы не ожидал каких-либо изменений в отношении бюджетного стимулирования, пока не пройдут выборы. После выборов, в зависимости от распределения сил, я думаю, вопрос об изменении правил бюджетного стимулирования будет изучаться со всей серьёзностью, и изменения могут оказаться значительными. Но это вряд ли произойдёт в ближайшее время. Я думаю, что, оценивая перспективы рынков, необходимо иметь в виду определённый временной горизонт, не забывая и границах выборных периодов. Отношения между США и Китаем тоже должны сыграть важную роль. Давайте, может быть, попробуем отступить на шаг назад и рассмотреть основные факторы в перспективе. Я думаю, что очень значимым фактором является то, что мы находимся в конце одновременно и краткосрочного, и долгосрочного долговых циклов, что подразумевает вероятные проблемы со способностью центральных банков принимать стимулирующие экономику меры – значительно понижать процентные ставки, проводить количественное смягчение и производить закупку. Это важно, но не безотлагательно. К необходимости решать этот вопрос мы подойдём вплотную в ближайшие год или два. Это можно видеть в Европе, в Японии и, в некоторой степени, в Соединённых Штатах. Кроме того, мы имеем колоссальный разрыв в уровне благосостояния. И на фоне такого разрыва возникает классический политический конфликт, очень напоминающий 1930-е годы, с ещё большим разделением и поляризацией общества, большей радикализацией обеих сторон, и это будет играть большую роль, усиливая реакции общества на политические изменения. Например, когда администрация Трампа снизила налог на прибыль коммерческих организаций, это подтолкнуло акции вверх, потому что если после выплаты налогов у вас остаётся больше денег, то вы готовы больше заплатить за свои акции. Это изменится. Итак, у нас есть это сочетание поляризации общества и неспособности центральных банков стимулировать экономику – эта ситуация очень напоминает 1930-е годы. И есть ещё Китай, развивающаяся страна, бросающая вызов Соединённым Штатам, стране развитой и обладающей большим авторитетом в мире, и это создаёт определённый нарратив, протекционистские настроения, что, опять же, очень напоминает 1930-е. Это тоже чревато конфликтами самого разного толка. Да и с эффективностью экономики, откровенно говоря, у нас тоже есть проблемы. Взять, например, сферу технологий – кто будет строить эти цепочки поставок? Мы построили экономику, в которой существовала взаимозависимость и эффективность, возникающая на основе цепочек поставок, работающих определённым образом. Теперь, когда мы вступаем в новую, конфликтную среду, необходимо прежде всего обеспечить личную и государственную безопасность, что подразумевает движение к большей независимости друг от друга. США говорят: «Мы не хотим ваших технологий». И Китай говорит: «Мы не можем зависеть от того, дадите ли вы нам свои технологии». Такое обособление меняет характер отношений и оказывает существенное влияние на экономику. И опять же, это очень похоже на то, что происходило в конце 1930-х гг. Такими я вижу основные доминанты на ближайшее будущее. Это эволюционирующие факторы, но они будут постепенно усиливаться в течение следующих нескольких лет, изменяя общую парадигму. Мир, в котором мы в результате окажемся, будет совсем не таким, как сегодняшний. Началом текущего периода можно считать 2008 г. Печатание денег и стимулирующие меры центральных банков являются его неотъемлемыми признаками и эти меры к сегодняшнему дню достигли своего предела – вот почему я считаю, что мы должны увидеть сдвиг парадигмы.

That is, do you recommend diversifying your investment portfolio through the purchase of gold?

Not certainly in that way. I say that gold is an important diversifying asset. But let’s make it clear: I don’t think that at least someone should now have a highly concentrated investment portfolio. So if you want to highlight some kind of recommendation from my readers, the most important thing they can do right now is to create a balanced portfolio. In my understanding, the world is now continuing to build up a long position by increasing leverage. In other words, people got a lot of loans to buy assets of companies. Companies scored loans to repurchase their shares and so on. All this cumulative long shoulder is the state the market is in right now. I consider this kind of portfolio to be very vulnerable, and gold is one of the assets with which it can be diversified. Although I understand that the media is likely to take my words out of context and trumpet, they say, Ray Dalio recommends going and buying gold. Although in fact I do not think that it should constitute a very large, or, conversely, a very small fraction of the portfolio.

Just out of curiosity: where, in your opinion, can the price of gold be, now fluctuating around $ 1,500? Will it exceed the $ 1900 highs set back in 2011?

I will not give price forecasts. I’m only talking about the fact that this situation carries significant risks for the value of currencies, because governments will print money to pay off their debt obligations, and therefore some part of the portfolio should be kept in gold. How exactly to do this and what proportions must be ensured - I do not want to give specific recommendations in this regard.

To put it more broadly, do you see the potential for growth in the value of gold in the near future?

I think this is a good hedging asset and yes, it probably has some potential for growth.

You have rightly noted that market volatility is due to a trade conflict between the US and China.

This is a factor, yes.

Could you share your vision of thisProblems? Do you think that the root of the conflict lies in the fact that China has clearly shown itself to be a growing force, which can no longer be ignored, with regard to technological innovation?

Yes, traditionally, when a growing power quitsa challenge to the world leader, this creates a large field for contradictions. The world is too small for these two countries, so their interests will continue to intersect in many different directions. Trade is just one of them. In fact, trade is the least significant part of this process. Technology is more important.

Is the main reason technology?

I would say there are three reasons. Trade also matters, but technology is perhaps the most important factor contributing to the achievement of many fundamental advantages. History shows that technology provides economic, military power, as well as the development of all other vital areas. As for the third area, this, of course, is geopolitics, world influence, alliances and everything connected with it. So, there are three areas: trade (in my opinion, the least important of them), technology (affecting both the commercial and military spheres) and geopolitics (the struggle for influence in the regions and in the world, the question of the South China Sea and everything related to this). Obviously, conflict occurs around these areas.

President Trump recently introduced 10 percent tariffsfor the next Chinese goods with a total value of another 300 billion dollars. After that, the People's Bank of China allowed the USD / CNY rate to cross the psychological mark of 7 yuan. And since then, Trump has delayed the introduction of some of these tariffs. But doesn’t it seem to you that we have reached a new stage in the trade conflict and are witnessing the beginning of a currency war?

Let’s make it clear: The People's Bank of China did not artificially lower the exchange rate. This is not a course manipulation. Currency has supply and demand. And the Bank of China made it clear that within certain boundaries, they would like to maintain order, but only within certain boundaries. This is the market. And if you are in favor of the complete absence of currency interventions, then this is what the United States is doing, although the question is whether we will find ourselves in a situation where currency interventions become the norm here. I would say it bothers me more that the United States may begin to artificially weaken its currency through interventions.

And how big is this probability?

I do not think this is very likely. But now, when the time is right to pay on long-term debt obligations, changes in interest rates have no effect, as does the quantitative policy, in these circumstances, the weakening of the currency is a generally accepted tool to stimulate the economy. Because when the exchange rate drops, the prices of shares or assets in your national currency will tend to rise, and this has a stimulating effect on the market. So I think that in the next three years you will see more examples of currency wars - be it explicit targeted interventions or the result of a systematic monetary policy. For example, when the Bank of Japan pursued its stimulating policy, it consisted of two parts: not only making money very cheap, but assets, therefore, unattractive in terms of providing interest rates, but also encouraging investments outside the country, which puts downward pressure on the currency . I think that in the near future we will see more examples of this kind. Thus, in the next three years, the global economy is likely to become more competitive, and exchange rates will become one of the instruments in the competition.

As for China, the breakdown level of 7 yuan perthe dollar - it happened for the first time in the last 10 years. From the height of your experience of interacting with China regarding the development of capital markets, can this fact indicate that a weak RMB exchange rate helps Chinese regulators cope with the consequences of the trade conflict?

As for the breakdown level of 7 yuan, I would notbegan to attach too much importance to this event. In my opinion, they did the right thing. The People's Bank of China is perfectly able to create bilateral, in fact, markets, so betting on the yuan or on it is always difficult. I think that from the point of view of the balance of supply and demand, they are doing well. Of course, if your economic position - in particular with regard to external settlements and trade - is weakened, then the depreciation of the currency is a natural consequence of this. This is a stimulating step, and this especially applies to the export part in a weak economy. You have a choice: how will you try to alleviate the economic situation? You can lower rates, you can go for some quantitative easing or some kind of regulatory measures, the so-called macroprudential regulation, in addition, you can weaken the currency or just not prevent its weakening. So I believe that the exchange rate is determined mainly by the market.

Will you remain optimistic about the Chinese economy if the yuan continues to decline?

Once again: currency weakening is part of a natural correction process…

So you have no problem with this.

I have no problems with weakening the currency. I look at the health of the economy as a whole and the health of specific companies of interest in terms of investing in them, or at bonds. For example, Chinese bonds offer an attractive interest rate. Which of these factors has the greatest weight - an attractive rate or a weakening currency? Such questions are more tactical in nature. A weakening currency is simply part of the correction process that occurs because it leads to the growth of other assets. This promotes, for example, stock growth and also has a stimulating effect, as well as lower interest rates.

Who can last longer - the United States or China?

The outcome of the war largely depends on the decisions takendecision process (and not just the initial distribution of forces). For example, China owns a lot of US bonds. But it also has many different dependencies and interdependencies with different countries. These are complex processes. No one can say in advance who will use what pressure points on the opponent. I can't say who is stronger. But the thought of what harm these countries could do to each other and what that would mean for the entire global economy can be unsettling. In my opinion, this is the most important thing. I can't name the winner in advance. And in historical wars, too, no one knew who would emerge victorious. But we know that the consequences of all these wars were, in one way or another, unfortunate for all parties involved. Even the aggressors subsequently regretted starting the war. I don't think we can predict exactly how the situation will develop. In a series of «mirror responses» and mutual accusations, these two countries can use any means, causing harm not only to each other, but to the entire world economy.

You raised a very important question becauseChina is the largest foreign lender in the United States, owning US Treasury bonds worth more than a trillion dollars. Does this create an additional opportunity for China to put pressure on the United States? Or is such a scenario unlikely? Can Beijing use its assets as a weapon in a trade war? Or is such a scenario unlikely?

Can they use their assets as weapons?Of course they can. When you enter a new cycle, there are always many unknowns. And you need to understand that there are different pain points that you can put pressure on. There was a symbiotic relationship between the United States. The US wanted to spend more than it earned and buy more Chinese goods and other imports on credit. As a result, in a sense, they got what they wanted. China wanted to become richer and accumulate savings. In general, both were realized. Now we have not just a trade relationship, but a relationship between debtor and creditor, and this can be dangerous.

What are the chances that these risks will come true?

I don't know. As I said, when you get deeper into the confrontation…

But you do not exclude the implementation of such a scenario, these risks?

I would not rule it out. Definitely not.

 

(To be continued…)

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