Linda Lacina
Ray Dalio: studying history can help leaders better understand and predict challenges to come
In 50 years of global investing, Ray Dalio has learned we're often surprised by things that have not happened before in our lifetimes. This led the Co-Chairman and Co-Chief Investment Officer of Bridgewater Associates to study 500 years of history, uncovering patterns that emerge, decade after decade, triggered by economic swings, social change and global conflict.
Such trends help him identify the big-picture issues of the day. For instance, he says, he's currently concerned about the impact of inflation as well as conflicts, both inside countries and between, them that can bring inefficiencies and resource mismanagement.
"I have a principle - if you worry, you don't have to worry. If you don't worry, you should worry."
Such worries are shaped and informed by the research he collected in his recent book, Principles for Dealing with the Changing World Order. The Meet The Leader podcast caught up with Ray in Davos during the 2022 World Economic Forum Annual Meeting. He shared how studying history can help leaders better understand and predict challenges to come -- and navigate our current turbulent time.
Ray Dalio: I'm Ray Dalio, I’m a global macro investor. I have done that for about 50 years in all liquid markets in the world — and the world is changing. And I learned it by having surprises in my lifetime, that many of the things that surprised me didn't happen in my lifetime before, but happened many times in history.
And these three things that are now happening are: the creation of enormous amounts of debt, and the monetization of that, which is having its affects inflation, and all. The second is the amounts of internal conflicts that are going on, populism of the left and populism of the right due to the largest wealth gaps and values gaps. That internal conflict is having a big effect. And the third thing is a great power conflict — the rising of a great power in the form of China and the relative decline of the United States and the conflict between different forces that we're also seeing reflected in the Russian-Ukraine-NATO conflict.
By studying the last 500 years of cycles, like a doctor who sees many, many cases, it's not just that there are patterns, there are cause-effect relationships.
So, for example, when there was a great power rivalry, and there's no such thing as a world court or a world justice system, there's different kinds of wars. And traditionally at those times, there is economic wars, of which we call sanctions. For example, the analogous situation to what's going on now is in Japan, they froze the Japanese financial assets the United States did, and they also put on economic sanctions that inhibited the importation of oil. And when we see these things, repeat the internal conflicts in World War Two, prior to World War Two, because of the economic conditions, there was populism of the left and populism of the right, that produced struggles that actually brought down four democracies during that period of time and made them autocratic governments.
So, when we see not only the patterns, but we see the cause-effect relationships, we can deal with what's happening now. The reason I did this study is because now, today, I have to make decisions on where do I put money, what is likely to happen?
For example, an important consideration is how resources are allocated. You know, we've been in an environment where resource allocation was primarily economic and mostly profit motivated. So, there was a world out there and it was an open world and wherever it was cheapest to produce, the resources would go, capital would go and they would build that, people there would earn more and that may take jobs from other places and so on. That would be evolving that way. Within countries it would be the same.
We're now shifting to an environment in which there's more ideological or political resource allocation. So, you're seeing more issues such as trade restrictions and so on. You could see foreign exchange controls, other matters in which those resources are allocated.
Because of this environment of much greater conflict, you're also seeing much more independence and self-sufficiency of countries because they are worried that they could be cut off in the event of a war. That is having a very big, negative efficiency impact on the economy, which is contributing to inflation. So, these three factors working together, how they work together, logically, make sense how the machine is working, and we wouldn't have a full appreciation of that unless we saw those patterns of history.
Linda Lacina: Digging into 500 years of history, was there one stat or one fact that kind of knocked you off your feet? You know, history has that effect. Was there anything that really stood out to you?
Ray Dalio: Well, there's the story that happens over and over again: You have a new world order. The new world order and new domestic order comes over a fight by two opposing sides. Then that side wins. Once you have that side winning and you control things and know that war is a great equalizer, and you wipe out debts, then you begin a period, typically of peace and prosperity peace. Nobody wants to go back to the war and also nobody wants to fight with the leading power and you go through a cycle of raising, living standards — prosperity. The industrial revolution was like that. The period after World War Two was like that, and so on. That raises living standards. But what it does is it increases, both the amount of indebtedness and it increases the amount of wealth gaps, because wealth is not distributed equally. And when those wealth gaps become larger, it also creates differences in opportunity. For example, those who have more money, have more power and they can also, help their children better.
You have more speculation. You also have a situation where you develop a reserve currency. The dominant power becomes a dominant economic power in the world and so it becomes the largest trading country and as it's the largest trading country, it brings its currency. And that becomes the world's reserve currency because other countries want to save in that currency. And of course, when they save in that currency, then they lend that to the reserve currency country. So that gives them the exorbitant privilege of getting more in debt. And so, indebtedness levels start to rise.
So, what you see is that three things then tend to happen. You have an overindebted situation and, and you lose hard money. That means that you can create a lot of debt and there's not enough money. So how do you pay for that debt? Do you pay it back in a hard money or do you print money to have it paid back? It starts to depreciate.
Typically that's the balance between a depression and an inflationary situation and almost all times in history — in fact, all times in history — when that choice is made, there's more printing of money. Very much like we saw in 2020, the need to print the money without the restrictions. That produces, then, an inflation set of circumstances. These larger wealth gaps and values gaps produce a greater amount of internal conflict. That's what we saw, for example, in the thirties. And it's populism of the left, populism of the right. Then, that was called communism and it was called fascism, but whatever it is, it's populism of those two and they become irreconcilable differences.
That's why in the thirties you saw four democracies, Germany, Italy, Spain and Japan, turn to having those conflicts and then turn into more autocratic type of systems.
Then, of course, there's also differences in strengths. In the beginning of the new world order, you have the dominant power. United States, for example, had 80% of the world's money. Gold was the world's money, then. It was half the world's economy and then had monopoly on military power. Over a period of time, that gap narrows. And as that gap, narrows competitions increase and as competitions increase, then you have those types of challenges.
So, you see that when those challenges, as we are now seeing, become manifest, you start to see the financial types of conditions: “We need more money. Where are we going to get it from you?” You either tax it or you print it. Taxing it becomes very politically difficult to do because you take it away from somebody. So they produce the money and everybody gets the checks and everybody seems happy because they didn't have the money taken away from them. They produce that money, but lo and behold, it produces more inflation.
Those conditions become politically more difficult. And at the same time, you have the internal conflict such as we're having now — populism — which means irreconcilable differences between the two sides. We're seeing that.
A populist is a person who fights for their side and will not lose. They are not compromisers. The democracy is a means of compromise, and so on. So, we're approaching a point where rule of law becomes questioned. For example, it's not inconceivable that you have presidential elections or other elections in which neither side accepts losing.
So, we're straining the rule of law. And then you also see the international conflict, such as the international conflicts now. You're seeing the world right now break up into sides. The Ukraine-Russian situation is an example of the fact that you could start to see which sides are aligning with other sides. In all great power conflicts, there are alliances of one side and the other. Such as the Allied powers and the Axis powers, and so on. And you're seeing that transform itself. And by watching history, you can see almost what the set next steps are. For example, we're quite close to the next steps, being something like economic sanctions on China. Or you can see even foreign exchange controls, because even though they become inconceivable because they didn't exist in our lifetimes before, they become somewhat logical in this set of circumstances. So that pattern happening over and over again, creates a template that you can follow and then put in the dots to see how actual events are transpiring relative to those other events, because it's logical.
In other words, military conflict for example happens because there's not a world court, there's not a means of adjudicating those types of things. And so as we come down there, following that history and so on, it's very relevant, not for the distant future — it's relevant for the near future, because what's going to happen in 2022, we can get into this 2022, 2023 and 2024, we can visualize those things. These forces are going to be very relevant then.
Linda Lacina: Is there anything that particularly worries you? Is there something that keeps you up at night knowing the patterns, thinking, gosh, this could happen. Is there something that is a cloud for you?
Ray Dalio: Uh, there were three things that are cloud, and one thing that could be done about the cloud. The three things that are a cloud (are): What is money? What is the store, hold, of wealth? Money has two purposes. It's a medium of exchange, and I think it'll remain a medium of exchange, but it has a store hold of wealth, because that means that one has to put deposits in investments that have the return that is reasonable relative to the inflation rate, and I don't see that happening. You’re seeing today the movement of money into other assets. How do I protect myself against inflation? So, I think inflation and the consequences of also a tightening monetary policy to try to control that will have economic bite. It'll be a bite because things cost more. It'll be a bite because tighter money will reduce that. And I think that that particularly worsens the wealth gap, because inflation is really almost a rich man's word because it implies it's a problem because you pay more. You pay more because you bid it away from somebody who doesn't have it and when they don't have it, that creates more social tensions.
So, the second thing that worries me a lot is the internal conflict that is going to result from this. We're seeing it in the form of the politics, and so on, and the way that we're playing hardball with each other. Certain things like the way that the Disney issue in Florida was handled. Or there's talk about Texas prohibiting a bank because of its policies on abortion, not having the ability to sell bonds and so on. So, you're seeing hardball play and you're not seeing compromises. That threatens the system. So that worries me.
And of course, the international wars and conflicts worry me. They worry me, even if there's not a shooting war, but they worry me in terms of the enormous inefficiencies and costs and other forms of conflict that exists.
The one thing that I think that I wish for is people to put those things as their greatest worry, because if we can all agree that those are the worst case scenarios, and how would we approach that, which has to do with reasonables in this and consideration, we can deal with that because the world right now has more resources, more productivity, greater longevity.
The conditions in the world should be better than they ever have been before. If there's not the fighting and the mismanagement, but it has to be really well managed. So I'm worried about that, but I sort of have a principle: if you worry, you don't have to worry. And if you don't worry, you need to worry, because if you worry and the world worries about these things and thinks about how we are together, then we can prevent those kinds of things.
The book is not a matter of a lot of just words. What it shows is a lot of measures so that you can see the different ways of strengths and weaknesses taking place and so on. So that there can be an objective analysis of that. That's what I worry about.
Linda Lacina: And on the ground, when you talk about these official inefficiencies, you talk about this conflict, how will people's lives be different maybe in the very, very near term? How would their lives be different in the next couple of years?
Ray Dalio: Well, certainly we're going to have a much greater level of inflation and inefficiency. That increasingly, perhaps in the next couple of years, could take the form of more supply chain problems.
Let's imagine that China was sanctioned. 22% of American manufactured imports come from China. We take [that] for granted. We buy the Nike shoes, the Apple products, and so on. Now let's just imagine that that wasn't going to happen. There would be shortages, there would be inflations. It would have an enormous negative impact. It also could create much greater controls. For example, it would not be inconceivable to have capital controls. Capital controls would mean that in your country — it could be in the United States, it could be other countries — that you wouldn't have the ability to move money outside the country. Or there would be restrictions of how you can move money outside the country. We're coming from an environment in which there was really free flowing of goods, services, and capital — the world is flat, kind of thing. Equal opportunities and the money flows and that's how resources are allocated, to a world in which those things don't exist.
We have to recognize the possibility of military. For example, there's an issue in Ukraine. There's a risk of an escalation, and that risk of an escalation could be military in various ways, nuclear or other ways. This is something we will find out within the next several months.
The second thing that we'll find out in the next several months is the power of sanctions. Will sanctions, which is really nowadays the only unique American power because the United States is no longer a dominant military power in the same way, will those sanctions have the effect of shutting down or doing what's necessary so that Russia doesn't have a win. How will that affect the behaviour of other countries?
And the third thing is: we'll see how countries align. So, as I say, traditionally there are Axis powers and there are Allied powers. We're beginning to see this, based on who's participating and why, and we'll see the pressure that the United States puts on other countries to try to pick a side. There's greater, right now, discussions of pick a side. One way or another, you're going to have to pick a side. And so, we're going to see how those sides get picked.
All of that will be increasingly apparent over the next six months or less than six months. We hope that there could be some kind of a settlement, but it's very difficult to imagine how both sides of this come out winners, and [reach] a sustained settlement. And that could lead to worse conflict. Worse conflict first economic.
So those are the things I think that we have to pay attention to, and history provides a very good guide of when countries are in certain circumstances, how they behave in those circumstances.
Linda Lacina: How has this changed you as a leader? Was there anything that you read about a leader in history who managed one of these situations, navigated something, where you thought, “oh gosh, that's really important right now.” Does something come to mind.
Ray Dalio: I would say that this confluence of situations through history does not produce many examples of reaching out and overcoming these. Because the population becomes more fighters and wants to have the conflict. So, the history concerns me more than helps me.
I have a responsibility — my main responsibility — to be as accurate as I possibly can and position clients, position investors, for that. And so this studying of history and relating it to this template, that I follow the dots with, has really helped me to do that.
The markets have been doing very poorly. We've been doing very well in this environment to be positioned for that. And that's really what I'm mainly focusing on as an investor. Because I'm 72 years old and because these issues are very important I’m passing this information along to others, really, who are in a better position to make decisions regarding policy.
Linda Lacina: Is there an economic trend right now that is overlooked? That a lot of people have been talking about? Of course, rising prices, there's lots of buzz about a potential recession — but is there any kind of economic hurdle or a trend or metric that maybe you think has been overlooked, isn't being talked about enough or not talked about in the right way?
Ray Dalio: Right. Well, one thing we haven't talked about is the tremendous inventiveness that is taking place. Really, an amazing development because of the use of the computer and its various ways to help in thinking. We we talk about AI, but in many other dimensions as well, there's a level of innovation that's taking place in productivity and the world is going to change, and from that basis, most likely is going to improve.
Of course, at the same time we have interconnectedness on the computer and that creates a greater cyber risk and other risks that go along with it. But I think the world will change in those ways.
One of the things that I also studied in following history, I mentioned four factors: the money and credit factor, the internal conflict factor, the external conflict factor and now we're talking about man's ability to adapt and invent.
The fifth factor that was very apparent through history was the impact of nature. That caused floods, droughts and pandemics that actually had bigger effects than the other things I was talking about. They killed more people. They toppled more civilizations, the droughts, floods, and so on. So I think climate change is something that we have to pay attention to. I think that that's a difficult issue. I think we've waited a long time to try to make climate change protections. So, we've come up right to the edge of that. There's very little time and that's going to be costly, because the technologies that have created cost-effective substitutions have not yet really adequately been developed. So there'll be a lot of costs to put into the development of that. And to the extent that there are policies, that are greener policies that need to be put into place for the environment, that makes it more difficult.
So, if you're, let's say a relatively poor person in a country and you'd rather drive a polluting car than not to drive a polluting car. The economics that we're seeing regard that as important and tends to have inflationary effects. I have no doubt the climate issue will be on top of the other issues that we're talking about.
Linda Lacina: What is maybe one concrete thing that leaders can do to make the most of these historical trends make the most of history so that they can navigate this new changing world.
Ray Dalio: The one big thing that leaders could do to make the best out of this situation to think about that the greatest risks are these wars. The greatest risks are irreconcilable differences that in one way or another are going to substantially hurt the world economy, which will hurt the poorest people the most.
If that's put as the number one thing that must be avoided, and you work between each other so that you could still have competitions, you can still do all of that other competing, but you don't cross those red lines that are going to lead to these types of terrible conflicts. That would be the most important thing.
If I was a leader of a country, I would want to have a bipartisan cabinet. For example, I'd want to draw moderates from both sides to try to work together and to not support the extremism. I would probably set up an economic program, something where those moderates, together, create a program that is going to create disruptive change so that the system works well — so that it is beneficial for the majority of people.
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