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Lots of Things Ray Dalio Knows he Knows

Unlike dopes like me, Ray Dalio doesn’t think he thinks stuff. He knows he knows stuff. And he gave a wonderful interview to Bloomberg last night.  I’d post the whole video for you, but Bloomberg only appears to have posted clips so here’s the whole transcript.  It’s worth reading if you have the time, but here’s a short summary if you don’t:

  • The United States is in the midpoint of its short-term debt cycle.
  • The Fed should not raise rates at present because the economy is still too weak to justify it and foreign risks are too substantial.
  • They certainly can’t raise rates quickly or substantially because the term structure of interest rates isn’t priced for it and it would cause economic and financial instability.
  • The Fed is the Central Bank to the global economy because it manages the world’s dominant reserve currency.  This means they must view policy in global terms and not just domestic terms.
  • Central Banks should be easing policy further, not tightening.  QE4 could be in the offing for the USA….
  • Risk Parity’s recent downturns have been overstated and overdramatized.
  • Future returns are going to be lower. “Guaranteed”.  Dalio says 3-4% can be expected because QE has pulled future returns into the present.

Here’s the full interview (via Bloomberg TV):

ANNOUNCER:  This is a special global edition of “Bloomberg Surveillance” in prime time.  Now, from the Doral Arrowwood Conference Center in Rye Brook, New York, here are Tom Keene and Michael McKee.


TOM KEENE:  Good evening, everyone.  Tom Keene and Michael McKee.  We are here on a beautiful, beautiful day north of New York City for one of our most anticipated events in the history “Bloomberg Surveillance” and “Bloomberg on the Economy.”  I would — let’s set up where we are first.  Should we do that before we introduce Ray?




KEENE:  I think we should.  We’re at Doral Arrowwood.  This is 114 acres, north of New York City.  I, I — we got the “Surveillance” call streaming at the Westchester Airport.  Worked out great.  Coming up today…


McKEE:  It was a short ride.


KEENE:  Short ride, but we did it.  Nine-hole golf course, which was great for the “Surveillance” par 60 that we played.  And it worked out as well.  And we will be here tonight courtesy…


McKEE:  Brand new conference center.  We’ve done this for five years in a row, and this is the first time we’ve been able to use this wonderful new facility.


KEENE:  Is it bigger than Delaware or Rhode Island?  (Bonnie Queen)(ph) got lost about 4:45.


McKEE:  Yeh, I think it’s, it’s about the size of Delaware, but without the freeway, without the I-95


KEENE:  It is in the course a benchmark hotels and resorts.  We say, Steve up in the back there with our audience here tonight, we say thank you to Doral Arrowwood.  We need to get started.  And when we planned this with Mr. Dalio months and months and months ago, we said we need a (set)(ph) meeting with a little drama.  We need, we need emerging markets imploding, we need (gut)(ph) feeder about productivity in this nation.  It would help to have a Presidential debate overlaid on the top of it.  That would well get how the economic machine works.  See, four of the five candidates tonight will be…


McKEE:  Addressing that.


KEENE:  …talking about that.  But we’re going to get a briefing before that.  Why don’t you start it with…


McKEE:  Well, if you…


KEENE:   We’ll get started with Ray Dalio.


McKEE:  Yes, we have to say that if you, if you sold in May and went away, it’s time to come back.  And we’re going to start with Ray tonight.  Thank you for joining us.  Interestingly enough, you began your career on a golf course in finance.


RAY DALIO:  It was a caddy.  I — six dollars a bag, I used to take double bags and it was, you know, the 60s and the 60s was the time when it was the biggest bubble.  Really, even more than 2007, and I remember betting $50 on a company by the name of Northeast Airlines.


KEENE:  Yeh.


DALIO:  It was the only company that was trading for less than five dollars a share, and I figured I could buy more shares.  And that was a good deal, so I bought it.  And it was — the company was about to go bankrupt, but somebody acquired it and it tripled in price, and I was hooked.


KEENE:  What did you learn from your first loss?  You’re a kid, you’re a genius, you (dated)(ph) right on Northeast Airlines, and then something bad happened.  What did you — what happened when you lost your first $282?


DALIO:  So it was — I remember it was then dollar-cost averaging and –’cause the economy was well-managed.  And it was 1966, and that was the first time the Fed inverted the yield curve since 1929, and I didn’t understand tight money, and we began a bear market.  Nineteen sixty-seven, sixty-eight was the peak.  We had the — we had a recession, and from then it was 18 years that we negative real returns in the stock market.  So I learned — I learned about selling short, I learned about, you know, markets go down as well as up and how to make money.  I learned what it was a lot about pain, you know.


KEENE:  With President Carter so ill now and, as we have two Presidents in their 90s, he was (repped)(ph) with the Carter malaise.  You lived through that, you learned through that.  (Shearston)(ph), you were at Dominick & Dominick, and commodity trading.  Was there a malaise there, and do we risk that malaise again in 2016.


DALIO:  Well, it was very different of course because, you know, that was the time.  So you could take these decades — all right, 50s was post World War II boom, plenty of capacity, not much debt.  Sixties, growth, tight money because we didn’t have deficits, inverted yield curve, and then we couldn’t pay our debts.  So the United States defaulted…


KEENE:  Right.


DALIO:  …on it’s debt in 1971 because it said it would pay in gold, right?  In other words, the money was like gold.  You would like a check in your checking account, and you would turn it in for what was perceived of value, gold, and we defaulted…


KEENE:  Right.


DALIO:  …in 1971 so that was the beginning of inflation.  So the 70s were inflation…


KEENE:  It was something.


DALIO:  …and then 1979 Paul Volcker’s appointed.  And so when you’re talking malaise, you’re talking essentially a wild runaway inflation, out of control.  Paul Volcker was appointed by Jimmy Carter…


KEENE:  Well…


DALIO:  …in 1979.  And then the exact reverse happened.  And the pattern is almost every decade is almost more likely to be the opposite than (inaudible).


KEENE:  All right stay, I want to stay right there with Paul Volcker, and we’ll come back to that.  Rate moderation is important.  My malaise right now is your mike’s not working, so Steve’s going to come up and fix it, and we’re going to reset for Bloomberg Television and Bloomberg Radio worldwide at Doral Arrowwood with Ray Dalio.  We’re going to speak here — it’s not going to be gotcha questions.  What’s a year (aldernod)(ph)?  What’s Janet to do?  I promise you I’m not going to ask you what Janet’s going to do tomorrow.  Mike is.  But within that, but within that is the idea of a serious discussion about the years of research Ray’s put into this.  Why don’t we get started on the economic machine?


McKEE:  Well, that’s sort of what you have based your entire career on.  It is your study of the economy.  Not just investing, but how the economy works.  Tell us about your concept of the machine, how you got to that, and how you developed it.


DALIO:  Well, you know, the same thing happens over and over again.  Anything that’s happened economically I learned how over and over again.  So let me just describe the machine.  It’s a very simple machine, I think.  And it’s the same for an individual.  A country is nothing more than the collection of its individuals or its companies.  And so there are three main factors.  There’s productivity, which produces income.  You can spend at the end of the day what you earn.  And what you earn is a function of your productivity.  And for a country it’s the same as for individuals.  If you worked hard, you’re well educated, you know, you can be more productive if you work harder or you can be more productive if you’re more creative.  And so that’s that.  Over a short period of time, you can spend an amount of money which is different from what you earn, and that’s because we have debt.


KEENE:  No, it’s called children.


DALIO:  OK, thank you.  So we debt cycles.  And there are two major debt cycles.  There’s a short-term debt cycle, which we’re used to, the business cycle we call it that, you know.  Recession, Fed eases, and what they do is they increase the spread between the short-term interest rate essentially and the return, expected return, of other assets.  And as a result, money goes out into the system, money and credit goes out into the system, and what it does is it bids up prices.  And so when we’re bidding up first asset prices, and we call — then we make items that are cheaper because interest rates go down — so we have that business cycle that we’re used to.  And when that cycle gets past a certain midpoint usually in the cycle, there’s a tightening of monetary policy as you get to the later part of the cycle, and then you start to have inflation.  It becomes too tight and you have the cycle go down.  And that’s the business cycle.  We’re all used to that.


So when we look at every country we can see where it is in that cycle.  We’re in the mid part of that cycle.  Hence, we’re having the conversation that we’re having bout the Federal Reserve.  And then there’s a long-term debt cycle because these cycles add up.  And a long-term debt cycle, just imagine you start off with no debt.  So low debt to GDP ratios, low debt to income ratios.  Start off with no debt.  Let’s say you’re earning $100,000 a year, and then you have no debt.  That means you can borrow a hundred — $10,000 a year, ’cause you have no debt.  You’re earning $100,000, you borrow $10,000.  You could spend $110,000.  You’re spending is somebody else’s income.  They are earning more and so they can spend more, and it becomes self-reinforcing until you get to the point where debts rise too much relative to the income, like a balance sheet.  You can leverage up to a certain point.  And the Central bank, all central banks are in the business of helping that cycle go along, so they lower interest rates.  And, as they lower those interest rates and those interest rates then hit zero, we then come to a dilemma.  We have the end of monetary policy as we traditionally have it and, as a result you can’t keep that cycle going.  Then, when you have big spreads and you put liquidity in the system, that putting the liquidity, money — in other words, there’s debt and there’s money.  So the difference between debt and money you have to pay back — excuse me, debt you have to pay back.  You do into a store, you buy a suit, you pay with a credit card, you have to pay it back.  Money settles the transaction.  So what the central bank does is that it can’t credit in the same way ’cause there’s too much debt, so what they do is they put money in the system.  And they put money in the system by buying financial assets.  And when they buy bonds, then that — the seller of that bond takes the cash and they buy something else.  And, as a result of that, causes the spreads to narrow.  It causes assets — prices to rise.  And then that appreciation in the asset prices that we experience then creates a normal term structure of interest rates.  So there are three equilibrium.  And then that appreciation in the asset prices that we experience then creates a normal term structure of interest rates.  So there are three equilibrium, three equilibriums that we have longer term.  First equilibrium is debt can’t rise faster than your income for long.  Second equilibrium is that the operating rate in the economy can’t be too loose or too tight.  Third equilibrium is that we have a term structure of a capital market structure.  In other words that cash is going to have a lower return than bonds, which is going to have a lower return than equities, and so on.  And there’s an equilibrium that keeps working itself through that system.  Monetary and fiscal policy are the two…


KEENE:  OK, we did that on World War II, we came up to Volcker…


DALIO: It always works that way.


KEENE:  …and it always works.  We worked up to Volcker and it collapsed.  You and I lived that.  Many people in this room lived that.  We come down with a great moderation, we’ve enjoyed the last seven years.  Where are we now in that continuum when we observe — ah, mathematically I would say — folks, we need some math on radio.  We’ve got a long chart with a lot of curves, I would say.  Like Indonesian Rupiah, Brazilian Real, and other challenges to the United States.  Ray Dalio, where are we right now within that equilibrium?


DALIO:  The United States is in the midpoint of its short-term debt cycle.  Capacity utilization, GDP gap and, so as a result, we’re talking about whether the Fed should tighten or not.  That’s what central banks do in the middle of it.  And we’re near the end of a long-term debt cycle.  Because that cycle of being able to raise — you have interest rates going to zero.  You have spreads that are — have come down.  So the spreads that have come down means that asset prices have gone up.  In other words, so now the expected return of asset classes is — are all very low.  Cash, we know that bonds are going to two and a quarter percent.  You know that you’re going to get for the next 10 years two and quarter percent on your bonds.  The equity price premiums look like three and a half or four percent on that.  So all of the asset classes now are aligned in normal risk premiums, that kind of thing.  That’s why if interest rates rise faster than it’s discounted in the markets, those markets are discountable — those markets…


KEENE:  Well, the (inaudible) for this room which is, I might point out for those of you worldwide on television and radio, is an exceptionally competent group of Bloomberg terminal users and cohorts in crime with Ray Dalio in the alternative investment funds business.  With that said, Ray, within the framework of your machine, machine, do you presume a jump condition as cycle things come out of this, or can they manage it with smooth vectors and smooth glide paths?


DALIO:  I don’t believe that they can raise rates faster than it’s discounted in the curve for large part.  Because that interest rate curve — in other words the rate at which it’s discounted to rise, which is built into the curve, is built into all asset prices.  And if you raise them much more than is discounted in the curve, I think that’s going to cause asset prices to go down.  Because all things being equal, all assets sell at the present value of discounted cash flow when we look at that.  And then all of them are subject to the same discount rate.  They all have that built into their structure.  So if you raise rates that’s faster than it’s discounted in the curve now, all things being equal, that produces a downward pressure on (inaudible).


KEENE:  Right.


DALIO:  And that’s a dangerous situation because the capacity of the central banks to ease is, is, has not been less in our lifetime.  So we have a very limited capacity of central banks to be effective in easing monetary policy.


McKEE:  Well that raises the question of what is discounted now?  The Fed is talking about 25 basis points to start, and then being on hold for a while.  And no other central bank is talking about raising.  Very asynchronous world.


DALIO:  Right.  So, well, you know what the curve is.  And so, if they raise it by 25 basis points, it’s a little less than — it’s a little more than discounted and we’re just really tweaking.  So very, very small rise in rates.  The issue is that the dollar is the world’s currency.  And the rest of the world would need an (inaudible) monetary policy.


KEENE:  Right.


DALIO:  When I say the world’s currency, I mean there’s a lot of dollar-denominated debt.  Even, wait, so the Federal Reserve has a responsibility, both as the U.S. central bank and the world central bank.  So we have a situation where, if we go around the world, you should have an easier monetary policy in Europe.  Europe, if we look at it in the same framework, is in the — Southern Europe — a depression.  So rather than GDP gap, we have a depression.  There’s a cyclical low point with a lot of political extremism beginning to emerge because of the pressure of that.  They need an easier monetary policy.  Japan needs an easier monetary policy.  China needs an easier monetary policy.  Emerging countries need easier monetary policies.


KEENE:  I find the most interesting thing — and, folks, I’ve got here a good amount of Ray’s recent work, which you most seriously published with Bridgewater, and the most fascinating thing I see within your economic machine is how currency plays into it.  Would you predict a stronger dollar a la pre Plaza Accord?  Or like the Rubin dollar of the 1990s?  How does the currency dynamic fit into what you see with the lack of productivity and with your growing indebtedness?


DALIO:  I think the picture that we’re in is very similar to the picture that was went from 1982 to 1987, in that we have a lot of countries, particularly commodity producers, who have a lot of dollar-denominated debt.  And as we had that environment, as they’re in a debt problem, it’s a self-reinforcing situation.  Because their debts are denominated in dollars, the revenues go down, they’re short of dollars.  A debt is a short position.  You have to cover that position.  That bids up the price of the dollar.  So we need now, we need a — so we have these commodity countries, very similar.  Emerging countries, very similar.  Dollar-denominated debt.  It’s a self-reinforcing cycle and, back then, it went ’til 1985.  And then we had the Plaza Accord, as you’re referring to it.  And also we had the need to have that easing of monetary policy.  What we were able to do in that period, which was a very good period, we were able to ease our monetary policy at the same time the economy grew.  It was fantastic.


KEENE:  That’s tough to do where we are right now.


DALIO:  It’s tough to do that where we are right now.


KEENE:  Yes.


DALIO:  So we have a situation where, if you would like to ease monetary — the pressure’s going to be more on easing monetary policy longer term.  In other words…


McKEE:  Well, let me just say we are this special prime time edition of “Bloomberg Surveillance” of Bloomberg Radio and Television worldwide with Ray Dalio.  He is the founder of Bridgewater Associates.  Everybody knows who you are.  What then do we do?  What does the central bank do when it is at that zero (bound)(ph)?


DALIO:  It’s a zero (bound)(ph), yeh.


McKEE:  When you at the end of that long-term credit cycle?


DALIO:  I think the thing that you do is you realize that the risks are asymmetrical.  You can tighten monetary policy, it’ll work.  There’s enough debt around, there’s enough sensitivity around, there’s the dollar.  You wait more to see what — because the risks are asymmetrical.  The risks of the world are asymmetrical.  So that’s the main thing.  The risks on the downside are totally different than the risks on the upside.


KEENE:  Ray, August 24th —  Mike, help me out with this, please.  You read this, I didn’t; I just read the headline.  August 24, 2015, the dangerous long bias and the end of the super cycle, Mr. Dalio and Bridgewater say the next big Fed move will be to ease via QE.  He’s channeling (Norwood)(ph) Rubini.


DALIO:  Yes.


McKEE:  You’re suggesting that the Feds — the Fed may raise rates, but the big move would be to bring in additional QE.  Do you think QE works anymore?


DALIO:  It’s going to work, it’s going to work a lot less than it worked last time.  Just like each time it worked a lot less.  I’m saying that we can’t have a big rate rise for the term structure rates on assets because the amount of debt, what it has to the dollar, what the disinflationary, deflationary pressures exist around.  So and that the — we will have a downturn.  And the downturn should be particularly worrisome because we don’t have the spread’s asset prices.  QE, when you’re asking whether it’ll work, QE is the purchase of those assets to get those premiums up.  Then when you keep pushing — you buy then more bonds.  If there’s not an attractive investment relative to bonds, the spread is what’s going to drive that.  If there’s not much spread in something else, then you get less effective monetary policy with all that pushing on a string.  So that dynamic…


McKEE:  So are we there?  Are we, are we there?


DALIO:  No, we’re not there yet, but we’re closer to being there.  And some countries, Europe is there.  Europe is very close to that.


McKEE:  Europe is pushing on a string?


DALIO:  Well, yes.  Because what happens is — what are you going to buy in the way of the bonds are — negative interest rates out (inaudible).


McKEE:  You can’t buy a German two-year.


DALIO:  OK.  So we’re very, very, very, very close to there.  And so that’s when you need more currency depreciation.  In other words, the effectiveness in Japan is there.  The effectiveness of monetary policy then comes through the currency.  Because when the person who’s receiving that cash for selling their bonds has to do something, it’s, it’s they’re indifferent between cash and that other asset.  So there’s a pressure moving out to the country.  So if you look at us, we have very high rates in the world, right?  Like in Paris and those in Europe and Japan.  So it comes through the currency.  But if you can’t have interest rate moves, you have to have currency moves.  And that’s what, that’s the environment we’re in.


KEENE:  OK.  Ray Dalio with us here on Bloomberg Television and Bloomberg Radio worldwide.  I want to get to this important video from economicprinciples.org.  All of Ray’s work is out of economicprinciples.org.  Why don’t you introduce the video that we’ve got?


DALIO:  Well…


KEENE:  You’ll hear it on Bloomberg radio.


McKEE:  Ray’s put together a video.  It’s been a huge hit.  Millions of hits on YouTube and other places, and you can see it at economicprinciples.org


KEENE:  You’re the Ariana Grande of economics.  It’s just unreal.


McKEE:…where he summarizes how the economic machine works.  Here’s a segment of it.


DALIO (ON VIDEO):  Over time we learn and that accumulated knowledge raises our living standards.  We call this productivity growth.  Those who are inventive and hardworking raise their productivity and their living standards faster than those who are complacent and lazy.  But that isn’t necessarily true over the short run.  Productivity matters most in the long run, but credit matters most in the short run.  This is because productivity growth doesn’t fluctuate much, so it’s not a big driver of economic swings.  Debt is.  Because it allows us to consume more than we produce when we acquire it, and it forces us to consume less than we produce when we have to pay it back.


McKEE:  Economicprinciples.org, how the economics machine works, put together by Ray Dalio.  Coming out of this, it raises a question.  I want to get back to what we were just talking about.


DALIO:  I’m going to — sorry to interrupt you.  I just want to emphasize that the reason that I did that and the reason that I’m doing these interviews is because I think we spend too much time arguing about what’s going to happen and what — and all that.  And I think it’s like, if we could agree on how the machine works, we will have a simpler foundation for agreement, and that would be positive.  I’ve seen so many economic tragedies.  I’ve been involved with so many economic tragedies that seem needless.  And so like printing of money.  We had — at the time that I did the video there was a debate about printing of money because they thought it would be inflationary.  But what I was trying to convey is, it’s the amount of spending that matters.  And if credit goes down and money goes up, and the amount of spending remains the same, it’s not going to put us in inflation.


KEENE:  OK, so this is critical, Ray.  This is absolutely critical.  So we have a Presidential debate, whatever the party is, and we don’t need to get into Republican and Democrat, this nation to many people is flat on its back.  They want productivity.  The smartest thing in your work is this discussion, this mystery of going to non-efficiency or inefficiency to efficiency.  What is Ray Dalio’s prescription for the next President to assist the nation in productivity?


DALIO:  Well, it — you know, it’s interesting this.  We’ve done a study going back 60 years, and we took the various factors and correlated them with the next 10 years’ growth rate.  And we did this across 20 countries.  And by the way, the study’s on economicprinciples.org, so you can read the study if you’re inclined.  And so the same things work in world countries.  The economy’s like a human body.  Basically it works the same in all countries.  You can see that.  And so it’s the same thing as an individual.  When you ask yourself, is that individual going to be productive and then whether it’s going to grow, you’re going to ask what is the education.  And most important single factor is what is the cost of an educated person?  So if somebody’s more educated, that’s a good thing.  But if you have adjust it by the number of hours worked and what that cost is, because let’s say in Europe — very interesting — southern European countries, France, Italy, Spain, after adjusting to — for the average hours worked in a week…


KEENE:  (inaudible)?


DALIO:  No, they cost twice as much as an American.  In other words, the income…


McKEE:  Culture matters then?


DALIO:  …the income.  So you can have an education, that’s good.  But if you’re expensive, it’s not good enough.  So you have to look at does the income pay?  And so when — I’m saying if you have a situation where you have an educated population, the single most important factor is what does it cost to have an educated person?  Second factor, biggest factor, is indebtedness.  Because you have these debt cycles.  Those have — are at the later parts of their debt cycles and closer to lower interest rates, have less capacity to increase their balance sheets and expand.  But it goes down to other things.  That you would judge — we have surveys of work attitudes.  Like different cultures have different work attitudes.  Some places live to work and some places work to live.  And so there’s a cultural — I’m not saying one is better than the other — but you can take surveys about that.  Do you want to work?  Are you trying to achieve?


KEENE:  So what is your prescription in the uproar of politics, whether it’s Mr. Corbin and Mr. Cameron in the House of Commons, today it’s Le Pen in France, where are…  Australia, we didn’t even know this was coming.  The Prime Minister of Australia is out on a Monday or whatever.


McKEE:  Yeh, he’s out.


KEENE:  What is the Ray Dalio prescription out of your study of our economic machine to a better America?


DALIO:  And/or a better world.  There are these various factors and — there’s not one factor, ’cause there’s various factors.  But they’re clear, and they’re in the study.  Those factors at the end of the day are the same factors.  Are you going to be well educated, are you going to be economically well educated, are you going to be inefficient?  There’s a 58 percent correlation for example between corruption and economic growth over a 10-year time frame.  So, as we go into that productivity is going to be the single biggest factor.  How do you make people productive?  Self-sufficiency.  Do you know that the single biggest factor for a number of countries is do people feel the consequences of their earning or their not working?  In countries where there’s self-sufficiency, then they feel those consequences rather than a greater social net, they’ll have higher levels of productivity.  So at the end of the day, it’s really the things that you, when you look at your neighbors and you say, if they can get an income and they’re not going to be penalized much, they’re going to be less motivated.  There’s a series of those.  And what I’m trying to direct the attention to is what those specific factors are so that it’s like a health index.  So I’d like to draw people to, you know, the productivity.  We did this productivity study and you could see what those correlations are.


KEENE:  Nation to nation.


DALIO:  Because — for all nations, same formula.  And because it’s like a health report.  If you can look at what is your cholesterol level, what is your — do you smoke, do you exercise?


KEENE:  You, you don’t want to know.


McKee:  Tom doesn’t want to find out.


DALIO:  You can know your 10-year prognosis.  And if you can look at that unemotionally with that benchmark, you can see what productivity is.  So it’s a series of those things that I’m mentioning and I don’t want to over simply it, but there is a formula.  And if we could look at that formula together, it’s like a health report and that’s what I would like to happen.


McKEE:  All right, you’ve put this together.  Let’s bring it back to investing.  How do you apply that when you are looking at investments that you want to make and what do you — what does it tell us about where America is and American companies are going?


DALIO:  Basically, I’m mostly just interested in who’s going to buy and who’s going to sell and why.  So the way I look at a price is it’s the aggregate of purchases divided by the quantity of goods sold, whatever that may be.  That may be a bond, it may be equities.  And I look down there and factor by factor.  So now when I’m trading at anything that’s going to give me an edge on, whether it’s insider buying or whatever it is, what we do is we take those rules and we have written those rules down.  It came really in 1982 or ’83, every time I’d put on a trade, I would write the reason I wrote that trade down on a pad.  And I’d look at those rules after I closed the trade.  What I discovered by doing that is that those rules could then be programmed into a computer.  And when they were programmed into a computer, I could then back that…


KEENE:  The computer’s called the Bloomberg terminal, Ray?


McKEE:  Shameless plug, shameless plug.


DALIO:  I, I used the Bloomberg terminal.


KEENE:  And we say thank you, sir.


DALIO:  I give you the endorsement.


KEENE:  I thank you very…


DALIO:  But so there’re all different ways that you can trade.  We trade 140 different markets…


KEENE:  Sure.


DALIO:  … all liquid (ways)(ph), and whatever the rules are — it’s a series of this rules (inaudible)…


KEENE:  Do you have an informational advantage now than you had in 1996?  We’ll get the risk parity here.  It’s not a big deal, guys.  We’ll get to it.  In the last two minutes we’ll talk about risk parity.  But, but seriously, Ray, you’ve been doing this for 10, 20, 30 years.  Is it tougher today, given the flow of information, or is there so much information across the Bloomberg terminal that you’re advantaged?  Which is it?


DALIO:  For me, the technology continues to empower me.  So, but I think it — there’s no getting around the deep thought.  The technology, if you put a lot of data in and you’re not spending the time with the deep thought, not thinking about how you’re going to be wrong, and you have the fundamental cause-effect linkages, it’s a dangerous tool.


KEENE:  Yeh.


DALIO:  And it’s always been the case through investing — by the way, artificial intelligence is not a new thing.  Nineteen fifty-three is when it started.  It was neural nets, there was all sorts of way of doing it.  It goes and every, almost manager, blew up who used it.  Because…  So there’s no escaping the fact that when you think about relationships, they have to be deep connected.  The cause-effect relationships.  But the same things happen over and over again through history.  And so, if you start to look at those…


KEENE:  OK, I don’t want you to choke there.  Get a — that’s gluten-free.  Get some water and, here, let me reset here for our audience at Doral Arrowwood.  We welcome all of you here, north of New York City, all of you worldwide, on Bloomberg Television, on Bloomberg Radio.  We’re with Ray Dalio of Bridgewater, with, with no need for introduction.  Former caddy.  Yes, he’s in the news.  We’ll get to that.  And also, very importantly, economicprinciples.org is where so many of these concepts and structures are that he’s put together.  What are we going to do next?  I lost (interest)(ph) (inaudible) up in the Gulf Stream.


McKEE:  I was just going to tell everybody, if you’re having a bad month, they’re openings for caddies here, maybe.  This is where I want to get to risk parity and, and, and, and not about the current situation, but how you develop the theory.  It comes out of this idea that everything happens over and over again.  You wanted, as I understand it, a way to invest that would enable you to sale through all the various ups and downs.


KEENE:  What happened to 1996 that got you to this introduction?  What was that moment where you decided to, to take a bet on the ballast that is risk parity?


DALIO:  Well in 90 — in the early 90s, I had earned enough money that I was putting together a trust for my family.  And I realized, I know that making money in the market is zero sum.  And the asset allocation mix is the important thing.  And I knew something about how markets work.  And the problem with most markets is that you can’t achieve balance.  Like if you have a stock-bond mix, you know, you want to diversify, and you buy stocks, 50-50 of your money.  Fifty percent in stocks, 50 percent in your, in bonds.  The problem with that is you’re dominated by equities ’cause it has twice the volatility.  So I need more, more volatility in order to create a balance ’cause I want to bet equally on two things.  The thing about it also that, in the traditional way, then you have to buy more bonds.  And as you buying more bonds, you’re buying a lower returning asset class.  And as that lower returning asset class you buy more, you dilute your return and you’re not getting much.  So in order to have an equal amount on each one of those things, you have to have an equal amount of risk.  And because there’s a — if you look at risk return through time, those that have riskier asset, more volatile asset, tend to have a higher return and they have a higher risk.  And that’s structural because they have a longer duration and also because assets are leveraged themselves.  Equites are leveraged.  The average S&P 500…


KEENE:  Right.


DALIO:  …has a dead equity ratio of one-to-one.  It has embedded leverage.  So idea of taking a bond and changing its complexion of its return by borrowing cash and having buying let’s say two bonds for the one bond, is going to produce a return stream that gives me about the same amount of risk…


KEENE:  Agreed.


DALIO:  …in both of those two assets, and it also raised the return because the return of cash is the lower of the return of bonds over that period of time.  And so that meant that I could create diversification.  Because the most important thing is how do you create diversification without lowering your return.  And so that was — and I don’t know in any 10-year period or in any period what’s going to be good and not good.  And I watched this…


KEENE:  What does this…


DALIO:  …so I needed balance.


KEENE:  What does that tested model say, Ray Dalio, when your leveraged bond portfolio and your unleveraged equity portfolio correlate and stock prices go down and bond prices go down together?  What is the shock analysis that you see within risk parity.


DALIO:  Well, as you’d imagine, what it would be is it’d be equal to if you owned stocks.  You had 100 percent correlation…


KEENE:  Agreed.


DALIO:  …between those two assets.  In other words, now I’ve made, I’ve made it more leveraged so it  has the same volatility, same risk, and they were 100 percent correlated, then the mathematical answer is it will equal the volatility of stocks.  So that’s what it would equal.  But the fact is, if it’s not 100 percent correlated, and we can get into what drives correlation, what is (inaudible)…


(unintelligible cross-talk)


DALIO:  But what it means is that you’re going to have, as a result, you’re going to have diversification without lowering your returns.  Comparable volatility.  Now if I apply that to different asset classes, so I get diversification, then I can have a diver — a well divers — the most important thing is to have a well-diversified portfolio.  Like I looked today and I say I would be terrified to own any other portfolio.  And the reason I’d be terrified to own any other portfolio, what am I going to own?  Am I going to own stocks?  I’m going to be concentrated in stocks?  Am I going to be concentrated in bonds?  I don’t want to be concentrated in bonds, I don’t want to be concentrated in stocks.


KEENE:  How do you respond to (inaudible) diversification where you’re almost too diversified, whether it’s by leveraging up an upper leveraged instrument, or it’s by going to different asset classes?  How do you respond to the criticism of diversification?


DALIO:  Diversification of assets that you don’t know which is going to be the better return…


KEENE:  Right.


DALIO:  …they have similar expected returns and similar expected risks, does not lower your return.  In other words, five similar — and I just don’t know what’s going to be good —


KEENE:  You don’t test it that this is operational within the great distortion that we’re living in right now?  Do you have to amend a risk parity strategy?


DALIO:  I ran this — I have almost my entire net worth in it.  I mean, meaning these are the trusts, and these are my investments in it.  And, and all I — and the reason I have is because I need a balanced portfolio.


KEENE:  Right.


DALIO:  If I don’t have a balanced portfolio, I’m scared.  I learned to be scared over the years.  And so I tested it through the most severe — I tested it through the Great Depression, I tested it through the Weimar Republic, 1923 in Germany, I tested it through the Je —


KEENE:  Did you test it through the Giants game this weekend?  No?  That was —  Arthur (Levitz’s)(ph) still getting over that.  But, seriously, it’s nice to make jokes about this, but this serious as we saw with the FT and with the (Wolf issue)(ph).


DALIO:  And I want to be clear, I mean nothing is a sure thing.  Let me, let me say that, if you have a well-diversified portfolio and it underperforms cash, the only times that, in that situation, that it did badly were depressions.  And what that means is, as the Federal Reserve is tightening monetary policy, if they cause asset prices as a whole to go down, that is the only times it really did badly, and in the Great Depression, and in 2008.  Something like both of those years, 20, 25 percent.  Those are very tolerable contractions because the traditional portfolio fell like 60 percent in those periods of time.


KEENE:  Right.


DALIO:  So, when I look at that, I’m saying we have the central banks on your side, and otherwise you’re going to be concentrated in some asset.


McKEE:  Well, what — are we in a depression now?  All Weather, your risk parity fund, lost five percent in August, according to most reports.  Is that a failure of risk parity or of the assets that you bought within that strategy?


DALIO:  So on a month-to-month basis, you know, I don’t know the stock market was down whatever — the stock market was down.  The assets were down on that.  I mean, just — I think it’s probably almost a good.  You know that was, that was a lousy month for us.  Up until then, you know, if you look at the longer term returns there’s, you know, they are what they are, which is good.  And so you have that.  You have the stock market down, whatever.  That was a month.  That’s all I’m saying.  You could lose five percent in a year.  Like I could look back and I could say I could lose — it’s down, you know, probably six percent each year.


KEENE:  I just want (inaudible).  Yeh.


DALIO:  I’m comfortable being in that position.  The stock market, if you then look at the whole history, the stock market in — not — 2008 was down 38 percent, right?  Warren Buffett, the greatest investor, one the greatest investors, his bad year was down 48 percent, 47 percent.


KEENE:  (You didn’t caddy him.)(ph)


DALIO:  These are — so when you have those kinds, like to me I feel like I’m fine.


KEENE:  Ray, I want to defend a hedge fund (inaudible).  I know there’s like three people in here that actually in the racket.  I need the coverage in August.  Do we remember that it was at 12 on a (dix)(ph)?  We went to 50 interday?  I mean, come on, you took six weeks off in August, right?  I mean it was wild.  These guys are down.  John (Paulson)(ph) (inaudible).


DALIO:  Now let me be clear.  I, I have — just to be, just to get the facts right.  So we our All Weather fund, which is at balance.  That’s down about six percent for the year now for those reasons, which — and I know, feel comfortable it won’t — it’ll be balanced.  We have our Pure Alpha funds and those, and they’re up materially, OK?  So…


KEENE:  We’ve got to make some news here.  How much are they up?


DALIO:  Well, about — depends on the, which fund you’re in, but somewhere about six percent.


KEENE:  OK, thank you.


McKEE:  Where are you getting the Alpha?


DALIO:  Well, again, we can go long and short in a lot of different markets, so.


McKEE:  So in this — you’re applying how the machine works basically to this time period, and you’ve said we’re in secular stagnation.  So to go back to the question I asked earlier about where is American business right now, and even global business?  What, what’s the ability of businesses to turn a profit so that you can make money?


DALIO:  American businesses right now are the number one thing is they’re flush with cash.  And as a result, the biggest force in the stock market right now is the buy backs and mergers and acquisitions.  So something like 70 percent of the buy, the buying in the stock market, is along those lines.  And in — and of course I think you know, as well as I have, the changing, the complexion of businesses.  I think, by the way, the productivity numbers are very severely distorted because of the fact that we don’t — we can’t account for productivity.


KEENE:  You’re an optimistic, like many others.


DALIO:  Well, I’m just saying let — the way we do our accounting for productivity…


KEENE:  Yeh.


DALIO:  …it means that — photos.  Photos have collapsed in terms of productivity because what is the value of a photo.


KEENE:  Are you on Instagram?


DALIO:  Facebook.


KEENE:  Are you on Instagram?


DALIO:  No, I’m not.


KEENE:  Oh, OK.  I’m not either.  Ray, seriously, when we look at the (mappiness)(ph) of this, and I promised Laura Chapman of Bloomberg I would not bring up probability distributions, but within the (mappiness)(ph) of Nassim Taleb has made quite a name for himself, looking at rare events.  Within all the work you’ve done, all the experience you have, are these derivative strategies around bonds and equities able to withstand the shock of the next black swan?


DALIO:  There are all sorts of embedded risks in different ways.  And I would — you know, all the time.  I would say that we’re better able to withstand them than we’ve been before.  There’s less liquidity in the markets, there is a fair amount of essentially dynamic hedging — dynamic hedging is a way of, like insurance companies when they take their projection in terms of their interest rate risk — you know, that’s an issue.  But by and large I would say we’re better able to withstand them in terms of, not the short term volatility type of thing…


KEENE:  Right.


DALIO:  …we’re going to lose liquidity, but in terms of like the bigger moves, we’re better able to withstand them, provided that we don’t have that big event that I’m talking about, which is tightening the monetary policy, so we get the doubt.  What scares me, or what worries me, is what the next downturn in the economy looks like with asset prices where they are, and the lesser ability of central banks to ease monetary policy.


McKEE:  Some, some central bankers would say, if we raise rates now, then we have some ammunition.  You sound like you disagree.


DALIO:  Again, it’s a restrictive policy.  I don’t care whether they raise 25 basis points.  I don’t care whether it moves along the curve.  But, just I don’t see the reason for it, frankly.  You know, like 2007, I was watching this incredible bubble happen.  It was a massive bubble and it was financed on a lot of debt, and it was an obvious bubble.  And the Fed just gave attention to the GDP gap, and they missed the whole bubble, and we had an economic collapse.  Now we have a situation in where were in the mid part of the cycle.  They’re trying to identify where the inflation is.  And what they’re worried about, and we have a lot of liquidity around.  And so when I look at this there are little glimmers here and there — there’re always little glimmers of something — but basically I, I think that they’re worried too much about the short-term debt cycle, and not enough about the long-term debt cycle.  So I don’t get it.  You know, given those asymmetrical risks.  And that’s, look at the world.  Where should we be? We’re in a world economy.  Tell me countries outside they should be tightening monetary policy.  They all should be easing monetary policy.


KEENE:  This is a prime time “Bloomberg Surveillance” special on Bloomberg Radio and Television worldwide.  We are at the Doral Arrowwood Conference Center in Rye Brook, New York, with Ray Dalio of Bridgewater.  And in the time we have left, I want to talk a little about you and Bridgewater.  You’ve been around for a while, as Tom noted.  And you have suggested to people that you’re starting to step back, and a lot of people are saying, this man with his abilities should stay in the game.  What, what, what are your plans?


DALIO:  OK, so — by the way, it’s been 40 years, we just celebrated 40 years.


McKEE:  I’m just trying to be nice, you know.


DALIO:  What I’m talking about is stepping back in management, not stepping back in investments.  I’m an addict.  I started at 12.  I can’t stop, I love the game, right?  So, that’s, that’s some confusion about what the stepping back is, you know.  I’ll always be playing the game.


McKEE:  Do you have a succession plan in place at Bridgewater or do you plan to run — I mean, obviously, not forever.


DALIO:  Well, Bob Prince, who has worked with me for 27 years — I think he’s 55.  Greg Jensen has worked with me for 17 years, and he just turned 40.  And this team, I got, you know, a lot of people who’ve been there a long time.  We’ve all played the game, we’re used to doing it.  I mean I could step out and that doesn’t matter really.


KEENE:  Alan Mulally at Ford Motor has a historic meeting when he was there, I believe it was Thursday mornings at 7:00 am, be there or don’t show up ever again.  Everybody runs a company differently.  With Mulally it was one plan.  Everybody had a style.  When you have a meeting at Bridgewater with the incredibly trained individuals you choose to hire, how do you inject humility into the meeting.


DALIO:  Oh, the business we’re in teaches us that, right?


KEENE:  I’ll say.


DALIO:  We have a — so we have a very unusual culture, right?  So the old unusual culture is that we…


KEENE:  We don’t have that at Bloomberg.


DALIO:  We make — well, nothing’s like this.  So it’s a total idea meritocracy.  And what we do is we tape everything so everybody can listen to everything, right?  So there’s nothing hidden behind, and it’s a very straightforward kind of a way.  So it’s a very, very unusual idea meritocracy.  That’s why a lot of people, the young best people, come there because they can — everyone has the right to make sense of anything.  There’s no traditional hierarchy.  So you can ask any questions, and that keeps you on your toes.  The best way to do it, it’s like — what do they call that in Parliament?


KEENE:  Question time?


DALIO:  Yeh. You stand up in front and you have everybody shoot at you, and you get the stress test.  And that’s way — that’s the best way to test your thinking.  And we find that that’s fantastic.  So, anyway, and there’s meaningful work and meaningful relationships are developed.


KEENE:  Are you having a greater debate at Bridgewater right now about China when you have meetings on China?  Are they heated?  Are they collegial?  Is everybody on the same page?


DALIO:  It’s very, it, it, it’s — it’s not heated ’cause it’s not — the culture’s very kind of analytical.  Keep it calm, say anything you want to say.  And China, if you have this template, we have this template, you just drop the numbers in the template.


McKEE:  But that’s an interesting situation because China’s one of the few times that people have seen you actually come out with a mea culpa and say we missed something.


DALIO:  What’s your question?


McKEE:  How did you miss it with the template?


DALIO:  What, what I was saying — by the way, we miss things.  That’s what I’m saying, that’s where we learn the humility.  But in terms of that, what happened was, when they went to the bubble bursting in stocks, you went from — you have two problems in China.  You have a debt problem.  You have to restructure, particularly local governments have to restructure and (SOEs)(ph) have to restructure.  So that — but that’s a manageable problem because it’s in their local currency.  And by the way, the people — I’ve gotten to know a number of the policy makers — they’re very intelligent, very capable, very prudent people.  More intelligent people understand.  So restructuring your debts in your local currency is a manageable exercise.  We’ve done it three times.  We defaulted in ’71, we had the Latin American debt crisis and we moved that, restructured, and then we had the S&L crisis, and the RTC.  So that is a manageable process.  If you’ve got your balance sheet, you can manage that.  The issue, second issue that they is that they have to restructure what they’re spending money on, what the economy is like.


KEENE:  Right.


DALIO:  Because those are — so they have to rebuild a new economy to replace the old economy.  That’s a challenge.  So that’s like a heart transplant, it’s a serious operation, tends to weaken them.  But, like most heart transplants nowadays, you’re going to get through it OK if you have good surgeons.  They have a bubble.  The third thing was they went from an equity market, which is normal in early emerging stages of many economies where you get the speculator in, hyped up, they get leverage on margin, and then you have the bubble.  And they had that bubble.  That bubble was a negative at the same time.  So when you went from a — all I’m saying is you went from a bull market and you were having essentially then another force, you have a negative force coming in at the same time.  You have those three negative forces.  Now if you at then what other economies?  We look at all economies that have analogous set of circumstances.  What are economies that have to restructure their debt?  What is it like?  That’s a negative for economic activity.  OK, so then what comes next?  So we know that certain things come next.  So my statement was, when we had that bubble burst, that we had shifted from one kind of set of circumstances, sort of two plus two minuses and a plus, in a sense, that’s another negative.  I still think that — I think we exaggerate over the short term a lot of the importances.  We look at everything up close.  And so when you look at China — I think China’s going to be just fine.  Just to be clear.  But it’s going to be weaker.  It, but their weak growth is still probably going to more than twice our normal growth.


KEENE:  Within this, and within your (inaudible) very carefully your work, and I love how you come back and you have some beautiful historical charts in it.  On currency depreciation, and we see that in dollar real right now in Brazil.  Many people predicting (four)(ph) on Brazil.  I promised you I wouldn’t ask you for currency quotes within this wonderful session we’re having with you, but at the end of the day is the solution to the international trilemma always going to be currency depreciation?


DALIO:  It’s always going to be the number one choice.  In other words, if you’re facing — it’s always been.  If you’re facing a domestic contraction and you have a choice, do you want to depreciate your currency — ’cause everybody judges their net worth based on their own local currency — and so what happens is — that was the lesson I learned in 1971.  I was clerking on the floor of the New York Stock Exchange.  I walk on the floor of the New York Stock Exchange.  Richard Nixon, then on Sunday night announces that he is going off the gold standard.  I thought, wow, we don’t have money.  I walk on the floor of the New York Stock Exchange and it’s up a lot, and I learned that in every time what you have is it stimulates.  And it makes everything cheaper and it causes things to go up.  So, yeh.  In other words that’s —  when you have zero interest rates, what are you going to do?


KEENE:  Well, I’m going to rip up the script here, Ray Dalio.  You live in Connecticut, you’ve done better than good.  I believe Mr. Immelt wants to warrant — take a small business out of Connecticut.  He wants to move GE somewhere.  How important to your state is it to have Generous Electric in Connecticut?  How important?  What’s the symbolism?


DALIO:  Well, that’s… Well, we, we have a, we have an issue of course in terms of the tax rates and the competitiveness in taxes.  And now Texas, that’s why Austin, Texas, is getting Silicon Valley people.  It’s the nature of that particular competition.


KEENE:  Agreed.


DALIO:  I, I, I think it’s up to the Governor and the legislature to try to balance that in the best practical way.  I don’t really care to comment on that.  I mean I think it’s, you know, it, it, it, it’s — I understand the dilemma.  There’s also a big wealth gap, right?  And so when you’re taking the big wealth gap, in one way or another you have to be dealing with — you have to deal with that wealth gap.


KEENE:  All right.


DALIO:  And I’m not being, I’m not the one to say how that’s best handled.


McKEE:  All right.  Let me ask you this to sort of bring it all together.  You’ve got an economic model, you’ve talked about the fact that the Fed probably has to do more QE and central banks around the world have to ease the U.S. in secular stagnation, you’re optimistic about China, but they’re going to be slow.  So for investors out there…


DALIO:  I want to clarify that I don’t think the, the secular stagnation — I’m sorry, I shouldn’t even have interrupted your question.  I’m sorry.


McKEE:  Well, let me just — fold that into, to the answer to this question.  What kind of returns, say 10 year time horizon, the next 10 years, can investors expect?  Now I’m not talking about your particular funds, but is it going to be different?


DALIO:  Oh, yes, you know it.  You’re going to have returns that are probably going to average in somewhere in the vicinity of three, four percent.  OK?  This is a major pension fund problem.  Because the way assets work is when there’s quantitative easing, when there’s purchases, and prices go up, that’s really just producing a present value effect.  So what — it’s like a bond.  As your bond price goes up, you invest in — let me, let me say — I’m sorry, I’m not saying it clearly.  Let me say it better.  If you invest in a 10-year bond and it’s two and a quarter percent, no matter what, you’re going to get two and quarter percent during that.  So if the bond price goes up, you can be really jubilant, but the reality is when you then collect that profit, sell it, and you’re going to invest at a lower interest rate, the lower interest rate means that you’re still going to get the two and a quarter percent.  So when you look at the whole structure of asset prices from cash to the two and a quarter percent that’s in the 10-year bond, and you carry that all the way through, that’s permeated all asset classes.  That’s permeated venture capital, private equity, real estate, (inaudible), so all asset classes going forward are going to have a very, very low return.  That means you need a whole lot more money in order to immunize something.  You figure, supposing you have a $100,000 a year expenditure.  How much money do you have to have in order to immunize $100,000 expenditure?  You need to have a lot of money.  We needed to have that in order to get the economy going as we did, but we have a situation where we’re going to have very — we know, it’s certain, we’re going to have very low returns.


KEENE:  OK, Ray, we’ve got one minute.  It was an option, I just had to give a signal to the cameras.  One minute or one more hour with you.  That was one more minute.  You’re at HBS, and everybody wants to go find the next Uber at Silicon Valley.  What do you say to a 26-year-old smart kid at your HBS to say go into finance?  How do you sell him on that in 2016?


DALIO:  Oh, it’s easy.  I think that when you can go long or short, anything in the world or everything in the world, that means that you don’t have any cycles.  That means you get to even think about the whole world and how it’s connected.  There’s nothing more exciting.  And there’s no excuses because, if you go into any other business, you’re going to have a cycle.  So if you go into — there’s going to be a peck cycle, there’s going to be anything.  And I think if you take financial engineering, every investment that you’re going to go into, a business — if I bought Doral (inaudible)…


KEENE:  I think you should do that.


McKEE:  Well, because he can caddy.


KEENE:  Because you caddied, that’s it.  Ray, we’ve run out of time.  Thank you so much.  Greatly appreciate.  Don’t — stay right there.


DALIO:  Thank you, (inaudible) so much.


KEENE:  (inaudible). What are we doing tomorrow?


McKEE:  Tomorrow’s Fed day.


KEENE:  Fed day tomorrow.


McKEE:  We didn’t ask Ray about Janet, but Janet will be present tomorrow in everybody’s thoughts.  Tom Keene and Kathleen Hayes will anchor special coverage of the decision, two o’clock Wall Street time tomorrow.


KEENE:  We need to say thank you to Ted (Fine)(ph), to Anthony (Mancini)(ph), and all Bloomberg Television.  And, Ray Dalio, a particular thanks again to Ray Dalio.  To all of you, good evening.