By Jonathan Burton, MarketWatch
Let’s make one thing perfectly clear: Ray Dalio sees parallels between the U.S. today and during the unstable 1930s, but the billionaire hedge-fund manager does not expect the next financial crisis to rival the one that knee-capped Americans in 2008 and nearly triggered another Great Depression.
That said, the founder of Bridgewater Associates, the world’s largest hedge-fund firm, is concerned that when the downturn hits — likely within the next couple of years, by his reckoning — investors, companies, politicians and policy makers will be blindsided, or worse. Capitalism and democracy, our system of government, will be under heavier fire than it is already.
“I worry about the next downturn, which isn’t imminent but also isn’t many years away ,” Dalio said in a telephone interview this week. “If you go out two or three years from now, there is significant risk of a downturn at a time that we have a political and social polarization. That is very similar to the late-1930s period.”
As someone who is obsessive about being completely prepared, Dalio knows that unwelcome surprises can spark panic, self-preservation and other fearful reactions even among normally rational people.
So he wrote a book to help them. “A Template for Understanding Big Debt Crises” is a free PDF, timed to the 10 years since major U.S. investment bank Lehman Brothers collapsed and the painful deluge that followed.
“I see significant other problems ahead in two or three years,” Dalio said, “because of the combined effects of debt, pension and health-care burdens, the wealth and opportunity gap that create polarity and populism, and less effectiveness of central-bank policies that makes it more difficult to reverse a downturn.”
Moreover, he adds, “The ability to ease monetary policy by lowering interest rates is limited in the United States and nonexistent in Europe and Japan, and quantitative easing will be a lot less effective in the future than it was in the past.”
In his book, Dalio teaches about debt by historical example and his own experience, namely what Westport, Conn.-based Bridgewater knew more than a decade ago about the shaky debt and shady derivatives that would trigger the 2008 crisis, and how it came by this knowledge.
Dalio tells readers that after poking for weaknesses in the then-ballooning mortgage and derivatives market, the hedge-fund firm concluded that creditors, investors and even the Federal Reserve were being too optimistic. So, with help from the firm’s “Depression gauge” and other proprietary algorithms developed from Dalio’s trademark principles, Bridgewater battened down the hatches and along with its investors rode out the world’s worst financial market upheaval since 1929.
Dalio’s narrative of Bridgewater’s thinking in the runup to, during and after the 2008 crisis gives a fascinating inside look at what it takes as an investor to go against the herd, and to have enough fortitude to be wrong until you’re proven right.
Polarization and paralysis
Debt, left unattended, can mutate from benevolent builder to malevolent destroyer. Dalio’s book details the stages of a debt cycle and discusses effective and ineffective responses when borrowing becomes dangerous. In this manual, Dalio describes how to defuse a ticking debt bomb (spoiler alert: quickly and carefully), and hands a prescription to current and future central bankers for diagnosing and treating a major financial crisis with skill. If policy makers know to pull the proper levers, they can temper the wrath and get an economy growing faster.
Warren Buffett explains the 2008 financial crisis
A decade after the financial crisis, billionaire investor Warren Buffett explains what was behind the 2008 mayhem, what we can do to limit the damage, and opportunities missed last time.