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Ray Dalio's Bridgewater On The "Self Re-Inforcing Global Decline"

Tyler Durden's picture





 

The world's largest hedge fund is not as sanguine about the hope that remains in the markets today. The firm's founder, Ray Dalio, who has written extensively on the good, bad, and ugly of deleveragings, sounds a rather concerned note in his latest quarterly letter to investors as the "developed world remains mired in the deleveraging phase of the long-term debt cycle" and has spread to the emerging world "through diminished capital flows which have weakened their growth rates and undermined asset prices". Between China, Europe, and the US, which he discusses in detail, he sees the lack of global private sector credit creation leaving the world's economies highly reliant on government support through monetary and fiscal stimulation. The breadth of this slowdown creates a dangerous dynamic because, given the inter-connectedness of economies and capital flows, one country's decline tends to reinforce another's, making a self-reinforcing global decline more likely and a reversal more difficult to produce. After discounting a relatively imminent return to normalcy in early 2011, markets are now pricing in a meaningful deleveraging for an extended period of time, including negative real earnings growth, negative real yields, high defaults and sustained lower levels of commodity prices. Lastly he believes the common-wisdom - that the Germans and the ECB will save the day - is misplaced.

 

Bridgewater Q2 Letter: Outlook and Markets Discussion

The developed world remains mired in the deleveraging phase of the long-term debt cycle. The European deleveraging has been badly managed and is escalating, bringing Europe closer to either a debt implosion or a monetization and currency collapse. The impact of the European deleveraging has spread to the emerging world through diminished capital flows which have weakened their growth rates and undermined their asset prices. In the US, the deleveraging is progressing in a more orderly fashion but continues to weigh on the economy's ability to grow without the monetary support of the Fed. Our studies of deleveragings have proven to be invaluable through this period (let us know if you would like a copy of the expanding library). Because the dynamics of deleveragings are understandable and observable throughout history, one can reasonably assess the nature of their outcomes over time. But because highly-indebted systems that are in deleveragings are also inherently unstable, the timing of discrete events is always highly uncertain (e.g., the shift from austerity to monetization, an exit from the euro, etc.). Through these studies we have continued to refine the indicators we use to measure how the forces of deleveraging are impacting various economies and markets, and we continue to make the relevant adjustments to our investment process that both allow us to anticipate these shifts and to control our risks through the unpredictable twists and turns.

At this point in time Europe is in the most critical stage of the deleveraging process, without a credible plan that will allow a transition from an "ugly" deleveraging, where incomes fall faster than debts decline, to a "beautiful" one, where income grows faster than debts. A transition from an "ugly" to a "beautiful" deleveraging requires an acceptable mix of default, redistribution and monetization. Steps have been taken in this direction, but they remain well short of what is necessary. The range of potential outcomes for Europe and the impacts on the global financial system are wide, so navigating this environment will require flexibility and an understanding of how new policy decisions will affect the path of the deleveraging.

The unresolved European imbalances and the differences in their impacts on each country have produced widening differences in the self-interests of these countries, which have led to political divergences that have magnified the risks. Unlike a year ago, Germany and France no longer stand in solidarity as backstops behind the euro system, but have been divided in their self-interest by divergent financial conditions which are leading to conflicting rather than unified political orientations. France's deteriorating finances and economy have shifted its self-interest toward alliances with "recipient" (lower credit rated) countries like Italy and Spain and away from "contributor" (higher credit rated) countries like Germany and the Netherlands, leaving Germany more isolated as a guarantor of the risks in the euro system and in its views about how to manage the imbalances. Given these shifts in the alliances between contributor and recipient countries we think that the popular assumption that the Germans and the ECB (which requires agreement of the key factions within it) will come through with money to make all of these debts good should not be taken for granted. Said differently, we think that there are good reasons to doubt that European bank and sovereign deleveragings will be prevented from progressing to the next stage in a disorderly way, without a viable Plan B in place. This fat tail event must be considered a significant possibility.

Given the lack of global private sector credit creation, the world's economies remain highly reliant on government support through monetary and fiscal stimulation. Now that the most recent round of global monetary stimulation has ended, world economic growth has slowed and central bankers are in the process of stimulating again. We estimate that in the past few months, global growth has slowed from about 3.3% to 1.9% and that 80% of the world's economies have slowed, including all of the largest. The breadth of this slowdown creates a dangerous dynamic because, given the inter-connectedness of economies and capital flows, one country's decline tends to reinforce another's, making a self-reinforcing global decline more likely and a reversal more difficult to produce. And at this point, while actions have been taken, none of the world's largest economies are stimulating aggressively via either monetary or fiscal policy, further reducing the odds of a reversal.

About half of the global slowdown has been due to slower growth in China. In recent years, China has been the locomotive of world growth and its recent sharp slowdown has had knock-on impacts on numerous countries and markets. China itself now makes up 12% of world GDP and its interactions with the rest of the world add to its impact. China is a large export destination for many countries and is the largest marginal consumer of raw materials in the world, so its slowdown has disproportionately hurt the economies which export to China, and its weaker commodity consumption has hurt the commodity producers. In response to this slowdown, China has begun to ease monetary policy and is contemplating more aggressive fiscal stimulation, but the actions have so far been gradual and have not yet been sufficient to produce a notable economic response.

US conditions have slipped with the rest of the world and the Fed has decided to extend its Twist operation; to end it would have been an inappropriate tightening. Last year's hump in growth has passed as numerous temporary forces have faded, and private sector credit growth remains weak, so growth is converging on the growth of income of around 1.5%. Besides the drag from Europe and the potential for a contagious debt blowup there, numerous US federal programs will expire in the fourth quarter, and given the likely political divisions after the election it will be a challenge for the new Congress to deal with these in a timely manner. Without action, the expiration of these programs represents a fiscal drag on growth of about 2.5%. Given the lack of new aggressive Fed stimulation, the threat from Europe, the simultaneous decline in major country growth rates and the fiscal cliff, the risks to US growth are skewed to the downside.

Over the past 18 months what markets are discounting has changed radically, with a clear bias toward discounting much weaker growth for a longer period of time. This shift is reflected in the rise in credit spreads, fall in bond yields, much lower discounted future earnings growth, flattening of the yield curve, currency moves and shifts in commodity prices. But such price changes simply reflect a transition from the discounting of one set of future economic conditions to the discounting of another set of future economic conditions. After discounting a relatively imminent return to normalcy in early 2011, markets are now pricing in a meaningful deleveraging for an extended period of time, including negative real earnings growth, negative real yields, high defaults and sustained lower levels of commodity prices. This pricing is the midpoint of discounted expectations and each market has an equal probability of outperforming or underperforming. By balancing the portfolio's exposure to discounted growth and inflation, a disappointment in one asset class will be offset by gains in another, without the necessity of predicting which it will be.

 


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Thu, 07/19/2012 - 16:58 | Link to Comment Dr Benway
Dr Benway's picture

It's a matter of how long Ben can tease the markets with more QE (without actually doing it) and still get a reaction

Thu, 07/19/2012 - 17:12 | Link to Comment Michael
Michael's picture

The acceptance phase is well, starting to be accepted.

In other news, and the dossier must be a couple inches thick;

HOPE 9: Whistleblower Binney says the NSA has dossiers on nearly every US citizen

Binney was at HOPE and while his entire keynote is not yet posted, journalist Geoff Shively and Livestreamer Tim Pool had an opportunity to speak with Binney about NSA spying. As you may recall, after covering the NATO protests, Pool and Shively were two of the journalists harassed by Chicago cops. In the short video interview, Binney explained a bit more about the NSA spying on Americans:

"Domestically, they're pulling together all the data about virtually every U.S. citizen in the country and assembling that information, building communities that you have relationships with, and knowledge about you; what your activities are; what you're doing. So the government is accumulating that kind of information about every individual person and it's a very dangerous process." He estimated that one telecom alone was sending the government an "average of 320 million logs every day since 2001."

https://www.networkworld.com/community/blog/hope-9-whistleblower-binney-says-nsa-has-dossiers-nearly-every-us-citizen

Thu, 07/19/2012 - 18:05 | Link to Comment Hype Alert
Hype Alert's picture

Is he talking about Facebook?

Thu, 07/19/2012 - 17:18 | Link to Comment DoChenRollingBearing
DoChenRollingBearing's picture

Deleveraging is going to be tough on everyone.  Best be diversified.  I think the author is CORRECT to say that this will a worldwide phenomenom, but so far we are not seeing this at our Peruvian business.  But, if China slows much more, Peru will definitely feel it.

Diversification includes not just foreign investments, but owning gold as well.  And who knows how bad things could get?  Guns & ammo to protect what stash you may have or build.

Thu, 07/19/2012 - 17:01 | Link to Comment kito
kito's picture

dalio is an optimist.....he believes that the worlds economies will stagnate over the next 10 to 15 years and then all will be well once the deleveraging is done.......he believes that the cbs will be able to create an equilibrium between debt destruction/deleveraging and money printing......kind of amazes me that a guy who supposedly sees the macro picture with one of the most discerning eyes cant see that the current monetary paradigm is DEAD....OVER....the monetary system is on a respirator and a feeding tube, and 10 years of that kind of care wont make the patient dance again................

Thu, 07/19/2012 - 17:11 | Link to Comment Robot Traders Mom
Robot Traders Mom's picture

"Dalio believes that some heavily indebted countries, including the United States, will eventually opt for printing money as a way to deal with their debts, which will lead to a collapse in their currency and in their bond markets."

http://www.newyorker.com/reporting/2011/07/25/110725fa_fact_cassidy#ixzz...

Thu, 07/19/2012 - 17:34 | Link to Comment kito
kito's picture

robomom, as per his statement in may of this year, dalio has said the united states has done a "beautiful" job deleveraging.....really? 

 

http://online.barrons.com/article/SB50001424053111904370004577390023566415282.html#articleTabs_article%3D1

Thu, 07/19/2012 - 23:59 | Link to Comment Cosimo de Medici
Cosimo de Medici's picture

Beauty is in the eye of the beholder.  It is also relative.  The US has done a better job than Europe, though neither smells of roses.  As for his longer term economic views, nothing is known with certainty.  Everything is an opinion.  Having accumulated $15 billion guesstimating market movements suggests Dalio has some facility with this stuff.

If during the height of the economic crisis four years ago someone had suggested that the Fed could triple its balance sheet, the ECB could do the same, and the result would be a 30% rise in the dollar vs. the euro, US 10-year rates at less than 1.5%, and many short term rates below zero worldwide, he would not have gained much of a following.  Weird shit happens, and it follows no set formula.

Perhaps Dalio is merely going with the odds in that the end of the world has been predicted thousands of times (about half of them in the Zerohedge Comments Section) and not once has it proven true.  When it does come true, there won't be anyone around to accept kudos for calling it.

Thu, 07/19/2012 - 17:23 | Link to Comment YC2
YC2's picture

Are you really "amazed"?  Im willing to bet that he has more AUM than you by at least a double digit multiple, to be conservative. 

Thu, 07/19/2012 - 17:44 | Link to Comment kito
kito's picture

if you mean AUM as in Assets Under my Mattress, i bet i have him beat by a mile......................

Fri, 07/20/2012 - 00:02 | Link to Comment Tijuana Donkey Show
Tijuana Donkey Show's picture

I have WUM, weapons under my mattress....

Thu, 07/19/2012 - 17:50 | Link to Comment Enceladus
Enceladus's picture

I think he sees it but there isn't a chance in hell he is putting it in his quarterly newsletter.

Dear Clients the world is over good day

 

which is prudent becuase as anyone who had been at ZH for a few weeks or more realizes this slow motion train wreck is taking FOREVER.

i.e. whats he going to write next quarter?

Thu, 07/19/2012 - 21:09 | Link to Comment MaxPower
MaxPower's picture

He's not Ray Dalio, but Ray Patterson said it best.

http://www.youtube.com/watch?v=5AAP7zORyWA&feature=related

Thu, 07/19/2012 - 17:02 | Link to Comment bob_dabolina
bob_dabolina's picture

negative real yields, high defaults

And that is what the end game looks like.

 

Thu, 07/19/2012 - 17:17 | Link to Comment A Lunatic
A Lunatic's picture

I think I'll open up a theoretical food store so people can still buy groceries with their theoretical profits.

Thu, 07/19/2012 - 17:20 | Link to Comment bob_dabolina
bob_dabolina's picture

Well you theoretically didn't theoretically open a food store. Someone did that for you.

Thu, 07/19/2012 - 17:26 | Link to Comment PiratePawpaw
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"In theory, there is no difference between theory and practice. In practice, there is"...Yogi Berra

Thu, 07/19/2012 - 17:30 | Link to Comment Robot Traders Mom
Robot Traders Mom's picture

Well you theoretically didn't theoretically open a food store. Someone did that for you.

 

Comment of the day. +1

Thu, 07/19/2012 - 17:20 | Link to Comment DoChenRollingBearing
DoChenRollingBearing's picture

@ bob_d

+ 1, good observation.

Thu, 07/19/2012 - 17:08 | Link to Comment pain_and_soros
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After discounting a relatively imminent return to normalcy in early 2011, markets are now pricing in a meaningful deleveraging for an extended period of time, including negative real earnings growth, negative real yields, high defaults and sustained lower levels of commodity prices. This pricing is the midpoint of discounted expectations and each market has an equal probability of outperforming or underperforming.

Which markets is he looking at?  S&P at 1376??? DJIA at 11665???

If he thinks these markets are pricing in "meaningful deleveraging for an extended period of time", he ain't seen nothing yet

 


Thu, 07/19/2012 - 17:43 | Link to Comment Hype Alert
Hype Alert's picture

That struck me as a little odd too.

Thu, 07/19/2012 - 21:42 | Link to Comment geewhiz190
geewhiz190's picture

what discounting is he refering to ? tsy yields ok, but stocks?

Thu, 07/19/2012 - 22:01 | Link to Comment chump666
chump666's picture

We got a crash coming anyday. 

Thu, 07/19/2012 - 17:14 | Link to Comment q99x2
q99x2's picture

So are things going according to the plan or not? We are all going to be united in the global village. No? Big happy family. Yes?

Thu, 07/19/2012 - 17:21 | Link to Comment jrpuffnstuff
jrpuffnstuff's picture

Oh WTF ever!  We're screwed and I don't need Dalio or any one else to tell me that.  Just look around a**hole.   

Thu, 07/19/2012 - 17:22 | Link to Comment q99x2
q99x2's picture

'About half of the global slowdown has been due to slower growth in China'

About half of the global slowdown has been due to the inability of Bansters to replicate the MORTGAGE FRAUD. Let's not beat around the bush here.

 


Thu, 07/19/2012 - 17:55 | Link to Comment spanish inquisition
spanish inquisition's picture

I see China as a lagging indicator. They don't have a robust internal economy and are at the mercy of orders from abroad.

So I would agree that it is up to the best and brightest western financial criminal minds to help pull us out with another fraudulent scheme that we can all get behind.

Thu, 07/19/2012 - 17:24 | Link to Comment PiratePawpaw
PiratePawpaw's picture

A staircase can either spiral up, or spiral down. It can not spiral in place.

And in either case, it is self reinforcing.

 

going down....................

Thu, 07/19/2012 - 17:28 | Link to Comment adr
adr's picture

Remember everything is fine as long as you told everyone you were going to jump a 12' bar, until the day before when all the reporters claimed you would only clear 4'. You made the bar at 5' and everyone cheered, forgetting you were supposed to clear 12' only a few short days ago.

Your dad is sitting in the corner yelling at everyone. Saying what the fuck is this cheering for. He said he was going to clear 12', I cleared 12' when I was his age. You people are insane.

When the reporter comes over to interview the father to ask how proud he is of his son, the dad takes out a gun and blows his head off.

Thu, 07/19/2012 - 17:33 | Link to Comment trilliontroll
trilliontroll's picture

"Lastly he believes the common-wisdom - that the Germans and the ECB will save the day - is misplaced."

http://www.historischer-bilderdienst.de/images/me1_sbt.jpg

last german sailor waving the flag on a sinking ship (1916?/1918 ?)

some music

http://www.youtube.com/watch?v=3hPAI3O-1Vg&ft=li

scuttling of the German fleet

http://en.wikipedia.org/wiki/Scapa_Flow#The_scuttling_of_the_German_flee...

Thu, 07/19/2012 - 17:37 | Link to Comment Doublescythe
Doublescythe's picture

I'm a believer in the only two asset classes that will go up no matter how much the market falls - GLD and AAPL.

All hail these two.

All hell everything else.

Thu, 07/19/2012 - 17:37 | Link to Comment Doublescythe
Doublescythe's picture

I'm a believer in the only two asset classes that will go up no matter how much the market falls - GLD and AAPL.

All hail these two.

All hell everything else.

Thu, 07/19/2012 - 17:38 | Link to Comment Piranhanoia
Piranhanoia's picture

Ray seems to want things to work out well, and not involve the removal of bankers and governments for their corruption.  I don't think that will be seen as an acceptable solution once the populus awakens to the chaos inflicted upon them.  

Thu, 07/19/2012 - 18:12 | Link to Comment graneros
graneros's picture

"I don't think that will be seen as an acceptable solution once the populus awakens to the chaos inflicted upon them"

Which begs the question what do these corrupt bankers and Politicians have in mind for the newly awakened populous.  These aren't stupid people that have enslaved us.  Evil and corrupt but not stupid.  Surely they have thought out everything.  That may seem conspiracy theory-esque but it does make one wonder.

Thu, 07/19/2012 - 18:36 | Link to Comment SwingForce
SwingForce's picture

Shouldn't we be at the point where the Bailouts pay the Consumer, the Consumer pays the Butcher, the Butcher pays the Plumber, the Plumber pays his bartender, you know, like that email?  Gobs & Gobs of "deleveraging". Why do we keep giving money to BANKSTERZ who Disappear it!    If there ever was a case for abolishing the FED, this is it. 

What did Dalio say, anyway? A whole lotta nuthin' we didn't know from reading ZH everyday.

Thu, 07/19/2012 - 21:05 | Link to Comment Tommy Gunner
Tommy Gunner's picture

Dinner conversation with a friend who runs a small hedge fund in Singapore about a year ago.

Me: So what do you think - are we fucked?  Clearly the EU is finished.

She: Yes the EU is unsolvable but we are not fucked.

Me: How are we not fucked, if the EU comes apart the US comes apart.

She: Well ya, but I still think it won't happen - the US won't come apart

Me: But you think that the EU is fucked - so how is the US and the rest of the world not fucked given the EU is the biggest economy?

She: It's like this - I have to have hope no matter what - because without it I wouldn't be able to go to work every day.

 

This was at the time the US was 'recovering' due to the latest QE heroin fix - she was buying it - I was not - we agreed to wait a year and see.  It's about a year now.

 

Point being tha Dalio surely can see what is coming - and he's probably positioning his personal wealth to preserve it in a worst case scenario - but he has to express some sort of hope for the future - otherwise he may as well just tell his clients to take their cash out of his fund and buy physical gold and guns.   He doesn't get paid if he does that

Thu, 07/19/2012 - 22:34 | Link to Comment sumo
sumo's picture

 "but he has to express some sort of hope for the future - otherwise he may as well just tell his clients to take their cash out of his fund and buy physical gold and guns.   He doesn't get paid if he does that"

When Michael Burry called out TBTB in his NYT op-ed, asking if he could see the crash coming why couldn't the Fed, he was raided by the FBI.

Ray Dalio is far more prominent and influential. For the sake of his health and life expectancy, he has to keep quiet - the reprisals for speaking out would be too severe. It's not about fees.

Fri, 07/20/2012 - 19:41 | Link to Comment SwingForce
SwingForce's picture

Dalio's going down with the ship http://en.memory-alpha.org/wiki/George_Kirk DO NOT LISTEN TO HIM.

Fri, 07/20/2012 - 19:34 | Link to Comment SwingForce
SwingForce's picture

Dalio is George Tiberius Kirk http://en.memory-alpha.org/wiki/George_Kirk

Sat, 07/21/2012 - 02:43 | Link to Comment Bill Shockley
Bill Shockley's picture

If stock prices drop and grocery prices rise we must have found de lever.

Ray says his fund has that covered.

So how's he gonna do that, did he say?

Hey ray, hey ray, how much gold did you buy today?

Is this the beginning?

Pensions good as gold???????????????????????????????

Per ray it's just so depressioning.

Guns gold and frozen pizzas.

Consider buying some rope.

   bill on de lever

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