Ray Dalio

Ray Dalio recently described the characteristics of a “beautiful deleveraging” in which equal doses of austerity, write-downs, and inflation gradually lighten the load of impaired debt. Two things can turn beautiful inflation into ugly inflation: Wages don’t inflate along with prices and the currency depreciates as money is printed excessively. This might not matter for a nation that is a net exporter of goods and services.  But for nations that import essentials such as oil and grain, this is a catastrophe, as wages are flat while the cost of imported energy and food skyrocket.  Households have less money to spend, and servicing debt becomes increasingly burdensome. Welcome to the United States of Ugly Inflation.  Real household income (i.e., adjusted for official inflation) has declined 8% since 2007; the cost of oil, medical care and higher education has climbed; and government revenues have stagnated even as demand for government services has increased. As a result, the entire beautiful deleveraging scenario is at risk.

Ray Dalio, founder and co-chief investment officer of Bridgewater Associates, L.P. and one of the most successful hedge fund managers of all time told Maria Bartiromo last week that he owns gold and that he sees no “sensible reason not to own gold”. The interview was part of the Council on Foreign Relations (CFR) Corporate Program's CEO Speaker Series, which provides a forum for leading global CEOs to share their priorities and insights before a high-level audience of wealthy and influential CFR members.  The respected hedge fund manager suggested that a depression and not a recession was likely and warned of social unrest and the risk of radical politics as was seen with Hitler and the Nazis in the Depression of the 1930’s. Dalio spoke about how “gold is a currency” and when asked by Bartiromo “do you own gold?”, he smiled and said “Oh yeah, I do.” The admission elicited a laugh from the CFR audience. Dalio’s interview is important as it again indicates how slowly but surely gold is moving from a fringe asset of a few hard money advocates and risk averse individuals to a mainstream asset. Wealthier people and some of the wealthiest and most influential people in the world are slowly realising the importance of gold as financial insurance in an investment portfolio and as money. This will result in sizeable flows into the gold market in the coming months which should push prices above the inflation adjusted high of 1980 - $2,500/oz. The interview section where Dalio is asked about gold by an audience member begins in the 43rd minute and can be seen here.

Some wonder why we have been so convinced that no matter what happens, that the Fed will have no choice but to continue pushing the monetary easing pedal to the metal. It is actually no secret: we explained the logic for the first time back in March of this year with "Here Is Why The Fed Will Have To Do At Least Another $3.6 Trillion In Quantitative Easing." The logic, in a nutshell, is simple: everyone who looks at modern monetary practice (as opposed to theory) through the prism of a 1980s textbook is woefully unprepared for the modern capital markets reality for one simple reason: shadow banking; and when accounting for the ongoing melt of shadow banking credit intermediates, which continues to accelerate, the Fed has a Herculean task ahead of it in restoring consolidated credit growth. Shadow banking, as we have explained many times most recently here, is merely an unregulated, inflationary-buffer (as it has no matched deposits) which provides the conventional banking credit transformations such as maturity, credit and liquidity, in the process generating term liabilities. In yet other words, shadow banking creates credit money which can then flow into monetary conduits such as economic "growth" or capital markets, however without creating the threat of inflation - if anything shadow banks are the biggest systemic deflationary threat, as due to the relatively short-term nature of their duration exposure, they tend to lock up at the first sing of trouble (see Money Markets breaking the buck within hours of the Lehman failure) and lead to utter economic mayhem unless preempted. Well, preempting the collapse in the shadow banking system is precisely what the Fed's primary role has so far been, even more so than pushing the S&P to new all time highs. The problem, however, as we will show today, is that even with the Fed's balance sheet at $2.8 trillion and set to rise to $5 trillion in 2 years, it will not be enough.

Moments ago, a stray headline crossing Bloomberg was the catalyst for violent selling across the precious metal complex. The headline in question is this:

• SOUTH AFRICA GOLD PRODUCERS TO CONSIDER BRINGING FWD WAGE TALKS

The reason for the puke in PMs is the goalseeked as follows: since miners are willing to negotiate wage hikes, the miner strike may soon be over. Well, they said that last week, when the Lonmin Maricana mine strike ended. All that happened next was for every other miner in South Africa to demand equitable terms, making the strike even worse than before. What it will mean, if indeed passed, is that a broad swath of PM miners will face default sooner rather than later, as they will be completely unable to pass on 20% cost surges to consumers, and many will file for bankruptcy sending capacity far lower in the long-run than currently, even with the mine strike. What is most funny, however, is the response in silver, which plunged in sympathy with gold and platinum as can be seen on the chart below. There is one small detail: please point out in the table below of the world's largest 20 producers of silver, just where is South Africa.

We discussed Bridgewater's Ray Dalio in depth late last week and his historical perspective on the world we are living through. It appears CNBC has found this intriguing too and the largest hedge fund manager in the world has been espousing his views all morning. Most notably he very concerned at the possibility for social unrest (just as we have pointed out again and again) highlighting the rise of Hitler in 1933 and its parallels to the current social disruptions around the world as global economies sufffer painful deleveragings. His suggestion is that gold "should be part of everybody's portfolio" as he explains the reality of the endgame of fiat monetary systems. As far as Warren Buffett's distaste for the yellow metal, he opines "I think he is making a big mistake."

"It's never different this time." Ray Dalio's recent discussion at the Council for Foreign Relations is probably the most in-depth access to his 'model' explanation of the way the world works we have encountered. From bubbles to deleveragings and how the inter-relationships of various cycles bring about consistent trends and corrections; the full-length discussion, succinct interview with Foreign Affairs, and full readings are perhaps more useful than ever as we tread Wile E. Coyote-like off the edge of traditional monetary policy and encounter apparently different environments that in fact have occurred in perhaps alternate ways again and again over time. Great weekend viewing/reading on the three ways out of the panic-crisis that the Fed clearly believes we are in and the inevitability of his findings that "in all deleveragings, in the end they print money."

Problem: this marginal utility of debt has trended lower and lower over the years, and actually reached zero in 2009. Meaning: you can add as much debt as you want, and it still won’t give you any additional GDP. To repeat: no amount of additional debt seems to be able to get economic growth going again. That is a dramatic revelation. We might have reached the maximum debt-bearing capability of the economy. If true, no growth is possible unless debt-to-GDP levels fell back to sustainable levels (in order to restart the debt cycle). This could take years. At this point, the only way to reset the debt cycle is to get rid of debt.... The amounts needed for the Fed to be able to create inflation are much, much higher than what we have seen so far. And it is not guaranteed to work. Destroying the trust in the value of a fiat currency is a dangerous experiment with mostly adverse consequences.

Confirming what we described in detail in March, Bridgewater's Ray Dalio notes in his Daily Observations that "Spanish banks' collateral is running out in a way that could force them into an ELA." The manager of the largest hedge fund in the world - so not some self-perpetuating political mouthpiece - estimates that the Spanish banking system has only a few hundred billion euros left in eligible collateral and that some of the weaker banks are likely already getting close to a point where their collateral is exhausted. Critically, if this occurs, then Spanish banks will need to turn to its own Emergency Liquidity Assistance (ELA) program. An ELA for Spanish banks would likely be several times the size of those in place for Greece and Ireland, further fracturing the uniformity of central bank standards across the eurozone, and the magnitude of funding coming through the national central banks could accelerate rapidly. This increasing Balkanization of European central banks and funding capabilities only entrenches the impossible task of fiscal union as 'more' sovereign control transfer will be required in return for any core backstopping. Furthermore, those who are hoping for LTRO3: no collateral, no deal! Which the IMF just confirmed is a flashing red warning:

• IMF: COLLATERAL AT ECB VULNERABLE TO DOWNGRADES, MARGIN CALLS

The attempt to manage the imbalances among the Euroland economies is an extremely dangerous highwire act, and to the extent that monetary policies diverge to serve individual countries' needs, the further capital flows will likely go in the opposite direction.

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.

Objective analysis, or media spin to gauge popular reaction to Plan Z? Whatever it is, today's staff lead article in the English section of Spiegel has a piece that will likely raise more than a few eyebrows: "The common currency union was supposed to benefit the economy of the entire European Union. Now that the euro is struggling, however, it is bringing growth down with it. Germany's economy, once seemingly immune to the crisis, is now facing mounting difficulties."

Lately, more and more professional investment "advisors" and newsletter recommendations boil down to just one catalyst: wait for either Germany, the ECB or the Fed to step in, as usual, and bail the world out, because, well, they have to, and any additional thought is rendered moot as fundamental analysis is meaningless under central planning (plus it is actually more work than just repeating the same stuff over and over while charging $29.95/month for it). Of course, when these same snakeoil salesmen are asked the simple question: what if said bailout does not happen, or if it happens late (for the purposes of this exercise let's assume one is not a central bank that can print its own money, have an infinite balance sheet, and can afford to be wrong almost into perpetuity), they give a blank stare, start mumbling something and walk away, especially if one mentions Lehman brothers and the simple detail that, oh, it failed. Which is why if Ray Dalio, head of the world's largest hedge fund, is correct, it may time to summarily fire and stop subscribing to each and every broken record Oracle whose template is "X will bailout Y" for the simple reason that it is wrong.

It has been a while since the Guardian came up with a European "bailout" rumor. Time to change that. In a nutshell: Germany will somehow allow a fund, the ESM, which does not yet even exist, overturn the primary principle of the Eurozone, the no sovereign bailout clause, and use money which has not been funded, to subordinate bondholders across the entire continent (because ESM is priming) and serve as an additional secured lender in addition to the ECB... In other words, the ESM will take place of the ECB's SMP. With the only difference that the ECB can print money, while the unfunded ESM will at best rely on the murky details of repo lending. Same subordination either way, of course.

Today's futures pop on short-term bill auctions in Europe (that remain in a world of their own and should not be considered as anything but emergent in nature rather than indicative of investor demand) and ad hoc data in Germany that disconnects from any sense of reality in true economic environs only confirms Morgan Stanley's Mike Wilson's perspective that there still isn't much fear out there. We remain in the midst of a longer-term deleveraging cycle, of that there can be little argument in reality (unless of course exponential trends are natural) and as Wilson points out we are likely to remain in the wide trading range that we have been in the past two years - however, many investors appear to disagree (not the least of which the effusively exuberant 'Ace' Greenberg this morning). Few expect a correction more than 5-10%, Buy-lists are already in great demand, and put-call ratios remain muted. "Of course, this is what happens when an animal becomes conditioned to buy the dip in a pavlovian manner over years during which they have remain unscathed by some of the biggest financial risks we have ever witnessed. As the saying goes, “the only fools bigger than those that are playing are those that are watching.” Of course, having some Fed official speaking every other day to remind us they are there to save the day in the event of trouble helps perpetuate this unnatural one way market." However, his bottom line is that slowing/disappointing economic data, zero percent earnings growth and a liquidity lull sounds like a recipe for more than a 5% correction.

Ray Dalio released a study he did on deleveraging. The piece was featured prominently here at ZH. I am a fan of Dalio, but his analysis was surprising. His interpretation of the economy is, remarkably, based on a very conventional ideas and is shockingly wrong. For a guy who is known for thinking out of the box and has who has led Bridgewater to become the biggest hedge fund in the world, he has got the deleveraging process all wrong. 

All you need to read.