By Alan Murray and David Meyer
September 12, 2018

Good morning.

Having made a fortune in hedge funds, Ray Dalio has now turned to the less lucrative business of book writing. His first—Principles—was a success among the CEO crowd, describing among other things his devotion to the management practice of radical candor. This week, book two comes out—A Template for Understanding Big Debt Crises. I’ve read the galleys, and can’t claim it’s a page turner. But it is a systematic and smart analysis of various debt crises in history—48 of them, to be exact—and it helps explain why Dalio’s investments performed so well in the last one.

What about the next crisis? Dalio doesn’t address that in his book. But he did in an interview with me last week. He strongly believes that the “same things happen over and over again,” only in slightly revised form. And so a careful study of history is the best way to predict the future. His study of debt crises leads him to believe the right historical parallel for the next few years is the period from 1935 to 1940—the run-up to World War II.

Dalio argues that the crisis 10 years ago was similar to the 1929-1932 period—both huge in their consequences. He claims both were characterized by interest rates that fell to zero, and both also led to a growing wealth gap and a rise in populism. Moreover in both crises, central banks spent all their ammunition fighting the after effects and so had little left to combat the next downturn.

And what about the war? “If you have populism and you have a downturn, tensions get exacerbated,” he says. He mentions the “Thucydides trap,” which is Graham Allison’s work on why shifting global power dynamics—like the current one between a retreating U.S. and an ascendant China—so often lead to global conflict.

None of this poses an immediate threat, he says. For the moment, the economy seems on track. “As a generalization, we find pockets of places that might be beginning to be a little worrisome,” he says, “but not much.”

But looking two years out, the story starts to change. “If you look at government debt, that’s something we are concerned about, particularly out there two years from now. The amount that will have to be sold to fund the deficit, to fund the Fed’s balance sheet… in addition there is all the non-debt liability—pensions and health care…” That will either lead to a painful spike in interest rates, choking the economy, he believes, or monetization of the debt which could trigger a dollar crisis that rocks the rest of the world. With the central bank disarmed and populism and tribalism rampant, the resulting brew could be toxic.

Is Dalio’s analysis right? Economists may argue with his reading of monetary history. But his general conclusion fits with what I’ve argued for some time: the political ramifications of the last crisis, much like the Great Depression, will last longer and prove more dangerous than the economic and financial consequences.

By the way, Dalio only hinted at this in his interview on CNBC yesterday. You can hear what he had to say here. And you can watch his self-produced video on how he spotted the last debt crisis here.

More news below.

Alan Murray


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