On this week’s episode of Fortune’s Leadership Next podcast, Alan Murray talks with Ray Dalio, founder and co-CIO of Bridgewater, about his book, Principles, and the three global issues happening now that today’s leaders are facing for the first time: debt overhang in the economy; the current degree of polarization between people; and the friction between some of the world’s most powerful countries.
Listen to the episode or read the full transcript below.
Alan Murray: Leadership Next is powered by the folks at Deloitte, who, like me, are super focused on how CEOs can lead in the context of disruption and evolving societal expectations. Welcome to Leadership Next, the podcast about the changing rules of business leadership.
I’m Alan Murray. Ellen McGirt is on a plane right now so she’s not going to be able to join me but I’m super excited about my guest. He is Ray Dalio, founder of the most successful hedge fund in history, Bridgewater. And then he turned the same analytical skills that allowed him to make many billions of dollars at Bridgewater and turned them to analyzing the patterns of history to try and see what those patterns and trends tell us about the future. So this is a different kind of Leadership Next than our normal podcast. We’re going to talk to Ray about some really big topics like where the world is headed, but I think you’re gonna find it fascinating. Ray, thank you so much for taking the time to do this conversation.
Ray Dalio: It’s great to be here with you, Alan. Thank you for having me.
Murray: It means a lot to us to have you here. Your dive into history, which you obviously took very seriously, you clearly developed your own kind of methodology is fascinating. And I’ve read the Principles book, learned a lot from it, but it also, I have to say frankly, scared me a little. I don’t know if that was your intention. But well…
Dalio: Just to be clear, I never intended to even write a book. And when I do for the last 50 years, I’ve learned that things that surprised me often were things that never happened in my lifetime, but happened many times before. And there were three big things that are happening now that didn’t happen in our lifetimes in the same way. And I needed to go back and study them. It was because I studied the Great Depression in 2008, I was able to anticipate that crisis and so it was that need and then I needed to pass that along. So I made the study into a book and that’s how I came about it. I wasn’t just studying history.
Murray: Yeah. Let me tell you the three things that scare me and you can talk about what you saw that led you to these conclusions. But three big topics. One is the debt overhang in the current economy, and what’s happened in the past when you have that kind of a debt overhang and where that’s going to live pretty much convinced me that the short and shallow recession theory that you see sometimes in the markets these days is out of touch with history. So that’s one, we’ll come back to it. Two is the degree of polarization, political polarization in our society that exists right now that you track back over hundreds of years is the kind of polarization that you might see before a civil war. That’s a pretty scary thought and I want to delve into that. And then finally, the relationship between the U.S. and China, a rising power, a declining power, what history tells you about those kinds of relationships and the danger that we’re at a very explosive, historical point. So I’d love to start with those three big topics in any order that you prefer.
Dalio: Yeah. When you have a spend-more-than-you-earn, and you finance that by creating a lot more debt than you can pay back, then that creates a debt cycle. A long-term debt cycle, because one man’s debts are another man’s assets. And if you have a good return for those assets, it’s a great burden for the debtor. So there’s a delicate balance that has to take place in order to achieve that and that balance becomes more and more untenable when more you have debt assets and debt liabilities.
So we have a situation now, of course, where we’re spending a lot more money than we’re earning. So in the next year, so for example, the government will spend about $1.2 trillion more than it will take in in tax revenues. That’s about 5% of GDP. And the Federal Reserve is wanting to sell about the same amount, a little bit less 10% of GDP, they have to sell it, and it’s a bad deal when you’re holding bonds that has a return that’s significantly less than the return of inflation, and that creates a shift in the supply and demand. And when you look at history, you see that that debt payment will end up needing to be a very poor return relative to inflation that creates the tax that is essentially how they get the money, and that that dynamic produces a stagflation environment. That was apparent before we experienced our stagflation. That is how history works. So when you look at what does tightness of monetary policy mean, you know, there’s a view, you tighten monetary policy and you get rid of inflation and who couldn’t, right, could argue for that. What that really means is that you take money and credit buying power away from individuals and companies at the time, there’s inflation, and it produces a lot of pain. So what the government and central banks do, is they’re always balancing inflation pain, with economic contraction pain, and so we’re in the part of the cycle now that we have stagflation. And since inflation is the obvious greater pain and economic contraction, you have the policy that’s taking place which will continue until economic pain is greater than the inflation pain, and that’s that dynamic.
Murray: And that’s the critical point, the point at which economic pain is greater than the inflation pain. So based on your study of history, how bad is it going to get and how long is it going to last?
Dalio: You know, there’s nothing sure but I can take you through the calculations the way I look at it. If there were no shocks, no future shocks, such as geopolitical or whatever, that it looks to me like you’ll have a hump in inflation that’ll bring it down toward a little bit less than the 4% area, and then it’ll rise again to somewhere in the vicinity of 4 or 5%. Then when I do the calculations, I say, how bad is it going to get for a holder of bonds or cash? How bad will the negative real return be? It was -1.5%, it’s now real yields are about plus 1%. And those are very low levels by historical so I would say that you’re going to have something in the vicinity of a 1% real yield or, let’s assume conservatively, it’s a zero real yield. That means that the bond yield is going to go up to 4.5 to 5.5%.
As you start to do the calculations of what a above 4.5% bond yield interest rate would do to the economy, it’s very damaging. It first has its effects on asset prices, because the interest rate use is the discount rate for calculating present value of cash flow. So when an investment or investments or a lump sum payment for future cash flow, and you look at the discount rate or another way of looking at it is competitive interest rates. And so rise in that amount of interest rates would be worth a little bit more than it would be abou 20% in the stock market. That does not include that just the change of the discount rate. That does not include the effect that it would have a negative effect on the economy because it would lower growth rates. So when we think about the present value, it would have that effect and it will have credit problems.
So I think that as we’re looking at that number, we’re looking at the pain point, probably rising to somewhere in the vicinity of 4.5% and possibly more, and that having a significant pain point, first in the markets in the order of magnitude of what I was referring to 20 or, with the discount rate, could be 30% even from this level, it’s like 20 30% And at that point, there’ll be negative, it’ll be negative to the markets. That will still not easily bring down the inflation rate. The real question is, how low will they want it to go? Is it 2?
So I think we have ahead of us that conflict and that tightening that rate rise which will have those kinds of an effect and begin to make economic and market pain greater than we’re experiencing. And then they try to balance the two and so that’ll produce an inflation rate, which is almost certainly above their target and inflation rate. You know, maybe that…
Murray: So it keeps going?
Dalio: Yeah, so that’s the cycle. Let’s go back to the basics. There’s too much debt, which is too much financial assets. And that either means that that debt’s paid in hard money that maintains its value, which is too much of a burden on the debtor so it produces a problem and it means curtailing credit, or it’s too much of a negative return for the creditor.
Murray: Yeah, and the and the size of that debt overhang means this isn’t going to happen quickly. We’re talking about several years of stagflation, tough times before we get this worked out of the system.
Dalio: Right, that looks like that to me. And we have to keep in mind that what we experienced was a very temporary and very extreme availability of money and credit and low rates that everyone has adjusted to. So corporations have used that for funding and so many adjustments, homeowners and people have used that, and so it recalibrated at those negligible nominal rates and significantly negative real rates.
Murray: So let’s move to the second one. And as you point out very clearly in the book, these things interact with each other. But the second one is that the terrible polarization that we see in our politics. At one point I think you say, even a not at all negligible chance of civil war being the result based on historical patterns.
Dalio: Yes, I said a type of civil war, 30% chance of a type of civil war, so let me clarify what I mean by that. But more importantly, I want to say that as one studies history, you see these cycles go on and on, and they’re logical. And so what happens is, when you have financial issues, such as this, at the same time, as you have very large wealth and values gaps, there is greater conflict. And what happens is always through history, there is populism of the left and populism of the right, so there’s conflict over wealth and power and it becomes more extreme. And the middle in all of those cases diminishes relative to the populace of either side. A populace is a person who will fight for me, you know that in other words, they’re fighters who will not lose, they’ll win at any cost. So we have that dynamic.
So what does that mean? Well, most importantly, do we have rule of law and compromise and an effective governance system to make the decisions that make things go well? And it becomes increasingly dysfunctional? And it becomes increasingly antagonistic and it causes a polarity. So we, as we look at this, we have to continue to see the rule of law. Does the rule of law govern, but simultaneously you see groups go to different areas. You see movement, from some geographic areas to other geographic areas, not just for tax reasons, but for values reasons, schools, education, and so on. And that changes the economics because if you take a city, could be New York, Chicago, San Francisco, Los Angeles, and so on, if there’s a movement to other locations and the tax base is lost, then the polarity in those places becomes greater. So the type of civil war that I’m referring to, I don’t mean guns and shooting, but the adherence to following what the Supreme Court says. Or you can have the federal government make mandates and you can have something like sanctuary cities and so on that says I’m not following that. And when you have that you have the breakdown of power. And there’s a question about democracies at these times because at these times, it’s especially important to have strong leadership that is willing to deal with the problems in a way that works. And so in the 1930s, four major democracies turned to autocracies, you know, to make the trains run on time. Yeah. So that kind of conflict. It also has implications for tax policy, which has implications for corporations or individuals on how the whole system works.
Murray: Yeah. And it’s clear listening to you talk how the political and the economic effects interact. The political forces you’re talking about can hurt the economy even more. The economy already dealing with this debt overhang can exacerbate the political issues. So it feels like it could be a pretty dangerous spiral.
Dalio: Well, can you imagine, and it’s not hard to imagine, what an economic downturn would mean going into the 2024 elections, a financial problem, an economic downturn, and then the 2024 elections.
Murray: Yeah, you could easily as you say, in the book, you could end up in a situation where the losing side doesn’t accept the results of the election, and you’re in a mess.
Dalio: It’s a win at all cost, and also fed up with the dysfunctionality that produces and dealing with those issues. And that also brings the third issue that’s this trifecta. The third issue is external conflict.
Murray: The U.S. Chinese…
Dalio: Well, U.S., China, Russia, and so on. It’s costly. You have to have military expenditures. You have the costs of the war, the economic costs. If we take the Russian Ukraine war, the estimated cost so far is something like, all-in cost, $9 trillion. They estimate to rebuild Ukraine is going to be somewhere between 500 billion and a trillion dollars if you were going to try to rebuild it. Do you rebuild it or not? Who do you go to for the money and then you look at the inefficiencies and the costliness of inflation because traditionally, you have economic warfare taking place with military warfare. So the implications of Russia not sending gas to Europe. And the implications that we’re seeing has costs that exacerbate the inflation.
Now that’s just the European Ukraine war. If you had something like China, let’s it let’s just imagine that it became politically undesirable socially, it’s unacceptable to invest China or to buy Chinese goods the way it is for Russian goods. The economic consequences of that are enormous. The United States imports 22% of its manufactured goods come from China. Russia is economically insignificant by comparison to China so just the costs I’m talking about the economic consequences of the economic war could be very, very [inaudible].
Murray: I’m here with Joe Ucuzoglu, the CEO of Deloitte US and the sponsor of this podcast for all three of its seasons. Thank you for that, Joe.
Joe Ucuzoglu: Pleasure to be here, Alan.
Murray: We had this rising talk about a notion of stakeholder capitalism that businesses have a responsibility not just to their shareholders but to their employees, to the communities they operate in, to the natural environment. Is all of that talk real and will it last particularly when times get tough?
Ucuzoglu: I see a pretty durable shift, Alan, with a lot of momentum here. CEOs are prioritizing sustainability. They’re prioritizing purpose. They’re prioritizing trust. You certainly see some noise. On one end, there’s some skepticism as to whether this is virtue signaling. On the other end, there’s some lingering debate about whether this broader focus on stakeholders detracts from shareholder returns. If you cut through all the noise, what we’re seeing is actually a huge convergence of interests. This is core to sustaining a vibrant capitalist system. If you take a long-term view, the only way that you’re going to deliver sustainable shareholder returns is to take really good care of all those constituents that you referenced.
Murray: And is it working, Joe?
Ucuzoglu: Well, business was at the heart of leading society through the panemic. Business is at the heart of addressing the climate challenge. We’re seeing massive momentum with very tangible commitments and tangible actions towards decarbonizing the economy. So yes, I think the evidence is ample.
Murray: Joe, thank you.
Ucuzoglu: Alan, it’s a real pleasure.
Murray: You know, Ray, we have a lot of conversations on leadership next about what companies are doing to prevent a future climate catastrophe. And the interesting thing about this conversation you and I are having is you haven’t even mentioned the climate yet. How does the climate compare to the three big scares that you just gave us?
Dalio: What I learned about was that acts of nature, droughts, floods, and pandemics had a bigger effect on number of people dying, disrupting toppling civilizations and empires than the other three I mentioned. Because the weather impact from droughts and floods or pandemics can be very important. And I think we can’t ignore that. It’s a very big influence.
Murray: But if acts of nature have a bigger effect than the other three, why focus on the other three?
Dalio: Well, I think that one has to focus on on all that matter, the confluence of those things. When you have three, it’s bad enough when you have all four then that’s a that’s a problem. So we have to just recognize that in history, the fifth influence that has always been the most important longer term influence that’s an optimistic is man’s inventiveness. Man’s inventiveness. These cycles take place, but you always go through the cycle. They may last a limited number of years. A war, a depression lasts a limited number of years. Inventiveness continues and inventiveness is the means by which one can deal with things things like the development of the vaccines. And the capacity of man to invent today is greater by far than any any other time in history, because we’ve used technology to help to invent through what we call it artificial intelligence in different ways. Even technology is a two-edged sword because whoever wins the technology way race wins both the economic race and the military race.
So it still comes down to how we are with each other. Because I would say if you look at everything, we have a higher living standard than we’ve ever had. Longevity is greater. The world is richer than it has ever been. So if we stepped down and we have these economic problems and so on, there’s no reason that that’s not an acceptable stand down you become more inventive you get through it, and things improve over time. It all matters on how we are with each other. So when I think of the domestic issue, like I wish for a strong middle that brings the country together and maybe we have that, maybe we have that as a pendulum to the extremism. And then globally, to try to find out the win-win rather than lose-lose. Because if you have peace and you don’t have that type of conflict, you have a much better outlook.
Murray: So Ray, I’ve known you for a while now. And you’re not just someone to analyze where we are and how we got here. You’re someone who’s going to want to try and get us to a better place. What can we do to create, you know, you say people need to be better, better with each other in order to get over these things. What can we do? What can you do? What’s the solution to getting us on a path where it turns out well and not disastrous?
Dalio: Well, I’ll speak in general terms and I’ll speak in more specific terms. You need to be smart and bipartisan and work together. I don’t think that’s going to happen. But that’s why this strong middle is something that I think is very important. You need to abide by the rules of debate and elections and whatever they are, but you need to be effective, and you need to be smart. Now there’s a question as to whether anybody is capable of doing that in such an environment. Because right now, everybody’s got strong opinions on almost every issue and they will fight about those strong opinions.
So the next thing you need to do is you have to get the fundamentals right. How can you earn more than you spend? The fundamental law of nature. That means you have to find out either how to be more productive, by the way there are lots of potential ways of being more productive, and being socially capable, like investing in education. So then there are basics and you see them in the chart, tthe determinants, there are 18 different determinants that are the measurements, and there are things like quality of education equalness of opportunity. There are some of those basics that have to keep you strong and healthy. You’ve got to go back to that and you got to work on those things together.
Murray: Ray, final question. You’ve referred several times to the importance of leadership. That’s really what this podcast is all about. How does leadership have to change and evolve to deal with the challenges? You’ve raised some really significant challenges. What do we need from our leaders? What does leadership in this tumultuous era need to look like?
Dalio: Well, I think there is the the fundamental question is, can the population choose a good leader and allow them to lead and do the difficult things? Okay. A leader will need to think about difficult things. How do you change the system, restructure things and make it happen?
Murray: And you’ve been talking about political leadership. How about business leadership? What role does business leadership have to play in getting us?
Dalio: Well, I think it’s it becomes a similar question of what the constituents allow the leaders to do. We have a situation in which the all-in costs of what we’re doing do not get passed along. They may be environmental costs, carbon, you know various ways. And then you have shareholders who many shareholders say it’s the return on the investment, your job is not to make social decisions, and so how such things are resolved, I hope to be proven wrong on this, I don’t believe that they can be adequately changed, the less the leaders are given a strong enough mandate leaders of companies to make sort of revolutionary changes. So I do like, for example, measurement, there’s been tremendous progress in measurement, for example, the environmental impact of each company. And when you look at that, that measurement in and of itself, is a step toward dealing with the all-in consequences of that, and it’s becoming socially but a leader is not the owner. The shareholder is the owner, and the law legal system is the governor. And so it’s going to require those to work with the leaders otherwise the leader can’t lead.
Murray: Yep. Ray fascinating and sweeping view of the current predicament, if I can put it that way. Clearly, your dive into historical patterns and historical data has produced some really interesting insights. Thank you for taking the time to share those with us on Leadership Next.
Dalio: It’s my great pleasure. Thank you for having me, Alan.
Murray: Leadership Next is edited by Nicole Vergalla, written by me, Alan Murray, along with my amazing colleagues, Ellen McGirt and Megan Arnold. Our theme is by Jason Snell. Executive producers are Mason Cohn and Megan Arnold. Leadership Next is a production of Fortune Media. Leadership Next episodes are produced by Fortune‘s editorial team.
The views and opinions expressed by podcast speakers and guests are solely their own and do not reflect the opinions of Deloitte or its personnel. Nor does Deloitte advocate or endorse any individuals or entities featured on the episodes.
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