Friday, March 9, 2012

Ray Dalio: Man and Machine

The Economist profiles [link to article] the kooky but incredibly successful CIO of BridgeWater, Ray Dalio today. We have written about Dalio before (see here and here), and we are amazed at his firm's ability to navigate these treacherous waters. BridegWater's Pure Alpha Strategy (18% volatility) was up 17.2% in 2008, 5% in 2009, 60.7% in 2010, and an astonishing 36.4% in 2011.

Dalio still believes that we are in the middle of a long deleveraging cycle, and he is careful to distinguish between a short-term business cycle and a long-term debt cycle.

Two sorts of credit cycle are at the heart of Mr Dalio’s economic model: the business cycle, which typically lasts five to eight years, and a long-term (“long wave”) debt cycle, which can last 50-70 years. A business cycle usually ends in a recession, because the central bank raises the interest rate, reducing borrowing and demand. The debt cycle ends in deleveraging because there is a “shortage of capable providers of capital and/or a shortage of capable recipients of capital (borrowers and sellers of equity) that cannot be rectified by the central bank changing the cost of money.”

He notes that deleveraging cycles are difficult to recognize and fix:

A deleveraging is much harder to end. According to Mr Dalio, it usually requires some combination of debt restructurings and write-offs, austerity, wealth transfers from rich to poor and money-printing. A “beautiful deleveraging” is one in which all these elements combine to keep the economy growing at a nominal rate that is higher than the nominal interest rate.

Print too little money and the result is an ugly, deflationary deleveraging (see Greece); print too much and the deleveraging may become inflationary, as in Weimar Germany.


And, more importantly, he is currently optimistic given the ECB's LTRO program:

Although he still expects debt restructuring in Spain, Portugal, Italy and Ireland, on top of that in Greece, he says that the “risk of chaos has been reduced and we are now calming ourselves down.”

Finally, according to a recent update from the firm, BW has now flipped to a short-treasury position, and is also net long equities.

Dalio at The Economist’s Buttonwood Gathering on October 26th-27th 2011

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