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Fixing a Deflation: A Most Intelligent Analysis
I have reprinted in total an interview between fund manager Ray Dalio and Barrons.This is the most detailed and well-thought-out description of what is a deflation andhow it is repaired that I have seen. It echoes my thoughts and commentary almostverbatim, but with a lot more detail and credibility. Read on to understand what ishappening and how we get out. I will put my commentary in brackets[]:http://online.barrons.com/article/SB123396545910358867.html?page=2&page;=spSATURDAY, FEBRUARY 7, 2009 INTERVIEW
Recession? No, It's a D-process, and It Will Be Long
Ray Dalio, Chief Investment Officer,Bridgewater AssociatesBy SANDRA WARDAN INTERVIEW WITH RAY DALIO: This pro sees a long and painfuldepression.
NOBODY WAS BETTER PREPARED FOR THE GLOBAL market crash than clients of Ray Dalio's Bridgewater Associates and subscribers to its Daily Observations. Dalio, the chief investment officer and all-around guiding light of the global money-management company he founded more than 30 years ago, began sounding alarms in Barron's in the spring of 2007 about the dangers of excessive financial leverage. He counts among his clients world governments and central banks, as well as pension funds and endowments."The regulators have to decide how banks will operate. That means they are going to have to nationalize some in some form." No wonder. The Westport, Conn.-based firm, whose analyses of world markets focus on credit and currencies, has produced long-term annual returns, net of fees, averaging 15%.In the turmoil of 2008, Bridgewater's Pure Alpha 1 fund gained 8.7% 
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net of fees and Pure Alpha 2 delivered 9.4%. Here's what's on his mind now.
Barron's:
 
I can't think of anyone who was earlier in describing the deleveraging and deflationary process that has been happening around the world.
Dalio:
Let's call it a "D-process," which is different than a recession,and the only reason that people really don't understand this process isbecause it happens rarely. Everybody should, at this point, try tounderstand the depression process by reading about the GreatDepression or the Latin American debt crisis or the Japaneseexperience so that it becomes part of their frame of reference. Mostpeople didn't live through any of those experiences, and what theyhave gotten used to is the recession dynamic, and so they are quick topresume the recession dynamic. It is very clear to me that we are in aD-process.
Why are you hesitant to emphasize either the words depression or deflation? Why call it a D-process? 
Both of those words have connotations associated with them that canconfuse the fact that it is a process that people should try tounderstand.You can describe a recession as an economic retraction which occurswhen the Federal Reserve tightens monetary policy normally to fightinflation. The cycle continues until the economy weakens enough tobring down the inflation rate, at which time the Federal Reserve easesmonetary policy and produces an expansion. We can make it morecomplicated, but that is a basic simple description of what recessionsare and what we have experienced through the post-World War IIperiod. What you also need is a comparable understanding of what aD-process is and why it is different.
You have made the point that only by understanding the process can you combat the problem. Are you confident that we are doing what's 
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essential to combat deflation and a depression? 
The D-process is a disease of sorts that is going to run its course.When I first started seeing the D-process and describing it, it wasbefore it actually started to play out this way. But now you can askyourself, OK, when was the last time bank stocks went down so much?When was the last time the balance sheet of the Federal Reserve, orany central bank, exploded like it has? When was the last time interestrates went to zero, essentially, making monetary policy as we know itineffective? When was the last time we had deflation?The answers to those questions all point to times other than the U.S.post-World War II experience. This was the dynamic that occurred inJapan in the '90s, that occurred in Latin America in the '80s, and thatoccurred in the Great Depression in the '30s. Basically what happensis that after a period of time, economies go through a long-term debtcycle -- a dynamic that is self-reinforcing, in which people finance theirspending by borrowing and debts rise relative to incomes and, moreaccurately, debt-service payments rise relative to incomes. At cyclepeaks, assets are bought on leverage at high-enough prices that thecash flows they produce aren't adequate to service the debt. Theincomes aren't adequate to service the debt.Then begins the reversal process, and that becomes self-reinforcing,too. In the simplest sense, the country reaches the point when it needsa debt restructuring.General Motorsis a metaphor for the UnitedStates.
As goes GM, so goes the nation? 
The process of bankruptcy or restructuring is necessary to its viability.One way or another, General Motors has to be restructured so that it isa self-sustaining, economically viable entity that people want to lend toagain.This has happened in Latin America regularly. Emerging countriesdefault, and then restructure. It is an essential process to get them
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