Recession? No, It's a D-process, and It Will Be Long
Ray Dalio, Chief Investment Officer, Bridgewater Associates

AN INTERVIEW WITH RAY DALIO: This pro sees a long and painful depression.
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. 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% 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 Matthew Furman for Barron's understand this process is because it happens rarely. "The regulators have to decide Everybody should, at this point, try to understand the how banks will operate. That means they are going to have to depression process by reading about the Great Depression or nationalize some in some form." the Latin American debt crisis or the Japanese experience so that it becomes part of their frame of reference. Most people -- Ray Dalio didn't live through any of those experiences, and what they have gotten used to is the recession dynamic, and so they are quick to presume the recession dynamic. It is very clear to me that we are in a D-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 can confuse the fact that it is a process that people should try to understand.

or any central bank. assets are bought on leverage at high-enough prices that the cash flows they produce aren't adequate to service the debt. OK. Are you confident that we are doing what's essential to combat deflation and a depression? The D-process is a disease of sorts that is going to run its course. and that becomes selfreinforcing.You can describe a recession as an economic retraction which occurs when the Federal Reserve tightens monetary policy normally to fight inflation. in which people finance their spending by borrowing and debts rise relative to incomes and. We will go through a giant debt-restructuring. more accurately. In the simplest sense. Emerging countries default. at which time the Federal Reserve eases monetary policy and produces an expansion. But now you can ask yourself. because we either have to bring debt-service payments down so they are low relative to incomes -. We can make it more complicated.S. economically viable entity that people want to lend to again. The incomes aren't adequate to service the debt. Then begins the reversal process. It is an essential process to get them economically healthy. that occurred in Latin America in the '80s.the cash flows that are being produced to service them -.or we are going to have to raise incomes by printing a lot of money.a dynamic that is self-reinforcing. making monetary policy as we know it ineffective? When was the last time we had deflation? The answers to those questions all point to times other than the U. too. and that occurred in the Great Depression in the '30s. As goes GM. This has happened in Latin America regularly. the country reaches the point when it needs a debt restructuring. . post-World War II experience. debt-service payments rise relative to incomes. You have made the point that only by understanding the process can you combat the problem. economies go through a long-term debt cycle -. exploded like it has? When was the last time interest rates went to zero. General Motors has to be restructured so that it is a self-sustaining. Basically what happens is that after a period of time. What you also need is a comparable understanding of what a D-process is and why it is different. and then restructure. This was the dynamic that occurred in Japan in the '90s. When I first started seeing the D-process and describing it. At cycle peaks. it was before it actually started to play out this way. General Motors is a metaphor for the United States. but that is a basic simple description of what recessions are and what we have experienced through the post-World War II period. so goes the nation? The process of bankruptcy or restructuring is necessary to its viability. One way or another. when was the last time bank stocks went down so much? When was the last time the balance sheet of the Federal Reserve. essentially. The cycle continues until the economy weakens enough to bring down the inflation rate.

Rep. There has been little in the way of debt relief yet. And because the risk of default has gone down. too. because different people will have different points of view about what should be done. it has forced the interest rate on the debt to go down. by and large. is to take an existing debt and say they will own it or lend against it. There is a giant financialsector piece -. Isn't the process of restructuring under way in households and at corporations? They are cutting costs to service the debt.banks and investment banks and whatever is left of the financial sector -that will need to be restructured. There is a corporate piece that will need to be restructured. 2009 and 2010 will be the years of bankruptcies and restructurings. has done a number of successful things. and then there is a commercial-real-estate piece that will need to be restructured. Very little corporate debt has been restructured. It is the same as all bankruptcies. So where do things stand in the process of restructuring? What the Federal Reserve has done and what the Treasury has done. What are you suggesting? An example is the Federal Reserve. The Federal Reserve. was the year of price declines. so that is good in a sense. and that raises the specter of the government and Congress trying to run the Federal Reserve. Is a restructuring of the banks a starting point? . There is a mortgage debt piece that will need to be restructured. That has had the effect of reducing the risk of that debt defaulting. but when it happens pervasively to a country. A lot of difficult questions will be asked of policy makers. Only when those debts are actually written down will we get to the point where we will have credit growth. However. But they haven't yet done much restructuring. it is preferable to print money and devalue. in particular. It will be a very difficult time. we will come out of it OK. Barney Frank [a Massachusetts Democrat and chairman of the House Financial Services Committee] is talking about examining the authority of the Federal Reserve. Last year. which has always been an autonomous institution with the freedom to act as it sees fit. The government decision-making mechanism is going to be tested. the reason it hasn't actually produced increased credit activity is because the debtors are still too indebted and not able to properly service the debt. It is going to surprise a lot of people because many people figure it is bad but still expect. Everybody will be second-guessing everybody else.It isn't complicated. Very. and that is good. 2008. very few actual mortgages have been restructured. The Federal Reserve went out and bought or lent against a lot of the debt. Loans will be written down and assets will be sold. as in all past post-World War II periods. But they haven't said they are going to write down the debt and cut debt payments each month. and the country has a lot of foreign debt denominated in its own currency.

we will still have the question of how those banks behave. They still aren't marking it down. To the extent we are going to have nationalized banks. But the future of banking is going to be very. The basic problem is that the borrowers had too much debt when their incomes were higher and their asset values were higher. The regulators have to decide how banks will operate. But the same question will be asked even after nationalization: What will happen to the pile of bad stuff? Let's say we are going to end up with the good-bank/bad-bank concept. let's say. you don't want to lend to them. .you are wrong. not nearly the amount needed. A lot of the banks aren't going to have money. The government will have to recapitalize them. So whose money is it. and who is protecting that money? The biggest issue is that if you look at the borrowers. 10 to 1. Does Congress say what they should do? Does Congress demand they lend to bad borrowers? There is a reason they aren't lending. very different. many of which will be broke. but I don't think they are going to come up with a lot of private money. the real-estate piece -.and going to get all the garbage at a leverage of. ultimately we need banks because to produce credit we have to have banks. The government will try to seek private money to go in with them. On the issue of the banks. but a trillion dollars' worth of garbage. Does this give you comfort? Then we have the remaining banks. we have got to do something.If you think that restructuring the banks is going to get lending going again and you don't restructure the other pieces -.say $100 billion -.the mortgage piece. The government is going to put a lot of money in -. They will have a trillion dollars. because they need financially sound entities to lend to. It is going on now and it will continue. the corporate piece. That means they will have to nationalize some in some form. and that won't happen until there are restructurings. Now net worths have gone down. but they are going to also have to decide who they protect: the bondholders or the depositors? Nationalization is the most likely outcome? There will be substantial nationalization of banks. and yet we can't just let them go to nothing.

how can you possibly lend to them now? I guess I'm thinking of the examples of people and businesses with solid credit records who can't get banks to lend to them.and most of them produced renewed optimism. and the budget deficit increased. with six rallies of returns of more than 20% -. stocks declined 89%. There are too many nonviable entities. the big picture.Let me give you an example. Those examples exist. in the bear market from 1929 to the bottom. But what happened was that the economy continued to weaken with the debt problem. By the way. Big pieces of the economy have to become somehow more viable. Most of them couldn't service their debt when the cash flows were up. and now the cash flows are a lot lower. This isn't primarily about a lack of liquidity. . but this is basically a structural issue. so therefore they have negative net worth. The '30s were very similar to this. If you shouldn't have lent to them before. Roughly speaking. The Hoover administration had the equivalent of today's TARP [Troubled Asset Relief Program] in the Reconstruction Finance Corp. most of commercial real estate and a good deal of private equity was bought on leverage of 3-to-1. There are certainly elements of that. The stimulus program and tax cuts created more spending. by and large. Most of it is down by more than one-third. but they aren't.

it doesn't mean necessarily that the bond market is bad. They can pull in their assets from abroad. Have you always been? No.and they have surpluses. creditor countries that don't have dollar-debt problems are the place you want to be. too. at first. Are you a fan of gold? Yes. But they did not rekindle lending. Ideally. The deficits will be greater than the savings. You print a lot of money. like Japan. Just as now. but they don't have the problems that we have -. I can easily imagine at some point I'm going to hate bonds and want to be short bonds. but. But like any other asset class. . and then long-term rates continued to decline because people still needed safety and liquidity.. countries couldn't get dollars because of the slowdown in exports. Not much in the way of inflation is produced. because I imagine gold could go up a whole lot and Treasury bonds won't go down a whole lot. which extinguished debt. Other currencies will decline in relationship to the yen and in relationship to gold. While the dollar is bad. a portfolio that is a mixture of Treasury bonds and gold is going to be a very good portfolio. because what you are doing actually is negating deflation. a Democratic administration replaced a Republican one and there was a major devaluation and reflation that marked the bottom of the Depression in March 1933. as there is now. Where is the U. countries around the world encountered a similar kind of thing. Everything is timing. or the United States during the Great Depression. because they will want to become defensive. everybody always should have a piece of it in their portfolio. So you will see the Federal Reserve buy long-term Treasury bonds. which will support their currency.S. So. What about bonds? The conventional wisdom has it that bonds are the most overbought and most dangerous asset class right now.At the same time. The Japanese economy will do horribly. and there was a dollar shortage. the first wave of currency depreciation will be very much like England in 1992. Gold is horrible sometimes and great other times. Gold went up a whole lot and the bond market had a hiccup. as it did in the Great Depression. and the rest of the world going to keep getting money to pay for these stimulus packages? The Federal Reserve is going to have to print money. with its currency realignment. In the U. when they printed money and devalued the dollar a lot.S. for now. Eventually there were a lot of bankruptcies. Efforts were directed at rekindling lending. and then you have currency devaluation. England went through then exactly what it is going through now. The currency devaluation happens before bonds fall. We are in a position where that will eventually create a problem for currencies and drive assets to gold.

because the idea was to make its goods competitive in the world. you want to create relief by having your currency go down. bringing inflation to a low. But they own too much in the way of dollardenominated assets to get out. You mentioned. However. roughly about two years. and will be an important step to our reflation and will make investments in China attractive. We have to get our prices in line. They are not going to continue to want to double down. you want your currency to go down. From the U.S. positive number rather than producing unacceptably high inflation -.and that will last for as far as I can see out. But there is a basic structural problem with China. that inflation is not as big a worry for you as it is for some. Given this outlook. they are going to have to go to a domestic-based economy. and we are not going to do it by cutting our incomes to a level of Chinese incomes. A devaluation gets your pricing in line. . one of the best ways to trigger a stock-market rally is to devalue your currency. what is your view on stocks? Buying equities and taking on those risks in late 2009. It is going to be a buying opportunity of the century. so a devaluation of the dollar in relation to China's currency is likely. the desire to have a weaker currency is everybody's desire in terms of stimulus. When there is a deflationary environment. When you have a lot of foreign debt denominated in your currency. Ray. All major currency devaluations have triggered stock-market rallies throughout the world. That is a complicated. for the most part. point of view. But they don't have to buy more. Could you elaborate? A wave of currency devaluations and strong gold will serve to negate deflationary pressures. or more likely 2010. we want a devaluation. China recognizes that the exchange-rate peg is not as important as it was before. too.And China? Now we have the delicate China question. touchy question. Ultimately. Its per capita income is less than 10% of ours. Thanks. will be a great move because equities will be much cheaper than now. and it isn't clear exactly where they would go if they did get out. But they have to come closer together. The Chinese currency and assets are too cheap in dollar terms. The reasons for China to hold dollar-denominated assets no longer exist. And they are not going to do it by having their per capita incomes coming in line with our per capita incomes.

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