3 Takeaways - An Urgent Warning on the Times Ahead with the Founder of the World's Largest Hedge Fund: Ray Dalio (#89)

Episode Date: April 19, 2022

Legendary investor Ray Dalio, who predicted the 2008 financial crisis, shares a similar urgent warning about what he sees ahead. He believes the times ahead will be radically different from what everyone today has experienced in their lifetimes, and he wants people to be prepared. Bill Gates said, “…super-provocative, super-important… A lot of facts line-up to create a scary picture that’s hard to refute.” Based on his study of the rise and fall of superpowers and history’s most turbulent periods, Ray is issuing a warning about the confluence of three major events that last happened between 1930 and 1945.He talks about debt creation, printing money, inflation, wealth disparity, populism and the rise of a great power to challenge the existing world order. Ray Dalio founded and built Bridgewater Associates into the largest hedge fund in the world and shares how to protect assets during the tempestuous and inflationary period ahead.His new book is Principles for Dealing with the Changing World Order: Why Nations Succeed and Fail.This podcast is available on all major podcast streaming platforms. Did you enjoy this episode? Consider leaving a review on Apple Podcasts.Receive updates on upcoming guests and more in our weekly e-mail newsletter. Subscribe today at www.3takeaways.com    

Welcome to the Three Takeaways podcast, which features short, memorable conversations with the world's best thinkers, business leaders, writers, politicians, scientists, and other newsmakers. Each episode ends with the three key takeaways that person has learned over their lives and their careers. And now your host and board member of schools at Harvard, Princeton, and Columbia, Lynn Thoman. Hi, everyone. It's Lynn Thoman. Welcome to another episode. Today, I'm excited to be with Ray Dalio, who founded and built Bridgewater into the largest hedge fund in the world. Ray predicted the 2008 financial crisis, and today he's going to share a similar urgent warning about what he sees ahead. He believes the times ahead will be radically different from what everyone today has experienced in their lifetimes, and he wants people to be

prepared. Ray is the author of two New York Times bestselling books. His newest book is Principles for Dealing with a Changing World Order. Welcome, Ray, and thanks so much for our conversation today. Well, thank you for having me. Ray, why did you study 500 years of world history? Well, I learned in my 50 years or so of global macro investing that many of the things that surprised me that were happening surprised me because they didn't happen in my lifetime before, but they happened many times before that, such as the Great Depression. You mentioned the anticipation of the 2008 financial

crisis. And if I didn't study the Great Depression, I wouldn't have understand and anticipated that. So there are three things that are happening in our lifetimes that have never happened before in our lifetimes, but did happen before that. And I needed to study those. And those three things are the amount of debt creation and the printing of money to monetize that debt creation. That's the first, the financial component of what's going on. The second is the amount of internal conflict, populism of the left and right causing a lot of conflict due to large wealth and values gaps. We have the largest wealth gaps, largest income gaps since the 1900 to 1930s period. And we have the largest amount of arguing

political conflict since 1900. So being at each other's throats, that internal conflict and the populism around that didn't happen in my lifetime, but happened many times before. And the third thing is the rise of a great power to challenge the existing great power and the existing world order. In other words, there's a system. The world order that we're in began in 1945 at the end of World War II, and the United States was the dominant power. And when you're the dominant power, you get to set the rules and there are no competitors. The Soviet Union was not a serious competitor because it was economically puny, but it had military power. But this is a different case because China is a comparable power economically and in many

different ways. So those three things led me to think I needed to study even the rise and decline of reserve currencies. And I needed to study then the rise and decline of all the things that went along with those, the empires, the various types of strengths and weaknesses that work together. So I needed to go back those cycles. These are big cycles, a rise and decline of an empire, a rise and decline of a reserve currency. These take place over 100 or 150 year type of time horizons, long time horizons. So I started back 500 years with the Dutch, then the British and so on. So that was what prompted me to do that. And can you tell us more about these cycles?

How do the positive ones compare to the negative ones? The cycle starts when things start anew. There's a new order. A new order means a new system. And usually it comes after a war because there's a fight for power, power and wealth. So 1945 was the new world order. And then after that world order, whoever's in power, that new system then creates a consolidation of power, making sure that there's not unacceptable opposition to that power. And then there comes a period of time of building and prosperity, peace and prosperity. The peace comes from the fact that nobody wants to fight the dominant power. And also nobody wants to fight because they went through this horrible war and they're done with it. And so they work together to build prosperity. And then there are certain signs that are healthy signs, signs like improving education.

So you can measure all these things and you can see education improves. Civility improves. Education is not just the education like you know how to do your reading, writing and arithmetic kind of thing. It's also knowing how to behave well to each other and on a mission. And then you have those periods that are Renaissance periods, but they produce wealth gaps and elements of decadence. So, for example, the Industrial Revolution led to the Gilded Age. And they also produce very large wealth gaps because in that process, wealth is not anywhere near equally distributed. And so those wealth gaps grow. And over a period of time, they also produce a belief in most people that the prosperity will continue and it'll raise the amount of indebtedness and speculation. So quite often that leads to bubbles with large wealth gaps. Also, what happens during that cycle is then there's a rise in competitors

around the world. So like we think about World War II, after World War II, the United States was the dominant power, half of world GDP, and we had 80% of the world's gold and the gold was money. But over a period of time, you get competitors and those competitors rise and you create ingredients, more indebtedness, larger wealth gaps and more competitors in the world. And those elements are signify the top. And then you start to see signs of that weakening. So you start to see maybe the educational advantages that the one country have, other countries are catching up, they gain the technologies and so on. So the gap lessens. And then you come into then the financial problems. In other words, very, very classically, they start with the financial problems, usually overextended. You spend more than you earn, like our country is doing,

and you do that with debt. And then a classic sign, because the coffers are empty, essentially, and then a classic sign is the printing of money. Like the Romans would change the amount of gold was in their gold coins and so on to try to stretch that, which is a symbol of that. And then there's internal conflict over these things that produces that greater polarity. For example, you could take the French Revolution, the Russian Revolution, the Chinese Revolution, the Cuban Revolution, many of them between the left and the right. And it threatens how people are with each other. They go from a rules-based system to fighting, which has elements that exist today. For example, it might be questioned

whether the next elections, any side will accept losing. And so is it rules-based or does it not? It's a test of the rules. In the 1930s, four countries that were democracies chose to be autocracies to get control of the conflict and then you have the rise of that and then you have then the fight an internal fight financial when financial conditions aren't good you have an internal fight you have an external fight you usually have one or the other because it's difficult to carry on both. And what happens is if you have an external opponent, it tends to minimize the internal conflict because they unite against the external opponent.

Or if you don't have that, you have an internal fight and then you have the fight and then you have the winner. And then the winner determines the new order, the new system. And that's how these things go i was fascinated that in your study you found that there were many declines in fact i think you found that seven out of ten countries had their wealth wiped out at least once and others had a decade or more of terrible returns Can you talk about the periods of decline and negative returns? Well, what happens is it's gone back thousands of years. There's always the issue of how many claims you have on money. So what is money? And then how many claims do you have on money? So financial wealth grows relative to the actual tangible wealth. It used to be before the Dutch invented the stock market and then stocks.

And before that, wealth was what you had as wealth. It wasn't promises about when I make wealth, I'll give you a certain share. The development of the making of wealth. And so those claims, when there's a lot of claims of wealth, financial wealth, like we have a lot of financial wealth and all that financial wealth, theoretically, you can sell it and you could buy the real wealth. And when those claims get large, they can't be met. I mean, literally, if we take almost anybody, they look at how much financial wealth they have, and it's much larger than the actual tangible number of things they have. And it's a little bit like musical chairs.

So if you want to turn in your wealth and get your real wealth, it can never happen. And so when that becomes very large, and also that happens at the same time as there are large wealth gaps, then the real returns have to go down. And so when you have a lot of debt, one man's debts is another man's assets, financial assets. So when you've got a lot of those, it's difficult to give both adequate returns to the holders of that debt and give them adequate returns. But those adequate returns and interest rates are too high for the debtors. So that balancing act becomes very, very difficult. And so when you see that with a large wealth gap, that's why you see that set of circumstances, which is the set of circumstances

we have now. Think about it, let's say, think about the transition or the deal. If you buy a bond and you buy it in the United States, and now let's say it's a 2% bond, and you say, what does that deal look like? Well, if you look at nominal returns, in other words, number of dollars without adjusting for inflation, and you say, I'm going to give you my money, how many years do I have to wait to get back what I gave you? You have to wait 50 years to get back what you gave me and what the profits are going to be after those 50 years. And if you do the same calculation in inflation adjusted terms, you'll never get back your money, your purchasing power. And so when you have that kind of a shift of financial assets and poor returns, money becomes worth less because they have to satisfy that. They have to print more money. So that causes the devaluation it's funny really it's odd because

people sometimes don't get that including central bankers because what happened in march of 2020 is we had the crisis and it's a very appropriate to try to help the provide the money and the credit to minimize that but so much about five times as much money and the credit to minimize that. But so much, about five times as much money and credit was produced as would be necessary to compensate for those who had losses arising from that. So everybody gets checks and everybody's happy. And then inflation rises and they're unhappy. Well, how could they be surprised? If everybody's getting checks, they're going to spend that money and that buying power, and that's going to make inflation rise. So that's the way that cycle works.

And when it's working that way, when there's the same conflict internally and then conflict externally, we have the kind of environment we have. Where do you think we are in the cycle? It sounds like you believe that we are late in the cycle. Yeah, we're late in the cycle. And also, I want to emphasize that my conclusions or anyone's conclusions are not as important as the reasoning that leads to those conclusions. So it was very important for me to have measures. And so in the book, you can see a number of measurements. How is education doing? How is inventiveness doing? How is our share of world trade? How is output doing? All

of those things. How are those numbers? How do they compare with other countries? And which has what power and what is rising? And so you could just see where we are. We are declining relative to other countries. China is growing the strongest. I've been going to China since 1984 and have long experience in intimate contact. When I started going in 1984, since then, per capita income has increased by 26 times. They are the largest trading company. They sell more exports in the world than any other country. They've raised their life expectancy by 10 years. They've eliminated poverty from the going hungry type of poverty from 88% to one

and so on. So if you look at technologically competitive and so on, they are competitive. It's the main competitive power. So we are seeing that power gap narrow, and we are also seeing our own financial conditions and what we are like reflected in those statistics. I think it's very important to be objective. So I just wanted to have the measurements so we can objectively look at that. And I felt that by providing these objective numbers and measurements, it also can provide a feedback loop that we might be able to then look at, are we becoming healthier or are we becoming less healthy? And what do we do about it? So you're seeing now what you've mentioned is the creation

of lots of debt and printing money you've talked about internal conflict and the rise of china as a challenging power so you believe clearly we're at the end of a long positive cycle i want to be clear that there are things that can be done but but they're difficult. OK, so it's just like health. You are where you are and the others are rising and getting stronger. The next generation is. And OK, that's a reality. But there are just the basics. Are you earning more than you are spending?

And do you have a good balance sheet which has more assets and liabilities? That's number one. If we're going to get healthier, we have to do that, which means we have to be more productive and more competitive in the world, or we have to cut our spending to live more within our means so that we don't have financial excesses. The second thing is, are you good with each other? Do you work in a harmonious, productive way? Competitive is good, but competitive, productive ways to improve productivity and have harmony. If you can do those things domestically and internationally, then you have a competition. It's a healthy competition

that you're competitive in. And so I think it comes back to how are we going to behave with what kind of self-discipline and harmony? Because there's another cycle, which is this war mentality. It's so interesting because you see this psychological cycle, psychological about spending, borrowing, but also about war. The new generation had never been through a serious war. So they're more readily willing to get into a war. But if you look at history, almost anybody, even the most eager to get in the war and fight, the wars have been so terrible that they never want to get into a war again. And so that enters into part of that psychology in terms of that arc. So I think we're kind of in that spot. Can we change our mentality, almost experience the things that

are like my parents experienced? They went through the depression and war. And can you have that self-discipline and work well together and avoid the war is the real question. And if there is a period of relative decline, how long are the periods of relative decline in countries that you've studied? They go on for a really long time. Very few empires have resurfaced as the new empires.

The Roman Empire, the Greek Empire, and all of those, as you go through that, there's a long, long time. And all empires have declined. And then there's new rising empires through history. China, of course, is one of the examples of an empire that declined and what a thousand years later is now. Yes, China is very interesting because I studied the dynasties going back to the

Tang Dynasty, which is around the year 600. And you could see the arcs of those. A successful dynasty might be 200 years old, sometimes a little bit longer, sometimes shorter. But China over the last, so that was since 600, you could see that they a number of times had a rise. The empire was the most powerful in the world, and then they decline, and then it rises, and it's the most powerful in the world. But the gaps between those are very long. So that's right. If you look at the last dynasty, which is the Chinda dynasty, and you go to 1840 or so, very much on top of the world,

but it was weak militarily in relationship to the powers, the British and so on. And then they had what they call their hundred years of humiliation. So about from 1840 to 1949 was when the People's Republic of China was formed. There was that hundred years of humiliation. And then you begin a recovery. So you have to go from a little past 1800 until now to be kind of up there as one of the world's great powers. and a depression, and no one foresaw inventions such as the telephone, the light bulb, the internal combustion engine, movies, planes, TV, antibiotics, the computer, nuclear weapons, GPS, the internet, CRISPR, and I think your list goes on and on.

But the question that I really want to ask you is, how do you invest since we can't foresee innovation or the future? First of all, to know how to diversify well, because this is the most important thing. You can reduce one's risk without reducing one's expected returns by knowing how to diversify well. Don't have all your eggs in one basket. Also, to know that at these times, cash is not a good investment. Look at your returns in inflation-adjusted terms, because that's buying power. The hidden tax and the hidden creation of wealth comes through the

printing of money. What I mean by that, you're losing money. People think that cash is safe. Inflation last year was 7%. Inflation had probably be the next year, maybe 5% more, maybe. And if you're holding your money in cash, you're thinking you're safe. Well, you've just lost a lot of money, a lot of buying power. So look at that in real terms and be diversified really outside of cash. And those would be the main thing. And that diversification means country diversification, currency asset class diversification. I think that's the most important thing. And broadly, what asset allocation categories do you recommend? You mentioned countries, you mentioned currencies. What other categories do you recommend people invest in passive stock indexes in different

countries? I would rather not get into all the particulars because there's so many things. To oversimplify, there are two main influences, inflation and growth, and they can go up or they can go down. So to own a mix of assets that is balanced in those environments so that there's not an environmental bias is very important. And then to do that in different countries. When I think about different regions, there are many. There's just so many that you can get into, just so many, and we'll digress into that, and I think we'd rather not.

So before I ask for the three takeaways you'd like to leave the audience today, what else would you like to mention that you haven't already talked about? I really want you to understand the story and the cycles of history and where we are in it so that you're prepared

and you're not surprised. I wrote the book and that's comprehensive. I also put out a short video and that's an animated video and it's called also the changing world order. It's on YouTube. I'd suggest it's entertaining and it tells the story in a nutshell. So you don't have to wade through that.

But I have a compelling desire to help pass this along for you to consider. The main thing is there are many dimensions, how you psychologically approach these things. There's always a path to be good. There's always a path to be safe, you individually. And there are many ways to do that. And there are many in the book. But to have enough money, enough resources, and to be prepared that no matter what happens, wherever it is, I think is very important. I saw your video that you mentioned, and it's terrific. It's also impressive that you have over 2 million views in its first 24 hours. So congratulations. Well, thank you. I think it's helping a lot of people i hope people check it out so ray what are the three takeaways you'd like to leave the audience with today

that what you don't know and how you deal with it is more important than anything you know so on that i want to emphasize how you can deal with that. You can deal with that by being radically open-minded and humble to take in the best thinking of other people and consider the situation and then reduce, eliminate your worst case scenarios. Second is, I think in addition to the arcs that I'm referring to, the big cycle, everybody is in a life arc to know where you are in the life arc. In other words, like I think that there are three phases, broadly speaking, in your life, which is the first phase. You're dependent on others and you're learning and you're in school. Second phase, you're working and others are dependent on you and you're trying to be successful.

Then the third phase, you are not working. And the ideal thing is for have people successful without you, people you love. And to know where you are in that life arc and where you're going, I think is very important. And then along those lines, let's say related to that is also know your nature, what you're like, your pulls and find the path that's suitable to that nature. Cause there's so many choices, but the right path is the right path for your nature. I've created personality profile tests. There's something called principlesples U, and it's free. And you can go online and you can take it, and it'll tell you more about your nature. But to know your nature and pursue those things,

like your work and your passion are the same things. And then, of course, you have to deal with the financial part. But just like we talked about before, like you're pursuing your passion and your work are the same things, and they're consistent with your nature. So I think that those would be the three. talked about before, like you're pursuing your passion and your work are the same things and they're consistent with your nature. So I think that those would be the three. Ray, thank you so much. This has been terrific. Thank you. I appreciate you giving me the opportunity.

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