The Breakdown - Ray Dalio on Dumb Dollar Debt, Bitcoin Controls and the Coming Assault on Capitalism

Episode Date: March 17, 2021

Today on The Breakdown, NLW reviews Ray Dalio’s latest essay, looking at: The six reasons why it doesn’t make sense to hold bonds anymore Why holding bonds is especially troubling in the concept of growing government money printing Why sovereign bond holdings are shifting from the U.S. to China  Why proposed wealth taxes are likely just the beginning of a more aggressive period of financial regulation  Why we could see the government try to ban gold and bitcoin as their grip on reserve currency status weakens -- Earn up to 12% APY on Bitcoin, Ethereum, USD, EUR, GBP, Stablecoins & more. Get started at nexo.io -- Enjoying this content?   SUBSCRIBE to the Podcast Apple:  https://podcasts.apple.com/podcast/id1438693620?at=1000lSDb Spotify: https://open.spotify.com/show/538vuul1PuorUDwgkC8JWF?si=ddSvD-HST2e_E7wgxcjtfQ Google: https://podcasts.google.com/feed/aHR0cHM6Ly9ubHdjcnlwdG8ubGlic3luLmNvbS9yc3M=   Follow on Twitter: NLW: https://twitter.com/nlw Breakdown: https://twitter.com/BreakdownNLW   The Breakdown is produced and distributed by CoinDesk.com

Many bitcoiners, even those who don't think you can ban Bitcoin, acknowledge how difficult governments could make it for their citizens to interact with it. But what they believe that someone like Dallio doesn't understand is that there is a paradigm shift in power on a more fundamental level. This is the shift in power from states to network. Bitcoin is both an outgrowth and an accelerant of this shift from state power to network power. And like trying to squeeze your fist around water in an ocean, Bitcoin will, like all network power, simply flow elsewhere. Welcome back to The Breakdown with me, NLW. It's a daily podcast on macro, Bitcoin, and the big picture power shifts remaking our world.

The breakdown is sponsored by nexo.io, Casper, and NEM, and produced and distributed by CoinDesk. What's going on, guys? It is Tuesday, March 16th, and today we are talking about Ray Dalio on Dumb Dollar Debt, Bitcoin Controls, and a coming assault on capitalism. Quickly before that, just a little bit of housekeeping, I just wanted to mention something. You'll probably notice that in the next week or two, I may have fewer guests than normal. This isn't because of any sort of moving away from having guests on the show. In the long term, I think the right balance is something like two to three guests a week and three to four regular shows per week. However, with the new baby, the scheduling of guests gets a little bit hairy, and so I'm probably

going to be backing off that just for a minute. It will not go away. And in fact, if you have guests that you're specifically interested in, I'm also really conscious of the fact that with so many great podcasts out there right now, it can be kind of a junket where you hear from the same people all the time. If there are specific voices that you're interested in or just perspectives that you'd like, but you're not sure who represents those perspectives, hit me up in a DM on Twitter and let me know I'm always taking into account who you want to hear from. I would say there will be more guests in March, but probably it will be April before I'm really back to the type of ratio and regularity that I think is good for the show in the long term. With that said, though, I want to dive into an interesting conversation today.

Ray Dalio wrote another piece yesterday on his LinkedIn that I think is useful for understanding the macro environment where we are. certainly useful in seeing how some investors who follow people like Dallio think about this larger debt cycle that we're coming to the end of. What I'm going to do is summarize a lot of his piece for those of you who haven't had a chance to read it and give it a little bit of context and response then after. Four relevant points on Dallio that I think help contextualize his relationship with Bitcoiners. First, I believe that for many, there is an appreciation of his high-level macro perspective, particularly when it comes to the long-term debtors. cycle. In other words, there are a lot of Bitcoiners out there who agree with the way that he sees the

setup. They just don't agree on the likely outcomes or the right response. Second, when it comes to a specific criticism around how he sees things playing out outside of just specific Bitcoin thoughts, which will get into in a minute, he has a lot more confidence in China as a good faith actor in the global economy than many, which obviously colors how he sees the right response to this macro setup. when it comes to Bitcoin, I see Dahlio is in the midst of an evolution. A few months ago, he started giving indications that he was open to changing his perspective on Bitcoin. In fact, he decided it was important enough to write down his exact take on Bitcoin because he kept feeling his words were being misinterpreted. Now, my take on all this is that he was paving the way to announce a Bitcoin-related

fund sometime this year, and that's still one of my 2021 predictions. I would be extremely surprised if we don't see a Bridgewater-slash-Dalio Bitcoin-related fund. Fourth and final setup piece, there is one specific area that he differs from Bitcoiners around, which is how much risk he sees in governments trying to shut down Bitcoin. He has said repeatedly that if Bitcoin gets too big, governments will just ban it. Obviously, on this show, we've talked a lot about realistically what a ban would mean, what it might not mean, how we think about it rightly and wrongly, and this will again be relevant for this new piece that he just wrote.

So let's actually talk about that piece. He published an essay on LinkedIn yesterday called Why in the World Would You Own Dollar Debt? Many of the Bitcoiners I've seen discussing it are honing on one specific line that we'll get to that relates to that banning confiscation idea, but I think it's worth understanding his arguments in light of getting a sense of this broader macro picture. So we're going to summarize his key arguments and then we'll get into a larger discussion. By the way, if you're not sure about some of this terminology, particularly around bonds, go check out Macro 101 with Kevin Kelly from last week. It has a whole overview of bonds. It might be useful. The essay is divided into two sections. The first section is why it doesn't

make sense in his mind to own bonds. Let me do the TLDR of the six points he makes and then we'll go into each of them a little bit more. The first is bond markets offer low yield. The second is economics of investing in bonds and most financial assets has become, in his words, stupid. Third, he thinks the world is substantially overweight in bonds at the same time that governments are producing enormous additional amounts of debt. Fourth, if bond prices fall, it would produce big losses that could induce more selling. Five, he has concerns around what happens if holders of these debt assets decide they want to sell, especially on mass. And six, he points to the history showing that central banks will be forced to devalue cash to address

these issues. So let's talk first about bond markets offering low yield. A couple of stats he points to are first, the real yields of reserve currency sovereign bonds are negative and their lowest ever. Real yields on cash, meanwhile, are even worse. They're not as negative as they were in the period between 1930 and 1945 or between 1915 and 1920, but they are negative. This has impact on institutions like pensions, insurance companies, and sovereign wealth funds that have specific financial obligations and increasingly can't use bonds the way they used to. Now to Dahlio's second point, the economics of investing in bonds and most financial assets has become stupid. Here, it's simply a look at how economically irrational it is to have to wait decades to get your money back when there's no

real return. The payback periods for holding cash in bonds in both nominal and real terms is right now the longest ever and quote, obviously a ridiculous amount of time. As Dallio says, rather than get paid less than inflation, why not instead buy stuff, any stuff that will equal inflation or better? This, of course, is one of the primary drivers of the idea of Bitcoin as an inflation hedge. And what's more, it gets into the idea from a show a week or two ago where I said that stocks are acting like Bitcoin and what I meant is that in a world of negative real rates, anything that preserves its value or goes up in value looks better than bonds that just decrease over time. Now, Dahlio's third point is also going to be highly familiar to people in the Bitcoin

space, and this is the idea that the world is substantially overweight in bonds at the same time that governments are producing enormous amounts of additional debt. U.S. bond holdings currently represent over one-third of global bond holdings by central banks, sovereign wealth funds, and international investors. This is because of the U.S. dollar's global reserve status, but there is a cycle here. First, you become a reserve currency. Second, you leverage exorbitant privilege to over-borrow. Third, that over-indebtedness threatens your reserve currency status. That's the cycle that Dahlio believes is playing out right now,

and in so doing, he identifies a shift from U.S. to Chinese bonds. Currently, Chinese bonds represent only 6% of allocations globally, but that is growing quickly. He gives a whole set of reasons why Chinese bonds are looking comparatively good. He identifies that they are relatively underweight compared to other types of bonds, that China is increasingly open to foreign investments, that their favorable balance of payments makes them relatively more attractive. And finally, he points to the increasing internationalization of the RMB. As I mentioned at the top of the show, Dahlio's perspective on China is one of the

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Basically, he argues here that bond investors have been too comfortable, saying, quote, bonds have been in a 40-year bull market that has rewarded those who are long and penalized those who were short. So the bull market has produced a large number of comfortable longs who haven't gotten seriously stung by a price decline. That is one of the markers of a bubble. Dahlio is also concerned around what happens if the holders of these debt, assets decide they want to sell. He notes that there is over $75 trillion of U.S. debt of various maturities, which holders assume, in fact, it is the predication of holding these assets that they can sell them to get cash and buy goods and services. Here's a key line from Dahlio's piece.

The problem is that, at current valuations, there is way too much money in these financial assets for it to be a realistic expectation that any significant percentage of that bond money can be turned into cash in exchange for goods and services. So what then would happen if this money tried to move? Any significant movement could create a run on the bank, what Dahlio calls a reverse wave. The only way to accommodate this, he says, is, quote, via printing a lot of money and devaluing it, and restructuring a lot of debt in government finances, usually including large increases in taxes. He points to the period of 1930 to 1945 and 1970 to 80 around this, which brings us to his final point. Quote, history and logic show that central banks, when faced with the supply

demand and balance situation, that would lead interest rates to rise to more than is desirable in light of economic circumstances, will print the money to buy bonds and create yield curve controls to put a cap on bond yields and will devalue cash. So again, here, Dahlio points to the example of 1930 to 1945. Arguing that for a time, central bankers can control the yield curve to make bonds comparatively less bad looking than cash. In that depression in World War II period, the Fed kept bond yields around 2.5% and cash around 1%, which made it profitable to borrow cash and use it to buy bonds. But he argued to do this, they had to outlaw gold and the movement of capital elsewhere. And this is perhaps the key part of this entire essay, that Dahlio sees that sort of outlawing

on the table again. Quote, such moves would signal the beginning of the very last and most disruptive stage of the long-term debt cycle. It is, in fact, that debt cycle that is the subject of the second half of this essay, which he titled, This Dynamic is typical of the late stage of the long-term debt cycle. He kicks off the section with the real TLDR, that credit growth is a stimulant which creates buying power that then causes spending on financial assets and the economy to go up, but which simultaneously creates debt obligations that eventually act like a depressant when it comes time to pay them back. And he argues that we are in that debt obligations that act like a depressant section. Over the years of stimulation, there comes a,

quote, unhealthy residual effect which comes in the form of growing debt liabilities. At some point, those that let money want to start getting paid. But this isn't so easy. Here's how Dahlio describes it. The debts are like nuclear waste that isn't easy to dispose of. Eventually, these debt liabilities and assets become too large and burdensome, so they have to be reduced one way or another. When that realization occurs abruptly, it triggers the previously described run-on-the-bank, central bank money-printing, market action dynamic that I call the reverse wave. That is traumatic for those who are holding the debt assets and traumatic for most everyone, though it eventually reduces the ratios of debt and debt service to incomes. It is also traumatic for capital markets, capitalism, and

economies. During this credit-dead collapse, people realize that they don't have as much buying power as they thought, and financial and economic conditions worsen. There is not enough real money and credit, so taxes are also typically raised a lot, and there is typically a lot of conflict over who should get how much money from whom. It appears to me that we are in that part of the credit debt cycle. Indeed, for Dahlio, that's actually part of a larger cycle as well. First, this credit and debt cycle. Second, the internal conflict that arises due to wealth values and political gaps. And third, the external conflict cycle due to, quote, the leading world power, its world order, and its reserve currency, now the U.S., being challenged by the leading rising power, China. Of course,

this isn't happening in a vacuum. We've had a year of a global pandemic, which has accelerated many of these forces. And here's how Dahlio sums that up. These circumstances created a lot of government debt because there wasn't enough free market buying of this debt, central banks had to buy it and print a lot of money to buy it with, so much that they drove rates down to artificially low levels, which artificially supported financial asset prices. That move was a classic move. there's just so much money injected into the markets and the economy that the markets are acting like a casino with people playing with funny money. Or, as I mentioned before, markets are in some cases acting as a store of value instead of things like bonds because in a negative real-rate

world they're guaranteed to depreciate in value. So here's the final key line to quote from Zalio's piece. What happens next? Based both on how things have worked historically and what is happening now, I am confident that tax changes will also play an important role in driving capital flows to different investment assets and different locations, and those movements will influence market movements. If history and logic are to be a guide, policymakers who are short of money will raise taxes and won't like these capital movements out of debt assets and into other storehold of wealth assets and other tax domains, so they could very well impose prohibitions against capital movements to other assets, e.g., gold, Bitcoin, etc., and other locations. These

tax changes could be more shocking than expected. This is the crux of the thing that people are responding to. He discusses then how the wealth tax proposed by Elizabeth Warren could lead to capital outflows to evade those taxes. He even says that the United States could become perceived as a place that is inhospitable to capitalism. So what's his answer? For Dalio, it's a move to emerging market assets versus assets in mature reserve currency countries, and also an idea to be mindful of these tax changes and possibilities of capital controls. Let's get now to the responses. As I mentioned, that Bitcoin a response is definitely focused on Dahlio's argument that governments could, quote, very well impose prohibitions against capital movements to other assets and other locations.

Michael Saler tweeted, I agree with Ray Dahlio that bonds no longer work as a treasury asset. Respectfully, Bitcoin is the obvious solution and much more practical than, quote, a well-diversified portfolio of non-debt and non-dollar assets in Asian emerging markets. Max Kaiser, in typical fashion, put it more bluntly, saying Ray is trying to change Bitcoin. He hasn't learned the primary lesson. You don't change Bitcoin, Bitcoin changes you. My Two Sense comes back to the same thing we've seen over and over again this year in these debates about government bannings. I think in many ways this argument from Dahlio is actually a more nuanced banning take than what he has said before. He has previously stated the more generic. If Bitcoin is a threat, governments will ban it.

Instead, this time he is pointing to a specific exemplary period, the 19th. 30s and 1940s. He's saying that part of the playbook implemented then was capital controls that limited people's options to the controllable cash or bonds. This is what gold forfeiture was a part of. Now, on the other side, the Bitcoins a response can sound glib on first pass, something to the effect of, okay, go ahead and try to ban it, or just simply you can't ban it. People who have lived in the state paradigm bristle at that idea. They think that Bitcoiners don't have a proper appreciation for the power of the state. Some certainly don't. However, many bitcoiners, even those who don't think you can ban Bitcoin, acknowledge how difficult

governments could make it for their citizens to interact with it. But what they believe that someone like Dahlio doesn't understand is that there is a paradigm shift in power on a more fundamental level. This is the shift in power from states to network. Bitcoin is both an outgrowth and an accelerant of this shift from state power to network power. And like trying to squeeze your fist around water in an ocean, Bitcoin will, like all network power simply flow elsewhere. In that squeeze, citizens and corporations of a nation could

find their situation much worse, and this gets to the idea that governments can't ban Bitcoin, they can only ban their citizens from Bitcoin. For my part, I think it is important to study this history. But when we acknowledge the notion that history doesn't repeat but it rhymes, we need to take into account what is fundamentally new about this global, borderless, pseudonymous peer-to-peer foundation of the Bitcoin system. In other words, governments might implement the same playbook, but how it plays out is likely to be very different. Maybe that doesn't matter. Maybe Dalyos thesis is as simple as the idea that if too many investors will be too scared off if the government does come after BTC, that it doesn't matter if it survives. What matters is how much

the price will go down. That's sort of a separate conversation. Still, I tend to think that Dahlio's writing serves to give himself intellectual pathways to different types of financial decisions. And my gut keeps telling me that he's going to make a major play as the market conservative king of Bitcoin later this year. The person who you can trust to help you buy and hold Bitcoin because it took him so long to get high conviction and because he still has these important skepticism that recognize the power of the old paradigm. Ultimately, no matter what he writes and what I say here. There is a power shift happening and it's going to remake the world in its wake. Anyways, guys, hope you enjoyed this little take on Dahlio's essay. I thought it was a fun context

to explore some of these bigger macro themes. Hope you enjoyed it. And like I said, guests are coming back even if there's a smaller number of them for the next couple weeks. Let me know who you want to hear from. Hit me up on Twitter in the YouTube comments. And until tomorrow, guys, be safe and take care of each other. Peace.