Ray Dalio on the D-Process in Europe
Ray Dalio, the founder of the macro hedge fund Bridgewater Associates, gives his take on the European sovereign debt crisis, investing and the global economy in the video below. Although Dalio doesn’t talk about this directly, when I have highlighted Dalio’s commentary in the past, I noted in particular what he calls the D-process. I think this is central to his macro view.
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 was before it actually started to play out this way. But now you can ask yourself, OK, when was the last time bank stocks went down so much? When was the last time the balance sheet of the Federal Reserve, or any central bank, exploded like it has? When was the last time interest rates went to zero, essentially, 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.S. post-World War II experience. This was the dynamic that occurred in Japan in the ’90s, that occurred in Latin America in the ’80s, and that occurred in the Great Depression in the ’30s.
Basically what happens is that after a period of time, economies go through a long-term debt cycle — a dynamic that is self-reinforcing, in which people finance their spending by borrowing and debts rise relative to incomes and, more accurately, debt-service payments rise relative to incomes. At cycle peaks, assets are bought on leverage at high-enough prices that the cash flows they produce aren’t adequate to service the debt. The incomes 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 needs a debt restructuring.
–A conversation with Bridgewater Associates’ Ray Dalio, February 2009
The D-Process played out with greater initial force in the US private sector. Now Europe is playing catch-up, but more via the public sector due to the restrictions imposed by the Euro.
Dalio’s macro view is very much aligned with mine. Here’s how I would describe it: The doom loop of greater private sector debt and larger financial crises was attenuated time and again via lower interest interest rates. This allowed for greater levels of debt for the same debt service cost to reach its apex when rates effectively hit zero percent. The D-process and the deleveraging of this secular debt cycle then reach a terminal stage (‘terminal debt’) at this point and a depression ensues (see “The origins of the next crisis” for a detailed discussion on this macro view).
For me, I see credit writedowns in the financial sector as the central element linking financial system fragility with the underlying economy. and will have more on this in an upcoming post.
In the meantime, the Ray Dalio video is below. Definitely watch it.
P.S. – Dalio is a superb fund manager based on a multi-decade track record that is second to none. He invests based on some cultural principles that guide Bridgewater Associates which see self-reflection and understanding as key to investing, personal relationships, and the economy as a whole. If you want to learn more about this approach, read Dalio’s Principles here.