Over the past week, Twitter has suddenly become the preferred venue of financial giants to post their ad hoc thoughts and observations. We already noted the tweetstorm by Jeffrey Gundlach who launched a brand new twitter account on the same day as his Ira Sohn conference, and now it appears to be Ray Dalio’s turn who after years of keeping quiet on the social network, blasted off 4 tweets in rapid succession – accounting for a quarter of his entire activity on Twitter – this morning, to wit:
This is new for me and a lot more fun than I imagined because of the back and forths. If you want to know what you’ll see from me here…
I’m particularly interested in seeing the world through the eyes of smart people who see things differently from me, idea-meritocratic decision-making, economics/markets, ocean exploration, neuroscience, and music (especially the blues).
he concluded with the following link to his latest thoughts on the global economy:
If you want to know what I think is the big picture for the world economy and markets, it’s linked here: https://t.co/HJ8pjWA0bH
— Ray Dalio (@RayDalio) May 12, 2017
So what does the man who several years ago predicted, incorrectly, a beautiful deleveraging think now about the “Big picture” state of the global economy? He is no longer quite as optimistic, because in his LInkedIn post, he writes that while “big picture, the near term looks good” … “the longer term looks scary.” His reasons:
- The economy is now at or near its best, and we see no major economic risks on the horizon for the next year or two,
- There are significant long-term problems (e.g., high debt and non-debt obligations, limited abilities by central banks to stimulate, etc.) that are likely to create a squeeze, Social and political conflicts are near their worst for the last number of decades, and
- Conflicts get worse when economies worsen.
And while Dalio writes that he has “no near-term economic worries for the economy as a whole” he is increasingly worried “about what these conflicts will become like when the economy has its next downturn.”
His gloomy conclusion: “Downturns always come. When the next downturn comes, it’s probably going to be bad.”
What follows next is a summary breakdown of Bridgewater’s big picture of “where we are within out own template” and why Dalio is suddenly as pessimistic as we have ever seen him.
Where We Are Within Our Template
To help clarify, we will repeat our template (see www.economicprinciples.org) and put where we are within that context.
There are three big forces that drive economies: there’s the normal business/short-term debt cycle that typically takes 5 to 10 years, there’s the long-term debt cycle, and there’s productivity. There are two levers to control them: monetary policy and fiscal policy. And there are the risk premiums of assets that vary as a function of changes in monetary and fiscal policies to drive the wealth effect.
The major economies right now are in the middle of their short-term debt cycles, and growth rates are about average. In other words, the world economy is in the Goldilocks part of the cycle (i.e., neither too hot nor too cold). As a result, volatility is low now, as it typically is during such times. Regarding this cycle, we don’t see any classic storm clouds on the horizon. Unlike in 2007/08, we don’t now see big unsustainable debt flows or a lot of debts maturing that can’t be serviced, and we don’t see monetary policy as a threat. At most, there will be a little touching the brakes by the Fed to slow moderate growth a smidgen. So all looks good for the next year or two, barring some geopolitical shock.
At the same time, the longer-term picture is concerning because we have a lot of debt and a lot of non-debt obligations (pensions, healthcare entitlements, social security, etc.) coming due, which will increasingly create a “squeeze”; this squeeze will come gradually, not as a shock, and will hurt those who are now most in distress the hardest.
Central banks’ powers to rectify these problems are more limited than normal, which adds to the downside risks. Central banks’ powers to ease are less than normal because they have limited abilities to lower interest rates from where they are and because increased QE would be less effective than normal with risk premiums where they are. Similarly, effective fiscal policy help is more elusive because of political fragmentation.
So we fear that whatever the magnitude of the downturn that eventually comes, whenever it eventually comes, it will likely produce much greater social and political conflict than currently exists.
The “World” Picture in Charts
The following section fleshes out what was previously said by showing where the “world economy” is as a whole. It is followed by a section that shows the same charts for each of the major economies. These charts go back to both 1970 and 1920 in order to provide you with ample perspective.
1) Short-Term Debt/Economic Conditions Are Good
As shown below, both the amount of slack in the world economy and the rate of growth in the world economy are as close as they get to normal levels. In other words, overall, the global economy is at equilibrium.
2) Assets Are Pricing In About Average Risk Premiums (Returns Above Cash), Though They Will Provide Low Total Returns
Liquidity is abundant. Real and nominal interest rates are low—as they should be given where we are in the longterm debt cycle. At the same time, risk premiums of assets (i.e., their expected returns above cash) are normal, and there are no debt crises on the horizon.
Since all investments compete with each other, all investment assets’ projected real and nominal returns are low, though not unusually low in relation to cash rates. The charts below show our expectations for asset returns (of a global 50/50 stock/bond portfolio). While those returns are low, they’re not low relative to cash rates.
Relative to cash, the ‘risk premiums’ of assets are about normal compared to the long-term average. So, both the short-term/business cycle and the pricing of assets look about right to us.
3) The Longer Term Debt Cycle Is a Negative
4) Productivity Growth Is Low
Over the long term, what raises living standards is productivity—the amount that is produced per person—which increases from coming up with new ideas and implementing ways of producing efficiently. Productivity evolves slowly, so it doesn’t drive big economic and market moves, though it adds up to what matters most over the long run. Here are charts of productivity as measured by real GDP per capita.
5) Economic, Political, and Social Fragmentation Is Bad and Worsening
There are big differences in wealth and opportunity that have led to social and political tensions that are significantly greater than normal, and are increasing. Since such tensions are normally correlated with overall economic conditions, it is unusual for social and political tensions to be so bad when overall economic and market conditions are so good. So we can’t help but worry what the social and political fragmentation will be like in the next downturn, which, by the way, we see no reason to happen over the next year or two.
Below we show a gauge maintained by the Federal Reserve Bank of Philadelphia that attempts to measure political conflict in the US by looking at the share of newspaper articles that cover political conflict from a few continuously running newspapers (NYT, WSJ, etc.). By this measure, conflict is now at highs and rising. The idea of conflicts getting even worse in a downturn is scary.
Downturns always come. When the next downturn comes, it’s probably going to be bad.
* * *
Dalio’s country by country breakdown – just as gloomy – can be found here.