Ray Dalio literally wrote the book on financial crises. So when he has something to say on the future of the market, investors of all shapes and sizes should listen.
After all, it was Dalio who repeatedly cried foul on the mounting credit collapse more than a decade ago that triggered the worst economic meltdown in modern history — even if his cries fell mostly on deaf ears.
Dalio — the founder and cochief investment officer of Bridgewater Associates — recently sat down with Business Insider CEO Henry Blodget to discuss his new book, which breaks down the anatomy of credit crises throughout history.
As part of the discussion, Dalio laid out his scenario for how the current economic cycle would end. In his mind, we’ve entered the uneasy part of the cycle in which central banks are tightening their purse strings, gradually putting an end to the accommodation that helped drive the economic recovery.
His forecast for the next recession stems from that simple fact: that monetary conditions are getting more restrictive.
“We’re about in the seventh inning of a nine-inning game,” he told Blodget. “We’re in the later part of the cycle, the part of cycle in which monetary policy is tightening and there’s not much capacity to squeeze out of the economy.”
He continued: “As interest rates tend to rise, if they rise faster than is discounted in the curve, it can hurt asset prices. And asset prices are fairly fully priced at this level of interest rates. At some point, we’re going to have a downturn because that’s why we have recessions. Nobody ever gets it perfectly.”
That last part raises an interesting point. Though an investor may know a downturn is coming, it can be perilous to try to accurately time such an event. Even esteemed market legends like Jeremy Grantham — the sage who called the two most recent bubbles — acknowledge that timing markets can be a fool’s errand.
So while Dalio is sure an economic reckoning is in the cards, he’s hesitant to give it an exact timetable. But he’s still willing to venture a guess: “I think it’s maybe in two years.”
Troubling parallels to the 1930s
But Dalio didn’t stop there. To him, the economic situation that’s brewing has many close parallels to that of the 1930s — the era of the Great Depression.
Dalio notes that both now and in the 1930s, the lowering of interest rates to near zero has created a wealth divide. That’s because the wealthier members of society are more exposed to financial assets, which have historically gotten the biggest boost from such easy monetary conditions.
“It’s caused populism, because that process creates a gap between the rich and the poor,” Dalio told Blodget. “Right now, the top one-tenth of 1% of the population’s net worth is equal, about, to the bottom 90% combined. That’s very similar to the late ’30s when we had that stimulation.”
That creates a toxic situation in which there’s conflict between the rich and the poor, Dalio said. He said that, in the end, the monetary actions of the Federal Reserve had majorly contributed to today’s political climate.
“Populism around the world is the selection of strong-minded leaders who tend to be more nationalistic,” he said. “And so, we’re in that type of position.”
Dalio says that type of tension is contagious and can be detrimental on a worldwide scale. And ultimately, these factors all combine to weaken economic prospects everywhere.
“There’s a risk that both sides are at odds with each other, and there’s also a greater international risk in tensions,” he told Blodget. “Economic tensions produce global tensions.”
He added that parallels to the 1930s were “quite similar.”
“Doesn’t mean that the same outcomes have to happen,” he continued. “But it does mean that I think we have to be alerted to the fact that, going forward, in a downturn, monetary policy will not be able to be as effective as it was last time, so we have to be cautious.”