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CNBC Exclusive: CNBC Transcript: Andrew Ross Sorkin Sits Down with Bridgewater Associates Founder and CIO Ray Dalio Today on CNBC

Thursday, 24 Jan 2013 | 11:17 AM ET

When: Today, Thursday, January 24th at 7:30AM ET

Where: CNBC's "Squawk Box"

Following is the unofficial transcript of a CNBC EXCLUSIVE interview with Bridgewater Associates Founder and CIO Ray Dalio today on CNBC's "Squawk Box." Additionally, here are links to embeddable videos of the interview: http://video.cnbc.com/gallery/?video=3000142389 and http://video.cnbc.com/gallery/?video=3000143315.

All references must be sourced to CNBC.

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ANDREW ROSS SORKIN: WE DO HAVE A BIG INTERVIEW RAY DALIO IS HERE. THE FOUNDER OF COURSE OF BRIDGEWATER, $130 BILLION YOU MANAGE. YOU WERE SAYING BEFORE WE STARTED YOU STARTED WITH $5 MILLION?

RAY DALIO: YEAH.

SORKIN: $5 MILLION AND A TWO BEDROOM APARTMENT.

DALIO: WELL THE WORLD BANK GAVE ME $5 MILLION IN 1985. THAT'S WHEN I STARTED.

SORKIN: DID YOU EVER THINK $5 MILLION WAS GOING TO TURN INTO $130 BILLION?

DALIO: NEVER THOUGHT MUCH ABOUT IT. I JUST LIKED TO PLAY THE GAME AND YOU KNOW JUST KEPT PLAYING THE GAME.

SORKIN: LET'S TALK ABOUT THE GAME BECAUSE THE OTHER THING WE WERE TALKING ABOUT BEFORE WE CAME ON WAS APPLE AND I WAS TALKING ABOUT THE APPLE STOCK AND HOW YOU THINK ABOUT IT. YOU SAID I DON'T REALLY THINK ABOUT APPLE AS A COMPANY. YOU THINK ABOUT IT IN A VERY DIFFERENT WAY IN THE SORT OF ECONOMIC MACHINE THEORY. HOW DO YOU LOOK AT SOMETHING LIKE THAT?

DALIO: WELL, I THINK EVERYTHING – I THINK IF EVERYTHING AS WORKING LIKE A MACHINE, THAT THE ECONOMY WORKS LIKE A MACHINE. THE MARKETS WORK LIKE A MACHINE. THERE ARE CAUSE/EFFECT RELATIONSHIPS. I THINK WE DON'T TALK ENOUGH ABOUT HOW THE MACHINE WORKS. SO WHEN WE'RE TALKING ABOUT IN INTERVIEWS LIKE THIS YOU KNOW I THINK OKAY, WHAT ARE WE GOING TO DO, TALK ABOUT WHAT'S THE NEXT HOT TIP?

SORKIN: RIGHT.

DALIO: WHAT'S IT GOING TO DO FOR AN INDIVIDUAL?

SORKIN: RIGHT

DALIO: YOU TAKE THAT AND WALK AWAY AND INVEST ON IT? SUPPOSING I CHANGE MY MIND TOMORROW.

SORKIN: RIGHT.

DALIO: THE ECONOMIC MACHINE OR THE MARKETS BASICALLY ARE OPERATING IN A CONSISTENT WAY. AND THE OUTCOMES THAT WE HAVE ARE JUST A FUNCTION OF UNDERSTANDING THAT. SO I HOPE THAT WE'LL TALK ABOUT HOW DOES THE ECONOMIC MACHINE WORK--

SORKIN: RIGHT.

DALIO: WHERE ARE WE IN THE ECONOMY? HOW DOES THE MARKETS WORK?

SORKIN: RIGHT.

DALIO: HOW DO YOU DEVELOP A STRATEGY? THESE ARE THE IMPORTANT THINGS AND THEN I COULD TELL YOU WHAT I THINK IN THAT CONTEXT.

SORKIN: SO, IN THAT CONTEXT, LET'S TALK ABOUT IT, THEN. HOW DO YOU THINK ABOUT – WHEN YOU TALK ABOUT THE ECONOMIC MACHINE, WHAT IS THAT, EXACTLY?

DALIO: OKAY. SO EVERYTHING IS A TRANSACTION, RIGHT? EVERY GOOD, SERVICE OR FINANCIAL ASSET, SOMEBODY'S BUYING.

SORKIN: RIGHT.

DALIO: AND THEY BUY WITH MONEY, OR THEY BUY WITH CREDIT. AND SO YOU GO IN TO A STORE AND YOU BUY A SUIT, YOU BUY IT WITH MONEY OR YOU BUY WITH CREDIT. CREDIT IS PROMISED TO DELIVER MONEY. YOU AND I CAN MAKE UP CREDIT. IF I SAY, LISTEN, YOU CAN HAVE THE SUIT AND YOU JUST PAY ME BACK LATER, THAT WILL CALCULATE AS GNP OR A SALE BUT YET THERE'S NO PAYMENT MADE.

SORKIN: RIGHT.

DALIO: AND SO AS A RESULT, CREDIT GROWS A LOT FASTER THAN MONEY. AND CREDIT GROWS FASTER THAN INCOME. AND WHEN CREDIT GROWS FASTER THAN INCOME, WHEN DEBT GROWS FASTER THAN INCOME, THAT CAN'T GO ON FOR LONG.

SORKIN: RIGHT.

DALIO: AT SOME POINT, YOU CAN'T SERVICE, BECAUSE IT'S PROMISED TO DELIVER MONEY. WHEN THAT MONEY CAN'T – YOU CAN'T COME UP-- YOU HAVE A DELEVERAGING.

SORKIN: RIGHT.

DALIO: SO WHAT HAPPENED IN 2007 WAS THEY RAN A BUBBLE. WE HAD CREDIT GROWING MUCH FASTER THAN MONEY. THAN MONEY OR INCOME.

SORKIN: RIGHT.

DALIO: AND WE HAD THAT BUBBLE. AND SO NOW WE'RE GOING THROUGH AN ADJUSTMENT. NOW LET ME EXPLAIN THAT ADJUSTMENT, IF I MAY.

SORKIN: PLEASE.

DALIO: OKAY. SO, IN A DELEVERAGING, AND DELEVERAGINGS HAVE HAPPENED THROUGHOUT TIME, RIGHT? IT JUST DIDN'T HAPPEN IN OUR LIFETIME BEFORE. BUT IT HAPPENED IN JAPAN. IT HAPPENED IN THE '30s. HAPPENED IN LATIN AMERICA. THEY HAPPEN ALL THE TIME. HOW DO THEY WORK? TOO MUCH DEBT RELATIVE TO INCOME. SO THERE ARE FOUR THINGS YOU CAN DO. ALL OF THEM ARE THE SAME. YOU CAN EITHER TRANSFER WEALTH FROM THE HAVES AND THE HAVE-NOT SO GERMANY CAN HELP SPAIN. YOU CAN DO THAT. OR YOU CAN WRITE DOWN DEBTS. BECAUSE IF THERE'S TOO MUCH DEBT YOU HAVE TO REDUCE IT. SO YOU CAN WRITE IT DOWN. BUT THE PROBLEM WITH WRITING IT DOWN IS ONE MAN'S DEBT IS ANOTHER MAN'S ASSETS. SO YOU WRITE DOWN ASSETS. AND IT FEEDS ON ITSELF AND IT HAS A PROBLEM. IT CAUSES PAIN. THE OTHER WAY YOU -- THE THIRD WAY YOU CAN DEAL WITH IT, IS THAT YOU CAN SPEND LESS. SO I'LL BORROW LESS. AUSTERITY. AND WE GO THROUGH AUSTERITY. AND THE FOURTH WAY YOU CAN DEAL WITH IT IS YOU CAN PRINT MONEY. SO CENTRAL BANKS CAN COME AND THEY CAN GIVE MONEY TO SPANIARDS WHO MAY NOT BE ABLE TO PAY THE DEALT, AND THAT HELPS THEM DO THAT. SO THERE ARE ALWAYS THOSE FOUR WAYS THAT HAPPEN. IN ALL DELEVERAGING THEY ALL HAPPEN. SO WHAT WE'VE GONE THROUGH, THE BUBBLE WAS OBVIOUS, BECAUSE IT COULDN'T EXTEND -- YOU CAN'T RAISE DEBT RELATIVE TO INCOME AND THE LEVERAGING COULDN'T CONTINUE. AND THE DELEVERAGING THAT WAS TAKING PLACE HAD TO HAPPEN IN THOSE FOUR WAYS. IT HAS LARGELY HAPPENED.

SORKIN: IT'S HAPPENED ALREADY.

DALIO: IT'S HAPPENED ALREADY.

SORKIN: YOU THINK IT'S DONE?

DALIO: NO, LET ME EXPLAIN WHAT IT IS.

SORKIN: OKAY.

DALIO: OKAY. THAT, THE CAPACITY OF LENDERS TO LEND, TO MEET THE BORROWING REQUIREMENTS, HAS LARGELY BEEN ADJUSTED. SO, SPAIN IS BORROWING, HAS FALLEN.

SORKIN: RIGHT.

DALIO: ITALY'S BORROWING HAS FALLEN. THOSE BORROWINGS HAVE COLLAPSED.

SORKIN: MM-HMM.

DALIO: WITH THAT, IS, OF COURSE, THE COLLAPSE OF THEIR ECONOMIES. THAT'S WHAT THE DEPRESSION IS. YOU HAVE TO SPEND LESS, BECAUSE YOU HAVE LESS ABILITY TO BORROW.

SORKIN: RIGHT.

DALIO: SO THAT CAUSES A COLLAPSE IN THOSE ECONOMIES. IT WAS STILL, EVEN WITH THAT, NOT ENOUGH MONEY TO SERVICE THE DEBT. SO, I USE SPAIN AS AN EXAMPLE BECAUSE IT'S REPRESENTATIVE. IF YOU TAKE SPAIN, BUT THE ECB CAME IN, AND PUT IN $450 BILLION OF MONEY. THEY PUT IN ABOUT 350 TO THE SPANISH BANKS.

SORKIN: WAS THAT THE RIGHT THING TO DO?

DALIO: THAT WAS THE RIGHT THING TO DO. THE POLICY SO FAR. THERE WAS A GAP. AN UNRECONCILABLE GAP. AN UNBRIDGEABLE FUNDING GAP.

SORKIN: RIGHT.

DALIO: OKAY. THAT -- SO NOW WHAT WE HAVE IS A SITUATION WHERE THE BORROWING NEEDS AND THE DEBT ROLLOVER NEEDS AND THE BORROWING ARE APPROXIMATELY IN LINE, AND A CUSHION HAS BEEN CREATED, THE ECB TOOK OVER FILLED THE GAP WHERE NORMALLY THE FREE MARKET DOES AND IT FILLS IT. AND THAT HAS NOW MOVED IT ALONG TO A DIFFERENT CONDITION. WE'RE GOING TO HAVE A DEPRESSION –

SORKIN: WE'RE HAVING A DEPRESSION?

DALIO: IN EUROPE. SPAIN, WE CALL THIS THE LOST DECADE IT MEANS IT DOESN'T MEAN YOU CAN GO BACK AND SPEND LIKE YOU DID BEFORE WHEN YOU GET PAST IT. IT MEANS THAT THE LEVEL OF SPENDING IS DOWN TO THE LEVEL OF INCOME.

SORKIN: AND HOW LONG -- YOU SAID THE LOST DECADE. WILL IT LAST LONGER THAN THAT? I MEAN, YOU TALK ABOUT THE ECONOMIC MACHINE, AND HISTORY. BUT PART OF THE CHALLENGE FOR ANY INVESTOR TRYING TO UNDERSTAND WHAT TO DO IS THE TIMING ELEMENT, RIGHT? WE ALL KNOW WHAT THE HISTORY MAY REPEAT ITSELF. THE QUESTION IS WHEN IT'S GOING TO REPEAT ITSELF. WE DON'T ALWAYS KNOW THAT PIECE OF IT.

DALIO: SO THE WAY I LOOK AT IT IS FIRST OF ALL, THERE'S ECONOMICS OF THE CAUSE EFFECT, AND SO, THIS WILL BE A LONG PROBLEM THAT NOW I'LL TALK THE ECONOMICS AND I'LL TALK ABOUT THE MARKETS. INDEPENDENTLY.

SORKIN: OKAY.

DALIO: BUT THEY'RE CONNECTED. THE ECONOMICS MEANS THERE WILL BE A LONG PERIOD OF ADJUSTMENT AND WHAT WILL HAPPEN MOST IMPORTANTLY IS PRODUCTIVITY, DOES EUROPE WORK HARD, DO THE THINGS THAT ARE NECESSARY TO RAISE ITS LIVING STANDARDS BECAUSE IT CAN'T BE ON MONEY, AND THERE WILL BE A SOCIAL CHALLENGE, SOCIAL, POLITICAL CHALLENGE OF TEN YEARS OR SO, MAYBE IT'S 15 YEARS. JAPAN HAS MADE IT GO ON FOR LONGER.

SORKIN: RIGHT.

DALIO: THE FUNDAMENTAL THING THAT THEY NEED TO DO MOST IS TO MAKE SURE THAT THE NOMINAL INTEREST RATE IS AT OR BELOW THE NOMINAL GROWTH RATE. AND I WON'T GET TECHNICAL. BUT OTHERWISE, WHAT YOU'RE GOING TO HAVE IS THE DEBT COMPOUNDING AT A RATE WHICH IS FASTER THAN THE ECONOMY IS GROWING. SO, ANYWAY, THAT PICTURE --THERE WAS A TREMENDOUS CHANGE, BUT IT WILL BE A TERRIBLE ECONOMY.

SORKIN: RIGHT.

DALIO: BECAUSE THE BALANCE IS, THE PREVENTING OF CHAOS, WE CAME VERY CLOSE TO HAVING CHAOS. RIGHT AT THE EDGE OF IT. BECAUSE THERE WAS NOT A BACKSTOP. WE GOT PAST THAT POINT. SO NOW AS WE MOVE FORWARD, WE CAN -- THAT CAN BE MANAGED, AND IT'S GOING TO BE VERY DIFFICULT AND VERY PAINFUL, AS FAR AS THE MARKETS GO, NOW, THE QUESTION IN THE MARKETS IS, HOW DO EVENTS TRANSPIRE RELATIVE TO WHAT'S DISCOUNTED. RIGHT?

SORKIN: RIGHT.

DALIO: SO, EVERYBODY -- THIS IS THE THING, TOO MANY INVESTORS ARE REACTIVE DECISION MAKERS. IF SOMETHING HAS GONE UP, THEY SAY, OH, THAT'S A GOOD INVESTMENT. THEY DON'T SAY THAT'S MORE EXPENSIVE. AND SO IT'S THE MOST COMMON MISTAKE IN INVESTING. YOU HAVE TO LOOK AHEAD AND SAY, WHAT IS THE TRANSACTION? WHAT WILL BE DETERMINING THE BUYER AND SELLER? CURRENTLY WHAT WE HAVE IS A LOT OF MONEY IS IN CASH, AND CASH IS A BAD THING. AND IT'S NOT NATURAL THAT IT CAME TO BE CASH BECAUSE THE CENTRAL BANKS PRINTED A LOT OF MONEY SO THEY PUT A LOT OF CASH. THAT'S WHAT JAPAN IS DOING, TOO, BECAUSE IT NEEDS TO DO THAT. SO IT PRODUCES A LOT OF CASH WITHIN THE SYSTEM. AND IN ADDITION, BECAUSE YOU HAVE THE RISKS, PEOPLE WANT TO BE SAFE.

SORKIN: RIGHT.

DALIO: SO THEY PUT THEIR MONEY IN CASH. AND THERE'S A LOT OF CASH HANGING AROUND--

SORKIN: SOUNDS LIKE YOU'RE SAYING THAT'S A MISTAKE, THOUGH.

DALIO: WELL, IT'S A NATURAL CONSEQUENCE, AND WHAT WILL HAPPEN IS THE NEXT BIG MOVES IN THE MARKETS, AND THE NEXT BIG MOVES IN THE ECONOMY, WILL BE BASED ON HOW THE CASH MOVES. BECAUSE THAT'S A BAD INVESTMENT. IT HAS A NEGATIVE REAL RETURN.

SORKIN: RIGHT.

DALIO: IT HAS A RETURN THAT'S SUBSTANTIALLY LOWER THAN THE NEGATIVE -- THAN THE ECONOMY'S GROWTH RATE. AND AT THE SAME TIME, WE'RE IN A SITUATION WHERE RISKS ARE BEING REDUCED. SO THE FEAR, THE DESIRE, TO HOLD THAT CASH IS REDUCED. YOU CAN GO OUT ON THE RISK SPECTRUM, BECAUSE THEY'RE REDUCED FOR THE REASONS WE'RE TALKING ABOUT. AND AT THE SAME TIME, IF YOU'RE AN INVESTOR, YOU CAN START TO MOVE OUT OF THE CASH, BECAUSE YOU'RE MISSING OUT ON RETURNS BECAUSE IT'S LOUSY. AS THAT HAPPENS, I THINK 2013 IS LIKELY TO BE A TRANSITION YEAR. OKAY? WHERE THAT CASH, LARGE AMOUNTS OF CASH EXISTED THAT WAY. THAT WILL START TO CHANGE.

SORKIN: CHANGE IN WHAT WAY?

DALIO: IT WILL MOVE --

SORKIN: MOVE WHERE?

DALIO: OKAY, IT WILL MOVE TO STUFF. IT WILL MOVE TO ALL SORTS OF STUFF. IT WILL MOVE TO GOODS, SERVICES AND FINANCIAL ASSETS. SO, THAT WILL INCLUDE MOST GOODS, SERVICES AND FINANCIAL ASSETS. PEOPLE WILL SPEND MORE WITH THE CASH. THEY WILL -- AND THAT WILL HELP THE ECONOMY. IT WILL MOVE INTO EQUITIES. IT WILL MOVE INTO GOLD. IT WILL MOVE INTO -- IT WILL MOVE.

SORKIN: RIGHT.

DALIO: INTO OUT ON THAT CURVE. AS THAT HAPPENS, WHAT HAPPENS IS, IT MAKES THE FEDERAL RESERVE'S CONCERNS CHANGE. BECAUSE BY PUTTING THE CASH IN THEY'VE LESSENED THE RISKS. AS THE RISKS HAVE LESSENED AND THAT MOVEMENT STARTS TO MOVE THEN THE TILT STARTS TO CHANGE. THAT'S PROBABLY SOMETHING THAT WON'T HAPPEN IMMEDIATELY. THIS IS LIKE A CLASSIC TRANSITION YEAR, I THINK. AND THEN AS YOU GET LATER INTO THE YEAR, I THINK THAT WE'RE GOING TO SEE MORE OF THAT.

SORKIN: OKAY.

DALIO: I APOLOGIZE FOR INTERRUPTING. JOE KERNEN IS BACK IN THE STUDIO. HE HAS A QUESTION. HE'S BEEN LISTENING TO THIS HISTORY-- ECONOMIC LESSON.

JOE KERNEN: I GET IT. NO, I GET IT. AND RAY BASICALLY I'M LOOKING AT SOME OF HIS NOTES THAT WE HAVE, AS THE TRANSITION YEAR GOES ON TOWARDS THE END. A LOT OF THIS CASH AND A LOT OF MONEY THAT PROBABLY SHOULDN'T BE IN THE BOND MARKET ANYMORE STARTS MOVING OUT INTO THE RISK CURVE EQUITIES, GOLD, COMMODITIES AND THAT MAKES A LOT OF SENSE. I WAS WONDERING RAY, ONE OF THE THINGS OF THE FOUR THINGS I THINK THAT THE CENTRAL BANKERS AROUND THE WORLD REALLY DID A LOT OF HEAVY LIFTING, AND I WOULD HAVE THOUGHT THAT GOLD WOULD HAVE CONTINUED TO MOVE. AND I WAS WONDERING HOW YOU EXPLAIN THAT. I GUESS IT MOVED FROM 200 TO 1800. SO, IT MOVED IN ANTICIPATION OF WHAT WE FINALLY SAW. BUT I WOULD IMAGINE YOU THINK THAT IT STILL GOT MORE ROOM TO GROW OR HOW DO YOU EXPLAIN IT FOR THE LAST YEAR AND A HALF THAT'S REALLY BEEN, YOU KNOW, ACQUIESCENT?

DALIO: SO I JUST WANT TO EMPHASIZE THAT THE WAY THAT I LOOK AT ANY MARKET IS TO LOOK AT THE BUYERS AND THE SELLERS. AND TO UNDERSTAND, YOU KNOW, SORT OF WHO'S BUYING AND WHO'S SELLING AND WHAT ARE THE MOTIVATIONS BEHIND THAT. AND SO IN EACH ONE OF THOSE CASES, AND I THINK IF I WAS TO GET IN TO THAT A LITTLE BIT MUCH I WOULD ACTUALLY BE DEALING WITH SORT OF SOME CONFIDENTIAL INFORMATION. I THINK THE IMPORTANT THING HERE TO UNDERSTAND IS THAT GOLD JUST GENERALLY IS SOMETHING THAT LARGE BUYERS, THOSE WITH LOTS OF PORTFOLIOS WOULD LIKE TO ACCUMULATE OVER A VERY LONG TIME, VERY SLOWLY. WHOOPS.

SORKIN: IT'S OKAY. KEEP GOING. WE'LL TALK.

DALIO: AND AND BUILD THAT – BUILD DIVERSIFICATION BECAUSE WE'RE IN A NEW ERA IN TERMS OF WHICH IS THE CURRENCY. WHAT ARE WE -- WE'RE IN A NEW WORLD. WHAT IS MONEY? AND SO THERE'S A NEED TO DIVERSIFY THAT. HOWEVER, GOLD IS A VERY SMALL MARKET BY COMPARISON TO THAT. AND IT'S NOT A BIG, EFFECTIVE, YOU CAN'T DIVERSIFY IT. SO I THINK THE BEHAVIOR OF GOLD MAKES, YOU KNOW, COMPLETE SENSE, AS DOES THE BEHAVIOR OF EQUITIES AND SO ON. I DON'T WANT TO GET TOO MUCH INTO ANY ONE ASSET CLASS, OR WHAT I THINK ABOUT THEM. I THINK THE IMPORTANT THING HERE, IF I'M AN INVESTOR, LET'S GO BACK TO THE INVESTOR, IS THE MOST IMPORTANT THING IS THAT YOU CAN HAVE IS A GOOD, STRATEGIC ASSET ALLOCATION MIX. IN OTHER WORDS YOU'RE NOT GOING TO WIN BY SORT OF TRYING TO GET WHAT THE NEXT TIP IS AND WHAT'S GOING TO BE GOOD AND WHAT'S GOING TO BE BAD. THAT'S -- YOU'RE DEFINITELY GOING TO LOSE. SO WHAT THE MOST INVESTOR NEEDS TO DO IS TO HAVE A BALANCED STRUCTURED PORTFOLIO. A PORTFOLIO THAT DOES WELL IN DIFFERENT ENVIRONMENTS. SO MUCH OF THE DRIVER OF MANY ASSET CLASS RETURNS IS BASED ON HOW EVENTS ACTUALLY TRANSPIRE RELATIVE TO EXPECTATIONS. SO THERE'S A CERTAIN DISCOUNTED GROWTH RATE IN EQUITIES. THERE'S A CERTAIN DISCOUNTED GROWTH RATE—THERE'S CERTAIN ASSETS. YOU CAN LOOK AT WHAT'S PRICED IN. AND THEN WHAT HAPPENS IS, YOU NEED TO HAVE ENVIRONMENTS A QUARTER OF YOUR PORTFOLIO, IN ASSETS THAT DO WELL, WHEN GROWTH IS FASTER THAN EXPECTED. OR, A QUARTER WHEN IT DOES WELL WHEN IT'S SLOWER THAN EXPECTED. A QUARTER WHEN INFLATION IS HIGHER THAN EXPECTED AND A QUARTER WHEN INFLATION IS LOWER THAN EXPECTED. SO YOU NEED TO CREATE A GOOD STRUCTURED PORTFOLIO, THEN YOU CAN MAKE YOUR BETS. BUT THIS IS A WHOLE CONVERSATION ON HOW TO INVEST.

SORKIN: BUT HERE'S A QUESTION JUST ABOUT BETS. YOU KNOW, YOU'RE MAKING THE ARGUMENT, AND EXPLAINING THE NEED TO HAVE A DIVERSIFIED PORTFOLIO. BUT MOST PEOPLE HAVE DIVERSIFIED PORTFOLIO FOLLOW THE MARKET. MEANING, WHATEVER THE S&P 500 IS ULTIMATELY YOU'RE GOING TO BE UP OR DOWN, SOMEWHERE AROUND THERE. YOU, AND SOME OF YOUR PEERS CONSISTENTLY OUTPERFORM THE MARKET. AND YOU DO THAT, I ASSUME, BY MAKING BETS.

DALIO: WE BREAK IT INTO TWO PARTS. WE HAVE TWO BASIC PORTFOLIOS. THERE IS THE STRATEGIC ASSET ALLOCATION MIX. WHICH WE CALL ALL WEATHER AND THAT JUST HAS NOTHING TO DO WITH BETS. IT HAS TO DO WITH HOW TO MAKE ALL THE ASSETS THE SAME RISK PARITY. CALL RISK PARITY. THE PROBLEM IS, WHEN PEOPLE TRY TO DIVERSIFY, AND THEY OWN EQUITIES AND EQUITIES HAS A VOLATILITY.

SORKIN: RIGHT.

DALIO: THAT'S LARGE. OR THEY OWN ASSETS THAT DO WELL WHEN THE ECONOMY DOES WELL AND DO BADLY WHEN THE ECONOMY DOES BADLY THEY HAVE A CONCENTRATION OF THEIR RISK IN SOME ASSETS.

SORKIN: RIGHT.

DALIO: THEY NEED TO HAVE. THEY NEED TO CHANGE THE PORTFOLIO. THEY NEED TO BUY LONGER DURATION BONDS OR LEVERAGE THE BONDS OR BRING UP SO THAT BONDS AND COMMODITIES AND PIECES HAVE COMPARABLE IMPACTS SO THAT WHATEVER HAPPENS IN THE ECONOMY WILL THEN HAVE A BALANCING EFFECT. BECAUSE THE ONE THING YOU CAN BE MOST CONFIDENT IS THAT ASSET CLASSES ON AVERAGE WILL OUTPERFORM CASH.

SORKIN: OKAY.

DALIO: SO IF YOU HAVE -- THAT'S A STRATEGIC ASSET ALLOCATION. THAT'S WHAT THE ALL-WEATHER PIECE IS. THEN THERE'S THE BETS. THE BETS ARE ZERO SUM. RIGHT? IN ORDER FOR YOU TO BEAT ME IN THE GAME, YOU'RE GOING TO HAVE -- IT'S LIKE POKER. IT'S A ZERO SUM GAME. I HAVE -- WE HAVE 1500 PEOPLE THAT WORK AT BRIDGEWATER. WE SPEND HUNDREDS OF MILLIONS OF DOLLARS ON RESEARCH AND SO ON. WE'VE BEEN DOING THIS FOR 37 YEARS. AND WE DON'T KNOW THAT WE'RE GOING TO WIN. IN OTHER WORDS WE WORK THAT. WE HAVE TO HAVE DIVERSIFIED BETS. WE HAVE A LOT OF DIVERSIFIED BETS AND SO ON SO IT'S VERY IMPORTANT FOR MOST PEOPLE TO KNOW WHEN NOT TO MAKE A BET. BECAUSE IF YOU'RE GOING TO COME TO THE POKER TABLE, YOU'RE GOING TO HAVE TO BEAT ME AND YOU'RE GOING TO HAVE TO BEAT THOSE WHO TAKE MONEY SO THE NATURE OF INVESTING IS THAT A VERY SMALL PERCENTAGE OF THE PEOPLE TAKE MONEY, ESSENTIALLY, IN THAT POKER GAME, AWAY FROM OTHER PEOPLE.

SORKIN: RIGHT.

DALIO: WHO DON'T KNOW WHEN PRICES GO UP, WHETHER THAT MEANS IT'S A GOOD INVESTMENT OR IF IT'S A MORE EXPENSIVE INVESTMENT.

SORKIN: WE'RE GOING TO SLIP IN A QUICK BREAK. I'M GOING TO SEND IT BACK TO JOE AND WE'LL COME BACK AND CONTINUE THE CONVERSATION.

KERNEN: THANKS, ANDREW. WE'LL BE RIGHT BACK WITH MORE FROM RAY DALIO.

SORKIN: WE'RE BACK NOW LIVE HERE IN DAVOS, SWITZERLAND AT THE WORLD ECONOMIC FORUM AND WE'RE SPEAKING EXCLUSIVELY WITH RAY DALIO, FOUNDER OF BRIDGEWATER ASSOCIATED AND WE'RE THRILLED TO HAVE YOU. YOU RARELY DO THIS SO WE'RE HAPPY TO HAVE THE EDUCATION. ONE OF THE QUESTIONS THAT CAME UP IN MY MIND WHILE YOU WERE SPEAKING IN THE LAST SEGMENT WAS POLITICS. AND A LOT OF THE CONVERSATION WE HAVE HERE AT THE WORLD ECONOMIC FORUM IS ABOUT POLITICS. HOW AS AN INVESTOR DO YOU PUT THAT IN TO YOUR ECONOMIC MACHINE, IF YOU WILL, YOU KNOW, WHEN IT COMES TO THIS DEBT CEILING ISSUE, OR IT COMES TO WHO'S GOING TO BE ELECTED, OR HEALTH CARE ISSUES OR WHAT HAVE YOU. HOW IS THAT -- HOW DO YOU PUT THAT IN TO YOUR INVESTING HAT?

DALIO: WELL, EVERYTHING IS A TRANSACTION, AND IT WON'T HAVE AN EFFECT ON PRICES, ANY EVENT, UNLESS IT HAS AN EFFECT ON A TRANSACTION. SO WHAT I DO IS I KNOW WHO THE BUYERS AND THE SELLERS ARE. AND THEN BY THINKING THAT THROUGH, I THINK HOW WILL IT HAVE AN EFFECT ON TRANSACTIONS. FAR MORE IMPORTANT THAN, OVER THE LONG TERM, THE LEADER OF A COUNTRY WILL HAVE SOME EFFECT ON THE WHOLE OVERALL HEALTH OF THE ECONOMY. BUT EVEN—THEY CAN'T EVEN RESOLVE THEIR OWN QUESTIONS. THEY'RE, YOU KNOW, IT'S A VERY DIFFICULT CHALLENGE. THE WHOLE POLITICAL SYSTEM. YOU COULD BE PRESIDENT OF THE UNITED STATES AND IT DOESN'T MEAN YOU CAN CHANGE POLICY. THEN, IF POLICY CHANGES, IT HAS TO BASICALLY CHANGE THE THINGS THAT PRODUCE -- HAVE AN EFFECT ON PRODUCTIVITY. IT'S SOMETHING THAT'S PERIPHERAL LARGELY. LIKE, FOR EXAMPLE, A BIGGER ISSUE IS HOW DOES FINANCIAL TRANSACTIONS WORK SUCH AS IF YOU LOWER INTEREST RATE, AND YOU HAVE NOTHING ON A MONEY MARKET FUND.

SORKIN: RIGHT. AND YOU CAN'T DO THAT --

DALIO: WHICH IS WHAT WE GOT NOW.

SORKIN: WHICH IS WHAT YOU GOT NOW. WHAT HAPPENS? HOW IS THERE THEN THE TRANS -- WHERE DOES THE MONEY GO? HOW DOES SOMEBODY EARN A RETURN? HOW DO FINANCIAL INTERMEDIARIES EARN RETURNS AND SO ON AS IT AFFECTS TRANSACTIONS. THOSE THINGS ARE FAR MORE IMPORTANT REALLY IN TERMS OF AN EFFECT IN LONGER-TERM THERE ARE CERTAIN BASIC THINGS THAT DETERMINE A HEALTH OF AN ECONOMY, AND POLICY CAN HAVE AN EFFECT. THERE ARE ALSO CERTAIN POINTS IN TIME THAT IT'S VERY CRITICAL. MARIO DRAGHI AND THE ECB AND HOW IT HANDLED MONETARY POLICY AT A PARTICULAR MOMENT IN TIME WAS CRITICALLY IMPORTANT. SO TO TRY TO STAY ON TOP OF THAT AND NOT ONLY PARTIALLY ANTICIPATE IT, BUT TO KNOW WHEN A CHANGE OCCURS, HOW TO PROPERLY INTERPRET IT AND WHAT DOES THAT MEAN IN TERMS OF THE KNOCK-ON EFFECT BECAUSE EVERYTHING IS CAUSE/EFFECT RELATIONSHIPS AND CAUSES HAPPEN BEFORE EFFECTS. AND IF YOU UNDERSTAND THE CAUSE/EFFECT RELATIONSHIP, THAT'S WHAT IT'S ALL ABOUT.

SORKIN: YOU'VE GOT TO GET A PIECE OF IT RIGHT WHICH IS SOMETIMES THE HARD PART. SCOTT SPERLING WHO RUNS T.H. LEE IS BACK IN THE STUDIO. SCOTT?

SCOTT SPERLING: HI, RAY, HOW ARE YOU? YOU'VE DONE THIS SPECTACULAR JOB AT BEING ABLE TO CALL MACRO TRENDS VERY WELL, AND SOMETIMES VERY AGGRESSIVELY. ONE OF THE THINGS THAT IS -- WE'VE NOTED OVER THE LAST, PARTICULARLY FEW MONTHS, IS THE USE OF JUDICIOUS AMOUNTS OF LEVERAGE ON BOND PORTFOLIOS TO TRY TO EMULATE EQUITY-LIKE RETURNS. I THINK RISK PARITY IS WHAT THEY CALL IT. AND YOU'VE DONE A GREAT JOB WITH THAT SORT OF THING. IS THAT -- IS THAT A MECHANIC OR IS THAT AN INDICATION OF DIRECTION OF ATTRACTIVENESS, RELATIVE ATTRACTIVENESS, OF FIXED INCOME TO THE EQUITY MARKET?

DALIO: A MECHANICAL THING. THE PROBLEM OF LET'S SAY A STOCK AND A BOND PORTFOLIO, IF YOU PUT 50% OF YOUR MONEY IN STOCKS AND 50% OF YOUR MONEY IN BONDS, THE PROBLEM IS, YOU HAVE ABOUT 80% OF YOUR RISK IN STOCKS, AND ABOUT 20% OF YOUR RISKS IN BONDS. AND SO YOU DON'T HAVE DIVERSIFICATION. BUT IF YOU JUST IMAGINE THAT YOU HAD A LONG DURATION BOND PORTFOLIO OR A BOND PORTFOLIO HAD ABOUT THE SAME VOLATILITY OF STOCKS AND YOU WENT THROUGH THE FINANCIAL CRISIS, MOST OF THE DECLINE IN YOUR PORTFOLIO WOULD HAVE BEEN PROTECTED. BECAUSE THE STOCKS WOULD HAVE GONE UP IN VALUE BY AN AMOUNT THAT WOULD HAVE HAD AN IMPACT THAT WOULD HAVE OFFSET THE OTHER. SO IN STRUCTURING A VERY GOOD PORTFOLIO, YOU HAVE TO HAVE COMPARABLE BASICALLY COMPARABLE AMOUNTS OF RISK IN THAT. EQUITIES IS MISLEADING. WHEN YOU THINK YOU TAKE A TREASURY BOND AND YOU LEVERAGE IT TWO TO ONE, REALIZE THAT THE AVERAGE COMPANY IN THE S&P 500 IS LEVERAGED TWO TO ONE. IN OTHER WORDS THERE'S AS MUCH DEBT AS THERE IS EQUITY IN THE COMPANY. IF THERE WAS A LAW THAT SAID THAT COMPANIES COULD NOT LEVERAGE, THEN THE RETURN OF EQUITIES AND THE RETURN AND THE VOLATILITY OF EQUITIES WOULD BE QUITE LIKE THAT OF BONDS. SO IT TENDS TO BE THAT THE ONE THING WE'RE MOST CONFIDENT ABOUT IS THAT ASSET CLASSES OVER A PERIOD OF TIME WILL OUTPERFORM CASH. THAT HAS TO BE, OTHERWISE WE DON'T HAVE CAPITALISM. AND IT ALSO HAS TO BE COMPENSATION. SO, IT'S TO GET THAT BALANCE THAT YOU NEED TO DO THAT.

SORKIN: RAY, WE'RE GOING TO HAVE TO GO. BUT JUST FINAL QUESTION. GIVEN THE MOOD HERE IN THE WORLD ECONOMIC FORUM, YOUR SENSE, LOOKING OUT OVER THE NEXT TWO YEARS, JAMIE DIAMOND WAS ON YESTERDAY, SAID HE IS VERY BULLISH. VIRTUALLY EVERYBODY I'VE TALKED TO SEEMS VERY BULLISH. I KNOW YOU TALK ABOUT A TRANSITION AND IT SOUNDS LIKE THAT'S WHAT YOU'RE SUGGESTING BUT TO THE EXTENT THE AUDIENCE IS TRYING TO UNDERSTAND YOUR SENSE OF WHERE THINGS ARE GOING, WHERE ARE WE RIGHT NOW?

DALIO: SO, I THINK IT DEPENDS WHERE -- WHEN YOU ENTER THE QUESTION, WHERE ARE WE RIGHT NOW IT DEPENDS WHERE IS. IF YOU'RE IN EUROPE IT MEANS ONE THING, IF YOU'RE IN THE UNITED STATES IT MEANS SOMETHING ELSE, IF YOU'RE IN CHINA IT MEANS SOMETHING ELSE. AND IT SOUNDS TO ME LIKE WE DON'T HAVE ENOUGH TIME TO COVER THOSE. I WOULD SAY IF I WAS TO MAKE A BIG GENERALIZATION, EUROPE WILL BE IN -- THEIR ECONOMY WILL BE TERRIBLE AND WE WILL HAVE A GRADUAL RESTRUCTURING AND THAT WILL GO ON FOR AWHILE AND IT WILL BE BAD. IN THE UNITED STATES, I THINK YOU'RE GOING TO HAVE THIS SHIFTING TO TAKING ON THE MORE RISK. IN JAPAN, WE ARE RELIQUEFYING THE PRINTING OF MONEY TO GET OUT OF THAT PROBLEM AND IT'S GOING TO BE MORE LIQUIDITY BROUGHT IN. AND IN CHINA, IT'S BOUNCING BACK AND THEY HAVE TO DEAL WITH THE FACT THAT DEBT MAYBE IS GROWING FASTER THAN INCOME.

SORKIN: RIGHT.

DALIO: AND THAT'S AN ISSUE. SO WE ARE IN A DIFFERENT KIND OF WORLD. WE WILL NOT -- SO I'M GOING ON TOO LONG. THAT'S THE BEST I CAN DO IN A TIME.

SORKIN: A MINUTE YOU JUST TOLD US A LOT. SO THANK YOU FOR THAT AND THANK YOU FOR THIS INTERVIEW. WE APPRECIATE IT VERY MUCH. HAVE A FUN TIME AT THE REST OF THE WORLD ECONOMIC FORUM. BACK TO JOE AND BECKY BACK IN THE STUDIO.


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