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CNBC Transcript: Ray Dalio, Founder, Bridgewater Associates - Part I

Below is the transcript of a CNBC exclusive interview with Bridgewater Associates founder, Ray Dalio. The interview will play out in CNBC's latest episode of Managing Asia on 23 August 2019, 5.30PM SG/HK (in APAC) and 11.00PM BST time (in EMEA). If you choose to use anything, please attribute to CNBC and Christine Tan.

Christine Tan (C): Ray, thank you so much for this exclusive interview. You are the founder & Chairman of the world's biggest hedge fund. Financial volatility is not new to you. But when you look at the markets today, are you surprised at how quickly the narrative has changed from a global synchronized recovery to a global synchronized slowdown?

Ray Dalio (R): Over the years, there are always paradigm shifts. One gets used to a certain type of environment and then, there are other periods of time when they shift to a very different kind of environment. For example, the 1920s were the exact opposite of the 1930s. So, the transition from the '20s to the '30s shocked people. The '40s were different from the '50s and so on, and all of their various ways. So you come to periods of time where something has gone on for a long time, such as the easing of monetary policy in the ways that it's been used through not only lower interest rates, to the point that we had negative interest rates, but also the quantitative easing. That paradigm, that leveraging up, for example, can't continue. But yet late in cycles, people extrapolate back which happened in the past, and so, there are these surprises. I think there are always these paradigm shifts. I think by stepping back and seeing history from a longer term perspective is very helpful.

C: But this time round, were you surprised at how quickly things have changed?

R: I'm never surprised to be surprised. I think what do we mean by those changes? I think that becomes the question.

C: At how suddenly from Fed hiking, we've suddenly gone into a Fed dovish mode.

R: Oh, I don't think that's surprising. I think the Fed made a mistake, and I think the Fed understands that it made a mistake in assuming that this is a normal cycle. What they thought was if you pick up growth and lower unemployment, you're going to produce inflation. We're living in a different world now. For various reasons -- a world of a lot of excess capacity and a world of digitalization and so on, in which that's not the big thing. The big thing is the fact that we're approaching an end of the power of central banks to stimulate. So the big thing is that we have a very big asymmetric risk. If the economy turns down, and we are late in the cycle so a downturn will come, there is a lack of ability by central banks to be able to be stimulative and to reverse that. And that's happening at a time where there's great wealth polarity. So if the left and the right, if the capitalists and the socialists or the rich and the poor are at each other's throats at this time, and this is when times are good, imagine what it's going to be like when we have a downturn, and there's an inability of central banks to respond to that. So that shift in Fed policy which came at the end of the year was necessitated by these weakening conditions around the world. The period that we're in is very much like the late 1930s and a number of ways I can explain, but I might go too long to explain it.

C: But after making money for 18 consecutive years, your flagship Pure Alpha Fund lost money 4.9% in the first half of the year. Do you think you do better in a second half?

R: Well, you know like every year, we were going to have that kind of fluctuation. You know everybody makes a big deal over a quarter or half a year, and I just want to be clear, we may not make money even every year. I mean that's not… there will be some variations. I think the key is -- staying on top of these changes that we're talking about and responding to them.

C: You recently talked about a paradigm shift in how one should actually consider putting gold in one's portfolio. Why do you think gold is now a good bet? Do you think a downturn is inevitable?

R: Well, first of all, I think every portfolio should have the right amount of diversification in it. And so, I'm going to approach the question as both a strategic asset allocation move to put gold in a portfolio, that I believe it always should be a certain part of the portfolio, because there's a certain environment that it diversifies a portfolio well and a certain environment to worry about. I also think that that environment is riskier more likely recently now, and that environment is one in which it becomes very difficult to stimulate the economy, and there's a desire to depreciate the value of currencies. Now think about a bond is really the currency. So when one owns a bond or one owns a debt instrument, one is paid a pile of currency over a period of time. When there are a lot of obligations like that, a lot of debt or even unfunded obligations like pension obligations or healthcare obligations that the world has -- a lot of obligations -- and there's not an effective monetary policy to lower interest rates and stimulate as we're talking about, there needs to be at the printing of money running larger deficits, we're going to come into an environment I think in which they're going to be larger deficits that are increasingly monetized. In that kind of an environment (where) the currencies are depreciating, that's an easy way to get out of paying your IOUs with cheaper money...

C: So just to be clear, you are expecting things to take a turn for the worse?

R: In an evolutionary way, over the next one, two and three years, there will be a turn for the worse, yes. I think that there'll be an environment in which you're going to have excess capacity, debt restructurings and political issues entering into it. I think the elections that we are going to have in the United States will have an important bearing. It is a contrast or a conflict between the capitalists and socialists. I think we're going to see more of that. I think that there's going to be an effect, a risk for capitalism, and we need to monitor it.

C: Is a recession in the U.S. inevitable?

R: Well, of course, recessions are always inevitable. Only question is when, and I think that...

C: Do you see one coming?

R: Yeah, I think that in the next two years, let's say prior to the next election, there's probably a 40 percent chance of a recession. And I think that you're seeing this around the world. We're in Singapore, I think you can see that there's borderline, limited amount of growth. You could see it through Asia. You can see it in Europe, and you could see that in the United States.

C: The Fed recently cut rates at the end of July – the first time it has done so since 2008. Where do you see interest rates? Do you think bigger cuts are needed at this stage?

R: I think that, yes. I think you will see greater interest rate cuts as you start to see the world economy starting to slow down. I think you're seeing that being led now by the bonds. In other words, long term interest rates are falling faster than short term interest rates, and that is inverting the yield curve. And when that happens, it means that cash is more attractive than bonds. And as a result, you tend to see then movement toward cash and a slowing up of lending. So we have a situation in which there's a lot of pressure to cut rates, at a time where the economy yet is fairly operating in a fairly high level of activity.

C: Do you think the Federal Reserve has the ability to avert a sharp and serious slowdown, or is the possibility of a fiscal stimulus now more likely?

R: I think that we're now in a political year. So, the fiscal stimulus is not going to be anything happening in the United States in the way of fiscal stimulus till we get past the elections, and then when we get past the elections I think then, there'll be examination of -- depending on who gets in -- there'll be a big change probably in fiscal policy. So, I don't think you're going to see much of a change in fiscal policy anytime soon. I think there's a time horizon that we should look at the markets --that is also marked by the election, and I think that will have a bearing on relations between China and the United States, and so on. Let's step back maybe and put the big factors in perspective I think, and then put a time horizon to that. I think the big factors are we are rather late in both the short term debt cycles and the long term debt cycles, meaning the capacity of central banks to produce stimulation -- it has to be measured by their ability to lower interest rates significantly, do quantitative easing, and have that purchase -- we have a problem there. That's a big thing. But it's not an immediate problem. It's a problem that is going to come in the next one or two years. You're seeing it in Europe, you see it in Japan, and to some extent, you're seeing in the United States. In addition, we have the wealth gap. And with that wealth gap, we have the classic political conflict -- very much like the 1930s -- in which that means that there's greater polarity, greater extremes in both of those, and that will be play a role because if you change policies, you will have a big effect. For example, when Trump administration cut corporate taxes, that pushed stocks up because after taxes you get more so you pay more for your stocks. That will change. So we have this polarity very much like the 1930s - an inability to stimulate in the same way, and a polarity. In addition, we have China, as an emerging country, challenging the United States as an established country and that creates a theme -- that creates a protectionist-type environment -- very much like the 1930s, and it also has implications in terms of all sorts of conflict, and frankly, sand in the gears of the efficiency of the economy. For example, the technologies -- who's going to build these supply lines. In other words, we built an economy in which there was interdependency and efficiency coming from supply lines working in a certain way. Now, as we enter this environment of conflict, there needs to be for personal security, for the security of the countries, there is a move toward independence. The United States says, "I don't want your technologies." And China says, "I can't depend on you giving me your technologies." And that changes, that separation changes the nature of the dynamic which is also an economic influence. Those influences are very similar as I said to the late 1930s. They will be dominant. They are evolutionary influences but they'll play out over the next one, two, three years in creating a paradigm shift. The world we're going to be in is a very different world than the world we were in. The world we were in started in 2008 and (it) had to do with central banks printing money and stimulating, and that is reaching its limit, and that's why I think we're going to see a paradigm shift.

C: So, you're effectively recommending gold as a portfolio diversifier?

R: I'm not… I'm not… I'm saying gold is an important portfolio diversifier. However, let me be clear, I don't think anyone should have a concentrated portfolio now, okay. So people can hone in on one comment I'm making -- that the notion of creating a balanced portfolio is the most important thing that they can do right now, because wealth can't be so much as destroyed as it can be shifted. And so, the world right now largely looks to me, leveraged long. In other words, there's been a lot of borrowing to buy assets, to buy companies. Companies have borrowed money to buy their equities back and so on. That whole move of leverage long is where the market is. I think there's a vulnerability what I'm saying is to that kind of a portfolio, and that gold is one of the items that can diversify that. But I know that these comments will be taken out of proportion because the media then grabs that and says, "Ray Dalio says to go out and buy gold." I think it should not be too much or too little of a part of the portfolio.

C: Just out of curiosity where do you see the price of the yellow metal now hovering around $1,500. Will they break the highs of $1,900s seen way back in 2011?

R: I'm not going to give a price forecast. I'm saying that there is an environment that is a risky environment to the value of currencies because the currencies have to be printed in order to satisfy the obligations - that is a risk, and that a portion of one's portfolio should be in gold. How to do that? I don't want to...

C: But broadly, you see there's upside to gold right now?

R: I think it's a good hedge, and I think it probably has upside, yes.

C: You were right to point out that the volatility in markets is due to the trade conflict between U.S. and China.

R: It's a factor.

C: Let me get your insights on this. Do you think the root cause of the conflict is because China has clearly shown itself to be a rising power when it comes to technological innovation and prowess?

R: Yes, yes, I think classically in history, when a rising power challenges an existing world power, there is plenty to argue about. It's a small world for these two countries. So, these countries are going to bump into each other in various ways. Trade is part of it. Trade is the least important part of it. Technology is very important.

C: It's the root cause?

R: Well, there are three causes. I'll describe it this way. There is trade but technology is probably the most important consideration because technology gives all kinds of strengths. If you read history, it gives economic strength. It gives military strength and so on. Then, if you take the third area, there are certain geopolitical geographies and world influence and alliances and all of those things that enter into it. So there are three areas I would say: there's trade, which I think is the least important of that; there is technology, which has both commercial and military implications; and there is the geopolitical - what regions, what influence such as the question of the South China Seas and that whole area. That's obviously something that there is conflict about.

C: President Trump recently slapped 10 percent tariffs on another $300 billion worth of Chinese goods. Now, this culminated in a PBOC letting the Chinese yuan slide beyond the psychological 7 level. Trump has since then delayed some of those tariffs. But in your mind, does it somehow seem to you that we've now reached a new phase in the trade conflict? Are we now looking at a currency war?

R: Well, let me be clear - the PBOC did not push the currency down. OK. That is not currency manipulation. The currency has a supply and demand of its own. And the PBOC made it clear that within certain boundaries, they'd like to keep order, but within certain boundaries. It is a market. And if you're in favor of having no currency intervention, it's what the United States does, and the question is -- will we come into an environment of currency intervention? I would say, I would be more worried almost that the United States might enter an environment of currency intervention to weaken its currency.

C: And how likely is that?

R: I don't think that that's very likely. But now, what happens later in cycles -- late and long term debt cycles -- when interest rates are not effective and quantitative policy is not effective such as that which we have now -- they will be less effective -- then currency weakness is the common vehicle for stimulating an economy. Because if your currency goes down, in domestic currency terms, and you look at your prices of your stocks or you look at prices of assets, they tend to rise and it's stimulative. So I think we are entering an environment that over the next three years, you will see more currency wars -- whether there are overt interventions or whether their monetary policies that produce that. For example the Bank of Japan when it pursued its stimulative policies, it was two parts: not only to make money very cheap and make the assets therefore unappealing in terms of providing interest rates, but actually the encouragement of investing outside of the country, so that has a depreciating effect on the currency. I think we're going to probably see more of those. So the environment over the next three years, I think will be quite... a lot more competitive in terms of the factors I mentioned in currency being one of them.

C: But when it comes to the Chinese, this breach of the 7 yuan level. This has not happened in the last 10 years. Does it somehow signal to you given your experiences helping China grow its capital markets that Chinese policymakers are getting more comfortable with a weaker yuan to help deal with a trade situation?

R: First of all, I think the 7 level... they said and anybody who's been trading currencies for a long time knows way too much is made out of a particular level, and so I think that they handled that appropriately. I think that the I think the PBOC is very skilled in being able to create essentially what is a two-way market, so that it's not easy to bet against or bet for the renminbi because if it becomes too easy one way or another, it becomes disruptive. So I think they manage that well around what is the supply-demand consideration. It's certainly the case that if you have a weakness or if you particularly have an external account weakness, a trade weakness, that currency weakness is the natural course of those of that. It's stimulative and it's particularly stimulative and compensatory for the export part of it in a weak economy. So you have your choices -- how are you going to ease an economy? You can lower interest rates, you can do some quantitative easing, you can do some regulatory what's called macro prudential moves, and you can weaken the currency or let the currency weaken. So, I think that the market is determining the currency for the most part.

C: Would you be bullish on China still if the Chinese renminbi, the Chinese yuan continues to weaken?

R: Again, the currency weakness is part of the natural adjustment process…

C: So you have no problem with that?

R: I have no problem with currency weakness, and I would also say, I look at the health of the economy and the health of the particular businesses that one is investing in, or bonds. For example, Chinese bonds offer an attractive interest rate. Now, as you look at that, is that more attractive -- that interest rate -- than the currency depreciation? Questions like that are all tactical. The currency depreciation is just part of the adjustment process that takes place because it causes other assets to rise. It causes equities to rise, for example, it has that stimulative effect like interest rate declines do.

C: Who can afford to hold out longer -- the U.S. or China?

R: Wars have a lot to do with how they're going to be played. For example, the United States has a lot of its bonds held by China. It also has its own dependencies and interdependencies in various ways. So, it's very difficult. Nobody can say who's going to use what pressure points in terms of the other. I'm not able to call who's stronger. But I think that it's a little bit scary, as we let our imaginations go, we could see the various harms that these countries can do to each other in the process, and what that'll mean for the world economy. I think that that's the important thing. I couldn't call who will be the winner. In wars in history, there was no knowing who would be the winner. But we do know that in all of those wars, in one form or another, the consequences of those wars were really regrettable by anybody who ventured into it, even those who chose to go into the war regretted the wars because the wars were so terrible. I don't think we know how this can evolve exactly. Once you get this tit-for-tat thing going, there are all sorts of ways that these two countries can do each other harm or do the world harm in terms of trade and other inefficiencies that are created in the capital markets, inefficiencies in trading, and in the supply lines of producing things. It's a lot of sand in the gears, and it's a bad situation.

C: You brought up a very important point because China is the U.S. largest foreign creditor, holding something like more than $1 trillion worth of U.S. treasurys. Does this somehow give China leverage? Could Beijing weaponize its holdings, as part of the trade conflict?

R: Could they? Of course, they could.

C: Or is this scenario unlikely?

R: When one goes into this new world, there are a lot of unknowns, okay. And you have to realize that there are different pressure points. There was a symbiotic relationship between the United States. The United States wanted to spend more than it earned, and use that to buy Chinese and other imports. As a result, they sort of both got what they wanted which were different things -- China wanted to get richer. China wanted to build savings. The United States wanted to get that, and really pay for it on credit. Both of those things happen. Now, we see that we have a debtor-creditor relationship, not just a trade relationship, and that can be a dangerous thing.

C: What are the chances of that happening?

R: I can't… I can't say. As I say, as you get deeper and deeper into wars…

C: But you wouldn't rule it out?

R: I wouldn't rule... I wouldn't rule it out, no.


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