Monday, December 19, 2016

Ray Dalio's Back To The Future?

Ray Dalio, Chairman and CIO at Bridgewater Associates, wrote a comment on LinkedIn, Reflections on the Trump Presidency, One Month after the Election (added emphasis is mine):
Now that we’re a month past the election and most of the cabinet posts have been filled, it is increasingly obvious that we are about to experience a profound, president-led ideological shift that will have a big impact on both the US and the world. This will not just be a shift in government policy, but also a shift in how government policy is pursued. Trump is a deal maker who negotiates hard, and doesn’t mind getting banged around or banging others around. Similarly, the people he chose are bold and hell-bent on playing hardball to make big changes happen in economics and in foreign policy (as well as other areas such as education, environmental policies, etc.). They also have different temperaments and different views that will have to be resolved.

Regarding economics, if you haven’t read Ayn Rand lately, I suggest that you do as her books pretty well capture the mindset. This new administration hates weak, unproductive, socialist people and policies, and it admires strong, can-do, profit makers. It wants to, and probably will, shift the environment from one that makes profit makers villains with limited power to one that makes them heroes with significant power. The shift from the past administration to this administration will probably be even more significant than the 1979-82 shift from the socialists to the capitalists in the UK, US, and Germany when Margaret Thatcher, Ronald Reagan, and Helmut Kohl came to power. To understand that ideological shift you also might read Thatcher’s “The Downing Street Years.” Or, you might reflect on China’s political/economic shift as marked by moving from “protecting the iron rice bowl” to believing that “it’s glorious to be rich.”

This particular shift by the Trump administration could have a much bigger impact on the US economy than one would calculate on the basis of changes in tax and spending policies alone because it could ignite animal spirits and attract productive capital. Regarding igniting animal spirits, if this administration can spark a virtuous cycle in which people can make money, the move out of cash (that pays them virtually nothing) to risk-on investments could be huge. Regarding attracting capital, Trump’s policies can also have a big impact because businessmen and investors move very quickly away from inhospitable environments to hospitable environments. Remember how quickly money left and came back to places like Spain and Argentina? A pro-business US with its rule of law, political stability, property rights protections, and (soon to be) favorable corporate taxes offers a uniquely attractive environment for those who make money and/or have money. These policies will also have shocking negative impacts on certain sectors.

Regarding foreign policy, we should expect the Trump administration to be comparably aggressive. Notably, even before assuming the presidency, Trump is questioning the one-China policy which is a shocking move. Policies pertaining to Iran, Mexico, and most other countries will probably also be aggressive.

The question is whether this administration will be a) aggressive and thoughtful or b) aggressive and reckless. The interactions between Trump, his heavy-weight advisors, and them with each other will likely determine the answer to this question. For example, on the foreign policy front, what Trump, Flynn, Tillerson, and Mattis (and others) are individually and collectively like will probably determine how much the new administration’s policies will be a) aggressive and thoughtful versus b) aggressive and reckless. We are pretty sure that it won’t take long to find out.

In the next section we look at some of the new appointees via some statistics to characterize what they’re like. Most notably, many of the people entering the new administration have held serious responsibilities that required pragmatism and sound judgment, with a notable skew toward businessmen.

Perspective on the Ideology and Experience of the New Trump Administration

We can get a rough sense of the experience of the new Trump administration by adding up the years major appointees have spent in relevant leadership positions. The table below compares the executive/government experience of the Trump administration’s top eight officials* to previous administrations, counting elected positions, government roles with major administrative responsibilities, or time as C-suite corporate executives or equivalent at mid-size or large companies. Trump’s administration stands out for having by far the most business experience and a bit lower than average government experience (lower compared to recent presidents, and in line with Carter and Reagan). But the cumulative years of executive/government experience of his appointees are second-highest. Obviously, this is a very simple, imprecise measure, and there will be gray zones in exactly how you classify people, but it is indicative.

Below we show some rough quantitative measures of the ideological shift to the right we’re likely to see under Trump and the Republican Congress. First, we look at the economic ideology of the incoming US Congress. Trump’s views may differ in some important ways from the Congressional Republicans, but he’ll need Congressional support for many of his policies and he’s picking many of his nominees from the heart of the Republican Party. As the chart below shows, the Republican members of Congress have shifted significantly to the right on economic issues since Reagan; Democratic congressmen have shifted a bit to the left. The measure below is one-dimensional and not precise, but it captures the flavor of the shift. The measure was commissioned by a National Science Foundation grant and is meant to capture economic views with a focus on government intervention on the economy. They looked at each congressman’s voting record, compared it to a measure of what an archetypical liberal or conservative congressman would have done, and rated each member of Congress on a scale of -1 to 1 (with -1 corresponding to an archetypical liberal and +1 corresponding to an archetypical conservative).

When we look more specifically at the ideology of Trump’s cabinet nominees, we see the same shift to the right on economic issues. Below we compare the ideology of Trump’s cabinet nominees to those of prior administrations using the same methodology as described above for the cabinet members who have been in the legislature. By this measure, Trump’s administration is the most conservative in recent American history, but only slightly more conservative than the average Republican congressman. Keep in mind that we are only including members of the new administration who have voting records (which is a very small group of people so far).

While the Trump administration appears very right-leaning by the measures above, it’s worth keeping in mind that Trump’s stated ideology differs from traditional Republicans in a number of ways, most notably on issues related to free trade and protectionism. In addition, a number of key members of his team—such as Steven Mnuchin, Rex Tillerson, and Wilbur Ross—don’t have voting records and may not subscribe to the same brand of conservatism as many Republican congressmen. There’s a degree of difference in ideology and a level of uncertainty that these measures don’t convey.

Comparing the Trump and Reagan Administrations

The above was a very rough quantitative look at Trump’s administration. To draw out some more nuances, below we zoom in on Trump’s particular appointees and compare them to those of the Reagan administration. Trump is still filling in his appointments, so the picture is still emerging and our observations are based on his key appointments so far.

Looking closer, a few observations are worth noting. First, the overall quality of government experience in the Trump administration looks to be a bit less than Reagan’s, while the Trump team’s strong business experience stands out (in particular, the amount of business experience among top cabinet nominees). Even though Reagan’s administration had somewhat fewer years of government experience, the typical quality of that experience was somewhat higher, with more people who had served in senior government positions. Reagan himself had more political experience than Trump does, having served as the governor of California for eight years prior to taking office, and he also had people with significant past government experience in top posts (such as his VP, George HW Bush). By contrast, Trump’s appointees bring lots of high quality business leadership experience from roles that required pragmatism and judgment. Rex Tillerson’s time as head of a global oil company is a good example of high-level international business experience with clear relevance to his role as Secretary of State (to some extent reminiscent of Reagan’s second Secretary of State, George Shultz, who had a mix of past government experience and international business experience as the president of the construction firm Bechtel). Steven Mnuchin and Wilbur Ross have serious business credentials as well, not to mention Trump’s own experience. It’s also of note that Trump has leaned heavily on appointees with military experience to compensate for his lack of foreign policy experience (appointing three generals for Defense, National Security Advisor, and Homeland Security), while Reagan compensated for his weakness in that area with appointees from both military and civilian government backgrounds (Bush had been CIA head and UN ambassador, and Reagan’s first Secretary of State, Alexander Haig, was Supreme Allied Commander of NATO forces during the Cold War). Also, Trump has seemed less willing to make appointments from among his opponents than Reagan was (Reagan’s Chief of Staff had chaired opposing campaigns, and his Vice President had run against him).

By and large, deal-maker businessmen will be running the government. Their boldness will almost certainly make the next four years incredibly interesting and will keep us all on our toes.
I read Ray Dalio's comment on Monday morning and replied the following on LinkedIn (click on image):

If you can't read it, here it is again:
Come on Ray, wait at least four years, then judge his and his administration's track record. By the way, inequality soared under Reagan, it will skyrocket under Trump. So, forget Ayn Rand, go back to the future and read John Kenneth Galbraith who once noted: '"If you feed enough oats to the horse, some will pass through to feed the sparrows" (referring to trickle down economics). Elites of the world unite and rejoice!
It's also worth noting that Bridgewater President David McCormick is rumored to be at the tippy top of President-elect Trump’s list to become the Deputy Secretary of Defense, an appointment which I'm sure sits well with Ray Dalio and might have influenced this glowing review of Trump's top picks.

Interestingly, the last guy in Washington who espoused Ayn Rand's philosophy was Alan Greenspan. Things didn't turn out quite like the Maestro thought when he let unfettered markets do their thing. He testified at an Oversight Committee back in 2008 where he basically admitted he failed to see the biggest financial crisis in history because he allowed his ideology to trump common sense (no pun intended). 

Now we have Ray Dalio and the folks at Bridgewater touting Trump's appointments, paying particular attention to their "serious business experience". The last world leader with "serious business experience" was Italy's Sylvio Berlusconi, the 'bunga bunga' clown who arguably did more harm to that country than all other leaders combined.

True, Trump isn't Berlusconi, even though they both exhibit similar pathological narcissistic traits. And to be fair, President-elect Trump and his administration have some interesting policies which can help at the margin (like spending on infrastructure), but I do know one thing, inequality will skyrocket under Trump's administration and that worries me because it reinforces the deflationary headwinds I keep warning my readers of.   

All weekend, I was reading and watching right-wing and left-wing nonsense that left me speechless. Whether it's Paul Craig Roberts warning that a "CIA-led Coup Against American Democracy Is Unfolding Before Our Eyes" or ABC This Week devoting an entire show on the Russian hackers conspiracy, I'm left dumbfounded at just how stupid some Americans are to buy this nonsense.

First, a note to Paul Craig Roberts. Excuse my English but Trump is the elites. They may not like his brash style and temperament but they sure as hell love his economic policies and despite the rhetoric, the financial and military elite will profit under his administration and that's all they really care about.

Second, if I have to hear CNN commentator Van Jones lecturing me and millions of others on how cyber war is real war, I'm going to literally puke. Note to Van Jones and the ignorant masses, successive American governments have been engaging in cyber war for as long as cyber space has existed and when it comes to hacking, the NSA and several other American agencies (like the FBI and CIA) can annihilate Russia and wreak havoc on its economy with a few key strokes (don't believe nonsense that the US has fallen dangerously behind Russia in cyber warfare capabilities).

My own conspiracy theory is that the Obama administration was well aware of Russia hacking the DNC and didn't intervene not because President Obama didn't want to interfere in the elections, but because deep down, he can't stand the Clintons and didn't want to throw Hillary a life jacket (as far-fetched as it sounds, I don't think he shed a tear watching her drown in her scandals).

All this to say when I watch CNN, Fox News, or read the New York Times and Washington Post, I put on my 'BS' detector glasses and basically filter out all disinformation coming my way, because behind the headlines lies the true story of power and corruption (and that goes for right-wing conservative Republicans and left-wing limousine liberal Democrats with their hypocritical nonsense)

I'm getting very cynical in my old age which is probably why I'm relating more and more to the late George Carlin who captured the essence of American politics brilliantly in his American Dream skit. "It's called the American dream because you have to be asleep to believe it."

On a more serious note, Ray Dalio thinks we are headed back to the future and that the 1930s hold clues to what lies ahead for the economy:
This is not a normal business cycle; monetary policy will be a lot less effective in the future; investment returns will be very low. These have come to be widely held views, but there is little understanding as to why they are true. I have a simple template for looking at how the economic machine works that helps shine some light. It has three parts.

First, there are three main forces that drive all economies: 1) productivity; 2) the short-term debt cycle, or business cycle, running every five to ten years; and 3) the long-term debt cycle, over 50 to 75 years. Most people don’t adequately understand the long-term debt cycle because it comes along so infrequently. But this is the most important force behind what is happening now.

Second, there are three equilibriums that markets gravitate towards: 1) debt growth has to be in line with the income growth that services those debts; 2) economic operating rates and inflation rates can’t be too high or too low for long; and 3) the projected returns of equities have to be above those of bonds, which in turn have to be above those of cash by appropriate risk premiums. Without such risk premiums the transmission mechanisms of capital won’t work and the economy will grind to a halt. In the years ahead, the capital markets’ transmission mechanism will work more poorly than in the past, as interest rates can’t be lowered and risk premiums of other investments are low. Most people have never experienced this before and don’t understand how this will cause low returns, more debt monetisation and a “pushing on a string” situation for monetary policy.

Third, there are two levers that policy-makers can use to bring about these equilibriums: 1) monetary policy, and 2) fiscal policy. With monetary policy becoming relatively impotent, it’s important for these two to be co-ordinated. Yet the current state of political fragmentation around the world makes effective co-ordination hard to imagine.

The long and the short of it

Although circumstances like these have not existed in our lifetimes, they have taken place numerous times in recorded history. During such periods, central banks need to monetise debt, as they have been doing, and conditions become increasingly risky.

What does this template tell us about the future? By and large, productivity growth is slow, business cycles are near their mid-points and long-term debt cycles are approaching the end of their pushing-on-a-string phases. There is only so much one can squeeze out of a long-term debt cycle before monetary policy becomes ineffective, and most countries are approaching that point. Japan is closest, Europe is a step behind it, the United States is a step or two behind Europe and China a few steps behind America.

For most economies, cyclical influences are close to being in equilibrium and debt growth rates are manageable. In contrast to 2007, when my template signalled that we were in a bubble and a debt crisis was ahead, I don’t now see such an abrupt crisis in the immediate future. Instead, I see the beginnings of a longer-term, gradually intensifying financial squeeze. This will be brought about by both income growth and investment returns being low and insufficient to fund large debt-service, pension and health-care liabilities. Monetary and fiscal policies won’t be of much help.

As time passes, how the money flows between asset classes will get more interesting. At current rates of central-bank debt buying, they will soon hit their own constraints, which they will probably have to abandon to continue monetising. That will mean buying riskier assets, which will push prices of these assets higher and future returns lower.

The bond market is risky now and will get more so. Rarely do investors encounter 
a market that is so clearly overvalued and also so close to its clearly defined limits, as there is a limit to how low negative bond yields can go. Bonds will become a very bad deal as ­central banks try to push more money into them, and savers will decide to keep that money elsewhere.

Right now, while a number of riskier assets look like good value compared with bonds and cash, they are not cheap given their risks. They all have low returns with typical volatility, and as people buy them, their reward-to-risk ratio will worsen. This will create a growing risk that savers will seek to escape financial assets and shift to gold and similar non-monetary preserves of wealth, especially as social and political ­tensions intensify.

For those interested in studying analogous periods, I recommend looking at 1935-45, after the 1929-32 stockmarket and economic crashes, and following the great quantitative easings that caused stock prices and economic activity to rebound and led to “pushing on a string” in 1935. That was the last time that the global configuration of fund­amentals was broadly similar to what it is today.
I'm not going to argue each and every point Ray makes but suffice it to say that given my deflation outlook which is reinforced by a developing US dollar crisis which will reverberate around the world, I disagree with Ray, Bob Prince and the folks at Bridgewater when it comes to US bonds.

And the only "Back to the Future" I see ahead is trickle down economic nonsense which will exacerbate rising inequality and deflationary headwinds for many more years.

Importantly, President-elect Trump and his group of billionaires surrounding him won't trump the bond market and if they're not careful, they will create a deflationary storm unlike anything else we've ever experienced which will set the global economy back decades (David Rosenberg gets it).

How's that for some Monday morning Christmas cheer? -:)

Below, I embedded various clips associated with this comment. As always, feel free to reach me at if you have something to add or just want to criticize me and tell me what a fool I am and shouldn't question Ray Dalio, the economic machine and American democracy hypocrisy.

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