Is the Capitalist System Really Broken?

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Catherine Clifford of CNBC reports on how America’s capitalist system is ‘broken,’ according to billionaire financier Ray Dalio:
“The world has gone mad and the system is broken.”

So says Ray Dalio, the billionaire financier and founder of Bridgewater Associates, the largest hedge fund in the world with $160 billion in assets.

There are several problems, including an overzealous lending market, a growing mountain of government debt and a widening divide between the rich and poor that’s becoming more tense, he says.

“This set of circumstances is unsustainable and certainly can no longer be pushed as it has been pushed since 2008. That is why I believe that the world is approaching a big paradigm shift,” Dalio wrote in a LinkedIn post published Tuesday.

Dalio, 70 and worth almost $19 billion, does not elucidate what that paradigm shift will be in his post, but he has been outspoken in his criticism of the very capitalist system that made him successful. In an interview with CBS’ “60 Minutes” in July, Dalio said the U.S. economy must change or there will be a “conflict” between the rich and the poor. And in January, he said “capitalism basically is not working for the majority of people.”



In his recent LinkedIn post, Dalio zeroed in on the way money is flowing through the economy.

First, says Dalio, we are in a situation known as “pushing on a string.” That is a scenario where central banks (like the Federal Reserve in the United States) are struggling to get their monetary policies to actually stimulate increased spending, according to Dalio’s book, “Principles for Navigating Big Debt Crises,” which he references in the LinkedIn post. That in turn leads to “low growth and low returns on assets,” he says in the book and echoes in the post. ”[T]he prices of financial assets have gone way up and the future expected returns have gone way down, while economic growth and inflation remain sluggish,” Dalio writes on LinkedIn. “Those big price rises and the resulting low expected returns are not just true for bonds; they are equally true for equities, private equity, and venture capital....”

In the venture capital and start-up space, this means “more companies than at any time since the dot-com bubble don’t have to make profits or even have clear paths to making profits to sell their stock because they can instead sell their dreams to those investors who are flush with money and borrowing power,” Dalio says.

At the same time, the U.S. government is out of money — and still spending, as deficits continue to grow. Governments need to fund obligations like pensions and healthcare, Dalio points out.

“Since there isn’t enough money ... there will likely be an ugly battle to determine how much of the gap will be bridged by 1) cutting benefits, 2) raising taxes, and 3) printing money...” Dalio writes.

“They are promises that have to be paid — they will either be paid by higher taxes or they’ll be not paid and defaulted on,” Dalio told CNBC at the Greenwich Economic Forum on Tuesday. “I don’t think they will be defaulted on. I think by and large, they’re going to be paid, but if they raise taxes too much, then it changes the nature of that economics.”

Dalio says higher taxes and less benefits will continue to create tension between the rich and the poor.

“The rich/poor battle over how much expenses should be cut and how much taxes should be raised will be much worse,” Dalio wrote on LinkedIn.

“Because the ‘trickle-down’ process of having money at the top trickle down to workers and others ... is not working, the system of making capitalism work well for most people is broken,” wrote Dalio.
It's Friday, I typically write about markets but I want to focus on Ray Dalio's LinkedIn post, The World Has Gone Mad and the System Is Broken (added emphasis is mine):
I say these things because:
  • Money is free for those who are creditworthy because the investors who are giving it to them are willing to get back less than they give. More specifically investors lending to those who are creditworthy will accept very low or negative interest rates and won’t require having their principal paid back for the foreseeable future. They are doing this because they have an enormous amount of money to invest that has been, and continues to be, pushed on them by central banks that are buying financial assets in their futile attempts to push economic activity and inflation up. The reason that this money that is being pushed on investors isn’t pushing growth and inflation much higher is that the investors who are getting it want to invest it rather than spend it. This dynamic is creating a “pushing on a string” dynamic that has happened many times before in history (though not in our lifetimes) and was thoroughly explained in my book Principles for Navigating Big Debt Crises. As a result of this dynamic, the prices of financial assets have gone way up and the future expected returns have gone way down while economic growth and inflation remain sluggish. Those big price rises and the resulting low expected returns are not just true for bonds; they are equally true for equities, private equity, and venture capital, though these assets’ low expected returns are not as apparent as they are for bond investments because these equity-like investments don’t have stated returns the way bonds do. As a result, their expected returns are left to investors’ imaginations. Because investors have so much money to invest and because of past success stories of stocks of revolutionary technology companies doing so well, more companies than at any time since the dot-com bubble don’t have to make profits or even have clear paths to making profits to sell their stock because they can instead sell their dreams to those investors who are flush with money and borrowing power. There is now so much money wanting to buy these dreams that in some cases venture capital investors are pushing money onto startups that don’t want more money because they already have more than enough; but the investors are threatening to harm these companies by providing enormous support to their startup competitors if they don’t take the money. This pushing of money onto investors is understandable because these investment managers, especially venture capital and private equity investment managers, now have large piles of committed and uninvested cash that they need to invest in order to meet their promises to their clients and collect their fees.
  • At the same time, large government deficits exist and will almost certainly increase substantially, which will require huge amounts of more debt to be sold by governments—amounts that cannot naturally be absorbed without driving up interest rates at a time when an interest rate rise would be devastating for markets and economies because the world is so leveraged long. Where will the money come from to buy these bonds and fund these deficits? It will almost certainly come from central banks, which will buy the debt that is produced with freshly printed money. This whole dynamic in which sound finance is being thrown out the window will continue and probably accelerate, especially in the reserve currency countries and their currencies—i.e., in the US, Europe, and Japan, and in the dollar, euro, and yen.
  • At the same time, pension and healthcare liability payments will increasingly be coming due while many of those who are obligated to pay them don’t have enough money to meet their obligations. Right now many pension funds that have investments that are intended to meet their pension obligations use assumed returns that are agreed to with their regulators. They are typically much higher (around 7%) than the market returns that are built into the pricing and that are likely to be produced. As a result, many of those who have the obligations to deliver the money to pay these pensions are unlikely to have enough money to meet their obligations. Those who are recipients of these benefits and expecting these commitments to be adhered to are typically teachers and other government employees who are also being squeezed by budget cuts. They are unlikely to quietly accept having their benefits cut. While pension obligations at least have some funding, most healthcare obligations are funded on a pay-as-you-go basis, and because of the shifting demographics in which fewer earners are having to support a larger population of baby boomers needing healthcare, there isn’t enough money to fund these obligations either. Since there isn’t enough money to fund these pension and healthcare obligations, there will likely be an ugly battle to determine how much of the gap will be bridged by 1) cutting benefits, 2) raising taxes, and 3) printing money (which would have to be done at the federal level and pass to those at the state level who need it). This will exacerbate the wealth gap battle. While none of these three paths are good, printing money is the easiest path because it is the most hidden way of creating a wealth transfer and it tends to make asset prices rise. After all, debt and other financial obligations that are denominated in the amount of money owed only require the debtors to deliver money; because there are no limitations made on the amounts of money that can be printed or the value of that money, it is the easiest path. The big risk of this path is that it threatens the viability of the three major world reserve currencies as viable storeholds of wealth. At the same time, if policy makers can’t monetize these obligations, then the rich/poor battle over how much expenses should be cut and how much taxes should be raised will be much worse. As a result rich capitalists will increasingly move to places in which the wealth gaps and conflicts are less severe and government officials in those losing these big tax payers will increasingly try to find ways to trap them.
  • At the same time as money is essentially free for those who have money and creditworthiness, it is essentially unavailable to those who don’t have money and creditworthiness, which contributes to the rising wealth, opportunity, and political gaps. Also contributing to these gaps are the technological advances that investors and the entrepreneurs that I previously mentioned are excited by in the ways I described, and that also replace workers with machines. Because the “trickle-down” process of having money at the top trickle down to workers and others by improving their earnings and creditworthiness is not working, the system of making capitalism work well for most people is broken.
This set of circumstances is unsustainable and certainly can no longer be pushed as it has been pushed since 2008. That is why I believe that the world is approaching a big paradigm shift.
In my opinion, this is one of the best comments Ray Dalio posted in a very long time. I read it carefully and with a critical eye.

You'll notice I asked a very simple question at the top, Is the Capitalist System Really Broken? Let me begin by emphatically stating "no", capitalists like Ray Dalio are still making off like bandits and rising inequality continues unabated as profits are increasingly being concentrated in fewer and fewer companies (and funds).

But some of them (like Dalio) recognize the severe structural problems plaguing the current system and how inherently unfair it has become, trapping billions in poverty or working poverty while a handful of "capitalists" enjoy an increasingly larger slice of the pie (I use the term capitalists in the broadest sense to include everyone from tech innovators, to hedge fund and private equity managers to corporate barons).

Before I get into my analysis of Dalio's latest post, you should all read Cullen Roche's fantastic response on Pragmatic Capitalism here. Roche critically examines important points he thinks Dalio got wrong and where he thinks he got it right.

Now, let me closely examine where I agree and disagree with Dalio.

First, his “pushing on a string” dynamic. No doubt, central banks are buying financial assets in their futile attempts to push economic activity and inflation up. The problem is central banks don't control inflation expectations, the only inflation they can really cause is asset inflation, which is what is happening.

Two years ago, I asked whether deflation is headed to the US and cited  seven structural factors that led me to believe we are headed for a prolonged period of debt deflation:
  1. The global jobs crisis: High structural unemployment, especially youth unemployment, and less and less good paying jobs with benefits.
  2. Demographic time bomb: A rapidly aging population means a lot more older people with little savings spending less.
  3. The global pension crisis: As more and more people retire in poverty, they will spend less to stimulate economic activity. Moreover, the shift out of defined-benefit plans to defined-contribution plans is exacerbating pension poverty and is deflationary. Read more about this in my comments on the $400 trillion pension time bomb and the pension storm cometh. Any way you slice it, the global pension crisis is deflationary and bond friendly.
  4. Excessive private and public debt: Rising government and consumer debt levels are constraining public finances and consumer spending.
  5. Rising inequality: Hedge fund (and private equity) gurus cannot appreciate this because they live in an alternate universe, but widespread and rising inequality is deflationary as it constrains aggregate demand. The pension crisis will exacerbate inequality and keep a lid on inflationary pressures for a very long time.
  6. Globalization: Capital is free to move around the world in search of better opportunities but labor isn't. Offshoring manufacturing and service sector jobs to countries with lower wages increases corporate profits but exacerbates inequality.
  7. Technological shifts: Think about Amazon, Uber, Priceline, AI, robotics, and other technological shifts that lower prices and destroy more jobs than they create.
These are the seven structural factors I keep referring to when I warn investors to temper their growth forecasts and to prepare for global deflation.

Now, central banks know all about these structural factors. There's not much they can do about these structural factors or is there?

That was my initial thinking but let me throw a curve ball your way, something I've been grappling with as I think about the end game for pensions.

Again, two years ago, I wrote about the Mother of all US pension bailouts and last year I discussed how Congress gave a multibillion Thanksgiving pension bailout to solve a retirement crisis that threatened more than 1 million Americans in “multiemployer” pensions.

Why is this important? Because it provides clues as to what will happen when many chronically underfunded state and local pensions hit the proverbial brick wall, they will be bailed out by Congress and the Fed and US Treasury will help them meet their obligations (by buying pension bonds or simply transferring money to them).

Of course, it won't be that simple. I suspect retired members of these underfunded US public pensions will take some haircut, either partial or full removal of indexation or a more pronounced cut in benefits.

This is where Dalio rightly warns there will be huge tensions because teachers and other public sector employees and retirees will fight tooth and nail against any cuts in benefits.

But mark my words, the Mother of all US public pension bailouts is coming and it will likely come after the next major financial crisis hits us, whenever that is.

This is why central banks are vigorously trying to reflate the bubble, they know the next crisis will lead to widespread pain and misery, mostly for the poor, working class and those a step away from pension poverty.

Now, Dalio says central banks are "pushing on a string," but are they really? Central banks are forcing investors out on the risk curve (while they warn pensions reaching for yield) by continuously lowering rates and engaging in QE or quasi-QE operations. Mohamed El-Erian recently posted this chart on LinkedIn:


I wryly quipped: "Wake me up when the Fed's balance sheet surpasses all other central banks combined, then the fun begins."

Of course, I was joking because if the Fed is required to significantly increase its balance sheet to that degree, it won't be a pretty world economy, it will be a depression.

But if the Fed is to replenish US public pensions by buying pension bonds or just lending them money at zero or negative rates, you will see its balance sheet mushroom.

At that point, we might see a crisis of confidence, the US reserve currency status might be challenged. I say might because the truth is the global pension crisis is global, it's affecting everyone and if everyone is using its central bank to prop up public pensions, the greenback will be no better or worse than other currencies.

I guess at that point -- or way before we reach that point -- gold prices will skyrocket but it's too early to make these forecasts, a lot can happen before we reach that point.

Still, I take Dalio's comments on central banks "pushing on a string"with a grain of salt. It remains to be seen just how high the Fed can go in terms of its balance sheet and nobody has provided me with a good analysis as why it can't quintuple or more from these levels.

The problem with "omnipotent central banks" is they create huge distortions across the capital market spectrum and are making the job of investing for the long run a lot more challenging. David Long, HOOPP's former co-CIO, alluded to this earlier this week when I went over the 2019 Power 100 List.

We actually see some of these distortions in the making, most recently with the rise and fall of WeWork. SoftBank, which I consider to be the world's largest Ponzi scheme, created the WeWork monster and is ultimately responsible for this spectacular blowup.

Dalio is right, there's too much money "chasing dreams" (more like hype and hope) and as long as we see this gross misallocation of resources, the wealth divide will only grow and cause a wider social rift.

He ends by stating the “trickle-down” process of having money at the top trickle down to workers and others by improving their earnings and creditworthiness is not working, the system of making capitalism work well for most people is broken.

I first chuckled reading this because it reminded me of an exchange between William F. Buckley Jr. and John Kenneth Galbraith on Firing Line where referring to "trickle down" economics, Galbraith stated his famous quote: “If you feed enough oats to the horse, some will pass through to feed the sparrows.”

But I also read Dalio's last sentence as a warning not only to his fellow capitalists, the prosperous few, but also to the rest of us mere mortals, the restless many: "This set of circumstances is unsustainable and certainly can no longer be pushed as it has been pushed since 2008. That is why I believe that the world is approaching a big paradigm shift."

What is this big paradigm shift Dalio is warning of? I suspect he hasn't got a clue (or is too scared to say it), nobody really knows but somewhere out there, Karl Marx is rolling over in his grave and having a good laugh. This as we celebrate the 30th anniversary of the fall of the Berlin Wall.

All I know is even the IMF is warning of the financial system's instability (which is probably good because it means the crisis isn't coming any time soon):



As always, hope you enjoyed this comment even if it's not my regular market comment.

Below, Meb Faber recently spoke with GMO’s Ben Inkler on the problem of good returns in the near term. Take the time to listen to this podcast here, it's excellent, especially the part on monopolies/ monosponies and how profits are increasingly being concentrated in a handful of large corporations. I also embedded it below.

Also, if you haven't read Jonathan Tepper's book, The Myth of Capitalism, make sure you read it, it is the best economics book I've read in a very long time even if my friend Jonathan Nitzan thinks otherwise.

Second, Bridgewater Associates founder and billionaire investor Ray Dalio sits down with CNBC's Leslie Picker to discuss the state of monetary policy in the US, income inequality and more. Great interview, take the time to watch it.

Third, Yahoo Finance's Julia LaRoche reports from the Greenwich Economic Forum 2019 on the comments made by Paul Tudor Jones and Ray Dalio regarding politics, the economy, and the market.

Fourth, Omega Advisors' Leon Cooperman gets emotional in talking about the current state of the United States. He and Bill Gates got berated by many leftist organizations for being "whining billionaires."

Fifth, I embedded an older clip where Stephanie Pomboy, founder and president of Macro Mavens, sat down with Real Vision's Grant Williams to discuss her global outlook after the Fed’s course-reversal late last year. Pomboy and Williams take a deep dive into the significance of the gaps between various economic indicators, and discuss the implications for capital markets. They also touch on associated topics such as pensions, China, cryptocurrencies, and gold. Filmed on April 18, 2019 in New York. Make sure you listen to her comments on pensions starting at minute 10.

Lastly, Ronald Reagan's famous Berlin Wall speech where he implored Mikhail Gorbachev to "tear down this wall." That speech led to one of the most important moments in history.





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