Ray Dalio thinks the dynamics of sound finance have vanished. Here are 3 reasons he sees an unsustainable future for a world that's 'gone mad.'
- Ray Dalio - the founder and cochief investment officer of Bridgewater Associates, the world's largest hedge fund - thinks the "world has gone mad."
- He backs his thesis by outlining a troubling culmination of irrationalities he's seeing in today's market environment.
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To Ray Dalio, the founder and cochief investment officer of Bridgewater Associates, irrationalities in financial markets are seemingly everywhere. And in a new LinkedIn post, the billionaire investor wasn't coy about airing his grievances.
"This set of circumstances is unsustainable and certainly can no longer be pushed as it has been pushed since 2008," he penned. "That is why I believe that the world is approaching a big paradigm shift."
Dalio's warning isn't without merit. The plethora of issues he sees molding the financial system are certainly not for the better.
Three of his biggest gripes with the overarching economy are a system awash with cheap capital, burgeoning government deficits, and massive pension and healthcare liabilities coming due.
Let's take a closer look.
1. Free money
It's no secret that central banks around the world have been voraciously trying to stimulate their economies. However, the growth and inflation that these policies have meant to spur has largely been absent.
"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," he said. "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."
In short, the stimulus provided by central banks is being pumped into assets and not into the economy. This lowers the expected return for stocks going forward, which is causing a big issue we'll get to in just a bit. Some are relying on those returns to fund future obligations.
2. Gargantuan deficits
"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," he said.
Dalio's overarching point here is that a rising deficit starts a domino effect.
In order to fund deficits, governments sell huge quantities of debt which have to be held by someone.
But if there's too much supply on hand, the market will demand a higher interest rate (lower price). The problem with that is that higher rates depress stock prices, as increasing risk-free rates of return start to look more attractive.
To Dalio, this means that central banks will have to be the buyer of this debt to keep markets afloat.
There's only one problem. The deprecating effect that this has on a country's currency.
"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," he said.
3. Pension and healthcare liabilities
The next big problem that Dalio sees poking its head over the horizon are the massive liabilities coming due with a dramatic shift in demographics.
"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," he said. "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."
He continued: "They are typically much higher (around 7%) than the market returns that are built into the pricing and that are likely to be produced."
Dalio sees the odds of these pensions meeting their upcoming obligations as slim. The cheap capital that was mentioned above has greatly depressed the forward looking returns for stocks. As of today, a 7% return seems more like a pipe-dream than a reality.
But that's not all.
"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," he said.