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Abu Dhabi, UAEFriday 16 November 2018

Ray Dalio's Big Debt Crises highlights the 1937 parallel with the next financial crash

The hedge fund guru's book examines the 1930s when stocks fell by 60 per cent and did not recover for 10 years

Ray Dalio is a billionaire and the founder of Bridgewater Associates. Photo: Bloomberg
Ray Dalio is a billionaire and the founder of Bridgewater Associates. Photo: Bloomberg

It takes a while to digest Big Debt Crises, the latest thought-provoking tome from Bridgewater Associates founder, Ray Dalio - the hedge fund multi-billionaire who these days focuses on the bigger picture of investing rather than day-to-day management.

His research team have painstakingly analysed the big debt crises of the past 100 years, finding remarkably repetitious patterns in how they develop and how central banks handle these cataclysmic phenomena.

Basically the conclusion that emerges from this huge pile of data is that the 2007-9 debt crisis was remarkably like the one that led to the Great Crash of 1929, and the subsequent Great Depression of the early 1930s; a crash like the one that happened in 1937 may be what comes next for us now; back then stocks fell by 60 per cent and did not recover for a decade.

However, the major difference between 2007-9 and the early 30s was the way the authorities responded to the crisis. In the first crisis they took several years before they got to grips with it and took an appropriately scaled response.

Thankfully by the time the 2007-9 debacle came around Ben Bernanke, Tim Geithner and Henry Paulson proved to be uniquely qualified trio to deal with the problem. Federal Reserve chairman Mr Bernanke was a lifetime student of the Great Depression, Treasury Secretary Henry Paulson, as a former chairman and chief executive officer of Goldman Sachs, knew markets and Wall Street backwards; New York Fed President Tim Geithner was a star of the regulatory community. They also got on well.

(left to right) US Treasury Secretary Henry Paulson, Federal Reserve chairman Ben Bernanke and Timothy Geithner, president of the Federal Reserve Bank of New York, stand together in the cash room of the Treasury Department after reading statements on a plan to rescue frozen credit markets in October 2008. Photo: EPA/REX/Shutterstock
(left to right) US Treasury Secretary Henry Paulson, Federal Reserve chairman Ben Bernanke and Timothy Geithner, president of the Federal Reserve Bank of New York, stand together in the cash room of the Treasury Department after reading statements on a plan to rescue frozen credit markets in October 2008. Photo: EPA/REX/Shutterstock

By acting fast, furiously and mobilising trillions of dollars there was not a second Great Depression, rather a somewhat frustratingly slow but very long recovery.

Author Ray Dalio admits he was impressed at the time, but did not know whether the trio would succeed in their quest - and he was quite the commentator.

At one point in the financial crisis, the three aforesaid gentlemen took one of Mr Dalio’s daily notes - which said they were doing all the right things - to show President Obama that they were on the right track.

It could have all turned out very differently. Mr Dalio recalls how close the economy sailed towards complete disaster. He actually stayed well-hedged and missed early opportunities because he was not that sure that it would work out.

How many experts got their commentaries right at the time? It was easy to reason that those now running the show were the same guys who had got us into trouble, and that did not give good reason to believe they would be any better at managing the crisis.

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Other experts were overly concerned about the inflationary effect of money printing on such a humungous scale. In truth, the hole in the US national balance sheet was so big it could absorb almost any amount of money for many years.

Still, the famous trio were right. The more important question is where we are going from here.

In television interviews to launch the book, Mr Dalio is quite circumspect: no major crash for a couple of years but corrections possible; the US dollar ‘could easily’ devalue 30 per cent from here; but a recession will follow.

Nonetheless, in the book he provides a historic parallel by looking at the debt crisis of 1937. It occurred when the Fed began to raise interest rates as the economy began to recover strongly from the 1929-33 crisis.

In 1937 the US stock market dropped 60 per cent, and it did not return to the same level for a decade.

Industrial commodities were the place to be after that with global rearmament for the Second World War, not equities, and other real assets that benefited from inflation such as land, property and precious metals.

Photo: Bridgewater Associates
Photo: Bridgewater Associates

If that sounds an unlikely scenario today, then don’t forget that Chinese stocks have already dropped 60 per cent over the past three years. The oil price has almost doubled over the past year. Dr Copper is around 10 per cent more expensive than a year ago.

World War III is thankfully not a realistic scenario. But the rise of nationalism and populism is very much a by-product of debt crises and their creation of inequality and social stress: today we have Trump, Brexit and Putin.

Meanwhile, warnings about the massive overvaluation of Wall Street, and by extension European stock markets, are not hard to find, and the high volatility in markets so far this October is ominous.

Still with new all-time highs being struck again and again this year, the mythical Greek forecaster Cassandra has lost most of her credibility. Yet the cyclical nature of stock markets is a fact of life, not sorcery.

What goes up and up, will eventually come down. It always does. Knowing exactly when this will happen is impossible. But you can prepare for it, and not leave yourself hopelessly exposed with debts up to your eyeballs, when the inevitable happens.

Ray Dalio is an old master with a $17 billion fortune to prove it.

Yet even he does not pretend to have all the answers, or to know the future. But he does know the past, and in the book he casually mentions how well this has served him before.

What I liked most about Big Debt Crises is its clear and logical analysis of historical events from a global macroeconomic perspective with investment in mind.

Normal history books understandably do this in passing, not as a central focus. If nothing else I thought Mr Dalio’s account of the last financial crisis about the best I have read.

How far his review of the 1937 crisis will help in understanding what may lie ahead for us today is harder to say, and Mr Dalio does not really try.

He looks across the probability of various scenarios and attempts to successfully hedge them, while leaving the maximum potential upside.

It’s what any successful hedge fund manager would do, and Mr Dalio is arguably the most successful of them all as he runs the biggest hedge fund in the world.

Peter Cooper has been writing about Gulf finance for more than two decades