What We Learned from Ray Dalio's "A Template for Understanding Big Debt Crises"

Written By Wealth Daily Research Team

Posted September 16, 2018

This year marks the 10th anniversary of the Great Recession

To mark the occasion, Ray Dalio, founder of Bridgewater Associates (the world’s largest hedge fund, which also happens to have navigated the 2008–09 crisis with ease), recently published a book of his research that allowed him to actually profit as the economy was crashing: A Template for Understanding Big Debt Crises.

The only thing “bigger” than the subject Dalio tackles in this tome is the success he has achieved: Mr. Dalio is personally worth an estimated $18 billion, having founded Bridgewater Associates, which manages an estimated $160 billion.    

This is one book that’s worth the read. Especially for anyone with even a cursory interest in financial markets. 

As Ray Dalio repeatedly proves throughout, there is “nothing new” in the economic world — all crises bear a similarity to previous ones. Beginning with part one, “The Archetypical Big Debt Cycle,” Dalio explains to the reader his definitions for what exactly credit and debt are and provides a template for what a debt cycle looks like. 

Next, he goes on to describe the phases of a classic deflationary debt cycle — one of two types of crises, the second one being of an inflationary nature. 

The subject matter is dense, but for anyone with a cursory interest in economic cycles, time will fly by, as Dalio goes through various period examples and case studies (everything from Germany’s Weimar Republic to the U.S.’s recent Great Recession) are analyzed in detail.

Throughout much of the book are “News & Bridgewater Daily Observations” — little tidbits of what Dalio, his team, and the world were saying at the time of each of the dozens of economic crisis case studies featured. 

The “News & Bridgewater Daily Observations” sidenotes alone make the book worth the read. They are classic Dalio. In his first book, Principles: Life and Work, Dalio talked about how, when building Bridgewater’s models over the past four decades, he would go to the library and read newspaper headlines from periods like the 1930s.

If you take one thing away from this book, it’s that Dalio knows his history. 

His thoughts on the Great Recession are also worth the read — Dalio points out perfectly how the period fits into the framework of an “Archetypical Debt Cycle” described earlier in the book.

Credit: A Template for Understanding Big Debt Crises by Ray Dalio.

As he says, “The housing market showed every sign of a classic bubble.”

The point he continually makes is that everything happens over and over again. History repeats itself. The book is a compilation of decades’ worth of research through Dalio’s career — long before there were computers, big data, or a “Great Recession.”

Following the release of the book, in an interview with Bloomberg, Dalio had this to say:

Everyone should know and understand the logical course of events that make all these [economic] crises the same.

The current troubles in Turkey and Argentina, for example, are noteworthy for Dalio because they were so predictable. Not only did both countries have to denominate their debts in the currency of another country (the United States), but both were running deficits — inevitably, this leads to trouble.

Dalio’s analysis of the situation in both countries, held up to the light of history, tell him that both are about two-thirds of the way through their currency-based debt crises. 

What This Means

First, a bit of sunshine: What we experienced in 2008–09 happens every 70 years or so. And despite the market’s highs, we’re not in the midst of another bubble at present. Times “are good” right now, according to Dalio.

But all good things must come to an end. 

In his estimation, and as he lays out in the book, we’re in a period similar to 1935–1940. This opinion seems to make sense given what happened in the 1929–1932 years. One further realizes that Dalio is onto something when comparing the two periods.

In a period like 2008–2009 or 1929–1932, there’s only one thing for central banks to do: print money and buy financial assets to expand the money supply. Eventually, this gets the economy going again — but the major beneficiaries (at least initially) of the central banks’ actions are the owners of financial assets, which inevitably leads to even greater inequality. 

And what’s the solution to this inequality? Populism. 

Sound familiar? Dalio thinks we’re in the seventh inning of the current economic expansion, but that in two to three years we’ll be due for some downturn — perhaps fueled by underfunded pension and health care liabilities.

The thing one realizes when reading Debt Crises is that the specifics may change, but the basics of every downturn will remain: more liabilities that can be reasonably serviced by people’s incomes. It’s that simple. 

At some point in the next few years, Dalio expects the following four things to happen like clockwork:

  1. Financial assets will fall due to increasing interest rates. 
  2. Increased societal conflict will emerge amidst peak inequality when the next downturn hits. 
  3. There will be alarm over how to pay for things like pension and health care promises. 
  4. The United States will find it increasingly difficult to sell Treasuries in the marketplace at the level we have enjoyed for the last few decades. 

The Bottom Line

What does this mean for readers?

One need only look to Dalio’s investment strategy for the answer. As a “global macro” investor, he is not married to good, old-fashioned long-term stock ownership. Dalio has traded futures, ETFs, options, commodities, and has publicly argued against Warren Buffett on the merits of gold in a portfolio. 

In our view, investors have a few options given what we’ve learned:

  1. Be picky about which stocks you own. Dalio noted in a recent interview that upside might be limited for the broad market. Investment newsletters like Technology and Opportunity and IPO Authority are great places to start.
  2. If there’s one thing we can all learn from Ray Dalio, it’s that markets move in cycles. For guidance on the ups and downs of the market, we recommend checking out Christian DeHaemer’s Bubble and Bust Report.

  3. Be thoughtful about your investment strategies, and always be ready to pivot toward what’s working. 

Success in investing requires insight into what’s going on not just in the markets but in the economy at large. For anyone interested in learning more, we highly recommend checking out Ray Dalio’s latest book, A Template for Understanding Big Debt Crises, free in PDF format.

Until next time,

The Wealth Daily Research Team

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