Monday, May 21, 2012

Ray Dalio on Beautiful Deleveraging (Barron's Online)

On deleveraging:
Deleveragings occur in a mechanical way that is important to understand. There are three ways to deleverage. Austerity. Debt Restructuring. Money Printing. The Beautiful part is the balance of these three approaches.

Deleveragings go on for about 15 years. The process of raising debt relative to incomes goes on for 30 or 40 years, typically. There's a last big surge, which we had in the two years from 2005 to 2007 and from 1927 to 1929, and in Japan from 1988 to 1990, when the pace becomes manic. That's the classic bubble.

And then it takes about 15 years to adjust.

On Europe:
The banks have something like 20 trillion euros ($25.38 trillion) worth of assets and less than one trillion euros of capital. They are very leveraged.

The banks are now overleveraged and can't expand their balance sheets. And the governments don't have enough buyers of their debt. Demand has fallen not just because of bad expectations, although everybody should have bad expectations, but because the buyers themselves have less money to spend on that debt.

What is happening in Europe now is essentially the same, almost totally analogous, to what happened in the U.S. in 1789. It is an interesting comparison.

In 1776, the colonies declared independence from Great Britain.

It wasn't until 13 years later, 1789, that those states started to form a central government, largely because of their debt problems.

Europe does not have an ability to borrow. It doesn't have central taxation, that's material, and it doesn't have a treasury.

I would say that there is maybe a 30% chance in the next six-month to two-year period of a really bad shock from Europe.

There are no provisions in the Maastricht Treaty for the breakup of the monetary union.

If a country is exiting the monetary union and then says I'm going to pay off the debt in my local currency, how does that work?

Every society has to have the ability to enforce laws. How does Germany actually force Italy to pay? It isn't clear.

There isn't a single means of achieving resolution in Europe, and that's the big problem here.

Everybody is asking, "Are we going to have a bull market or a bear market?" I expect we will have both with no big trend. Typically, in these up and down cycles, the upswing will last about twice as long as a down swing. We are now in the higher range of the up-cycle.

On Gold:
Most people should have in the vicinity of 10% of their assets in gold, not only because I think it will be a good investment longer term, but because I think it is a very effective diversifier against the other 90%.

I'm treating it as an alternative currency.


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