Author: Ray Dalio Translator: Block unicorn
Foreword
The first phase of the China-US deal was reached quickly and completed in a very reasonable manner (optimism about future negotiations is reasonable), Donald Trump and his team are now on a Middle East tour in Saudi Arabia to reach investment deals (I believe they will succeed, and it looks like other reasonable trade deals will follow), and soon he and his team will try to reach a good budget agreement with Congress (I am not very optimistic about this). At the same time, the Iran deal and the Russia-Ukraine deal are in the works, and I think these agreements will make some progress.
In my opinion, there are two situations: a) daily issues tend to attract people's attention, affect people's emotions, and cause short-term market fluctuations; b) big issues and forces that drive major changes in the world order. While both require attention, the big issues and forces that drive everything are most important, so we cannot let short-term, headline-grabbing events distract us from the big forces and issues that will determine how the story unfolds. This perspective is especially important when betting on the future through investing.
As for the big issues and forces, I will reiterate the five major forces that drive almost everything and what they look like to me. They are:
1) Debt/monetary forces that drive markets and economies and determine the monetary order;
2) Domestic wealth and values gap forces that determine the political order;
3) International order/disorder forces that determine the world order;
4) Natural disasters (droughts, floods, and epidemics), and;
5) The power of human invention and creativity, especially new technologies.
On the Brink
These forces are each in different configurations, which makes the current situation very different from when these forces were in different configurations. Regardless of who the leaders are, their configurations determine the environment they must deal with and the choices they must make. More specifically:
1) Regarding debt/monetary forces that drive markets and economies and determine the monetary order.
The U.S. government and some other governments are now carrying huge debts and deficits, and markets and economies will be shaped primarily by these conditions, even more than by daily news and the choices of specific leaders. In other words, this over-indebtedness will require governments to obtain more funds through fiscal means (i.e., taxes and spending) and/or monetize more debt, which will have a significant impact in some way. This is because the law of monetary reality dictates that when government debt is already high and the debt is increasing faster than the demand for debt assets (such as bonds), it must be responded to by cutting spending, increasing tax revenues, and/or implementing looser monetary policies (which are bad for creditors). This is true no matter who is president. There will be a lot of fights about what should be done (e.g., between President Trump and congressional leaders and Fed Chairman Powell). This will make a lot of news and cause a lot of short-term volatility. In any case, as I make the case in my new book, How Nations Go Bankrupt: The Big Cycle, the budget deficit will either be reduced to around 3% of GDP or it won’t, with huge consequences for the value of the debt and the currency. At the same time, the United States, the only large capital market in the world (accounting for almost half of the global market) and the world’s largest buyer of commodities, has proven itself to be a staunchly capitalist environment that respects investment vehicles as a store of wealth and still has the rule of law, a culture of entrepreneurship and innovation, and relatively free speech that together make up “American exceptionalism.” Keeping money flowing into the United States and creating mutually beneficial investment deals can greatly improve this situation. Everything depends on how well this is managed.
2) On the power of domestic wealth and value gaps that determine the political order.
These have led to irreconcilable divisions with little willingness to compromise, manifested in the rise of populism, the emergence of populist leaders, and the classic rise of more authoritarian leadership, the weakening of democracy, and the weakening of the rule of law as more populist and authoritarian leaders fight their opposition to achieve the changes they deem necessary. The relative power of the president versus the judicial and legislative branches, and American democracy as we know it, may be tested. Moreover, the problem of the bottom 60% has not been solved, and the inevitable political and media backlash will almost certainly intensify soon.
3) On the forces of international order/disorder that determine the world order.
The lack of a single dominant world power—combined with more countries having strong-willed populist leaders who face the aforementioned problems, tend to fight for their own interests, and prefer victory over harmony—leads to more unilateral rather than multilateral decision-making, and greater conflict. During this period, there is a greater risk of trade, technology, geopolitical, and military wars, which leads countries to behave more aggressively and defensively. This leads to ensuring secure sources of domestic production and other needed goods. Multilateralism is receding, while bilateralism (two-way deals) is on the rise, with the United States and China each responding in their own way. The country that offers the best deal to other countries will get bigger and better results. How this is handled will be critical to the changes in the world order.
4) On natural disasters (droughts, floods, and epidemics).
The situation is clearly getting worse, and this will be very costly economically, and equally huge in terms of physical losses. How countries and people adapt will be key.
5) On the power of human invention, especially new technologies.
This will greatly enhance the human ability to think in most areas, and it is likely to be used to produce great improvements and great harms.
In short, the overall picture presented by numerous objective indicators is that the existing monetary, domestic political, and international geopolitical order is deteriorating and declining, with the threat of natural disasters increasing and technology making great strides. At the same time, most of these factors are being recognized and addressed by a uniquely right-wing/capitalist American president and his administration.
What are we doing about these problems?
Make a deal that includes: a) enacting tariffs designed to increase tax revenues and bring better business to domestic producers and American exporters; b) attracting large amounts of foreign capital into the United States; and c) promoting better global investment.
Reduce government regulation to improve productivity.
Reduce government waste and improve the management of government assets.
Reduce the budget deficit and deal with the government debt, although it is not yet clear how.
Use the power to challenge the established legal and regulatory system to achieve the goals of the president and his hard-right base without losing the needed swing voters.
How to deal with these situations and forces? That is the big question.
Will these situations and forces be handled well or mishandled? In other words, will they be handled reasonably or out of control? Does Donald Trump's transactional approach and friend-and-enemy negotiating style indicate that he and his administration can handle our problems well? Was his announcement of a full 145% tariff on China on "Liberation Day" just an effective cover that ultimately led to two days of productive talks and a very sensible short-term agreement, after which serious negotiations will be held? What has happened so far supports the view that Donald Trump is handling the important and long-neglected issues mentioned earlier in a relatively unstable but productive way. But frankly, it is too early to draw conclusions.
A few suggestions: on the verge of crisis
Remember that news, to be valuable, should be viewed in the context of the big forces that together determine the direction of big cycle changes, most importantly the monetary order, the domestic political order, the world geopolitical order, climate change, and technological change (i.e., the five forces).
Remember that we are on the verge of major changes in the monetary, domestic political, and international order, and everything depends on whether these things are handled in a smart, cooperative way.
Remember that in investing, it is important to: 1) develop a well-thought-out investment plan, including smart diversification, and stick to it; and 2) not react to news and market fluctuations after the fact without careful consideration.
Finally, the opinions expressed here are my own and do not necessarily represent the opinions of Bridgewater Associates.
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