Megainvestor builds portfolio for end-of-the-world scenarios

Ray Dalio uses 22 of the more than 550 pages of his new book to describe his investment strategy, but he could have done so with just the testimony he reserved for the final sheets: he has a portfolio diversified enough for “end of world”.

It’s not necessarily a surprise that the founder of the world’s largest hedge fund, Bridgewater Associates, is looking for assets so different from one another that he can profit even from Armageddon. This is basically the logic of a hedge fund.

What Dalio aims at in “Principles for the Changing World Order” is to show the reader how to perceive the coming of the next financial apocalypse, which will be marked by the reconstruction of the world order with China taking over from the United States.

Underpinning this view are detailed analyzes of the patterns of credit and money cycles during the rise and fall of economic powers over the past five centuries.

In the power game of geopolitics, credit plays a central role. Empires rose and fell in cycles whose peak is associated with the holding of a strong reserve currency and, the decline, with the devaluation of this currency due to high indebtedness. The end occurs when creditors lose faith and start looking for another asset (another hard reserve currency or something that can replace it, such as commodities).

In Dalio’s model, this period of hegemony lasts up to a century, although there is some imprecision in the account. The current one began in 1945, after the war, when the United States definitively took over from the United Kingdom.

If the dispute were between climbers, the elevation of the dollar to the status of the main global reserve currency would mean that Americans reached the summit after having overcome the other determinant barriers to a nation’s wealth and power, which are: education, competitiveness, technological innovation. , economic production, wide participation in trade, military might and its strengthening as a financial center.

This rise, of course, began long before the Second World War. Dalio points out the departure for the conquest of the “key determinants” mentioned above two and a half centuries before, in a period even before the War of Independence.

And why would this reign be coming to an end? The answer requires a quick summary of the history of the US economy over the past few decades.

Within a great cycle of rise of a nation, whose peak is reached after some kind of revolution capable of establishing a new order, there is also a cycle of long-term indebtedness composed of up to a dozen stages of short-term debt.

As occurred in other moments of restructuring, the post-war period was a period of prosperity and explosion of capital markets, whose essence is the negotiation of promises of payment.

Large-scale indebtedness is what made the American economy spin fast in the post-war period, providing a real estate boom and spreading benefits throughout society, a movement that Dalio unravels in narrating the rise and what he considers to be the fall. of the great cycle of the United States.

The big credit party usually ends when inflation knocks on the door. Crises that have price hikes in the eye of the hurricane mark short-term debt cycles.

One of these milestones occurred in 1971, when the volume of debt in dollars began to significantly exceed the gold reserves to which the American currency was linked, as established in 1944 with the creation of the Bretton Woods monetary system.

No interest rate would prevent debt holders from trying to exercise their right to convert paper money into gold and this led the United States to default on its promise to pay in metal.

The unanchored currency could be printed out of control and, of course, was largely devalued. Inflation and economic stagnation dragged on through the 1970s.

Starting in 1979, the Jimmy Carter administration opted for a strong monetary tightening. The growth of the money supply became limited. Interest has skyrocketed. Debtors failed, but banks did not, as the Fed (Federal Reserve, the American central bank) guaranteed cash flow to banking institutions that suffered from default.

The crunch ensured the appreciation of the dollar and, from 1990 onwards, the great economic power of our times was ready to lower interest rates again to revive the economy and did so repeatedly until 2008, when indebtedness led to the bursting of the bubble.

Dalio especially points to the 2008 crisis as something that can be understood as the end of the US’s long-term debt cycle. For the first time since the Great Depression, the Fed needed to zero interest rates and, in addition, print money and buy assets on a large scale, using virtually every monetary tool available to save the economy. Something that would be repeated at the beginning of the Covid pandemic.

One of the problems with artificially injecting money and free credit into the economy is that distribution reaches the rich in greater proportion. As the author says he learned with the end of the Bretton Woods system, measures that produce currency devaluation generate appreciation of financial assets and this benefits those who have them in greater quantity.

It is when bubbles burst that the ideological foundations on which an empire was built are most undermined by the social disruptions brought about by inequality.

Sharper conflicts between classes and political polarization favor the seizure of power by populists, whether left or right.

For Dalio, 70% of the puzzle whose pieces form the photograph of the collapse of the great cycle dominated by the US is assembled, leaving only one major rupture event (something like a civil war, for example) for the end.

At the same time, China is making rapid progress in achieving the predicates that would allow it to take the position of global leadership, something that Russia, even in the days of the Soviet Union, was never close to doing due to the enormous financial disadvantage it always had in relation to the U.S.

By successfully applying a mixture of communism and capitalism that significantly reduced the population’s poverty and generated a period of stability and development (financial, educational and technological, among others), Beijing captured the second largest share of world trade and built the foundations for call the shots when the new world order takes hold.

Although the renminbi is far from facing the dollar as a reserve currency – the Chinese currency represents only 2% of reserves and the American currency, more than 50% – this scenario could be quickly changed in a crisis of faith by creditors regarding the US economy.

Raymond Thomas Dalio, a New Yorker who started investing at the age of 12 and who became a billionaire by taking advantage of the opportunities offered by America, says he is able to recognize the merits of the Asian giant because over decades of business and frequent visits to the country he learned to distance itself from the prejudices that cloud the view of many investors regarding the Chinese.

To make it clear how seriously he takes the country, in 1995 he sent his 11-year-old son Matt to live in China and attend a local school so he could learn the language by immersion.

In his book, Dalio does not propose to make a manual on how to invest in the times to come. What he presents is a detailed survey of how the transition between economic empires changes the investment game, something that invariably brings periods of great collective suffering until the resumption of stability.

Agreeing with him or not, it is difficult to remain undaunted by the author’s reflections. Understanding the past to prepare for the future, as challenging as that may seem, sounds like an urgency after reading.