Exploring Markets

The Best and Worst Things Ray Dalio Sees in the 2017 World

No other investor can explain the macro economy in its current form like Ray Dalio. He does it with ease, clarity, and focus. If you're an investor, trader, or deep thinker about the world, you have to follow his insights. He rarely makes his writings public and only occasionally goes on TV. His investor letter, which he publishes monthly, is only available to investors with hundreds of millions of dollars under management. If you missed it, here's what he recently wrote about the world economy in 2017:

Four things he sees right now

"1. The economy is now at or near its best, and we see no major economic risks on the horizon for the next year or two,
2. There are significant long-term problems (e.g., high debt and non-debt obligations, limited abilities by central banks to stimulate, etc.) that are likely to create a squeeze,
3. Social and political conflicts are near their worst for the last number of decades, and
4. Conflicts get worse when economies worsen."

The three things that drive economies

"There are three big forces that drive economies: there’s the normal business/short-term debt cycle that typically takes 5 to 10 years, there’s the long-term debt cycle, and there’s productivity. There are two levers to control them: monetary policy and fiscal policy. And there are the risk premiums of assets that vary as a function of changes in monetary and fiscal policies to drive the wealth effect."

A coming big squeeze we all need to know about

"At the same time, the longer-term picture is concerning because we have a lot of debt and a lot of non-debt obligations (pensions, healthcare entitlements, social security, etc.) coming due, which will increasingly create a “squeeze”; this squeeze will come gradually, not as a shock, and will hurt those who are now most in distress the hardest."

Productivity is an important measure to always know about

"Over the long term, what raises living standards is productivity—the amount that is produced per person—which increases from coming up with new ideas and implementing ways of producing efficiently. Productivity evolves slowly, so it doesn’t drive big economic and market moves, though it adds up to what matters most over the long run."

Dalio sees no debt crises coming

"Liquidity is abundant. Real and nominal interest rates are low—as they should be given where we are in the longterm debt cycle. At the same time, risk premiums of assets (i.e., their expected returns above cash) are normal, and there are no debt crises on the horizon."

Political polarization has never been worse

"We show a gauge maintained by the Federal Reserve Bank of Philadelphia that attempts to measure political conflict in the US by looking at the share of newspaper articles that cover political conflict from a few continuously running newspapers (NYT, WSJ, etc.). By this measure, conflict is now at highs and rising. The idea of conflicts getting even worse in a downturn is scary."

The Fed needs to tighten just to have its tools back in case another downturn happens

"Secularly, the US is at the end of the long-term debt cycle. Debt levels are high and have leveled off after a period of deleveraging. The Fed has started to tighten gradually, but interest rates remain low, so the Fed has limited room to ease in the event of a downturn."

Japan is trying to boom and spark inflation

"Over the last several years, the BoJ’s policies have produced a cyclical upswing and eased deflation. Japan is now around its cyclical equilibrium, growth rates have picked up a bit, and inflation is still very low but the economy is no longer in deflation."

China has two economies

"Under the hood, these aggregate conditions are the net of “two economies” that look very different: a slowing, heavily indebted “old economy” with pockets of excess capacity, and a steadily expanding “new economy” driven by higher-end industries and household consumption."

Europe faces the biggest political challenges

"Secularly, Europe is also at the end of the long-term debt cycle. Debt levels are high and haven’t fallen much. Nominal interest rates on both the short and the long end are around zero and are priced to stay low for years. We won’t go into detail here, but Europe also faces one of the most challenging political backdrops due to the growing support for populism."