Ray Dalio and the Potential of Class Warfare

Location Date: 
October 26, 2011

When Ray Dalio speaks, markets, and especially the media, take notice.  Mr. Dalio, 62, is the founder of Bridgewater Associates LP, reportedly the world’s largest macro hedge fund manager with over $120BN of assets under management.  The simple reason why pension plans, sovereign wealth funds and central bankers listen to Dalio is that he gets it “right” most of the time.  In 2008, when other hedge funds lost an average of 19%, his fund posted a 9.5% gain.  He backed that up with a great 2009 as well.  He has been featured in the New Yorker Magazine (click here to read), Bloomberg, and now even Charlie Rose is getting in on the celebrity – his interview with Dalio earlier this week is a must-watch for any investment professional. Why? Because it demonstrates both his “thoughtfulness” (that comes with thorough analysis) and his passion for performance.

One of the macro themes that Dalio discusses in the interview and appeared a few days ago in an FT Op Ed (click here if you are a subscriber), is an issue we noted last week – the idea that “class warfare” is a very real threat.  The New Yorker Magazine (insert hyperlink) noted a few days ago how everyone from Mayor Bloomberg to Mitt Romney have done an “about face” on their feelings towards the “Occupy Wall Street” movement.  “Apparently some of those dopey kids, staggering under student loans and bereft of job prospects, have lots of parents and friends of all ages who understand exactly what they’re talking about.”  The principal culprit for this growing issue is the ongoing deleveraging in the developed world’s economies.  To quote Dalio from his recent FT piece:

“We are in the midst of a deleveraging, we are nearly out of ammunition and we are at each other’s throats. Being in a deleveraging and nearly out of ammunition is a very difficult position to be in. But, being at each other’s throats is our biggest problem.

Our character and our political and social systems are now being tested in ways that have typically been tested in past deleveragings. In deleveragings bad economic conditions typically lead to emotional reactions, social and political fragmentation, poor decision-making and increased conflict. When this occurs in democracies, the checks and balance system, which is intended to yield the best decisions for the whole, can stand in the way of thoughtful leadership and lead to ineffective “mob” rule. This dynamic can lead to a self-reinforcing downward spiral.”

As Dalio discussed with Charlie Rose, we are quickly running out of policy options – both monetary and fiscal.  Monetary policy is down to “twisting and shouting,” while fiscal debt and deficit debates are reduced to political sound bites and irrational discourse.  As a result:

“Tensions between the rich and the poor, capitalists and socialists, those in and out of power and different factions in each group are now intensifying in a manner that is classic in deleveragings. Politicians who are fighting for power in a political year are fanning the flames and are increasingly willing to do risky things (like shutting down the government) in pursuit of their missions and popular support.”

These tensions are highlighted in a recent BCA Research report that shows since the 1970s, real family income has barely increased, but has tripled for the top 1%.  In fact, as they note, “the increase in the income of the top one percent is really more a story about the surge in income for the top tenth of one percent” (emphasis mine).  In combination with high unemployment, it is hard to see how “it will not spawn populist movements in favour of increased income redistribution.”

Additionally, the CBO released a paper (click here to view) last night entitled “Trends in Distribution of Household Income Between 1979 and 2007”.  Their findings confirm what BCA has shown as well – in particular, they noted the “middle three income quintiles all saw their share of after-tax income decline by 2 to 3 percentage points.” In short, the middle class is really being hit, relatively speaking.

Hedge Fund Manager Doug Kass has coined the term “screwflation” – where incomes are stagnant and costs (i.e. basic necessities of food, gas etc.) continue to rise.  Add to this the “deleveraging” in the economy and voilà – you get a consumer confidence number in the U.S. like we got yesterday.

Let's hope for the best but have an insurance policy just in case.

Jim McGovern