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Kindle Notes & Highlights
by
Ray Dalio
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October 19, 2018 - June 21, 2020
Political turmoil in Europe led funds to flow into the US, which increased demand for US Treasuries and pushed down interest rates. In an attempt to lessen the demand for dollars, the Federal Reserve reduced its discount rate
Notice how insignificant that 35 percent rally looks within the bigger moves.
Throughout the Great Depression, announcements of big policy moves like this one repeatedly produced waves of optimism and big rallies, amid a decline that totaled almost 90 percent.
bear market rallies like this are classic in a depression, since workers, investors, and policy makers have a strong tendency to exaggerate the importance of relatively small things that appear big close-up.
Hoover would not budge. He described his reasoning in his memoir: “This was a banker-made crisis… the bankers must shoulder the burden of the solution, not our taxpayers.”
Hitler was gearing up to run for Chancellor; he adopted the strongly populist stance of threatening to not repay the country’s reparation debts at all.
Germany’s problems proved to be a key source of contagion.
having exhausted all of its foreign loans and with just over £100 million in gold reserves remaining, the Bank of England stopped supporting the pound and let it fall sharply,
Other countries followed the UK in abandoning gold convertibility so they could finally “print money” and devalue their currencies.
the devaluation and money printing kicked off a beautiful deleveraging
As other currencies devalued and the dollar rose, it created more deflationary/ depressing pressures in the US.
The fear of devaluation led to particularly acute runs on US banks, so banks needed to sell bonds to raise cash, which contributed to rising yields.
Classically, in a balance of payments crisis, interest rate increases large enough to adequately compensate holders of debt in weak currency for the currency risk are way too large to be tolerated by the domestic economy, so they don’t work.
The rally made some believe the worst was over, as most significant rallies do. Yet there was no significant change in the total money and credit available, so the fundamental imbalance between total debt coming due and the amount of money available to service it wasn’t resolved.
Stocks reached a new low near the end of December.
Lending against a widening range of collateral and to an increasingly wide range of borrowers is a classic lever that policy makers pull to ensure that sufficient liquidity gets to the financial system, sometimes provided by central banks and sometimes by central governments.
The 1932 Banking Act, signed by Hoover on February 27, attempted to alleviate the liquidity squeeze while maintaining the gold standard by increasing the Federal Reserve’s ability to print money, but only to buy government bonds (which 75 years later would be called “quantitative easing”).
abandonment of mark-to-market accounting for banks. In
Early in the crisis, government efforts to increase lending and spending had led to sustained rallies in asset markets. At this stage, however, investors had become disillusioned.
Social unrest and conflict continued to rise globally.
It was at this time that conflicts both within countries and between countries intensified, sowing the seeds of populism, authoritarianism, nationalism, and militarism that at first led to economic warfare and then military warfare in Europe in September 1939 and with Japan in December 1941.
Outrage over the government’s role in “bailing out” financial institutions is one outgrowth of the “Main Street versus Wall Street,” or “workers versus investors” conflicts that classically occur during depressions.
also classic in deleveraging scenarios, the debate about what to do became antagonistically political, with strong populist overtones.
The collapse of the economy throughout 1932 was breathtaking.
populism was a global phenomenon in the interwar period (the 1920s to the 1930s),
When policy makers fail to rescue systemically important institutions, the ripple effects can quickly spread to the whole system.
Most important, the act granted the Fed the ability to issue dollars that were backed by bank assets instead of gold, which broke the link between the dollar and gold and allowed the Fed to print money and provide the liquidity that banks desperately needed.
debt and liquidity problems prompted by runs can be rectified by providing liquidity rather than holding it back.
To get all that money, the link to gold had to be broken. But with all that printing, the dollar’s value plunged against both other currencies and gold. This was virtually identical to what happened in August 1971,
that I was surprised by events that hadn’t happened in my lifetime but had happened many times in history.
the Dow was up by almost 100 percent over the next four months.
leaving the gold peg was the turning point;
The shock and awe of all those big announcements of spending, coming week after week, built confidence among investors and the public, which was critical to putting the economy on a good footing.
Deleveragings become beautiful when there is enough stimulation to offset the deflationary forces and to bring the nominal growth rate above the nominal interest rate.
It is typically the case that the first tightening does not hurt stocks and the economy.
By 1936, war was brewing in Europe, driving capital flight to the US, which continued to fuel advances in stocks and the economy.
To help to convey the picture in the 1930s, I will quickly run though the geopolitical highlights of what happened
see these as new ways of providing leverage outside the protection and regulation of authorities.
I encourage you, at each point, to think about what you would do a) as an investor and b) as a policy maker.
In the early and healthy part of the typical debt cycle, debt grows appropriately in line with income growth because the debt is being used to finance activities that produce fast income growth to service debts. The debt-to-GDP ratio is a proxy of whether or not this is happening
The big rate cuts stimulated borrowing and spending, especially by households.
Because debt bubbles typically emerge in one or a couple of markets, they are often hidden beneath the averages and can only be seen by doing pro forma financial stress tests of the significant areas to see how they would hold up and what the knock-on effects of them not holding up would be.
Because most houses are bought with borrowed money, home price gains have magnified impacts on equity values.
Household debt rose from 85 percent of household disposable income in 2000 to about 120 percent in 2006.
To repeat my defining characteristics of a bubble: Prices are high relative to traditional measures. Prices are discounting future rapid price appreciation from these high levels. There is broad bullish sentiment. Purchases are being financed by high leverage. Buyers have made exceptionally extended forward purchases (e.g., built inventory, contracted forward purchases, etc.) to speculate or protect themselves against future price gains. New buyers (i.e., those who weren’t previously in the market) have entered the market. Stimulative monetary policy helps inflate the bubble, and tight policy
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is typically the case that the worst debt bubbles (e.g., the US in 1929, Japan in 1989) are not accompanied by high and rising goods and services inflation, but by asset price inflation financed by debt growth.
High debt growth to fund consumption rather than investment is a red flag, since consumption doesn’t produce an income,
Growth of new ways of lending outside of the normal banking system—often called the “shadow banking” system—is a common feature of bubble periods.
During the bubble, there were five key components that helped fuel leveraging outside the traditional banking system:
Borrowers and lenders had severe asset/liability mismatches, which left them especially vulnerable in a downturn. This is a classic ingredient of a severe debt crisis. Most commonly these mismatches come in the following forms:
