The “D-Process”

Barron’s has an interview with Ray Dalio, founder of Bridgewater Associates, a global money manager.  “He counts among his clients world governments and central banks, as well as pension funds and endowments.”  According to the article, he called the crisis in the spring of 2007 and his hedge funds had positive returns last year in excess of 8%.

Dalio says we are now in a depression, or “D-process” to emphasize the lengthy and unusual nature of what we are about to go through.  If you don’t have a Barron’s subscription, keep reading for the highlights of a sobering interview.

Everybody should, at this point, try to understand the depression process by reading about the Great Depression or the Latin American debt crisis or the Japanese experience so that it becomes part of their frame of reference.

Last year, 2008, was the year of price declines; 2009 and 2010 will be the years of bankruptcies and restructurings. Loans will be written down and assets will be sold. It will be a very difficult time. It is going to surprise a lot of people because many people figure it is bad but still expect, as in all past post-World War II periods, we will come out of it OK. A lot of difficult questions will be asked of policy makers. The government decision-making mechanism is going to be tested, because different people will have different points of view about what should be done.

What the Federal Reserve has done and what the Treasury has done, by and large, is to take an existing debt and say they will own it or lend against it. But they haven’t said they are going to write down the debt and cut debt payments each month. There has been little in the way of debt relief yet. Very, very few actual mortgages have been restructured. Very little corporate debt has been restructured.

Only when those debts are actually written down will we get to the point where we will have credit growth. There is a mortgage debt piece that will need to be restructured. There is a giant financial-sector piece — banks and investment banks and whatever is left of the financial sector — that will need to be restructured. There is a corporate piece that will need to be restructured, and then there is a commercial-real-estate piece that will need to be restructured.

There will be substantial nationalization of banks. It is going on now and it will continue. But the same question will be asked even after nationalization: What will happen to the pile of bad stuff?

There are too many nonviable entities. Big pieces of the economy have to become somehow more viable. This isn’t primarily about a lack of liquidity. There are certainly elements of that, but this is basically a structural issue. The ’30s were very similar to this.

By the way, in the bear market from 1929 to the bottom, stocks declined 89%, with six rallies of returns of more than 20% — and most of them produced renewed optimism. But what happened was that the economy continued to weaken with the debt problem.

The Federal Reserve is going to have to print money. The deficits will be greater than the savings. So you will see the Federal Reserve buy long-term Treasury bonds, as it did in the Great Depression. We are in a position where that will eventually create a problem for currencies and drive assets to gold.

A wave of currency devaluations and strong gold will serve to negate deflationary pressures, bringing inflation to a low, positive number rather than producing unacceptably high inflation — and that will last for as far as I can see out, roughly about two years.

Buying equities and taking on those risks in late 2009, or more likely 2010, will be a great move because equities will be much cheaper than now. It is going to be a buying opportunity of the century.

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