Ray Dalio and GMO's Jeremy Grantham on How They're Seeing the World Right Now
May 17, 2022
The founders of Bridgewater and GMO discuss the big risks they’re watching, including inflationary pressures, political conflict, asset bubbles, and climate change—and what investors can do to protect themselves.
The conversation, which was recorded on May 9, is moderated by Jim Haskel, editor of the Daily Observations, and Alex Shahidi, co-CIO of Evoke Advisors, and is separated into two broad sections. In Part 1, Ray and Jeremy cover the major risks they are tracking — including strong inflationary pressures, rising political conflict, and asset bubbles. Then, in Part 2, they talk through how investors can adjust their portfolios to prepare for these risks. Jeremy concludes the discussion by describing the threat that climate change and the overuse of natural resources poses to humanity, and the most promising solutions he sees to these problems.
Transcript
Note: This transcript has been edited for readability.
JIM HASKEL
I’m Jim Haskel, editor of the Bridgewater Daily Observations, and I’m so fortunate today to be joined by my longtime friend, and a longtime client of Bridgewater’s, Alex Shahidi. Alex is the co-CIO of Evoke Advisors, based in Los Angeles, California. And together, we moderated a discussion with Bridgewater founder and co-CIO Ray Dalio and Jeremy Grantham, the co-founder and long-term investment strategist for Grantham, Mayo, Van Otterloo—otherwise known as GMO. And, Alex, maybe you can explain what we’re about to do and how it all came about.
ALEX SHAHIDI
Sure, Jim. It’s great to be with you. I remember we started talking about putting this conversation together over a year ago, so I’m very excited to finally get both Ray and Jeremy in the room together, particularly given all the major forces at play today. We are truly living in historic times, so I can’t think of a better duo to share the perspectives of the big cycles they see and what investors should do about it to help preserve and grow their wealth.
Jim, I’ve spent the last 23 years searching for insightful investors who have the unique ability to zoom out and see what others don’t. And because they’re better positioned to see big waves coming, I always think that they’re less likely to get wiped out. I met Jeremy for the first time about 20 years ago and Ray about 15 years ago. I still remember the first conversations with both, and I’ve been following them very closely ever since. And in my mind, they are two legends. They’re both studying the past and writing about it, and they’ve demonstrated remarkable track records as proof, especially during big inflection points.
JIM HASKEL
I totally agree. And essentially what we did here is structure this conversation in two parts. In the first part, we asked both Ray and Jeremy to share their thoughts on the biggest dynamics they see in the world today—whether it was inflation, stock market bubbles, political shifts, or just the changing world order. And then the second part covers what investors can do about these things when it comes to their own portfolios. So, I thought it was a really interesting conversation.
ALEX SHAHIDI
I couldn’t agree more, Jim. And it’s a privilege to be able to share a conversation with these two investors with our clients as well. So, why don’t we just jump right in?
JIM HASKEL
So, Ray and Jeremy, thank you both for joining us. It’s so great to have you both here. And just before we start—you’ve both known each other for a very long time, and, Jeremy, in a conversation we had before actually taping this, you were talking to us about the first time you actually met Ray. It was at a Kodak pension fund event, and it was with the legendary investor Rusty Olson. I thought it was a funny story. Maybe you can just quickly recount that story.
JEREMY GRANTHAM
I can’t tell you the date, but I’m sure Ray can. But it was 25 years ago or thereabouts, and it was in Martha’s Vineyard, and we had taken an earlier flight. And so, we had like an hour and a half before cocktails started on this two-day event. And all of Eastman Kodak’s managers, including the ancient Roy Neuberger, were going to be there, and Hilda Ochoa, as I recall, a pal of mine and maybe Ray’s as well. And so, Ray and I, in desperation, took an hour-and-a-half walk along the beach. And Ray, as I suppose is his wont, talked, and I, as is definitely not my wont, listened. I usually do all the talking. Anyway, this time I listened, and Ray expounded to such effect that three days later, we had our annual conference. We were one of the first people to do that in the institutional investment business. We’ve done it for 41 years. And in my presentation, I had a page toward the end that said, “How the market really works.” And it was just one page of numbers and at the bottom, it said, “Plagiarized from Ray Dalio.”
RAY DALIO
Well, I remember it almost identically, except I remember picking your brain at least—in any case, learning a lot from you. And I certainly remember the conversation as being really, really interesting. And then we’d sit together on the bus as they would move us around. And the conversations—that began our relationship, which has had a number of interesting conversations over the last few decades. So, I’m really happy to do this again with you.
(Part 1) Ray on What We Can Learn from the Past about Today’s Risks
ALEX SHAHIDI
Ray, why don’t we kick off this conversation? You’re a student of history, as is Jeremy, and you’ve both spent many, many decades throughout your careers thinking deeply about the lessons we can all learn from the past. Can you take a few minutes to describe how you’re thinking about the current environment and how it’s similar or different from what you’ve seen in the past?
RAY DALIO
One of the things I learned, really, in 1971 and then repeatedly is that surprises that happen in my lifetime—happened to me—in many cases were for things that didn’t happen in my lifetime but happened in prior lifetimes, such as in 1971, I was clerking on the floor of the New York Stock Exchange. August 15, Nixon severs the relationship between gold and the dollar, so essentially defaulting, and I walked on the stock exchange. I said financial crisis. And I would expect it to be down a lot. It was up a lot. I studied history and found that the exact same thing happened on March 5, 1933, with Roosevelt doing the same thing basically on the radio. And then I understood things better.
So, what happened for me over the last number of years is there are three big things that are happening in my lifetime that didn’t happen. And I actually found, with research, five [big things]. So, the first is the amount of debt creation and monetization of that and how it’s carrying through the system. The second is the amount of internal political, social, economic conflict that is now going on. And the third is the rising of a great power to challenge the existing world order and the existing world power, China, and the geopolitical in which—you know, I was born in 1949 and four years after the new world order began in ’45. And the United States, of course, was a much more dominant country then—had 80% of the world’s gold, 50% of the world’s economy, a monopoly on military power because of nuclear and all of that. And it’s declined on a relative basis, and that led me to do research, which I needed to do the last 500 years of research to follow. I wanted to study the rise and decline of currencies—and reserve currencies—and their empires. And I went back, and in doing that, I also discovered that acts of nature actually had bigger effects than the first three of those, even with the wars, because of droughts, floods, and pandemics. And I know that you really have thoughts about climate change and its effects. So, I’ll be interested in hearing those because I think that’s a factor. And then No. 5, the greatest, of course, is man’s capacity to adapt and invent because in one way or another, if you look at that, per capita income rises, living standards rise over periods of time. But these big cycles and these big events are dominant. So, I think almost everything could fall into those five categories, you know? And so, that’s how I look at it.
ALEX SHAHIDI
Just to quickly get into a few. How do you see those categories playing out right now? Is there anything specific that comes to mind?
RAY DALIO
I think that we’re in a period in which there’s a supply and demand for debt and credit—because one man’s debts are another man’s assets—and there’s a supply and demand for credit that is having an effect on making us move into a stagflation kind of environment. In other words, the trade-offs between the two will become more difficult. But I think that No. 2 influence, the political, is the most important. What I mean by that is I think we have been used to being in an environment in which economics ruled. You’d have a global economy and those who could produce items more efficiently or cheaper would get the business, and they would raise their living standards and other places'. So, it was a global competition largely run by economic considerations and resources would shift that way.
I think we’re now in—that doesn’t exist as much that way. And there’s been a transition to an ideological allocation of resources and so on, such as the acquisition by Elon Musk of Twitter. It’s not a financial transaction as much as it is for the purpose of—it’ll have controls. And when we have that conflict, such as with Disney and DeSantis in Florida and those political ideologies, it’s the belief that economics has got to fall within that agenda. That will have very big implications, I think. And then, of course, there’s external. So, I’ve been rambling here a little too long, threw a few things on the table, and I’ll pass it over to you, Jeremy.
(Part 1) Jeremy on Stock Market Bubbles
JIM HASKEL
Thanks, Ray. Yes, let’s move the discussion now over to Jeremy. And, Jeremy, you’ve just heard the big dynamics that Ray has articulated as he looks at the current environment, and it would be great to get your perspective on the big things you’re watching, too, especially considering some of your recent writing on stock market bubbles.
JEREMY GRANTHAM
I must say, in my old age, I’m reaching a point where I have a little trouble convincing myself that the stock market is that important, and that we live in an age where some much more important issues are playing out. And I know Ray shares that view to some considerable degree, but I view the stock market now, really, as a hobby, and the one thing that I have kept going is resources- and climate-change-related investing, and also, for old times’ sake, investment bubbles, since I’ve been doing that for 40 or 50 years and since I find myself unexpectedly in the third great investment bubble of my career, basically, in the US. So, I can’t avoid it.
And this is a wonderful day to be having this discussion. It’s not only victory over Hitler and Russia day, but it’s also a day where the market is showing signs of breaking down. Through yesterday, it’s the worst opening of a year for the S&P since I was 1 year old in 1939. I am a pre-war baby, unlike Ray. And, of course, the Nasdaq is down, as we speak, 27.5% from its high, and the Russell 2000 about 23%, S&P about 15.5%. So, it’s getting to be interesting, and as we were saying before, Bitcoin from some point in the last 24 hours is down 10% to $32,000 and change, so that is getting interesting. And ARKK, Cathie Wood’s wonderful instrument, is back to it where it was in 2018. I’m not kidding you. It is back below this entire event now, which is quite remarkable, down 75% from its peak, as is AMC, down 75% from its peak. And the other meme stocks are in ragged disarray. So this is the real McCoy—seems to be playing out pretty close to 2000.
JIM HASKEL
And I’m just wondering how you’re assessing all of this in the context of your research on asset bubbles.
JEREMY GRANTHAM
I’ve always considered myself a fairly serious amateur historian. What I’ve done in bubble territory is I don’t try and build models to explain every day as you guys do. I focus on the four great bubbles, which are characterized by nearly hysterical behavior—really seriously weird over-optimism, which is very rare—and by accelerated price moves on the upside, and by a weird deviation on the upside between the blue chips going up and the risky stocks going down. And that is rare as hen’s teeth. It happened brilliantly in ’29, it happened during the year 2000, again, in spades, with the S&P ex-growth continuing to go up through September of 2000, and the growth stocks basically going down 50% and the internet stocks dropping maybe 60-70% by then. So, that was spectacular, and we saw a very handsome deviation between the S&P rising last year and the Russell 2000, for example, dropping quite handsomely. So, there was a 20-25-point spread on the upside.
That, for me, is a pretty good indicator. And I’ll tell you what it describes: it describes Mr. Prince’s “I’ve got to keep dancing because the music is still playing.” And we understand that completely, the enormous commercial imperative of the industry to play up to and over the edge. But they’re not complete idiots. And so, they say, “Well, I’ve got to keep dancing, but I don’t have to keep dancing with Pumatech, the most advanced stock in ’99. I’m going to transfer to Coca-Cola. And I’ll keep dancing off the edge, but I’ll go off with Coca-Cola.” And it works. The Coca-Colas may be handsomely overpriced, but in 1929 and 2000-01, and so on, they always go down a lot less as the bubble breaks. And that’s the phenomenon that causes this very rare indicator of impending doom, which we saw last year.
And so, by early this year, it seemed clear to me that this was not only the real McCoy bubble, which had been clear for a year or so in terms of pricing and enthusiasm, but it had triggered this very rare indicator of impending doom. In other words, now. And so, our piece of a year and a bit ago was called “Waiting for the Last Dance.” And our equivalent follow-up this January was “Let the Wild Rumpus Begin”—i.e., we’re in it, dudes. And I do believe we are, and I believe the declines will be very substantial.
(Part 1) Ray on the Next Big Inflection Points
ALEX SHAHIDI
Ray, why don’t we turn it to you now? I want to get your thoughts on how the trends you and Jeremy have been describing and have identified are likely to play out. What do you see over the next 5-10 years in terms of some of these big inflection points that we may be going through?
RAY DALIO
I think, looking at it year by year, that this is the third year of the expansion with a very aggressive monetary policy. And so, we’re in the part of the typical expansion where there’s a lot of inflation pressures because it happened in a giant, big way, and everybody’s long. The world is—it’s the end of a paradigm because everybody believes—they want everything to go up. And of course, that creates a dynamic where policy is long. Everything goes up. And of course, that happens by creating money and credit, which creates debt. And that dynamic means that you must have a decline in real wealth measured by that, because the financial wealth has become enormous relative to the real wealth. Everybody who’s holding bonds or assets, and particularly the debt assets, believes—or financial assets in general, which are just journal entries; they're claims—but they believe that they can take that buying power and sell it and buy goods and services. And they can. And by its necessity, there must be negative real returns, negative returns relative to buying power.
So, if we take it chronologically, I think there’s the short-term cycle, which is usually the business cycle—takes seven years on average, depending on where you start the cycle, give or take a few years. I think we’re moving along here quicker. So, we’re now going to be in a very tight environment and that changes everything. So, when we look at the returns of equities and we look at the well-being of companies, you see that the cost of interest relative to the expected returns of equities creates a squeeze on equities, changes the economics. A lot of borrowing has been done at much lower interest rates and so on. The return on equity for a company versus the return—the cost of debt is changing, and all of those things are changing. And like all bubbles or paradigm shifts, the mentality that did exist—we don’t have to worry about inflation, cash is a safe place, and so on—gets a shock. There’s a punch in the face. There’s been a 40-year bull market, and there’s a punch in the face to all investors. We’re going through it, as Jeremy described. And when that happens, things that were never supposed to happen—because everybody believes in the tech companies, which is the same as the Nifty Fifty or the dot-com companies, they get hammered; like you say, 75% decline in Cathie Wood’s funds and so on and so forth—that causes the adaptation. So, we’re in the beginning of that adaptation. That is most similar, I think, to the 1970s period, and it becomes financial.
And so, I think we’ll come to the 2022 elections, and that’ll have economics and markets as a big impact. So, we’ll be in the 2022 elections. I think that you’ll see greater political extremism coming out of that. Moderates are leaving and even those who are running are populists. Populists are people who will fight to win and will not accept losing and will fight for their constituency. So, you’ll see more populism of the left and more populism of the right. So, if I look at 2023, I look at 2024, and I’m worried about neither side accepting losing. And I think that there’s a big risk that nobody—that this system is in jeopardy because history has shown when the causes that people are behind are of greater importance to them than the system, the system is in jeopardy. Those types of things change the world landscape. I’m emphasizing the United States, and certainly Europe is in that type of a position. So, I think that, when I look at it, it’ll be very important to not only diversify well, but to be able to be long and short different assets in order to perform well in that environment.
(Part 1) Jeremy on Risks of Long-Term Inflation and Too Much Debt
JIM HASKEL
Jeremy, Ray just described how he’s seeing some of the risks ahead in terms of politics and the risks of rising debt, inflation, and the debasement of buying power. Anything else you would add to that?
JEREMY GRANTHAM
Listening to Ray is that we have a market today that feels superficially like 2000, and I think it’s going to play out initially like 2000 and then, unfortunately, is going to phase, as he suggests, into the ’70s, where the deflationary effects on the economy and the stock market will result in a world rather like the ’70s, where all assets are simply much lower priced than they are today. A word on inflation, too—I completely agree with Ray on the short-term problems, which I would summarize as monetary and general Federal Reserve over-stimulus for 30-35 years, the war, and COVID—all of those three influences guaranteeing that we have a relatively intractable problem in the short to intermediate term.
What worries me is the longer-term arguments for inflation, which is, one, we are running out of people. In China, where the 500 million extra farmers precipitated globalization, they have now had diminishing cohorts of 20-year-olds for 20 years, and they are guaranteed, since they’re alive now, we know the baby cohorts are dropping like a stone. They are simply going to have a shortage of labor, as is the developed world together. That is not a trivial bloc. The developed world plus China, all of them will be squeezed for labor. After the bubonic plague, they had a 100-year honeymoon period in which wages went up so much, it wasn’t reached for another several hundred years in the Industrial Revolution, and we are entering a period where labor is simply scarce, which feels to me inflationary.
At the same time, we have a scarcity beginning in resources, and we keep an original, unusual index at GMO. It’s 36 equal-weighted—the most important—commodities. So, it’s not dominated by oil. And it showed a declining pattern for 102 years, from 1900 to 2002. And yes, it was interrupted by World War I and World War II and OPEC. Why wouldn’t it be? But it wanted to go down. It went down 70%. It took the index down to 30. Today, 122 years later, the index is down 10%. It has gone to 90. The average important commodity has just spent the last 20 years going from 30 to 90. It has tripled. The reason is, of course, the growth of China, but I believe—fairly passionately, looking at the data—that it also represents the intrinsic scarcity, the war between deeper wells, worse iron ore, etc. The best go first. The struggle is always between technology, which for 100 years got ahead of scarcity. It was two paces down for deeper and three-and-a-half paces up for technology. And now we’ve reached a phase where we’ve gone through that stuff, and now we have two paces up for technology and three paces down for scarcity.
The data is screaming at us now for 20 years that we’re beginning to run out. And a war, of course, and COVID, we’re so fragile. All you have to do is cough now, and it ricochets around the world in price spikes and shortages and bottlenecks. And that is the world we’d better get used to living in. We’re going to have a world of increasing number of bottlenecks and shortages. And the same applies to food. The UN Food Index is higher today than any time in its history over the last 50 years since it started. So, you have price pressure on raw materials, metals, food; you have price pressure long-term on labor. This surely feels like a new era in which inflation will be part of the background music just like it was in the 20th century and perhaps more so.
JIM HASKEL
Ray also mentioned the dangers of high debt levels, and you’ve certainly spoken about that in the past. And so, could you share some of your thoughts there as well?
JEREMY GRANTHAM
The risks of a debt bubble breaking—the risks of an equity bubble breaking—have simply not been understood by our Federal Reserve since Paul Volcker. They are incredibly naïve. They haven’t even got a clue. They’re not even interested in the idea. The idea—Bernanke is saying, “Well, the US housing market always has never declined. It merely reflects a strong US economy.” Alan Greenspan, encouraging, etc., etc., right through until today. They don’t realize that they’re playing with such fire.
My second point: high levels of debt are just far too often seriously dangerous and should be, in general, discouraged actively. That should be one of the responsibilities of top management, including the Fed, etc. And let me just give you an example. Why do you like low rates? Because it encourages debt. Why do you like more debt? Because it encourages growth. That’s the argument. So, let me give you the ultimate statistical test of that. We started in 1985, and we have been modestly increasing the debt-to-GDP ratio, all debt together, just drifting slightly up due to technology. And by technology, I mean the introduction of more and more sophisticated financial instruments, but not rising dramatically. And then in ’85, it tilts to a 45-degree angle and shoots across any page and goes from about 1.1 times GDP to well over 3. So, in that little window of 35 years, we triple the debt-to-GDP ratio. It’s a big chunk of time. It’s the biggest, most important economy on the planet, a pretty good test. So, what happens to growth? It inflects downward, and from ’85 we grow more slowly. Grant you, there are many other factors at work; it’s a complicated picture. But there is little room in that equation for the idea that more debt creates more growth. It is not proven in the data. It is held to be the case. It is an assumption like most of modern economics, but it is not proven by the data. I would suggest that there is no evidence at all that increased levels of macro-debt-to-GDP have anything to do with growth. They have everything to do with higher risk, though, from time to time.
(Part 2) Ray on How Investors Can Respond to Today’s Risks
ALEX SHAHIDI
Ray, I want to turn it back to you. You and Jeremy have described a very difficult environment with a lot of potential for risk and instability. As investors, how should we think about positioning for something like that?
RAY DALIO
My main things are, first, cash is trash. And bonds and debt, it’s not going to be good. And the claims of financial assets—either avoid those or position yourselves so that when those things operate—and position yourself for inflation. And so, lots of investments pertaining to inflation. I agree with Jeremy’s comments about commodities, and the big commodity cycles are reactive. There’s a giant—just like the 40-year bull market in bonds associates with a commodity cycle where everybody adapts to that. Companies don’t hedge. Inventories are drawn down. There’s less investment in those things. That, when that switches, switches to that kind of an environment. And the big overarching thing is that the amount of financial claims that exist—and there’s charts that I repeatedly show when I deal with the changing world order. What is the amount of financial claims, assets, relative to real assets? And you could see that through history when those financial claims—it’s like a bank has too many IOUs on its real money and that thing. Then, you always get into these environments where it’s undesirable to own the debt and you have negative real returns.
And so, to position one’s portfolio in a tilt that way—but of course, the way that we do it is to separate alpha and beta, right? So, two parts: core. We’re all talking tactical. How do you create a truly well-balanced core portfolio? And we know that the typical portfolio is not well balanced with its greatest vulnerability being in that upper-right quadrant in our box, which is the inflation box. And we know that we’re in that environment.
So, from a starting point of view, I would encourage all investors to look at that four-quadrant box, that box that we have—rising inflation, falling inflation, rising real growth relative to discounted, falling real growth relative to discounted—and see what the biases are in those portfolios. I believe that now you can simultaneously reduce risk and raise returns: reduce risk of that portfolio by having more in that upper-right quadrant, rising inflation, and you will reduce your risk, because if you look at your portfolio, typical investor’s portfolio, that is the environment that is missing. So, you start with that. How do you get more neutral? How do you get better balance and you cover yourself from that exposure? And then you make your tactical moves around it, and the tactical moves, again, should not be in those debts. It should be very well-diversified.
I think that the social and political conflicts are going to be a big investment thing coming forward. And so, that’ll mean—the way I look at it is I want to look at places that have good income statements and balance sheets. So, when I say places, I mean countries as well as individuals that make up those countries, the individual people and the individual companies. So, do they have a good income statement, financial stability, if they have a good balance sheet so that they can weather those things, and also, it’s a sign of their productivity. Are they productive? And then, No. 2, are they civil with each other? I really do believe that internal conflict and bad finances are going to be defining characteristics of where to invest or even where to be.
And then if I carry that forward to the third, am I going to have the risk of being in an important international war? Because that international war will raise lots of threats. So, when I’m picking those locations, I want to be out of those debt instruments, largely minimized on the financials, the inflation-hedge assets, well-diversified. Look to parts of the world that are not as plagued with this. So, emerging Asia is very interesting. India is interesting. So, diversify. Look at neutral countries during that period of time. Watch out for government controls on capital markets because that’s the logical next step. History has shown that. Watch out for foreign exchange controls, could be. Watch out for those things.
So, those are the themes that I think are most important and will be most important in investing.
(Part 2) Jeremy on How to Diversify for an Inflationary Environment
JIM HASKEL
Jeremy, Ray just described his framework for diversifying a portfolio, and obviously that is so important to preserving wealth, particularly in the environment today. So, do you have any thoughts on diversification today?
JEREMY GRANTHAM
Ray made me think that, when we’re selling our resource portfolio, we have a wonderful exhibit that looks at the correlation between all the major sectors, utilities, consumption, and so on, consumer goods. And there’s only one where, as the time period lengthens, the correlation drops, and that is resources. And resources drops to such good effect that based on the last 80 years of data, every rolling 10-year period, that the 10-year correlation is negative. So, if you believe in inflation, you know that resources do very well. You also know that in the long run, it’s strongly negative—it’s negatively correlated modestly with the rest of the portfolio. As we’re seeing today, when they do well, it puts a burden on the rest of the economy, and they do badly. So, there is a very strong case here for a resource portfolio.
On resources, just a point that the last time we had a super-bubble in commodities, there were very large new mines waiting to come online. What has happened since the 2011 crunch, when China slowed down in its heavy industrializing, the growth rate for iron ore and coal dropped from double digits to zero—dead flat for three years in a row, breaking the back of the resource industry. They have not done any capex. It takes 5-15 years to bring on a mine. They have not been doing this. There are no great reserves of lithium, cobalt, copper, nickel, even iron ore to come online this time, and everybody knows it. If you look at the need for these, particularly green metals, greening metals, it doesn’t compute. There are no backup resources. And that applies right across the length and breadth of resources. They have not been capexing, even in oil and gas, for the last 10 years to a remarkable degree.
(Part 2) Ray on Currencies and Storeholds of Wealth
ALEX SHAHIDI
Ray, there is an important question that I want to get to you, and it’s related to concerns that you’ve shared about the US dollar potentially losing its reserve currency status. As an investor, how should they think about constructing a portfolio given this concern that you’ve talked about?
RAY DALIO
Well, there are two purposes of a currency, which is a medium of exchange and a storehold of wealth. And we’re living in a world where we have three major currencies that are fiat currencies with the same kind of problems. So, you can’t look at one currency in relationship to another. I think people make a lot of mistakes of thinking—you know, it’s an ugly contest. And so, the questions that we’re going to have is what is your storehold of wealth? And money is a storehold of wealth that also is widely accepted in other countries so that you can move it around. It’s not just limited to currencies. Don’t think that medium of exchange is the only important thing. So, think about the storehold of wealth. That’s when we deal with the quadrant of the four pieces to try to find a balanced storehold of wealth. And then you have to think, “Can I move that and sell that anywhere? Am I going to have the free capital markets to do that? Or are they going to be a problem?”
So, the diversification of that, and I think we are entering a period where all currencies, the traditional medium of exchange type of currencies, are going to—a lot of currencies will compete. What will be the medium in which I could take something and go someplace else and cost-effectively convert that into buying? The medium of exchange. So, I think we’re in a storehold of wealth issue. In other words, focus in on that. And then your transaction cost of converting that storehold of wealth, a balanced portfolio, into buying power. And then you transact, because even in the worst inflations, the worst environments, the currencies, most of the time, still could be mediums of exchange, even though they’re devalued. So, I encourage people to think about bad fiat currencies generally and think about storeholds of wealth and what the liquidity is, and think about even what capital wars look like.
JIM HASKEL
And in terms of storeholds of wealth, I’m wondering if you have any particular asset in mind. So, for example, would gold serve that purpose?
RAY DALIO
Gold, as an overlay on a portfolio, on top of a portfolio, works like an insurance policy. Gold is a dead asset. It just sits there, but it’s got characteristics that are limited in supply. One of the most important things: it’s the third-highest reserve currency held by central banks. And in periods of time of war or such periods of time of credibility, it is the medium—like they say, it’s the only asset that you could have that’s not somebody else’s liability. That means you have to be dependent on them giving you money or giving you something. And it is international, it can be moved, and it’s tried and true. So, in that regard—but its behavior isn’t very environmentally specific. So, as a hedge asset, as an overlay, it’s really like a great insurance policy, because when the other assets go down—and so, something like that or the equivalent of it plays a role in a portfolio, not as the core asset, but as the effect of diversification of assets. And if you do it as an overlay, it’s about 15% of the portfolio, not taking away assets from other parts of the portfolio.
But I come back to my basics, which is the four quadrants, the timeless and universal. The one thing that you can be sure of is that cash will not be the best asset class. And when you diversify a portfolio, so you got a well-balanced portfolio of other things, whenever you have that diversified portfolio, it will outperform cash because that’s the nature of the system. The central bank puts money on deposit. People with better ideas come along, take the elements of risk, and it works. When that diversified portfolio of asset classes doesn’t work well, that balance—there are times—it works better than the traditional portfolio and the down moves by a lot. Like, when the markets—although it goes down 60% or so. Worst cases are like 20%, maybe a little bit over that. And it never stays there because central banks can’t let capitalism, which is dependent on those other assets performing a higher return than cash, can’t let that continue. So, they come in there and they produce money and credit, and it produces the pop.
So, I want to emphasize what I said before—I think in terms of storeholds of wealth, how you can move it from country to country, where it’s acceptable and that way, and don’t view money just through that idea of the fiat currency because a fiat currency is short-term cash, and cash is trash.
(Part 2) Jeremy on the Environment, Climate Change, and the Threat to Humanity
JIM HASKEL
Jeremy, we’re coming to the end of our time. But before we go, I want to circle back to something you said at the beginning, that your major focus recently has been on the environment and climate change. And so, can you say more about that issue and how you’re thinking about it? And perhaps we can close on that.
JEREMY GRANTHAM
I think the world has simply been running way over its capacity. And the great luxury of the last 200 years of fossil fuels—coal, and then oil and gas—have catapulted us far above our long-term ability to sustain. The good news is that catapulted science and research as well as income and consumption. And we’re going to have to rely enormously on research and our inventiveness to save our bacon. And I do believe there is a decent chance that it will. Quite a number of years ago, I got into studying the rise and fall of civilizations, and I always like to recommend Immoderate Greatness by Ophuls, O-P-H-U-L-S. He’s done all the heavy lifting for us. He’s, in a series of chapters, condensed all the major reasons for civilizations failing in the past, and he’s read everything. He knows it like the back of his hand. And it’s like the CliffsNotes, very, very serious, well-written, quotable CliffsNotes on civilizations failing. And he gives five or six major reasons, which include overburdening the local environment, your soil, and your nature, and your water—complexity, which is very energy-intensive and so on.
And he concludes two things: one, that the current global civilization checks off every single one of them, which is rather creepy, and two, that humans appeared to be hardwired to self-destruct. And my take on that is that, like every other organism, we’ve spent a few million years fighting for survival, and we have learned to grab what we can when we can. And like other organisms, to grow, we propagate basically as much as we can for our first few million years, and we’ll expand to fill the space available. And we are not programmed to think about long-term, slow-moving consequences. And so, we don’t. And we have to look at things today, like the president of Brazil encouraging the greatest deforestation in Brazil’s history in the last 12 months, to everybody’s shock. But we also have to live in a world where President Trump was doing his best to undo all the good that EPA and environmental movements had been trying to do. It’s pretty bizarre to have a couple of serious countries attempting to ignore the greatest threat, perhaps for hundreds of years.
And I believe that we do have some escape clauses from Mr. Ophuls’s prediction of self-destruction. And that is twofold: one, unexpected by everybody, including Malthus in 1798, we are choosing—despite getting wealthier—to have fewer children since 1961. It’s a remarkably unexpected outcome. It was not predicted, as far as I’m aware by anybody, let’s say, as recently as 1950. And the degree and the speed with which fertility rates are contracting is not really appreciated by anybody, including the financial community. We are not only way down from replacement rate in every developed country, except Israel, but we are, if anything, accelerating. And so, in the US, we are at 1.65 versus 2.1 children. We’re at 1.65. And so, way down, a quarter below what is necessary. And many countries in Europe—Italy, Hungary—are way below that. And of course, in the Far East, you culminate in South Korea, which has incidentally overtaken Japan in individual wealth—individual income, I should say. They have a fertility rate below one. I mean, it’s just inconceivable. And China, Japan, Taiwan are all down there at the 1.5 level, quite remarkable. And this is not a sufficient condition to save our bacon, but it is a very necessary condition.
ALEX SHAHIDI
Jeremy, you’re saying that one of the pressures working in our favor is less people. So, that obviously leads to less pressure on natural resources. What’s the second factor working in our favor?
JEREMY GRANTHAM
The other factor is the speed of our science, and the fact that, if anything, it seems to be maybe accelerating. And we do have some “getting-out-of-jail-free” cards. Thank heavens. The problems we face basically are all the cures so far have been contained within a finite world. We’re trying to compound on a finite planet, but the get-out-of-jail-free cards have a whiff of the infinite, and they are: fusion, a source of infinite energy if we can pull it off. It’s green, we never run out, and it may be cheap. It remains to be seen. I’m reasonably optimistic, but it’s certainly far from a probability of one. Geothermal, the ability to drill several miles down and tap the heat of the inner core, which is, for all intents and purposes, infinite and green, and we have a vast learning curve from fracking to tap into. But there are massive problems of dealing with the heat several miles down, though not necessarily problems that we won’t learn to handle. And the third one is a major breakthrough in energy storage to go with the spectacular progress of solar and wind—again, year after year, that has outperformed early forecasts. If you look at the international energy authorities and others, you will see an almost laughable pattern, where each forecast for 2030 has been below the actual. Each year, it’s ramping up. It’s like an investment model that never learns from the past, it seems. But if we can take the cost of energy storage down to 10 cents or 20 cents on the dollar from today, and blend it and mix it with solar and wind, that will also be basically an infinite source of green energy.
So, I like to say, in all probability, the lack of cheap, available green energy is not the factor that will bring us to our knees. The problem is the time it will take to get there. We have wasted, arguably, 50 years getting the point that climate change is ultimately dangerous. And by the time we have all this cheap green energy, an enormous amount of damage will have been done, and the parts per million in the atmosphere will have gone from what we need, which is about 280-300, where you’ve got a very stable world—it’s currently 420, and it is on its way, for sure, beyond 500. This is the kind of burden that we will have to deal with. And if we have fusion or one of the others, we will be able to set about the slow, steady business of subtracting carbon dioxide and returning the planet to a decent state. So, if we have that and we combine with it a declining population, we really do have a chance of survival, as I like to say.
ALEX SHAHIDI
Jeremy, I know the Grantham Foundation is working very hard on some of these technological solutions to climate change that you’ve described.
JEREMY GRANTHAM
We are, thank heavens, a very inventive species. And our foundation for the protection of the environment has a target of 50% green venture capital and 25% other early-stage venture capital. The world is getting behind the need to green the economy, getting behind the need to be frugal with resources, and change and improve the food structure. The governments are getting behind it, corporations are getting behind it. Why would early stage, new enterprises in those areas not be a candidate for highest return on the planet? I think they are, and it’s thoroughly exciting. It gives a sense of purpose, and it may very well be the best investment you can make. The topline revenue of people going to solve climate change is going to dwarf the rest of the economy. It’s the topline of electric vehicles versus the topline of the old vehicles. The topline of electricity versus fossil fuels. The topline of efficiency versus business as usual. That’s where the growth will be.
JIM HASKEL
All right. I think we’ll wrap it up there. Jeremy and Ray, thank you so much for joining us. I hope we can do this again sometime soon.
JEREMY GRANTHAM
It was a real pleasure.
RAY DALIO
And it’s always a pleasure, Jeremy.
JEREMY GRANTHAM
Thanks. Thanks for having me.
JIM HASKEL
Well, Alex, that was a lot of fun. I hope we can do this again also sometime soon.
ALEX SHAHIDI
I had a lot of fun, Jim, and I look forward to it as well.
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The conversation, which was recorded on May 9, is moderated by Jim Haskel, editor of the Daily Observations, and Alex Shahidi, co-CIO of Evoke Advisors, and is separated into two broad sections. In Part 1, Ray and Jeremy cover the major risks they are tracking — including strong inflationary pressures, rising political conflict, and asset bubbles. Then, in Part 2, they talk through how investors can adjust their portfolios to prepare for these risks. Jeremy concludes the discussion by describing the threat that climate change and the overuse of natural resources poses to humanity, and the most promising solutions he sees to these problems.
Transcript
Note: This transcript has been edited for readability.
JIM HASKEL
I’m Jim Haskel, editor of the Bridgewater Daily Observations, and I’m so fortunate today to be joined by my longtime friend, and a longtime client of Bridgewater’s, Alex Shahidi. Alex is the co-CIO of Evoke Advisors, based in Los Angeles, California. And together, we moderated a discussion with Bridgewater founder and co-CIO Ray Dalio and Jeremy Grantham, the co-founder and long-term investment strategist for Grantham, Mayo, Van Otterloo—otherwise known as GMO. And, Alex, maybe you can explain what we’re about to do and how it all came about.
ALEX SHAHIDI
Sure, Jim. It’s great to be with you. I remember we started talking about putting this conversation together over a year ago, so I’m very excited to finally get both Ray and Jeremy in the room together, particularly given all the major forces at play today. We are truly living in historic times, so I can’t think of a better duo to share the perspectives of the big cycles they see and what investors should do about it to help preserve and grow their wealth.
Jim, I’ve spent the last 23 years searching for insightful investors who have the unique ability to zoom out and see what others don’t. And because they’re better positioned to see big waves coming, I always think that they’re less likely to get wiped out. I met Jeremy for the first time about 20 years ago and Ray about 15 years ago. I still remember the first conversations with both, and I’ve been following them very closely ever since. And in my mind, they are two legends. They’re both studying the past and writing about it, and they’ve demonstrated remarkable track records as proof, especially during big inflection points.
JIM HASKEL
I totally agree. And essentially what we did here is structure this conversation in two parts. In the first part, we asked both Ray and Jeremy to share their thoughts on the biggest dynamics they see in the world today—whether it was inflation, stock market bubbles, political shifts, or just the changing world order. And then the second part covers what investors can do about these things when it comes to their own portfolios. So, I thought it was a really interesting conversation.
ALEX SHAHIDI
I couldn’t agree more, Jim. And it’s a privilege to be able to share a conversation with these two investors with our clients as well. So, why don’t we just jump right in?
JIM HASKEL
So, Ray and Jeremy, thank you both for joining us. It’s so great to have you both here. And just before we start—you’ve both known each other for a very long time, and, Jeremy, in a conversation we had before actually taping this, you were talking to us about the first time you actually met Ray. It was at a Kodak pension fund event, and it was with the legendary investor Rusty Olson. I thought it was a funny story. Maybe you can just quickly recount that story.
JEREMY GRANTHAM
I can’t tell you the date, but I’m sure Ray can. But it was 25 years ago or thereabouts, and it was in Martha’s Vineyard, and we had taken an earlier flight. And so, we had like an hour and a half before cocktails started on this two-day event. And all of Eastman Kodak’s managers, including the ancient Roy Neuberger, were going to be there, and Hilda Ochoa, as I recall, a pal of mine and maybe Ray’s as well. And so, Ray and I, in desperation, took an hour-and-a-half walk along the beach. And Ray, as I suppose is his wont, talked, and I, as is definitely not my wont, listened. I usually do all the talking. Anyway, this time I listened, and Ray expounded to such effect that three days later, we had our annual conference. We were one of the first people to do that in the institutional investment business. We’ve done it for 41 years. And in my presentation, I had a page toward the end that said, “How the market really works.” And it was just one page of numbers and at the bottom, it said, “Plagiarized from Ray Dalio.”
RAY DALIO
Well, I remember it almost identically, except I remember picking your brain at least—in any case, learning a lot from you. And I certainly remember the conversation as being really, really interesting. And then we’d sit together on the bus as they would move us around. And the conversations—that began our relationship, which has had a number of interesting conversations over the last few decades. So, I’m really happy to do this again with you.
(Part 1) Ray on What We Can Learn from the Past about Today’s Risks
ALEX SHAHIDI
Ray, why don’t we kick off this conversation? You’re a student of history, as is Jeremy, and you’ve both spent many, many decades throughout your careers thinking deeply about the lessons we can all learn from the past. Can you take a few minutes to describe how you’re thinking about the current environment and how it’s similar or different from what you’ve seen in the past?
RAY DALIO
One of the things I learned, really, in 1971 and then repeatedly is that surprises that happen in my lifetime—happened to me—in many cases were for things that didn’t happen in my lifetime but happened in prior lifetimes, such as in 1971, I was clerking on the floor of the New York Stock Exchange. August 15, Nixon severs the relationship between gold and the dollar, so essentially defaulting, and I walked on the stock exchange. I said financial crisis. And I would expect it to be down a lot. It was up a lot. I studied history and found that the exact same thing happened on March 5, 1933, with Roosevelt doing the same thing basically on the radio. And then I understood things better.
So, what happened for me over the last number of years is there are three big things that are happening in my lifetime that didn’t happen. And I actually found, with research, five [big things]. So, the first is the amount of debt creation and monetization of that and how it’s carrying through the system. The second is the amount of internal political, social, economic conflict that is now going on. And the third is the rising of a great power to challenge the existing world order and the existing world power, China, and the geopolitical in which—you know, I was born in 1949 and four years after the new world order began in ’45. And the United States, of course, was a much more dominant country then—had 80% of the world’s gold, 50% of the world’s economy, a monopoly on military power because of nuclear and all of that. And it’s declined on a relative basis, and that led me to do research, which I needed to do the last 500 years of research to follow. I wanted to study the rise and decline of currencies—and reserve currencies—and their empires. And I went back, and in doing that, I also discovered that acts of nature actually had bigger effects than the first three of those, even with the wars, because of droughts, floods, and pandemics. And I know that you really have thoughts about climate change and its effects. So, I’ll be interested in hearing those because I think that’s a factor. And then No. 5, the greatest, of course, is man’s capacity to adapt and invent because in one way or another, if you look at that, per capita income rises, living standards rise over periods of time. But these big cycles and these big events are dominant. So, I think almost everything could fall into those five categories, you know? And so, that’s how I look at it.
ALEX SHAHIDI
Just to quickly get into a few. How do you see those categories playing out right now? Is there anything specific that comes to mind?
RAY DALIO
I think that we’re in a period in which there’s a supply and demand for debt and credit—because one man’s debts are another man’s assets—and there’s a supply and demand for credit that is having an effect on making us move into a stagflation kind of environment. In other words, the trade-offs between the two will become more difficult. But I think that No. 2 influence, the political, is the most important. What I mean by that is I think we have been used to being in an environment in which economics ruled. You’d have a global economy and those who could produce items more efficiently or cheaper would get the business, and they would raise their living standards and other places'. So, it was a global competition largely run by economic considerations and resources would shift that way.
I think we’re now in—that doesn’t exist as much that way. And there’s been a transition to an ideological allocation of resources and so on, such as the acquisition by Elon Musk of Twitter. It’s not a financial transaction as much as it is for the purpose of—it’ll have controls. And when we have that conflict, such as with Disney and DeSantis in Florida and those political ideologies, it’s the belief that economics has got to fall within that agenda. That will have very big implications, I think. And then, of course, there’s external. So, I’ve been rambling here a little too long, threw a few things on the table, and I’ll pass it over to you, Jeremy.
(Part 1) Jeremy on Stock Market Bubbles
JIM HASKEL
Thanks, Ray. Yes, let’s move the discussion now over to Jeremy. And, Jeremy, you’ve just heard the big dynamics that Ray has articulated as he looks at the current environment, and it would be great to get your perspective on the big things you’re watching, too, especially considering some of your recent writing on stock market bubbles.
JEREMY GRANTHAM
I must say, in my old age, I’m reaching a point where I have a little trouble convincing myself that the stock market is that important, and that we live in an age where some much more important issues are playing out. And I know Ray shares that view to some considerable degree, but I view the stock market now, really, as a hobby, and the one thing that I have kept going is resources- and climate-change-related investing, and also, for old times’ sake, investment bubbles, since I’ve been doing that for 40 or 50 years and since I find myself unexpectedly in the third great investment bubble of my career, basically, in the US. So, I can’t avoid it.
And this is a wonderful day to be having this discussion. It’s not only victory over Hitler and Russia day, but it’s also a day where the market is showing signs of breaking down. Through yesterday, it’s the worst opening of a year for the S&P since I was 1 year old in 1939. I am a pre-war baby, unlike Ray. And, of course, the Nasdaq is down, as we speak, 27.5% from its high, and the Russell 2000 about 23%, S&P about 15.5%. So, it’s getting to be interesting, and as we were saying before, Bitcoin from some point in the last 24 hours is down 10% to $32,000 and change, so that is getting interesting. And ARKK, Cathie Wood’s wonderful instrument, is back to it where it was in 2018. I’m not kidding you. It is back below this entire event now, which is quite remarkable, down 75% from its peak, as is AMC, down 75% from its peak. And the other meme stocks are in ragged disarray. So this is the real McCoy—seems to be playing out pretty close to 2000.
JIM HASKEL
And I’m just wondering how you’re assessing all of this in the context of your research on asset bubbles.
JEREMY GRANTHAM
I’ve always considered myself a fairly serious amateur historian. What I’ve done in bubble territory is I don’t try and build models to explain every day as you guys do. I focus on the four great bubbles, which are characterized by nearly hysterical behavior—really seriously weird over-optimism, which is very rare—and by accelerated price moves on the upside, and by a weird deviation on the upside between the blue chips going up and the risky stocks going down. And that is rare as hen’s teeth. It happened brilliantly in ’29, it happened during the year 2000, again, in spades, with the S&P ex-growth continuing to go up through September of 2000, and the growth stocks basically going down 50% and the internet stocks dropping maybe 60-70% by then. So, that was spectacular, and we saw a very handsome deviation between the S&P rising last year and the Russell 2000, for example, dropping quite handsomely. So, there was a 20-25-point spread on the upside.
That, for me, is a pretty good indicator. And I’ll tell you what it describes: it describes Mr. Prince’s “I’ve got to keep dancing because the music is still playing.” And we understand that completely, the enormous commercial imperative of the industry to play up to and over the edge. But they’re not complete idiots. And so, they say, “Well, I’ve got to keep dancing, but I don’t have to keep dancing with Pumatech, the most advanced stock in ’99. I’m going to transfer to Coca-Cola. And I’ll keep dancing off the edge, but I’ll go off with Coca-Cola.” And it works. The Coca-Colas may be handsomely overpriced, but in 1929 and 2000-01, and so on, they always go down a lot less as the bubble breaks. And that’s the phenomenon that causes this very rare indicator of impending doom, which we saw last year.
And so, by early this year, it seemed clear to me that this was not only the real McCoy bubble, which had been clear for a year or so in terms of pricing and enthusiasm, but it had triggered this very rare indicator of impending doom. In other words, now. And so, our piece of a year and a bit ago was called “Waiting for the Last Dance.” And our equivalent follow-up this January was “Let the Wild Rumpus Begin”—i.e., we’re in it, dudes. And I do believe we are, and I believe the declines will be very substantial.
(Part 1) Ray on the Next Big Inflection Points
ALEX SHAHIDI
Ray, why don’t we turn it to you now? I want to get your thoughts on how the trends you and Jeremy have been describing and have identified are likely to play out. What do you see over the next 5-10 years in terms of some of these big inflection points that we may be going through?
RAY DALIO
I think, looking at it year by year, that this is the third year of the expansion with a very aggressive monetary policy. And so, we’re in the part of the typical expansion where there’s a lot of inflation pressures because it happened in a giant, big way, and everybody’s long. The world is—it’s the end of a paradigm because everybody believes—they want everything to go up. And of course, that creates a dynamic where policy is long. Everything goes up. And of course, that happens by creating money and credit, which creates debt. And that dynamic means that you must have a decline in real wealth measured by that, because the financial wealth has become enormous relative to the real wealth. Everybody who’s holding bonds or assets, and particularly the debt assets, believes—or financial assets in general, which are just journal entries; they're claims—but they believe that they can take that buying power and sell it and buy goods and services. And they can. And by its necessity, there must be negative real returns, negative returns relative to buying power.
So, if we take it chronologically, I think there’s the short-term cycle, which is usually the business cycle—takes seven years on average, depending on where you start the cycle, give or take a few years. I think we’re moving along here quicker. So, we’re now going to be in a very tight environment and that changes everything. So, when we look at the returns of equities and we look at the well-being of companies, you see that the cost of interest relative to the expected returns of equities creates a squeeze on equities, changes the economics. A lot of borrowing has been done at much lower interest rates and so on. The return on equity for a company versus the return—the cost of debt is changing, and all of those things are changing. And like all bubbles or paradigm shifts, the mentality that did exist—we don’t have to worry about inflation, cash is a safe place, and so on—gets a shock. There’s a punch in the face. There’s been a 40-year bull market, and there’s a punch in the face to all investors. We’re going through it, as Jeremy described. And when that happens, things that were never supposed to happen—because everybody believes in the tech companies, which is the same as the Nifty Fifty or the dot-com companies, they get hammered; like you say, 75% decline in Cathie Wood’s funds and so on and so forth—that causes the adaptation. So, we’re in the beginning of that adaptation. That is most similar, I think, to the 1970s period, and it becomes financial.
And so, I think we’ll come to the 2022 elections, and that’ll have economics and markets as a big impact. So, we’ll be in the 2022 elections. I think that you’ll see greater political extremism coming out of that. Moderates are leaving and even those who are running are populists. Populists are people who will fight to win and will not accept losing and will fight for their constituency. So, you’ll see more populism of the left and more populism of the right. So, if I look at 2023, I look at 2024, and I’m worried about neither side accepting losing. And I think that there’s a big risk that nobody—that this system is in jeopardy because history has shown when the causes that people are behind are of greater importance to them than the system, the system is in jeopardy. Those types of things change the world landscape. I’m emphasizing the United States, and certainly Europe is in that type of a position. So, I think that, when I look at it, it’ll be very important to not only diversify well, but to be able to be long and short different assets in order to perform well in that environment.
(Part 1) Jeremy on Risks of Long-Term Inflation and Too Much Debt
JIM HASKEL
Jeremy, Ray just described how he’s seeing some of the risks ahead in terms of politics and the risks of rising debt, inflation, and the debasement of buying power. Anything else you would add to that?
JEREMY GRANTHAM
Listening to Ray is that we have a market today that feels superficially like 2000, and I think it’s going to play out initially like 2000 and then, unfortunately, is going to phase, as he suggests, into the ’70s, where the deflationary effects on the economy and the stock market will result in a world rather like the ’70s, where all assets are simply much lower priced than they are today. A word on inflation, too—I completely agree with Ray on the short-term problems, which I would summarize as monetary and general Federal Reserve over-stimulus for 30-35 years, the war, and COVID—all of those three influences guaranteeing that we have a relatively intractable problem in the short to intermediate term.
What worries me is the longer-term arguments for inflation, which is, one, we are running out of people. In China, where the 500 million extra farmers precipitated globalization, they have now had diminishing cohorts of 20-year-olds for 20 years, and they are guaranteed, since they’re alive now, we know the baby cohorts are dropping like a stone. They are simply going to have a shortage of labor, as is the developed world together. That is not a trivial bloc. The developed world plus China, all of them will be squeezed for labor. After the bubonic plague, they had a 100-year honeymoon period in which wages went up so much, it wasn’t reached for another several hundred years in the Industrial Revolution, and we are entering a period where labor is simply scarce, which feels to me inflationary.
At the same time, we have a scarcity beginning in resources, and we keep an original, unusual index at GMO. It’s 36 equal-weighted—the most important—commodities. So, it’s not dominated by oil. And it showed a declining pattern for 102 years, from 1900 to 2002. And yes, it was interrupted by World War I and World War II and OPEC. Why wouldn’t it be? But it wanted to go down. It went down 70%. It took the index down to 30. Today, 122 years later, the index is down 10%. It has gone to 90. The average important commodity has just spent the last 20 years going from 30 to 90. It has tripled. The reason is, of course, the growth of China, but I believe—fairly passionately, looking at the data—that it also represents the intrinsic scarcity, the war between deeper wells, worse iron ore, etc. The best go first. The struggle is always between technology, which for 100 years got ahead of scarcity. It was two paces down for deeper and three-and-a-half paces up for technology. And now we’ve reached a phase where we’ve gone through that stuff, and now we have two paces up for technology and three paces down for scarcity.
The data is screaming at us now for 20 years that we’re beginning to run out. And a war, of course, and COVID, we’re so fragile. All you have to do is cough now, and it ricochets around the world in price spikes and shortages and bottlenecks. And that is the world we’d better get used to living in. We’re going to have a world of increasing number of bottlenecks and shortages. And the same applies to food. The UN Food Index is higher today than any time in its history over the last 50 years since it started. So, you have price pressure on raw materials, metals, food; you have price pressure long-term on labor. This surely feels like a new era in which inflation will be part of the background music just like it was in the 20th century and perhaps more so.
JIM HASKEL
Ray also mentioned the dangers of high debt levels, and you’ve certainly spoken about that in the past. And so, could you share some of your thoughts there as well?
JEREMY GRANTHAM
The risks of a debt bubble breaking—the risks of an equity bubble breaking—have simply not been understood by our Federal Reserve since Paul Volcker. They are incredibly naïve. They haven’t even got a clue. They’re not even interested in the idea. The idea—Bernanke is saying, “Well, the US housing market always has never declined. It merely reflects a strong US economy.” Alan Greenspan, encouraging, etc., etc., right through until today. They don’t realize that they’re playing with such fire.
My second point: high levels of debt are just far too often seriously dangerous and should be, in general, discouraged actively. That should be one of the responsibilities of top management, including the Fed, etc. And let me just give you an example. Why do you like low rates? Because it encourages debt. Why do you like more debt? Because it encourages growth. That’s the argument. So, let me give you the ultimate statistical test of that. We started in 1985, and we have been modestly increasing the debt-to-GDP ratio, all debt together, just drifting slightly up due to technology. And by technology, I mean the introduction of more and more sophisticated financial instruments, but not rising dramatically. And then in ’85, it tilts to a 45-degree angle and shoots across any page and goes from about 1.1 times GDP to well over 3. So, in that little window of 35 years, we triple the debt-to-GDP ratio. It’s a big chunk of time. It’s the biggest, most important economy on the planet, a pretty good test. So, what happens to growth? It inflects downward, and from ’85 we grow more slowly. Grant you, there are many other factors at work; it’s a complicated picture. But there is little room in that equation for the idea that more debt creates more growth. It is not proven in the data. It is held to be the case. It is an assumption like most of modern economics, but it is not proven by the data. I would suggest that there is no evidence at all that increased levels of macro-debt-to-GDP have anything to do with growth. They have everything to do with higher risk, though, from time to time.
(Part 2) Ray on How Investors Can Respond to Today’s Risks
ALEX SHAHIDI
Ray, I want to turn it back to you. You and Jeremy have described a very difficult environment with a lot of potential for risk and instability. As investors, how should we think about positioning for something like that?
RAY DALIO
My main things are, first, cash is trash. And bonds and debt, it’s not going to be good. And the claims of financial assets—either avoid those or position yourselves so that when those things operate—and position yourself for inflation. And so, lots of investments pertaining to inflation. I agree with Jeremy’s comments about commodities, and the big commodity cycles are reactive. There’s a giant—just like the 40-year bull market in bonds associates with a commodity cycle where everybody adapts to that. Companies don’t hedge. Inventories are drawn down. There’s less investment in those things. That, when that switches, switches to that kind of an environment. And the big overarching thing is that the amount of financial claims that exist—and there’s charts that I repeatedly show when I deal with the changing world order. What is the amount of financial claims, assets, relative to real assets? And you could see that through history when those financial claims—it’s like a bank has too many IOUs on its real money and that thing. Then, you always get into these environments where it’s undesirable to own the debt and you have negative real returns.
And so, to position one’s portfolio in a tilt that way—but of course, the way that we do it is to separate alpha and beta, right? So, two parts: core. We’re all talking tactical. How do you create a truly well-balanced core portfolio? And we know that the typical portfolio is not well balanced with its greatest vulnerability being in that upper-right quadrant in our box, which is the inflation box. And we know that we’re in that environment.
So, from a starting point of view, I would encourage all investors to look at that four-quadrant box, that box that we have—rising inflation, falling inflation, rising real growth relative to discounted, falling real growth relative to discounted—and see what the biases are in those portfolios. I believe that now you can simultaneously reduce risk and raise returns: reduce risk of that portfolio by having more in that upper-right quadrant, rising inflation, and you will reduce your risk, because if you look at your portfolio, typical investor’s portfolio, that is the environment that is missing. So, you start with that. How do you get more neutral? How do you get better balance and you cover yourself from that exposure? And then you make your tactical moves around it, and the tactical moves, again, should not be in those debts. It should be very well-diversified.
I think that the social and political conflicts are going to be a big investment thing coming forward. And so, that’ll mean—the way I look at it is I want to look at places that have good income statements and balance sheets. So, when I say places, I mean countries as well as individuals that make up those countries, the individual people and the individual companies. So, do they have a good income statement, financial stability, if they have a good balance sheet so that they can weather those things, and also, it’s a sign of their productivity. Are they productive? And then, No. 2, are they civil with each other? I really do believe that internal conflict and bad finances are going to be defining characteristics of where to invest or even where to be.
And then if I carry that forward to the third, am I going to have the risk of being in an important international war? Because that international war will raise lots of threats. So, when I’m picking those locations, I want to be out of those debt instruments, largely minimized on the financials, the inflation-hedge assets, well-diversified. Look to parts of the world that are not as plagued with this. So, emerging Asia is very interesting. India is interesting. So, diversify. Look at neutral countries during that period of time. Watch out for government controls on capital markets because that’s the logical next step. History has shown that. Watch out for foreign exchange controls, could be. Watch out for those things.
So, those are the themes that I think are most important and will be most important in investing.
(Part 2) Jeremy on How to Diversify for an Inflationary Environment
JIM HASKEL
Jeremy, Ray just described his framework for diversifying a portfolio, and obviously that is so important to preserving wealth, particularly in the environment today. So, do you have any thoughts on diversification today?
JEREMY GRANTHAM
Ray made me think that, when we’re selling our resource portfolio, we have a wonderful exhibit that looks at the correlation between all the major sectors, utilities, consumption, and so on, consumer goods. And there’s only one where, as the time period lengthens, the correlation drops, and that is resources. And resources drops to such good effect that based on the last 80 years of data, every rolling 10-year period, that the 10-year correlation is negative. So, if you believe in inflation, you know that resources do very well. You also know that in the long run, it’s strongly negative—it’s negatively correlated modestly with the rest of the portfolio. As we’re seeing today, when they do well, it puts a burden on the rest of the economy, and they do badly. So, there is a very strong case here for a resource portfolio.
On resources, just a point that the last time we had a super-bubble in commodities, there were very large new mines waiting to come online. What has happened since the 2011 crunch, when China slowed down in its heavy industrializing, the growth rate for iron ore and coal dropped from double digits to zero—dead flat for three years in a row, breaking the back of the resource industry. They have not done any capex. It takes 5-15 years to bring on a mine. They have not been doing this. There are no great reserves of lithium, cobalt, copper, nickel, even iron ore to come online this time, and everybody knows it. If you look at the need for these, particularly green metals, greening metals, it doesn’t compute. There are no backup resources. And that applies right across the length and breadth of resources. They have not been capexing, even in oil and gas, for the last 10 years to a remarkable degree.
(Part 2) Ray on Currencies and Storeholds of Wealth
ALEX SHAHIDI
Ray, there is an important question that I want to get to you, and it’s related to concerns that you’ve shared about the US dollar potentially losing its reserve currency status. As an investor, how should they think about constructing a portfolio given this concern that you’ve talked about?
RAY DALIO
Well, there are two purposes of a currency, which is a medium of exchange and a storehold of wealth. And we’re living in a world where we have three major currencies that are fiat currencies with the same kind of problems. So, you can’t look at one currency in relationship to another. I think people make a lot of mistakes of thinking—you know, it’s an ugly contest. And so, the questions that we’re going to have is what is your storehold of wealth? And money is a storehold of wealth that also is widely accepted in other countries so that you can move it around. It’s not just limited to currencies. Don’t think that medium of exchange is the only important thing. So, think about the storehold of wealth. That’s when we deal with the quadrant of the four pieces to try to find a balanced storehold of wealth. And then you have to think, “Can I move that and sell that anywhere? Am I going to have the free capital markets to do that? Or are they going to be a problem?”
So, the diversification of that, and I think we are entering a period where all currencies, the traditional medium of exchange type of currencies, are going to—a lot of currencies will compete. What will be the medium in which I could take something and go someplace else and cost-effectively convert that into buying? The medium of exchange. So, I think we’re in a storehold of wealth issue. In other words, focus in on that. And then your transaction cost of converting that storehold of wealth, a balanced portfolio, into buying power. And then you transact, because even in the worst inflations, the worst environments, the currencies, most of the time, still could be mediums of exchange, even though they’re devalued. So, I encourage people to think about bad fiat currencies generally and think about storeholds of wealth and what the liquidity is, and think about even what capital wars look like.
JIM HASKEL
And in terms of storeholds of wealth, I’m wondering if you have any particular asset in mind. So, for example, would gold serve that purpose?
RAY DALIO
Gold, as an overlay on a portfolio, on top of a portfolio, works like an insurance policy. Gold is a dead asset. It just sits there, but it’s got characteristics that are limited in supply. One of the most important things: it’s the third-highest reserve currency held by central banks. And in periods of time of war or such periods of time of credibility, it is the medium—like they say, it’s the only asset that you could have that’s not somebody else’s liability. That means you have to be dependent on them giving you money or giving you something. And it is international, it can be moved, and it’s tried and true. So, in that regard—but its behavior isn’t very environmentally specific. So, as a hedge asset, as an overlay, it’s really like a great insurance policy, because when the other assets go down—and so, something like that or the equivalent of it plays a role in a portfolio, not as the core asset, but as the effect of diversification of assets. And if you do it as an overlay, it’s about 15% of the portfolio, not taking away assets from other parts of the portfolio.
But I come back to my basics, which is the four quadrants, the timeless and universal. The one thing that you can be sure of is that cash will not be the best asset class. And when you diversify a portfolio, so you got a well-balanced portfolio of other things, whenever you have that diversified portfolio, it will outperform cash because that’s the nature of the system. The central bank puts money on deposit. People with better ideas come along, take the elements of risk, and it works. When that diversified portfolio of asset classes doesn’t work well, that balance—there are times—it works better than the traditional portfolio and the down moves by a lot. Like, when the markets—although it goes down 60% or so. Worst cases are like 20%, maybe a little bit over that. And it never stays there because central banks can’t let capitalism, which is dependent on those other assets performing a higher return than cash, can’t let that continue. So, they come in there and they produce money and credit, and it produces the pop.
So, I want to emphasize what I said before—I think in terms of storeholds of wealth, how you can move it from country to country, where it’s acceptable and that way, and don’t view money just through that idea of the fiat currency because a fiat currency is short-term cash, and cash is trash.
(Part 2) Jeremy on the Environment, Climate Change, and the Threat to Humanity
JIM HASKEL
Jeremy, we’re coming to the end of our time. But before we go, I want to circle back to something you said at the beginning, that your major focus recently has been on the environment and climate change. And so, can you say more about that issue and how you’re thinking about it? And perhaps we can close on that.
JEREMY GRANTHAM
I think the world has simply been running way over its capacity. And the great luxury of the last 200 years of fossil fuels—coal, and then oil and gas—have catapulted us far above our long-term ability to sustain. The good news is that catapulted science and research as well as income and consumption. And we’re going to have to rely enormously on research and our inventiveness to save our bacon. And I do believe there is a decent chance that it will. Quite a number of years ago, I got into studying the rise and fall of civilizations, and I always like to recommend Immoderate Greatness by Ophuls, O-P-H-U-L-S. He’s done all the heavy lifting for us. He’s, in a series of chapters, condensed all the major reasons for civilizations failing in the past, and he’s read everything. He knows it like the back of his hand. And it’s like the CliffsNotes, very, very serious, well-written, quotable CliffsNotes on civilizations failing. And he gives five or six major reasons, which include overburdening the local environment, your soil, and your nature, and your water—complexity, which is very energy-intensive and so on.
And he concludes two things: one, that the current global civilization checks off every single one of them, which is rather creepy, and two, that humans appeared to be hardwired to self-destruct. And my take on that is that, like every other organism, we’ve spent a few million years fighting for survival, and we have learned to grab what we can when we can. And like other organisms, to grow, we propagate basically as much as we can for our first few million years, and we’ll expand to fill the space available. And we are not programmed to think about long-term, slow-moving consequences. And so, we don’t. And we have to look at things today, like the president of Brazil encouraging the greatest deforestation in Brazil’s history in the last 12 months, to everybody’s shock. But we also have to live in a world where President Trump was doing his best to undo all the good that EPA and environmental movements had been trying to do. It’s pretty bizarre to have a couple of serious countries attempting to ignore the greatest threat, perhaps for hundreds of years.
And I believe that we do have some escape clauses from Mr. Ophuls’s prediction of self-destruction. And that is twofold: one, unexpected by everybody, including Malthus in 1798, we are choosing—despite getting wealthier—to have fewer children since 1961. It’s a remarkably unexpected outcome. It was not predicted, as far as I’m aware by anybody, let’s say, as recently as 1950. And the degree and the speed with which fertility rates are contracting is not really appreciated by anybody, including the financial community. We are not only way down from replacement rate in every developed country, except Israel, but we are, if anything, accelerating. And so, in the US, we are at 1.65 versus 2.1 children. We’re at 1.65. And so, way down, a quarter below what is necessary. And many countries in Europe—Italy, Hungary—are way below that. And of course, in the Far East, you culminate in South Korea, which has incidentally overtaken Japan in individual wealth—individual income, I should say. They have a fertility rate below one. I mean, it’s just inconceivable. And China, Japan, Taiwan are all down there at the 1.5 level, quite remarkable. And this is not a sufficient condition to save our bacon, but it is a very necessary condition.
ALEX SHAHIDI
Jeremy, you’re saying that one of the pressures working in our favor is less people. So, that obviously leads to less pressure on natural resources. What’s the second factor working in our favor?
JEREMY GRANTHAM
The other factor is the speed of our science, and the fact that, if anything, it seems to be maybe accelerating. And we do have some “getting-out-of-jail-free” cards. Thank heavens. The problems we face basically are all the cures so far have been contained within a finite world. We’re trying to compound on a finite planet, but the get-out-of-jail-free cards have a whiff of the infinite, and they are: fusion, a source of infinite energy if we can pull it off. It’s green, we never run out, and it may be cheap. It remains to be seen. I’m reasonably optimistic, but it’s certainly far from a probability of one. Geothermal, the ability to drill several miles down and tap the heat of the inner core, which is, for all intents and purposes, infinite and green, and we have a vast learning curve from fracking to tap into. But there are massive problems of dealing with the heat several miles down, though not necessarily problems that we won’t learn to handle. And the third one is a major breakthrough in energy storage to go with the spectacular progress of solar and wind—again, year after year, that has outperformed early forecasts. If you look at the international energy authorities and others, you will see an almost laughable pattern, where each forecast for 2030 has been below the actual. Each year, it’s ramping up. It’s like an investment model that never learns from the past, it seems. But if we can take the cost of energy storage down to 10 cents or 20 cents on the dollar from today, and blend it and mix it with solar and wind, that will also be basically an infinite source of green energy.
So, I like to say, in all probability, the lack of cheap, available green energy is not the factor that will bring us to our knees. The problem is the time it will take to get there. We have wasted, arguably, 50 years getting the point that climate change is ultimately dangerous. And by the time we have all this cheap green energy, an enormous amount of damage will have been done, and the parts per million in the atmosphere will have gone from what we need, which is about 280-300, where you’ve got a very stable world—it’s currently 420, and it is on its way, for sure, beyond 500. This is the kind of burden that we will have to deal with. And if we have fusion or one of the others, we will be able to set about the slow, steady business of subtracting carbon dioxide and returning the planet to a decent state. So, if we have that and we combine with it a declining population, we really do have a chance of survival, as I like to say.
ALEX SHAHIDI
Jeremy, I know the Grantham Foundation is working very hard on some of these technological solutions to climate change that you’ve described.
JEREMY GRANTHAM
We are, thank heavens, a very inventive species. And our foundation for the protection of the environment has a target of 50% green venture capital and 25% other early-stage venture capital. The world is getting behind the need to green the economy, getting behind the need to be frugal with resources, and change and improve the food structure. The governments are getting behind it, corporations are getting behind it. Why would early stage, new enterprises in those areas not be a candidate for highest return on the planet? I think they are, and it’s thoroughly exciting. It gives a sense of purpose, and it may very well be the best investment you can make. The topline revenue of people going to solve climate change is going to dwarf the rest of the economy. It’s the topline of electric vehicles versus the topline of the old vehicles. The topline of electricity versus fossil fuels. The topline of efficiency versus business as usual. That’s where the growth will be.
JIM HASKEL
All right. I think we’ll wrap it up there. Jeremy and Ray, thank you so much for joining us. I hope we can do this again sometime soon.
JEREMY GRANTHAM
It was a real pleasure.
RAY DALIO
And it’s always a pleasure, Jeremy.
JEREMY GRANTHAM
Thanks. Thanks for having me.
JIM HASKEL
Well, Alex, that was a lot of fun. I hope we can do this again also sometime soon.
ALEX SHAHIDI
I had a lot of fun, Jim, and I look forward to it as well.
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