The economy is in slow growth mode, consumers are paying down debt, jobless numbers remain high and trade frictions are mounting. That’s enough to keep anyone in the U.S. from feeling too good. Except for, perhaps, Ray Dalio, the founder and CEO of Bridgewater Associates, the world’s largest hedge fund firm. Bridgewater is among the few big investment firms that foresaw the credit crisis, and its team of analysts had a smart take on how it would play out. The payoff, as the Wall Street Journal notes this morning, is that Bridgewater’s flagship fund is up about 38% so far in 2010, versus average hedge fund returns of 4.8% (the performance is compiled by Hedge Fund Research, Inc.) While that’s a great return, what’s most interesting about Dalio–I haven’t spoken with him recently but I interviewed him last year– is that his firm made its money by understanding economic history in a way that few do. Of course, other analysts have valuable insights on the economy and a good sense of history. The “new normal” that money managers speak of is simply another version of what the Bridgewater folks have been talking about for years. But Bridgewater’s team were there waiting for all this to happen,–the housing collapse, the credit contraction, even today’s protectionist saber rattling–and it didn’t come from a crystal ball or a smart hunch but from intense analysis of the past.
Back when the economy was growing quickly and credit was flowing freely (too freely, as it turns out,) Dalio and his team could see that risks were escalating. Given that awareness, which we all had to some degree, Dalio also knew that his firm needed to better understand the cycles of debt creation and subsequent deleveraging. They studied the Great Depression, Japan, and other instances of excess, and from that developed new economic and financial models. The consequence of extreme credit excesses, they surmised, would be a harsh, extended period of economic adjustment as things return to normal, a phase Dalio calls the ‘D-Process.’
The D Process is simply a phrase that encompasses all the ‘d’-things that happen after a credit blowout, such as deleveraging, economic depression, devaluation, etc. Understanding the D-Process doesn’t tell you what will happen, but it does make you keenly aware of the interconnected nature of many seemingly unrelated economic developments.
When I spoke to Dalio last year he was not quibbling about the nature of the federal rescue (Tarp, and the rest) and he was generally positive that appropriate steps had been taken. The popular criticisms we hear today about of Obama’s wild spending, the lack of shovel ready projects, and the fact that the jobless rate has failed to improve as a result of the stimulus, don’t really mean much in a D-Process evaluation. As Dalio explained it, when the financial crisis happened private demand cratered, so the U.S. Government needed to step in and spend heavily to fill the void. Simple. Dalio was not only accepting massive federal spending as necessary, he was also pretty certain that the economy would need a second stimulus before the D Process was over. Interestingly, Dalio told me at the time that the dollar was vulnerable–he was pointing to the current account deficit as he said it– and that trade frictions would probably rise, all forthcoming chapters in the D Process. Inflation was a risk down the road, he said, and he was relatively optimistic about stocks.
I’m not privy to Bridgewater’s current strategy, but I would guess that they are not too bullish about this latest wave of European austerity. In fact, as the G-20 meet in South Korea and try to hammer out a coordination that will keep the world economy growing, I wish they had a D-Process model on their big table, one that could quickly tell them whether and how their policy decisions would affect this long economic funk. Of course, Treasury Secretary Geithner probably already has Ray on his speed dial.