The Pathology of Debt Crises
Ray Dalio runs the very successful $150
billion Bridgewater Associates hedge fund and he is more than qualified to
understand the pathology of debt. His book offers up a template for
understanding of how a debt crisis develops where early optimism leads to
over-leveraging that can longer be serviced which leads to analyzing the appropriate
policy responses to it and a great deal of pain for society as a whole. He also
fully understands that once a crisis is in full train there can be very
negative political feedbacks that can make things far worse.
To Dalio policy makers have to ignore,
at least initially, the problem of moral hazard. That is bailing out the ones
who were in up to their eyeballs in making the crisis. He was fully supportive
of the banker bailout program which in his opinion and my opinion was necessary
to save the system. Where I would differ is that once a crisis has past the critical
phase, those responsible have to be held to account. One of the reasons why
there is so much populism on the right and the left is that no major banker in
the U.S. went to jail. That was unlike the savings and loan scandals of the
late 1980s and the dot.com frauds of the late 1990s. Our pagan society needs
ritual sacrifices to cleanse the system.
Where his book is most valuable is his
discussion of the three major debt crises of the past 100 years: Wiemar Germany 1918-24, the Great Depression
1928-1937 and the recent Great Financial Crisis of 2007-2011. He goes through
each of those crises in great detail and in many cases on a nearly day-by-day
basis. In the case of the recent crisis he includes his contemporaneous
Bridgewater Daily Observations publication to get his thinking in real time. By
doing this he puts you into the shoes of investors and policy makers as they
scramble to make sense as to what is going on. In the case of the German
hyper-inflation he notes that given all of the constraints that might have been
the least bad alternative policy to follow.
Dalio credits the work of Bernanke,
Paulson and Geithner in preventing the U.S. in falling into a second great depression
after the failure of Lehman Brothers. However letting Lehman go in hindsight
looks like a big mistake. However as I have written elsewhere letting Lehman go
was analogous to killing the chicken to scare the monkey. He also credits the
smooth hand-off between the Bush and Obama administrations which contrasted to
the lack of a hand-off between Hoover and Roosevelt in 1933.
I have several quibbles with the book.
In the Wiemar inflation he rightly notes that the assassination of highly
respected finance minister Walter Rathenau made it more difficult for Germany
to renegotiate reparations payments, but he ignores the untimely death of
foreign minister Gustav Stressemann in 1929 who might have been able to ease
Germany’s external debt problem. He further ignores the untimely death of New
York Fed president Benjamin Strong in 1928, who in Milton Freidman’s view might
have saved the U.S. from the worst of the depression. Dalio, although he
mentions it, under-rates the Treasury’s gold sterilization policy in the mid-1930s
that triggered the 1937 relapse into depression.
Dalio also ignores the role of
Bridgewater during the crisis. After all Bridgewater was part of the problem in
that it was very likely they were shorting mortgages, high yield debt,
equities, and bank stocks while being long treasuries, the U.S. dollar and
gold. How else could Bridgewater have made money in 2008? Lastly the book is
too long, but read the three case studies with great care which are magnificent.
The full amazon URL appears at: https://www.amazon.com/review/R14MDUVXEYA262/ref=pe_1098610_137716200_cm_rv_eml_rv0_rv
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