Much in the world has changed since TheTeCHyWorLD launched in 2007. What will we confront over the next 15 years? In the first installment of our Conversations series, focusing on finance and competition, former Treasury Secretary Larry Summers sits down with Ray Dalio, the founder of hedge fund Bridgewater Associates and author of several books, including his latest Principles for Dealing with the Changing World Order.
Starting with the risk of inflation in the post-Covid world, the two then look ahead to the challenges of political polarization and global competition with China. “If one doesn’t worry, one needs to worry,” said Dalio. Added Summers: “I will worry most for our future when we become complacent and serene.”
Held in New York City, this conversation has been edited for length. You can watch the video above and read a full transcript below.
Larry Summers So Ray, let’s start on that question of inflation.
My sense is that we’ve had a set of developments that you’ve studied over a long time period, but that we very dramatically, about a year ago, ramped up the level of fiscal spending, ramped up the amount of liquidity that the Fed was providing; we did it at a time when, because of Covid, there were limits on how much consumers could spend, so they built up a big overhang; and that the economy almost had to overheat; that, to mix the metaphor, the bathtub almost certainly had to overflow. And I don’t think that the market in general and I don’t think many of the policymakers appreciate just how big that overheating is. And that if we want to cool things off and get to anywhere near two percent inflation, if we want to maintain confidence in our currency, we’re going to have to make some fairly substantial adjustments. And that that is probably going to be a thing that’s going to come with a bunch of uneasiness, turbulence in markets, maybe even a recession. So I think it’s a very, very difficult, probably as challenging a moment for monetary policy as we’ve had in decades.
What’s your sense?
Ray Dalio There’s cyclical inflation and there’s monetary inflation. And I think that people are not looking, and the Fed is not adequately looking, at the fact that when there’s a lot of debt, and you create a lot of debt and money, which of course, is a great stimulant. Also, one man’s debts are another man’s financial assets. And so, what we’ve seen is that throughout history, we can go back literally thousands of years, as the debts rise and there’s somebody’s financial assets, there’s a balancing act that becomes increasingly difficult.
And so, when we look at what’s ahead, we do know how these cycles work. We know that you have a recession to a recession, and on average they’ve been about seven years, and they’re shorter when you start quicker. And so, we’re in a cycle where there was a lot of money and credit. I mean, from the investor’s point of view, think about how bad that debt is. I’m holding cash. Last year, I lost seven percent to cash. One would have lost seven percent in buying power. And now if you have a five percent inflation and so on, the things are changing. And so, because they’re changing in that way, inflation psychology is going to change. They don’t want to hold the bonds or they don’t want to hold the cash, much less. And so we have an extra risk that they may sell those bonds and that cash, and when they do, then that creates a bigger deficit in funding, because not only do you have to sell the Treasury, what the Treasury has to sell, there has to be enough buying to buy what the sellers are selling. And when that comes up, it puts the central bank in the position of either having interest rates rise a lot, and that shuts things off, or having to come in and fill the gap in a bigger way than it was done before. So as that psychology changes and wages change and all of that, we are on the brink of that happening. So yes, we have a big issue pertaining to inflation.
The trade-off, it appears to me, that a high enough interest rate to adequately contain inflation, of what we might think is adequate, is too high of an interest rate for the markets and the economy. So the trade-off that the Fed is going to face will be an even greater, more difficult trade-off between inflation and growth. Think about it, the tightening that might be priced into the market might take it to two percent, maybe, give or take a bit. Two percent interest rate, when you have something that could be a five percent inflation rate and you have the supply-demand imbalance, is something that is really a problem.
Summers So all things considered, you frame the question exactly the way I would, which is we can bring inflation under control, but we might lose some control of the real economy and financial markets, or we can try to keep the real economy going, in which case we’re probably not going to see inflation go down to two percent. What do you think the chances are — ?
Dalio Almost any prospect is, you’re going to have a much higher level of inflation than you will have an interest rate. And when that happens, you’re going to have continued losses in buying power, and that’s not going to be palatable.
Summers So the Fed believes, the Fed’s latest forecast, if you listen to policymakers, if you take the consensus economic forecast, it involves a kind of soft landing where inflation recedes substantially from current levels (maybe not all the way to two but to below three), where unemployment stays below four percent. What do you think the prospects are that the economy achieves that kind of soft landing? Is there any prospect?
Dalio I think that the Fed’s forecast, that it was transitory, was obviously wrong — okay — I think they are misunderstanding things. I think they put too much on the cycle, a normal cycle. Why are real interest rates — since we started, when we started setting inflation index bonds, they were four percent real. How did they get to minus one percent? Why is the equilibrium in interest rates 500 percent, 500 basis points, lower than it was back then? There is something bigger going on. And that bigger thing that’s going on is the accumulation of debt, because that’s buying power. That’s stored buying power. So everybody’s got to believe that that stored buying power is real. Yet if you think about: How are you going to get that? Can everybody sell those bonds and actually convert that into purchases? No way. So if you look at history, throughout history, there is this bigger thing that’s going on, this bigger debt cycle thing that’s going on. And so, I think there’s not enough attention paid to that.
Summers Ray, I think the chances of a soft landing over the next few years are maybe one in four. I think it’s odds off. I think the Fed has very much the difficult choice that you describe. I suspect that usually when people have very difficult choices, they end up somewhere in between. So I suspect we’re going to see a fair amount of turbulence in the real economy, and I suspect we’re going to see inflation that’s going to remain well above two percent for a long time. And I think it’s going to be a divisive thing. My own instinct is that the more firmly we deal with it and the sooner we deal with it, the better the ultimate prospect is likely to be. I suspect you share this view.
I’m sorry to see economic analysts talk about this as a morality play in terms of corporate greed or tell it as a story of specific sectors: This is happening in used cars, and this is happening in chips, and this is happening in meatpacking and so forth. I think the kind of broad financial approach that looks at the price level as the value of goods relative to paper that the government creates is the right fundamental way to think about this.
Dalio I’d agree with what you said before, which is that there is going to be, when you’re stuck with two trade-offs, too much inflation or you’re stuck with too much economic weakness, then you navigate through the middle, and that means something like stagflation. And so I think we are entering a period of stagflation. And I think the political and the wealth gap issues and so on create a set of circumstances that it’s not easy to get out of, because everybody needs more money. And so, do you get real money? Taxation is the way to do it normally, but it’s taking money away from somebody; whoever it is becomes controversial.
The one easy thing throughout history that’s always been done is the printing of money, because nobody even pays much attention to where the wealth is coming from. So what it does is, like, everybody got the check and nobody had money taken away from them. And so it’s politically easier, but it devalues — think about the enormous amount of supposed buying power that’s in these bonds or other assets. I want to buy a bond, so I’m going to give a lump sum of money. It’ll take me 50 years to get back what I gave. And then I’ll begin to earn money after that, because it’s a 50-year return in nominal terms. If you do it in real terms, I will never get back my money. I’ll continuously lose my money. So, that for a creditor, that for a holder, is a difficult thing. And when you get that swing, that’s an important force, I think.
Summers I think that’s right, and it brings us to the fact that we’ve got a probably more divided society than we’ve had, certainly any time that I can remember, with more polarization, more people get information from sources that reinforce their prejudices, more anger between different groups in the society. I knew that all kinds of things could happen, and you have to always think about big tails, but I really was surprised by the events of January 6. The idea that there could be an orderly transition of power, that that could be disrupted in the United States, was not something I had ever imagined as a serious possibility until a little while ago. You’ve done lots of study of history. Was it something you imagined as happening in the United States before recently?
Dalio Only because I needed to study the past five hundred years because these are things that happened in the past. And so when I studied this combination, when you have three things going on: You have, first, the financial problem. The coffers are empty, you print more money, that dynamic. And then, the emergence of populism of the left and populism of the right. Both of that never happened in a developed country, until recently. I started to study the populism and how that worked. And then in the study, I studied the French Revolution, the Russian Revolution, the Chinese Revolution or Civil War, the Cuban Civil War, and all of those. And it was that same combination of financial problems and very large wealth gaps that produced this populism of the left and populism of the right, together. Populists are people who represent an important segment of the society that are fighters, and they say, I will fight for that. They’re not compromisers. And our system is based on compromise.
So all the statistics, I follow a lot of statistics, as you know, showed greater and greater movement than that. And so it wasn’t surprising because there was plenty of dots to connect as it was emerging there. And I think if we look ahead, we have to ask ourselves about that issue, because we have in the cycle received all this money and we’re almost at the best of where we are and we’re now have that polarity. As the cycle progresses, it becomes riskier, the economic cycle, and there’s not going to be the same amount of money. And as you look at the 2022 elections, 2023, 2024, it is conceivable, although it seems inconceivable, that you could have neither side accept losing. Can you imagine that?
And you’re starting to see this type of polarity or civil war conflict of any form happening also geographically. People are moving not just because of tax issues. They’re moving because of wanting to be around people more like them, different values. They might say, I go to Texas, I go to Florida, I go to Nevada, and I’m leaving California, San Francisco, I’m leaving Chicago, I’m leaving New York for these various reasons. Yes. So I think this polarity is an important, important issue and will play a role even in how much spending. When you hear of the discussions of ‘We need to spend money on this’ and ‘We need to spend money on that,’ there’s not much talk about ‘Where does the money come from?’
Summers Americans, I’ve read, used to feel that if their children married someone of a different religion, that was something they didn’t like. Now, the vast majority of American families are fine whatever religion their children marry into. But if their children marry someone from a family from a different political party, that’s something that’s very, very upsetting to them.
Dalio Yeah.
Summers And I think that level of division that makes it hard to have the kind of conversations. I’ve been on the Democratic side, you’ve been on the Republican side, but we both —
Dalio I’m apolitical. I just want to say, I’ve never donated to, you know, I’m apolitical.
Summers But you, but we’ve been able to have a sort of rational debate back and forth. Don’t you think we need higher taxes in America if we’re going to meet the needs — ?
Dalio Of course, of course.
Summers And some of that should come from those of us, and I don’t compare myself to you, but those of us who are in the very top of the income distribution.
Dalio Of course.
Summers Shouldn’t we be taxing the use of carbon much more heavily —
Dalio Of course.
Summers — than we are? And shouldn’t we be doing it to contain the accumulation of debt and to make necessary public investments? Is there a way forward with meeting all these needs in a sustainable way without figuring out how to get more revenue from the federal government?
Dalio Yeah, I think, I think we just, right. The question is whether, how that happens, or what happens, right? I mean, how do you actually get there? I just want to bring back the American dream, you know? I benefited from the American dream. You know, my dad was a jazz musician. My mom stayed home. I went to a public school as a kind of a lower-middle class thing. And everybody should have the American dream. Not only is it fairer, but it also means that you tap the greatest population because you don’t know where the talent is going to come from, and that’s a better set of circumstances. And so yes, in terms of like, education is one of the best investments that you can make. How can you have the educational disparities and so on, so forth?
The issue really is there’s not bipartisanship to deal with it. Like, if I was president of the United States, I would have a bipartisan cabinet and I would say that there should be something the equivalent of a bipartisan Manhattan Project to find out how, with sensible engineers who understand enough about the economy and how it works, how to both increase the size of the pie and to divide the pie well, because you have to raise productivity as well as redistribute.
Redistribution of wealth has never worked. You know, the Russians take the wealth in 1917 in the war and they think they’ve got wealth, but it’s productivity. Wealth doesn’t last. So yes, you have to go back to that. So you’ve got to do certain basic things right. I think the most important thing is that you have every society, every person over a period of time, has really has to earn more than they spend. OK? A society that doesn’t earn more than it spends, inevitably, is going to live on debt and there’ll be limits to that for the reasons we talk about. And they have to work well together to be productive in order to raise the living standards. Because you’re not eating the paper you’re producing in the form of debt, you’re eating what you produce. So you have to be productive.
If we don’t do those things, being together, bipartisan, and bring the extremes and somehow the middle, a thoughtful middle, analyzes how to do that, and we don’t then get that productivity, yes, I think we’re going to be in a problem. But that’s what it’s about, and the question is whether we can do that, right? So yes, of course, I agree with everything that you said and more, because I could list more things that need to be done.
Summers How much more of GDP do you think we need to spend? Do we need to — you know, the American federal government spends 20 percent of GDP, a bit more than 20 percent of GDP. Do you think we need to spend another two percent, another 10 percent? What is it?
Dalio I think it’s how you spend it. There are so many cost-effective things that actually produce high returns to spend it on. I think of education, by way of example. It’s cost-effective to educate well, OK? And it also makes a fairer society. What a great return on investment. And history has shown throughout societies that that pays off, but we don’t. So I think that if you spend on things that produce productivity, which I see a lot of and a lot of other people see a lot of, those are great returns on investments.
Summers Of course, there’s always the question of: If you put money into the school system, does it come out in the form of more education of more kids or more administrators, more comfortable lives for those in the existing system?
I often think we are caught in a trap where there’s less confidence in government, so there’s less resources provided, so there’s less confidence. So to try to rebuild confidence, people make very ambitious promises, they’re then not able to catch up with those promises, and then the cycle repeats itself.
I think there are very big risks. It is the sort of ‘both and’ thing. I think, in general, progressives are right that we need to invest more, and conservatives are right that we need to invest better, faster and tougher. And instead of having a sterile argument about whether there should be more money or there should be more toughness in the investment, we need to adopt both and do both together. And I think that’s what we need to do in education, that’s what we need to do in infrastructure. And I wish I saw more evidence that we were making these systems work better so that people could be confident that more investment in them would actually yield those kinds of returns.
I do think, I’ve been struck because I’ve observed that people who have a successful restaurant who try to make clones of that restaurant in other parts of their city or in other cities, the vast majority of the times, they don’t succeed. And I think this problem of scaling — Bill Clinton used to say there’s no problem in American education that hasn’t been solved somewhere in American education. And I think he was right about that. But it’s a big challenge to take a success that some innovative social entrepreneur is doing and get that to a large scale so it has a real impact, and I wish we had a government that was more interested in the insights of some of our great business leaders in how to grow something successful to a very large scale.
Dalio Well, one thing we didn’t talk about is the third big force, which is the changing world order, which is the rise, particularly of a competitive power, you know, a great power to challenge the existing.
I saw that all three of those — the financial problem, the internal conflict problem and the external — when they have happened together, it’s a very risky set of circumstances. And when we look at that, I think, I’ll get your thoughts, but China is a rising great power. I mean, since I started going to China in 1984, per capita income has increased by 26 times. And so, if you were to say a competitor, we use the word war, there’s a trade war, there’s a technology war, there’s a capital war, there’s a geopolitical war and there’s a military war. Or you can call those competitions. They’ve become very effective competitors, and there’s more than four times as many Chinese as Americans. So if you get them to have half the GDP per capita, they’ll be twice as large.
Summers Ray, I first visited China in 1979, and I went to Shanghai, and it was like Boston during the worst blizzard in the sense that you walked down the middle of the streets and every once in a while a motorized vehicle would come and then you’d have to go to the side of the road. But the norm was people walking right down the middle of broad avenues because there were no cars. And so what’s happened in China over the last 40 years is by far the biggest story in all of economic history. Completely dwarfs the industrial revolution.
I think we’re living in a time when we’re not at the end of history and the question of whether the ultimate organization of societies that’s going to work best is one like Abraham Lincoln talked about at Gettysburg when he talked about ‘By the people, for the people,’ is still an issue, because China has a very different model and they’ve had really very remarkable results.
I think, and this is someplace where I think you and I may not have the same view, I think the combination of forces that they are now facing: the huge overhangs of real estate, the difficulty of exiting from Covid, the consequences of being a society where the average woman only wants to have one child, the difficulty of running by socialist control an economy as large as theirs. I have a suspicion that they will continue to grow. But just as we look back at the early ’60s and think that America greatly exaggerated the Soviet Union, and just as we look back at the early ’90s and we think that America greatly exaggerated Japan, I think we’re — have a substantial chance that China is going to run into a substantial variety of problems in the years ahead, and we need to be very careful to be engaged with China in a way that is respectful of their economic scale and power, but engaged in a way where we cannot be blamed for the difficulties and problems that they may well encounter as a society.
And so, I worry about the degree of truculence that I hear coming out of Washington. Seems to me that whether you agree with somebody or you don’t agree with somebody, whether you like somebody or you don’t like somebody, it’s almost always better to be engaged in some kind of dialogue and some kind of search for issues of mutual understanding. When historians look back at TheTeCHyWorLD’s 30th anniversary, I don’t think China is going to seem quite as formidable relative to the United States as it does today, but it’s a very hard judgment to make.
Dalio I think your last words, it’s a very hard judgment to make, is the most accurate way. I’ve been through five major debt crises in the United States when we couldn’t pay our bills, and I know that we know about debt restructuring, and if the debt is in your currency and how you can deal with that. And I’m not arguing one way or another. I’m saying that that can’t be taken — and hope is not a strategy. That being strong yourself and us doing the first two things right is very, very important. So I don’t think we can hope. We have to deal with the elements of the realities.
I would say, like even the biggest question is a political question. If people work well with each other and they operate where they’re doing the finances right and they don’t get into a war, then I think that they can be productive. And if they don’t — So in any case, it’s a test of our systems and I want, the number one thing is I want to go back to the American dream of us being strong because we’re working together and we’re dealing with the wonderful blessings that that’s created.
But even questions like, even the media, where is truth? And where are the facts? We have to make ourselves strong most importantly, I think, and I think you agree with that. And so we are living in a changing world order. The reason I wrote this book or I did the study for myself and then made the book was because I needed to see those patterns. And it makes me worry. And you worry. And I believe if one worries, one doesn’t need to worry. But if one doesn’t worry, one needs to worry. Because if you worry, then you start to do the things that will prevent the things you’re worrying about. So that’s, I guess, my punchline.
Summers I think the great American gift, Ray, is the capacity for self-denying prophecy of doom. That if you look at American history, whether it’s what people thought the Cold War was over and Japan had won, whether it’s the missile gap, whether it’s the worries about our democracy during the McCarthyist period, whether it’s the people who say Franklin Roosevelt should have become a dictator at the beginning of the Depression because that was the only way we’d get out of the Depression, whether it was Patrick Henry who said in 1792 that the spirit of the Revolution had been lost. We have these jeremiads of doom and fear, and that is what is the catalyst to change and repair that makes us resilient. And the moment I will worry most for our future is when we become complacent and serene. And as long as there are people like you, Ray, who signal the need for alarm, as long as we have that capacity to become alarmed, I think we will make our way through. But it will not be easy, and we are financially, in terms of polarization and in terms of the international order, in a very challenging place right now.
Dalio We agree completely. If we have it in us, we’ll be fine.
Summers I always learn something when you and I talk, and that was very good.
Dalio Me too. Maybe we’re all wrong together.