The Fault is ours, Ray

According to Forbes Magazine, Ray Dalio, founder of Bridgewater Associates, is America’s second richest money manager. He trails only George Soros in the pantheon of hedge fund “masters of the universe”. Dalio appeared last month on CBS “60 Minutes” to lament the demise of the American dream. He called inequality a national emergency, and said capitalism is no longer “redistributing opportunity”. Coming from one of the world’s richest men, this seems odd. Dalio has been a major beneficiary of the stellar American free-market system. How could this system flip from massive wealth generator and distributor to abject failure in one man’s working lifetime?

Born in 1949, Mr. Dalio’s early life and young adulthood reflected a halcyon period for the U.S. – one in which our economy dominated the world. Dalio repeatedly mentions his public-school education and modest upbringing as key elements of his success. This combination made for nearly boundless opportunity in the period 1950 through 1980, when Dalio was coming of age and beginning his career as an investment manager. He certainly took advantage of it, founding Bridgewater in 1975 with a handful of blue-chip U.S. companies (McDonald’s was one) as clients.

The mid-1970s were also a period when U.S. economic primacy began to be challenged. Both Japan and Germany had fully recovered from the ravages of World War II and began to make serious inroads in world markets for autos, appliances, machine tools and other high-value consumer and industrial goods. Facing this aggressive economic challenge, how did the U.S. respond? Did we double down and compete, or did we take the “easy” road and try to borrow and spend our way to continued prosperity?

You guessed it. Since 1980, combined public and private debt has grown at nearly twice the rate of U.S. Gross Domestic Product. This enormous growth in debt relative to the real economy has benefited financiers and money managers alike. As money and credit became steadily cheaper (interest rates uniformly declined during the period), massive investment funds like Bridgewater soared on an ever-rising wave of financial leverage.

The result: this latter period became a chosen and predictable denouement of the first. It is therefore key to understanding how America went off the rails, at least in Dalio’s eyes. As a people, we chose the easy way out. We chose to spur the economy with borrowing and asset inflation as an offset to diminished U.S.competitiveness. Over the last 40 years, we’ve essentially papered over the problem of reduced competitiveness with ever rising debt and concomitant inflation in asset prices.

Capitalism is not broken. What’s broken is the political and economic policy response over time to a fundamental lack of competitiveness within broad swaths of the U.S. economy. True capitalism would’ve more aggressively liquidated uncompetitive businesses and recycled the capital into new industries, rather than allowing them to float along on a lazy river of credit. This process would’ve entailed short-term economic and political pain in return for long-term gain. New winners and losers would’ve been created, with the broader populace benefiting from greater economic dynamism and growth. True capitalism might not have lifted the S&P 500 Index 26X since 1980, for example, but it also might not have allowed real wages to stagnate for nearly three decades either.

The misguided policies of continuous inflation and borrowing not only blunted the political fallout from a basic lack of competitiveness, they exacerbated income and wealth inequality. The best current examples? People like Ray Dalio at one end of the spectrum, and millennials suffering under $1.5 trillion in student debt unable to afford a house at the other. Yes Ray, your kids (well – maybe not your kids) are worse off than you were, but the cause is not what you think. This violation of the fundamental American dream arises not from a basic failure of capitalism itself, but faulty government policies overlaid on it.

Our leaders continue to steadily borrow and inflate. Federal debt just passed $22 trillion, and the Fed’s 2% inflation “floor” is inviolable. After the millennium, these policies resulted in 8 years of financial boom/bust culminating in the Great Recession. Then came a decade of economic malaise characterized by the Obama administration’s 2% growth “ceiling”. Sadly, even more radical policies are on the horizon. Some are now propounding the notion of Modern Monetary Theory (MMT) – essentially unlimited money and debt creation in service of ever larger government spending and borrowing. Where does it end? No Ray – the problem is not in our stars, but in ourselves.