>> his view on monetary policy. >> i don't believe they can raise rates faster than his discount in the curve. >> analyzing the global economy. a roughnk china will be

spot. it will be weaker. >> what his future holds. >> i can't stop. i love the game. >> on this special edition of "bloomberg surveillance." tom: good evening, everyone. we are here on a beautiful day north of new york city for one of our most anticipated events in the history of bloomberg "surveillance." this is 114 acres north of new york city. darrell. steve and it jarell

michael: if you sold in may and went away, it is time to come back. we will start with ray tonight. tell us about your concept of the machine. how you got to that and how you develop it. >> the same thing happens over and over again. anything that has happened happens over and over again. it is a very simple machine. individualame for an . there's productivity, which produces income. when you earn is a function of your productivity. for a country, and is the same for individuals. you work hard, you are well educated, you can be more productive if you work harder or

if you are more creative. d of time, youerio can spend more than what you earn. that is called debt. we have debt cycles. there is a short-term debt cycle . , that eases burden --y increase the spread money goes out to the system. when we are bidding up asset , we make items that are cheaper others interest rates go down. we have that business cycle we are used to. when that cycle gets past a certain midpoint mother is a

tightening of monetary policy. -- there is a tightening of monetary policy. you have inflation, gets too tight and that cycle goes down. we are in the mid-part of that cycle. hence, we are having a conversation we're having paid there is the long-term debt cycle. the long-term debt cycle, imagine you start up with no debt. low debt to gdp ratios. start off with no debt. borrowans you can $10,000 ear because you have no you can spend $110,000. you are spending somebody else's income. they are earning more, so they can spend more.

until you get to the point where that's rise to much relative to the income, like a balance sheet. all central banks are in the business of helping that cycle go along so they can lower s.terest-rate sprea those rates hit zero and we come to a dilemma. when you have big spreads and -- liquidity in the system there is a difference between debt and money. debt you have to pay back. money settles the transaction. what the central bank does, they put money in the system and they put money in the system by buying financial assets.

when they buy bonds, the seller of that bond takes the cash and they buy something else. as a result of that, it causes the spreads to narrow. that appreciation in the asset prices that we experience creates a normal term structure of interest rates. there are three equilibrium that we have longer-term. first equilibrium is debt can't rise faster than your income. second, the operating rate in the economy cannot be too loose or too tight. the third, we have term structure of the capital market structure. in other words, the cash will have a lower return than bonds. which will have a lower return than equities and so on. there is an equilibrium that keeps working itself through

that system. tom: we did that after world war ii. you and i lived that. a great moderation, we have enjoyed the last seven years. where are we now in that continuum when we observe -- we need some math. where are we right now within the equilibrium? ray: the united states is in the midpoint of a short-term debt cycle. as a result, we are talking about whether the fed should tighten or not. we are near the end of a long-term debt cycle. that cycle of being able to raise -- if you have interest rates going to zero, you have

spreads that have come down. those spreads that have come down means asset prices have gone up. now the expected return of asset classes are very low. we know that bonds are 2.25%, you know for the next 10 years you will get 2.25% on your bonds. the equity price premiums -- all of the asset classes are aligned, normal risk premiums. that is why if interest rates rise faster than is discounted in the markets --

tom: within the framework of your machine, do you presume a junk position as central banks -- junk condition as central banks come out of this? or can they manage it with smooth vectors? ray: i do not believe they can raise rates faster than is discounted in the curve. that interest rate curve, the rate at which it is discounted to rise, it is built into all asset prices. if you raise them much more than is discounted in the curve, that is going to cause asset prices to go down. all things being equal, all assets are subject to the same discount rates. if you raise rates faster than is discounted in the curve, all things being equal, that produces a downward pressure on rates.

that is a dangerous situation because the capacity of the central banks ease is not -- has not been less in our lifetime. we have a very limited capacity of central banks to be affected in easing monetary policy. -- effective in easing monetary policy. we have a situation where you should have an easier monetary policy in europe. europe is in a depression. we have a depression, a cyclical low point. with a lot of political extremism beginning to emerge because of that. japan needs an easier monetary policy. china needs an easier monetary policy. ♪

tom: your work which you most recently published with bridgewater and the most fascinating thing i see within your economic machine is a currency and how it plays into it. would you predict a stronger dollar like the pre-plaza accord or the rubin dollar of the 1990's? how does currency fit into how

you see a lack of productivity and growing debt? ray: the picture we are in is very similar to the picture that was painted from 1982 to 1987. in that, we have a lot of countries, particularly commodity producers, who have a lot of dollar-denominated debt. as we had that environment, as they are in a debt problem, it it is a self reinforcing situation because their debt is denominated in dollars and revenues go down. they are short of dollars. a debt is a short position and you have to cover it. that bids up the price of the dollar. what we need now, we have these commodity countries. very similar, emerging countries, very similar. dollar-denominated debt. it is a self reinforcing cycle, and back then until 1985. then we have the plaza accord as you refer to. and we have the need to ease monetary policy.

but we were able to do which was a good period, we were able to ease our monetary policy as the economy grew. it is tough to do that where we are right now. mike: this primetime edition of bloomberg surveillance on radio and television worldwide with ray dalio, founder of bridgewater associates. what then do we do? what does a central bank do

when it is at that zero bound? when you're at the end of that long-term credit cycle. ray: the thing that you do is you realize that the risks are asymmetrical. you can tighten monetary policy. there is enough debt, enough sensitivity. you wait more to see, because the risks are asymmetrical. that's the main thing. the risks on the downside are different than the risks on the upside. mike: do you think qe works anymore? ray: it will work less than it does last time just like each time it worked a lot less. i am saying we cannot have a big rate rise. the term structure on assets, because of the amount of debt, what it has with the dollar with deflationary pressures. we will have a downturn. the downturn should be worrisome because we do not have the spreads. qe, you're asking if it will work. it is the purchase of those assets to get those premiums up. when you keep pushing, buying more bonds. if there is not an attractive investment relative to bonds, the spread is what will drive that. if there is not much spread in something else, you get less effective monetary policy.

ike: are we there? ray: no, not yet but we are closer to being there and some countries like europe, they are there. what happens is, what are you going to buy in the way of the bonds? we are very close to there. that is why you need more currency depreciation. the effectiveness in japan is there. the effectiveness of monetary policy that comes through the currency. when the person who is receiving that cash for selling their bonds has to do something, and they are in different between cash and that other asset. there is a pressure to move it out of the country. we have very high rates. in comparison to those in europe and japan. it comes through the currency. you have to have currency moves. that is the environment we are in. tom: this is absolutely

critical. we have a presidential debate, we don't need to get into republican and democrat. this nation, to many people, is flat on its back. they want productivity. the smartest thing in your work is the mystery of going from non-efficiency or inefficiency to efficiency. what is your prescription for the next president to assist in productivity? ray: we have done a study going back 60 years. we took the various factors and correlated them with the next 10 years growth rate. we did this across 20 countries. the study is on

economicprinciples.org so you can read this. economies like a human body, it basically works that way. it is the same thing as an individual. when you ask yourself is that individual going to be productive and grow, you will ask what is the education and the most important single factor is what is the cost of an educated person? someone is more educated, that is a good thing. if you have to adjust it by the number of hours worked and what that cost is, because let's say in europe. southern european countries like france, italy, and spain, after adjusting for the average hours worked in a week, they cost twice as much as an american. you can have the education. that is good, but if you are expensive it is not good enough. does the income pay? if you have a situation where you have an educated population, the single most important factor is what does it cost to have an educated person?

the second biggest factor is indebtedness. you have the later parts of these debt cycles, they have less capacity to increase their balance sheets and expand. it goes toward other things. we have surveys of work attitudes. different cultures have different work attitudes. some places live to work and some places work to live. there is a cultural, i'm not saying one is better than the other, but you can take surveys. tom: what is your prescription in the uproar of politics, whether it is mr. corbin or mr. cameron. australia? we didn't even know this was coming. the prime minister of australia is out. aat is the prescription for

better america? ray: and for a better world. there are these various factors. there is not one factor. they are clear and in the study. those factors, at the end of the day, are the same. are you going to be well educated or economically well educated? inefficient? there is a 58% correlation between corruption and economic growth over the ten-year timeframe. as we go into that, productivity will be the single biggest factor. how do you make people productive? self-sufficiency. the single biggest factor for a number of countries is do people feel the consequences of their earning or not working? in countries where there is self-sufficiency, they feel those consequences rather than a greater social net with higher

levels of productivity. at the end of the day, it is when you look at your neighbors and say if they can get an income and they are not going to be penalized, they will be less motivated. what i am trying to direct the attention to is what those specific factors are so that it is like a health index. i like to draw people to productivity in this study. you can see what those correlations are because, for all nations, same formula. it is like a health report. if you can look at your cholesterol level, do you smoke, do you exercise? mike: tom does not want to find out. ray: you can know your ten-year prognosis and if you look at that with that benchmark, you can see what productivity is. it is a series of things and i

don't want to oversimplify it it is like a health report. i don't have a balanced portfolio, i learn to be scared. ♪

mike: how do you apply that when you are looking at investments you want to make? what does it tell us about where america is and where american companies are going? ray: i am mostly interested in who is going to buy and sell and why. the way i look at the price is it is the aggregate of purchases divided by the quantity of goods sold.

that may be a bond, or equities. i look down there and factor by factor. when i am trading, anything that will give me an edge, whether it is insider buying or whatever it is, what we do is we take those rules and have written them down. it came in 1982 or 1983, every time i put on a trade, i would write down and look at those rules. what i discovered by doing that is those rules would be programmed into a computer. when they were programmed into a computer -- tom: did you just say bloomberg terminal? mike: shameless plug. ray: i give you the endorsement. so they are all different ways. we trade 140 different markets, all liquid.

tom: do you have an informational advantage now that you had in 1986? we will get to it but seriously, you have been doing this for 10-20-30 years. is it tougher today given the flow of information or is there so much information across the bloomberg terminal to your advantage? ray: the technology continues to empower me. i think there is no getting around the deep thought. the technology, if you put a lot of data in and are not spending the time with the deep thought, thinking about how you are going to be wrong and you have the fundamental cause-affect linkages, that has ways been the case. artificial intelligence is not a new thing. 1953 is when it started. there were narrow nets and

different ways of doing it. almost every manager blew up has used it. there's no escaping the fact that when you think about relationships, they have to be connected cause effect relationships. the same things happen over and over again through history. tom: gluten-free. get some water and let me preset you for the audience. we welcome all of you worldwide. bloomberg television on bloomberg radio. ray dalio of bridgewater, with no need for introduction, former caddie, yes he is in the news, we will get to that. very importantly, economicprincipals.org is where so many of these concepts and

structures are. mike: if you are having a bad month, there are openings for caddies here. this is where i want to get to risk parity, but not about the current situation but how you develop the theory. where is the moment where you decided to take a bet on the disparity? tom: when is the moment where you decided to take a bet on the disparity? ray: in the early 1990's, i earned enough money that i was putting together trusts for my family. i realized making money and the market is zero some and the allocation is the important thing. i realized how markets work. the problem with those markets is you can't achieve balance. if you have a stock-bond mix, and you want to diversify, and you buy stocks, 50-50 of your

money, you are dominated by equities because it has twice the volatility. i need more volatility in order to create a balance because i want to that equally on two -- bet equally on two things. in the traditional way, you have to buy more bonds and as you buy more, you are buying a lower return of assets. -- lower returning asset in order to have an equal amount on each one of those things, you have to have an equal amount of risk. if you look at risk-return through time, those that have risky assets or volatile assets, tend to have a higher return and a higher risk. that is structural because they have a longer duration and because assets are leveraged themselves. the average s&p 500 company has a a debt-equity ratio of 1-1.

it has embedded leverage. the idea of taking a bond and changing its complexion of return by borrowing cash and having, buying 2 bonds. tech gives me the same amount of risk in those assets and raised the return because the return of cash is lower than the return of bonds over that amount of time. in so that meant i can create diversification. the most important thing is how do you create diversification without lowering your return? i don't know in any ten-year amount of time what will be good and not good. i watch this. i needed balance. tom: when your leverage bond portfolio and you're on everagedraged -- unl equity correlate and stock and bond prices go down together,

what if the shock analysis that you see with this? ray: i imagine it would be equal to stocks. you have 100% correlation between these two assets. i have made it more leveraged so it has the same volatility and risk. they were 100% correlated, the mathematical answer would say it would equal the volatility of stocks. but the fact is if it is not 100% correlated we get into what drives correlation. what it means is that you are going to have, as a result, diversification. comparable volatility. if i apply the different asset classes, so i get diversification, then i can have -- the most important thing is diversify my portfolio. i look today and i say i would be terrified to own any other portfolio. the reason i would be terrified to own any other, am i going to

own stocks? well i be concentrated in stocks? will i be concentrated in bonds? i don't want to be concentrated in either. tom: where you are almost too diversified whether it is by leveraging up or it is by going to different assets? how do you respond to the criticism of diversification? ray: diversification of assets where you don't know which is going to be the better return, similar expected returns and risk, it does not lower your return. tom: is this operational within the great distortion we live in right now? ray: i have almost my entire net worth in it. these are the trusts and these are my investments. the reason i have is i need a balanced portfolio.

if i don't have a balanced portfolio, i am scared. i learned to be scared. i tested it through the most severe. i tested it through the great depression. i tested it through ar republic in germany. tom: did you tested through the giants game this weekend? it's nice to make jokes about this but this is serious. ray: i want to be clear. nothing is a sure thing. let me say that. if you have a well diversified portfolio, and it underperforms in cash, the only times in that situation that it did badly were depressions. what that means is as the federal reserve is tightening monetary policy, if they cause asset prices as a whole to go

down, the only time it really did badly in the great depression and in 2008, something and both of those years, 20%-25%, those are tolerable contractions because the traditional portfolio fell like 60%. when i look at that i am saying we have the central banks on your side. otherwise, you will be concentrating and some assets. brendan: you have suggested to people that you are starting to step back. what are your plans? ray: i'm talking about stepping back in management, not investment. i am an addict. ♪

♪ brendan: your risk fund that lost 5% in august according to most resorts. is that a failure of risk parity or the assets you bought? ray: on a month-to-month basis, i didn't know the stock market was down. the assets were down. i think it is a lousy month for us. if you look at the longer-term returns, they are what they are which is good. you have the stock market down, whatever. that was a month. you could lose 5% in a year. i could look back and say it is down 6% this year. i am comfortable being in that position. the stock market, if you look at the whole history, the stock market in 2008 was down 38%. warren buffett, one of the

greatest investors, his bad year was down 48 -- 47%. to me, i feel like i'm fine. tom: i want to defend the hedge fund industry. there are people here that are actually in the racket. coverage in august, was it -- we went to 50 intraday. he took six weeks off in august. it was wild. these guys are down. ray: let me be clear, just to get the facts right. we have are all weather fund which is down 6% for the year now because of those reasons. i know it will be balanced. we have our pure alpha funds that are up materially. tom: how much are they up?

ray: depends on which fund you are in, somewhere about 6%. brendan: where are you getting the alpha? ray: we could go long and short in a lot of different markets. brendan: you are applying the how the machine works to this time period. you said we are in secular stagnation, i will go back to where is american business right now and even global business? what is the ability of businesses to turn a profit so you can make money? ray: american businesses right now are the number one thing, they are flush with cash. force inlt the biggest the stock market is the buybacks and purchase and acquisition. something like 70% of my buying in the stock market is along those lines. i think you know as well as i

have the change in the complexion of the businesses. i think productivity numbers are very severely distorted because -- tom: youcount are more optimistic. ray: the way we do our accounting for productivity, it means photos have collapsed. what is the value of a photo? tom: are you on instagram? ray: no. tom: i'm not either. when we look at the map of this and i promised i would nothing of how mobility distributions but in the math of it, looking , at rare events. with all the work you have done, all the experience you have, are these derivative strategies around bonds and equities able to withstand the shock of the

next black swan? ray: there are all sorts of embedded risks in different ways. o'er all the time. -- or all the time. i would say that we are better able to expand them then we have been before. there is less liquidity in the market. there is a fair amount of essentially dynamic hedging. that is a way for insurance companies when they take their protection in terms of insurance rate risks, that is an issue. i would say we are better to -- able to withstand them in not the short-term volatility type of thing but in terms of the , bigger moves, we are better able to withstand them provided that we do not have that big event i am talking about just the tightening of monetary policy. we get the doubt. what scares me or worries me is what the next downturn and the economy looks like with asset prices where they are, and

lesser ability of central banks to ease monetary bonds. brendan: some would say if we raise rates now, we have ammunition. you sound like you disagree. ray: it is a restrictive policy, i don't care whether they raised 25 basis points. i don't care if it moves along the curve. i don't see the reason for it. in 2007, i was watching this incredible bubble happen. it was an asset bubble and it was a finance on a lot of debt and it was an obvious bubble. the fed just gave attention to the gdp gap and we had an economic collapse. now we have a situation in the mid part of the cycle, they are trying to identify where inflation is. what they are worried about, we have a lot of liquidity around. when i look at this there are little glimmers here and there of something. i think they are worried too much about the short-term debt

cycle and not enough about the long-term debt cycle. i don't get it given those asymmetrical risks. and that is a look at the world. we are in a world economy. countries outside should be tightening return policy. brendan: this is a prime time bloomberg surveillance special on radio and television worldwide, we are at the corel arrowwood conference center in new york. we are with ray dalia of edgewater. -- edgewater. -- bridgewater. you have been around for a while. you have suggested to people you are starting to step back. a lot of people are saying, this man with his abilities, should stay in the game. what are your plans? ray: it has been 40 years. we just celebrated 40 years. brendan: i was just trying to be nice. ray: what i'm talking about is stepping back in management, not

setting back in investments. i am an addict. i started at and can't stop. 12 i love the game. there is some confusion about what stepping back is. i will always be playing. brendan: do you have a succession plan in place? ray: bob prince, who has been working with me for 27 years, i think he's 55. greg jensen has worked with me for 17 years. he just turned 40. i have a lot of people that have been there for a long time. we have all played the game and are used to doing it. i could step out and that doesn't matter. tom: a historic meeting, i think it was thursday morning. everybody runs a company differently. with him it was one plan. everybody has a style.

when you have a meeting at bridgewater, with the incredibly trained individuals you choose to hire, how do you inject humility? ray: the business we're in teaches us that. tom: i'll say. ray: we have a very unusual culture. the unusual culture is that we -- tom: we don't have that a bloomberg. ray: it is a meritocracy and what we do is we take everything so everything can listen to everything. there is nothing hidden. it is a very straightforward way. it is an unusual idea and meritocracy. that is why the young, best people can come there. because everyone has the right to make sense of anything. there is no traditional hierarchy. you can ask any question. that keeps you on your toes. the best way to do it, what did

they call it in parliament? brendan: question time? ray: you stand up in front and you have everybody shoot at you and you get the stress test. that is the best way to test your thinking. we find it is fantastic. there is meaningful work and meaningful relationships. tom: are you having a greater debate at bridgewater about china? ray: you have two problems in china. ♪

♪ tom: are you having a greater debate about china, when you have debates about china, are they heated or collegial? ray: it is not heated because the culture is very analytical. keep it, say anything you want to say. if you have this template, it just dropped the number in the template.

brendan: that is an interesting situation because china is one of the few times that people have seen you actually come out with a mia culpa. ray: what's your question? brendan: how did you miss it with the template? ray: we miss things. that is where we learn the humility. what happened is when they went to the bubble bursting, you went from -- you have two problems in china. you have a debt problem, local governments have to restructure. that is a manageable problem. it is in their local currency. by the way the people -- i've gotten to know a number of policymakers. they are intelligent and capable in prudent people. more intelligent people

understand. restructuring debt in local currency is a manageable exercise. -- we have done it three times. we defaulted in 71, the latin american debt crisis. and the snl crisis -- . that is a manageable prices -- crisis. the other issue they have is they have to restructure what they are spending money on. they have to rebuild a new economy to replace the old one. that is a challenge. that is like a heart transplant, a serious operation. like most heart transplants nowadays you will get through it ok if you have good surgery. they have a bubble. the third thing is they went from an equity market, which is normal in the early emerging stages of many economies where you get the speculator in and hyped up and leverage. and they had that bubble. that bubble was a negative at the same time.

you went from a bull market and and you are having negative force coming in at the same time. you have those three negative forces. if you look at the economies having an analogous set of circumstances, what are economies that had to restructure debt? what is it like? that is a negative for economic activity. what comes next? we know certain things come next. my statement was when we have that bubble burst, that we shifted from one set of circumstances two minuses and a , plus. another negative. i think we exaggerate over the short-term. a lot of importance is. we look at everything up close. when you look at china, i think china is going to be just fine.

just to be clear. it will be weaker. but their weak growth will probably still be twice our normal growth. tom: i love how you come back with these beautiful historical charts on currency depreciation. we see that now in brazil. i promised i wouldn't ask you for currency quotes. but at the end of the day, is the solution to the international prilemma always going to be currency depreciation? ray: it has always been that if -- the number one choice. if you are facing a domestic contraction, and you have a choice, you want to depreciate your currency. everybody judges their net worth by local currency.

that was a lesson i learned in 1971. i was clerking on the floor of the new york stock exchange. i walked on the floor, richard nixon on sunday night announces we are going off the gold standard. i walk on the floor of the nyse and it is up a lot. and i learned that every time, but you have is it stimulates and makes everything cheaper and causes things to go up. when you have a zero interest , what will you do? brendan: you have an economic model. central banks around the world have to ease. the u.s. and secular stagnation. you are optimistic about china but they will be slow. for investors. ray: i don't think the secular stagnation, i shouldn't even

interrupt your question. brendan: what kind of returns, and the next 10 years, can investors expect? i'm not talking about your particular fund. is it going to be different? ray: you know it. you will have returns that are probably going to average somewhere in the vicinity of 3% or 4%. this is a major pension fund problem because the way assets work is when there is quantitative easing for these purchases and prices go up, that is producing a present value effect. it is like a bond. as your bond price goes up, you invest in -- sorry, i am not saying it clearly. if you invest in a 10 year bond and it is 2.25%, you are going to .25% in that.

5% --rendan:. brendan: 2.25% in that. if your bond price goes up you can be jubilant but when you collect that profit and sell it and invest it at a lower interest rate, the lower interest rate means you will still get the two and a quarter percent. when you look at the whole structure of asset prices from cash to the 2.25%, and you carry that all the way through, that has permeated all assets. that has permeated venture capital, private equity, real estate. all asset classes going forward are going to have a very low return. that means you need a whole lot more money in order to immunize something. supposing you have $100,000 per year expenditures. how much money do you have to immunize a $100,000 expenditure? we do that to get going as it did but we have a situation where we know it is certain have low returns.

tom: i had to give a signal to the cameras, one minute or one more hour with you. we went with one more minute. you are at at hbs, everyone uber ine find the next silicon valley. what the you say to a 26-year-old smart kid to go into finance? have you sell them on that in 2016? ray: i think that when you can go long or short, anything in the world, or everything in the world, that means you don't have any cycles. that means you get to think about the whole world and how it is connected. there is nothing more exciting and there are no excuses. because if you go into any other business, you'll have a cycle. they will be a tech cycle, anything. if you take financial engineering, every investment that you are going to go into, i think we can:

do that. brendan: well, he can caddy. tom: we have run out of time, thank you so much. ♪

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