Yahoo Finance Editor-at-Large Brian Sozzi sits down with Bridgewater Associates Founder Ray Dalio to discuss his new animated video “Principles for Dealing with the Changing World Order” which examines how historical events help us understand what is happening now, and to anticipate what will happen in the future.

Video Transcript

[MUSIC PLAYING] BRIAN SOZZI: Joining me now on Yahoo Finance Presents is Ray Dalio. Ray, good to see you again, and welcome back to Yahoo Finance. Really appreciate you taking some time. I stumbled upon on YouTube "Principles for Dealing with the Changing World Order-- Why Nations Succeed and Fail." This posting by you has amassed close to 10 million views. RAY DALIO: Eventually out of these conflicts, whether they're violent or not, come new winners who get together and restructure the loser's debts and political systems and establish the new world order. Then the old cycle and empire ends, and the new one begins, and they do it all over again. That's a lot of detail I just threw at you to paint a picture of how the typical big cycle transpires. Of course, not all of them transpire exactly this way, but most largely do. BRIAN SOZZI: Take us through how you came up with it and why did you put this together. RAY DALIO: Well, the study I needed to understand things that were happening, happening to us. I'm a global macro investor. And there are things that are happening in our lifetimes that never happened before, the amount of spending financed by debt, the amount of internal conflict, the rise of great power in the form of challenge-- China to challenge the existing world order, and so on, the alliances with Russia and all of that. And so I needed to study the rise and decline of reserve currency. So I went back 500 years to see the Dutch Gilder and the patterns of the past. It helps me. And then when I did the study, I did a book because I thought it was important to pass along. And then I wanted to make it very clear and digestible. So the animation that you're talking about is very clear and digestible so people can put what's now happening in the perspective of these historical patterns, which helps people think about what's coming next. BRIAN SOZZI: I will bring this more current momentarily, but I do want to ask. How does this type of exercise or this type of research by you help you become a better investor? RAY DALIO: Well, it helps me understand what's likely to come next. You know, like for example, right now, the US is imposing sanctions. Sanctions are-- it's a form of economic warfare, and it has a big implication for the dollar, right? OK, now others are trying to get out of the dollar system. There's the dollar system that now is being changed. India is dealing directly with Russia, and holders of dollar denominated assets don't want to hold those dollar assets if they feel that they're going to be grabbed and so on. So what's happening now has happened many times before. And without that kind of perspective, I wouldn't be able to deal with it. And I learned this in my past because-- well, just quickly, in 1971, I was clerking on the floor of the New York Stock Exchange. And President Nixon gets on, and he says we're not going to give you the gold that the dollar is backed by. And we had a devaluation. It took me by surprise. I worked on-- worked on the floor of the Stock Exchange. I thought it was going to go down a lot. It went up a lot. And that's because I never experienced the currency devaluation. I found the same exact thing when I studied history, same exact announcement took place on March 5, 1933 by Roosevelt and had the same effect. So I understood then how history before me was important. Studying the Great Depression allowed me and Bridgewater to anticipate the 2008 financial crisis. If I didn't study that, what's happening now is very relevant as a guide to-- the past is a guide to what's happening now. BRIAN SOZZI: Let's talk about what is happening now. Is globalization-- and just using this in the context of what you have written here-- is globalization at a point of failure or has it failed? RAY DALIO: As we are approaching a challenging of the world order, in other words, a great power challenging another, there is an increased likelihood of some kind of war. There are five kinds of wars. There's a trade war, a technology war, a geopolitical influence war, a capital war, which we're in the midst of, and then there's a military war. And those things drive countries to be self-sufficient and independent. And as a result, globalization diminishes, and nationalism increases. Yes. BRIAN SOZZI: What does that mean for financial markets? Because by and large, I think a lot of folks would be surprised that stocks are hanging tough, all things considered. RAY DALIO: Well, it's-- yeah, it's not the stock market. Stock market-- so in the book, it takes you through the stock markets during war periods. And so the only thing that matters for stocks are the cash flows. And as you get into the conflict, that's a different story. You begin to see as it progresses those that are affected by the individual events have an effect, for example, tech stocks. But anyway, in answer to your question, how does it affect the markets? It affects the value of money most fundamentally. Like what we're seeing now is that the value of money when you run very large deficits, and you have to spend a lot. You have to spend a lot on social programs. You have to spend a lot on defense. You have to spend a lot on environmental programs and so on. And so when you spend a lot more money than you earn, then you have to print money to make up that difference to make the purchases. And then that devalues money. And so it's like the examples I gave you of the two currency devaluations that you had before. 1971 led to the inflationary period of the 1970s. And so you have the stock market. Yes, the stock market goes up and other things. But cash is trash. And people then begin to learn that the bonds that they're holding have negative returns, and it starts to change the value of money, the value of money, the value of dollars and so on. So money goes into other assets. It produces more of an inflation, and you start to enter a certain type of environment. And the environment that we're in is beginning to be very much like that of the 1970s. BRIAN SOZZI: Can the US be successful over the next, let's say, decade, given where inflation levels are today and given how much debt this country is in fact sitting on? RAY DALIO: Well, there's two ways of dealing with debt. You pay it back in hard money, or you pay it back and soft money. You pay it back in hard money, and you have a problem. You have a depression. So throughout history, whenever that was done, pay it back in hard money, eventually that was abandoned, and you print money that was what '71 was. That was March 1933 was. And so I think that what you have to think about is the value of money. How much money does one have in debt instruments? And do you want to own that as an asset? I think they're bad assets. And so-- and then how do you diversify? And the system also has to deal with what is money. What is money? Is the dollar going to remain the same sort of reserve currency? And then you see the development of alternative monies. We're seeing a variety. I think different types of money will compete with each other in the environment we're in. Maybe it's crypto. Maybe it's gold. Maybe it's other things. Maybe the digital renminbi competes with the US dollar. We're going to come into an environment because everybody thinks that there's-- think about how much money is being stored in debt instruments, those debt assets. Think about how poor of those returns are. So that kind of a shift, I think, is very important. BRIAN SOZZI: Can the dollar stay the world's reserve currency when we are running-- when inflation is at this high current level and likely to remain this way for some time? RAY DALIO: So all currencies have a lot of debt. And so when you look at one relative to the other, there will be a lot of printing. I mean, currency equals debt, and when you hold a currency, you're holding a debt instrument. And so all of those will decline in value relative to other things. Now, will the dollar decline more than other currencies? It's almost certain that we're going to come into this environment. We're in this environment. And there's a shifting of those currencies. So you're going to see more of China's renminbi being used. You're seeing India have a direct link with Russia on the currency. So we're an important change in the currency. But how that is a store of wealth is a different question. So a currency is a medium of exchange and a storehold of wealth. And its storehold of wealth is now a problem, particularly for the dollar. But it's also a problem for other countries. So that's why you have inflation. As money goes into other things and the cost of borrowing is so low relative to the inflation rate, then it encourages the borrowing of money and the sale of money, in other words, not holding financial assets like that. So that's-- yes, I think you're changing the nature of what money is and what the dollar is as a storehold of wealth. BRIAN SOZZI: On a scale of 1 to 10-- and this is the only way I think I can maybe ask this one. But on a scale of 1 to 10, how concerned are you about inflation right now? RAY DALIO: Oh I'm-- I don't know, like an 8 to 10 or something like that. We're beginning a paradigm shift. A paradigm shift is a shift from a mindset, one mindset and positioning of that mindset to another mindset and another positioning of that. So for example, the mindset that we were in was that you have low inflation. And when you're owning bonds, and you're owning cash, or you are operating one way. And you don't worry about that. Companies don't worry about it in their inventories, having larger inventories. Or homeowners don't worry about inflation as much in the purchases of the houses and so on. Once that shift begins, it causes a reinforcing dynamic. It's like everybody is long bonds. We've been in a 40-year bull market in bonds. And so it's been fine to have. And when that shift starts to take place, you see behavioral shifts that reinforce that cycle and the paradigm. So for example, when there is the selling of bonds, it makes it more inflationary in and of itself because the amount of debt that has to be sold is not just the deficit, but also, the amount of debt that's being sold is those bonds. So now interest rates have to rise a lot or the Federal Reserve has got to come in there and buy more. And then you get wages. People make wage settlements and such things. So a paradigm shift is beginning to take place, and that will be also self-reinforcing. And it's taking place in this context of the conflict, which then creates the breakdown of efficient systems. Each country wants to be self-sufficient. It needs to to protect itself. And in being self-sufficient in that way, then you have less efficiencies in the system. And all of that becomes self-reinforcing. So it's all happened before. It's all happened many, many times before. That's covered both in the video and the book. So yeah, I'm concerned about that. BRIAN SOZZI: You're obviously a student of history of all kinds. When you hear folks project that the Federal Reserve might raise interest rates seven times this year and given where inflation is, is what the Federal Reserve likely to do on rates this year push countries from success into failure? Not just the US, but even emerging markets. RAY DALIO: Yeah, it's funny because everybody says, OK, there'll be seven increases or something like that. And that sounds like a lot. But you're taking interest rates up to something like 2%. And that 2%, which starts to squeeze the capital markets, starts to make it more difficult for a holder of equities because the equity when you raise the return on bonds, and you raise the return on cash, and you tighten the money, then that makes other assets less attractive, such as risky assets, particularly long duration assets, like tech stocks and the like. So you produce that squeeze, yes. But that's still only at 2% or a little bit over 2% with an inflation rate, which is considerably higher than that. We've had a 7% inflation rate, and we'll probably settle-- it'll be a 5% ish or something. And so you're still losing that money to inflation. People are. So what you have is enough tightening by the Federal Reserve to deal with inflation adequately is too much tightening for the markets and the economy. So the Fed is going to be in a very difficult place a year from now, as inflation still remains high, and it starts to pinch on both the markets and the economy. BRIAN SOZZI: What can they do? Can they do anything? RAY DALIO: You know, it's like-- here's the problem. If you're borrowing more money than you're lending, and you have a lot of debt, you either are going to pay back in hard money or in soft money. And so it creates a very difficult trade off. So what can you do? Do you spend less money? So the trade off becomes more and more difficult, and that's what brings about a stagflation environment because they tried to navigate between those two undesirables. In other words, they want to contain inflation, but too high of an interest rate that's good enough for inflation causes too much economic environment. So what can they do? No, they're in a position already because of that dynamic, spending more than they're earning, creation of a lot more debt and a lot of other debt, which one man's debts are another man's assets, and the holder of that assets is losing money. Imagine holding a bond now. And look at how much money's in bond funds and cash, OK? Not only in cash, you don't get any return to compensate for the interest rate, and in your bond fund, you get negative returns. And how's that feel? So are you going to continue to hold those bonds in that bond fund? It's a dynamic that they have to deal with that is really beyond their capacity to deal with it. They can't change those fundamentals. BRIAN SOZZI: So is the soft landing just pie in the sky stuff? RAY DALIO: When you say soft landing, I-- there's no going to be-- yeah, I don't-- it's pie in the sky stuff. I think that most likely what we're going to have is a period of stagflation. And then you have to understand how to build a portfolio that's balanced for that kind of an environment. BRIAN SOZZI: Where-- the topic du jour today or right now is this inverted yield curve. Does that-- are we making too much as that being a predictor to future recessions? RAY DALIO: Not too much, no. It changes-- there's a whole relationship between cash, bond yields, and equity returns. So every investment is an exchange of a lump sum payment for a future cash flow. And so the cost of money is a consideration based relative to the return on money. And so when we look at that return, when we say I can hold cash, or I can hold a bond, that changes the inclination to hold cash. But also, one has to look at the return-- expected return on equities. In other words, one calculates the present value of future cash flows. You estimate what are those earnings going to be in the future and what are they worth today. And so bond-- stocks are now having expected returns, which are not very much more than bonds, which would be not very much more than cash. So as that happens-- so that why should I own equities farther out and have the volatility of equities, so that shift in the curve, in other words, the relationship between cash, bonds, and then the relationship between bonds and equities and the relationship for corporations between the rates at which they borrow at and the rates at which they can earn money at have a pervasive effect on the economy and the markets. So no, it's important to take a look at that relationship, that yield curve structure that way. But you should go beyond that and include the returns of other assets. What can you do in the way of generating returns relative to the costs of money, the relative attractiveness of those instruments? BRIAN SOZZI: Last one. I know you're a very busy guy. And I want to leave people thinking a little more about this. Tying back to your posting on YouTube. Does redistribution of wealth-- does that help solve inflation? Does it help keep countries moving from success to failure? RAY DALIO: You have to have an economy in which the people believe that you have a fair system, and you have to have productivity. So I would say the most important thing is the redistribution of opportunity to make people productive and to eliminate the internal conflict or to reduce the internal conflict, which can be so disruptive. When you see large wealth gaps, and at the same time, you see economic problems, you have a lot of internal conflict. And that internal conflict is bad economically, and it's bad socially. So yes, I think-- but it's not just the wealth gap. It is the productivity level that results. So yeah, the wealth gap is a problem. The opportunity gap is a problem. The productivity that allows-- and productivity can be measured in what you earn relative to what you spend. So yes, all of that gap is an issue. And it's certainly going to be a political issue. So when we talk about markets and the economy and all of these things, we have to realize, for example, that there's a great internal politics, populism of the left and populism of the right. And the polarity is becoming greater. It's entirely possible that neither side accepts losing the 2024 elections, in other words that we lose that-- well, the democracy in a sense, you could find ourselves in a situation where the rules no longer apply because of that type of internal conflict. Internal conflict will have a big effect. BRIAN SOZZI: We'll leave it there. I know it's very rare to get this much amount of time. We greatly appreciate you coming back on Yahoo Finance. Ray Dalio, always good to see you. Stay safe. We'll talk to you soon. RAY DALIO: Thank you. [MUSIC PLAYING]