• John Prior

What will now be considered a 'Store of Value'​

Updated: Apr 23, 2020

Last Thursday, Bridgewater founder Ray Dalio, the world’s most successful hedge fund manager in terms of total profits generated, gave an interview to Bloomberg in which he gave his thoughts on markets and assets in a post coronavirus world. As I listened to the interview, it struck me that there was a recurring theme in the message he was trying hammer home, again and again, which resonated with our own views. The interview is too long to reproduce in full, but below is a list of quotes (in italics) that I believe are the most instructive. Emphasis added is mine. I have tidied up the language to be most suitable to a written format and added my own comments and interpretations.

There’s been a heck a hole in income and a hole in balance sheets and then there’s the capacity of central banks and governments to fill in those holes. Governments produce money and credit out of thin air, and they can fill in those holes and so this is a moment which is very analogous to announcements that have happened in the past. March 5th (1933) I think it was that President Roosevelt announced that there would be the printing of money and credit and there would be a severing of the relationship with gold so that they could print money and credit and create credit and to fill in those holes and that was the exact bottom of the economy in March 1933 and the exact bottom of the markets. Similar things have happened throughout history.”

In a fiat money system, central banks can literally create infinite quantities of money out of thin air which they can swap for debt securities that the market no longer wants or can afford to carry. The analogy he makes is with the market low in 1933 (when the reflationary policies began) rather than the initial fall in the market in 1929 which many are overlaying on the recent fall.

“There are two dimensions to that, you can't grow you can't raise production you can’t raise real wealth by producing money and credit you could just fill in the debt holes”

Printing money doesn’t generate real wealth, but it is one way a dealing with losses that have already occurred. The other way is by mass defaults which has other implications.

“It'll be in a total new world order; the world won't resemble the world that we’re used to; it’s going to change in various ways. It’s a big hole, it’s not an unsustainable hole because the capacity of producing money and credit is unlimited. It means that we have to look at what is the value of money and credit in that new world? What is the value of money and credit? What is a store hold of wealth? You just can’t produce it (money and credit) without it having an effect on its value. Production will adapt and we’ll get past it, but how wealth will change will be very, very big.”

There are two sides to the debt, there is the hit to the asset values themselves and there is a hit to the currencies in which the assets are denominated from the policy response. This can’t repair asset values, but it can impact asset prices.

Q: In your opinion, is what we’ve seen thus far in the way of fiscal stimulus from the Federal Government and monetary stimulus from the Federal Reserve appropriate? Are both of those organs of the US government doing what they should be doing and if they're not doing quite enough yet what else should they be doing?

A: Yes, there’s no choice”

This brought to mind the following quote from “Lords of Finance – 1929, The Great Depression and the Bankers who Broke the World” by Liaquat Ahamed about Rudolf Von Havenstein, Head of the Reichsbank in the Weimar Republic. It has been used presciently by Luke Groman of FFTT in recent times.

“Von Havenstein faced a real dilemma. Were he to refuse to print the money necessary to finance the deficit, he risked causing a sharp rise in interest rates as the government scrambled to borrow from every source. The mass unemployment that would ensue, he believed, would bring on a domestic economic and political crisis, which in Germany’s current fragile state might precipitate a real political convulsion. As the prominent Hamburg banker Max Warburg, a member of the Reichsbank’s board of directors, put it, the dilemma was ‘whether one wished to stop the inflation and trigger the revolution,’ or continue to print money. Loyal servant of the state that he was, Von Havenstein had no wish to destroy the last vestiges of the old order.”

My point here is not that we are set to repeat the experience of the hyperinflationary collapse of the Weimar Republic. However, the US government and governments around the world are going to have to run massive deficits as far as the eye can see. There are not enough buyers for these bonds from the private sector and hence unless the central bank prints the money to directly finance their respective Treasury departments, the government will crowd out the private sector, yields will rise in a fashion that already weak and massively overindebted economies can’t bear. The central banks have no choice. This has implications.

“We have to deal with the monetary inflation, and I think in the early stages of this you’re going to see it reflected in asset prices, to some extent in gold and to some extent into stocks and other things. It’ll be a different kind of world, a very selective world but pay attention to the value of money, what is a store hold of wealth? I think we’ll be in an environment where that’ll be a very important issue.”

“Q: Is it surprising for you Ray, to see global equity markets enter what amounts to a new bull market while we’re still in the middle of one of the worst health economic and financial crises in modern history?

A: No not at all.”

“It’s a reflation in which the value of money will go down and the value of other things that are of a certain nature, certain types of stocks, certain types of other financial assets in certain places in the world will go up.”

It may be both intellectually and ethically offensive to many, the fact that stocks can go up (at least in domestic currency terms) when the population at large is suffering, but it is the reality.

“I believe that when you look at bonds and debt, a bond is a promise to deliver currency so when you’re holding a bond that gives you no interest rate or a negative interest rate and they’re producing a lot of currency and you’re going to receive that, why would you hold that bond? This period, like the 1930-1945 period, is a period in which I think you’d be pretty crazy own bonds. A debt in a fiat currency is a promise to receive currency and it’s pretty clear they’re going to make a lot of currency, so I think that changes the appeal of bonds.

“Why in the world would you want all the bonds? That has a big effect when you start to think about how much wealth is in bonds and where is that wealth going to go and how is that going to work and how are they going to control it. What is a good store hold of wealth when we're all holding all of these debt assets and how will that play out? That’ll be an important consideration that has to do with store hold of wealth. When I think of store hold of wealth I think what are the stable store hold of wealth in the form of stocks and other kinds of debt I want those that have strong balance sheets stable incomes that will perform well in any kind of an environment.”

No one in history has made more money out of owning bonds than Ray Dalio. In fact, his fabled risk parity strategy was based on being leveraged long bonds, to increase their risk to be in line with stocks. He just said, in the middle of the biggest equity crisis in living memory that you would be crazy to own the one asset class that one historically runs to in times of crisis and that were the cornerstone of his success. Just let that sink in. And remember, “a bond is a promise to deliver currency”, therefore the same argument applies to cash. The implications of this cannot be overstated.

“History is shown that central banks have bought stocks, central banks have done anything, they will do practically anything and buy practically anything in order to save the system. You ask what” systemically important and they’ll probably buy it and therefore you won’t have a regular market, and then you as an investor get to make the choice of what do you own.”

1. Practically anything! 2. This isn’t a real market because the price of everything is what the central bank wants it to be so invest accordingly.

There is rage on my twitter feed about the way the authorities are acting to bail out the system, create moral hazard, etc. And I get that 100%. But that doesn’t mean it is not going to happen. The economy is in a horrible place, is likely to get a lot worse before it gets better and be changed forever. But that is only one piece of the puzzle. The message, from this interview at least, a message that comes across over and over again – is that what we consider a “store of value” is in the early innings of being changed forever. This implications of this will be with us long after the coronavirus has been consigned to the history books.

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