Friday, July 20, 2012

Ray Dalio - Disorderly Outcome in Europe "A Significant Possibility"

Ray Dalio and Bridgewater have been among the top performing hedge funds for many years. More importantly, Dalio is probably one of the best minds in understanding and explaining business cycles with a focus on credit. In his most recent letter (courtesy of Zero Hedge), Dalio paints a dour picture of global growth with a strong chance of further weakening as the deleveraging cycle continues to play out. As for Europe:
The unresolved European imbalances and the differences in their impacts on each country have produced widening differences in the self-interests of these countries, which have led to political divergences that have magnified the risks. Unlike a year ago, Germany and France no longer stand in solidarity as backstops behind the euro system, but have been divided in their self-interest by divergent financial conditions which are leading to conflicting rather than unified political orientations. France's deteriorating finances and economy have shifted its self-interest toward alliances with "recipient" (lower credit rated) countries like Italy and Spain and away from "contributor" (higher credit rated) countries like Germany and the Netherlands, leaving Germany more isolated as a guarantor of the risks in the euro system and in its views about how to manage the imbalances. Given these shifts in the alliances between contributor and recipient countries we think that the popular assumption that the Germans and the ECB (which requires agreement of the key factions within it) will come through with money to make all of these debts good should not be taken for granted. Said differently, we think that there are good reasons to doubt that European bank and sovereign deleveragings will be prevented from progressing to the next stage in a disorderly way, without a viable Plan B in place. This fat tail event must be considered a significant possibility.

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