Bridgewater Associates founder Ray Dalio: Silicon Valley Bank is the "canary in the coal mine," rate cut could happen within a year

Founder of Bridgewater Associates, Ray Dalio, offered an analysis of the recent Silicon Valley Bank situation, referring to it as the "canary in the coal mine." Dalio described the current period as a classic bursting of a bubble, predicting challenging financial and economic conditions in the next one to two years, with a likelihood of interest rate cuts within a year. He advised investors to maintain diversified investment portfolios to mitigate risks. Source

Classic Bubble Burst

Ray Dalio mentioned that the current event is a very classic bubble burst event in the short-term debt cycle, where the tight monetary policy aimed to curb credit growth and inflation has led to a self-reinforcing debt credit contraction, resulting in a domino effect.

This process continues until central banks create loose money to offset the debt credit contraction, generating more new credit and debt, sowing the seeds for future crises. Eventually, these debt assets and liabilities accumulate to unsustainable levels, and the whole event collapses in debt restructurings and debt monetizations.

According to Dalio's research, such debt cycles occur roughly every 75 years, with each lasting about 25 years.

Dalio mentioned the current situation occurring in risk investments, private equity firms, and commercial real estate companies with negative cash flows. They are unable to withstand the impact of rising interest rates and monetary tightening, ultimately leading to bank runs and closures in Silicon Valley, acting as "canaries in the coal mine" that will trigger chain reactions in the venture capital industry, far beyond expectations.

Note: The "canary in the coal mine" metaphor refers to a leading indicator or early warning concept, derived from the practice of miners using canaries to detect gas leaks in mines due to their extreme sensitivity to toxic gases.

Where Are We Now?

Dalio believes we are in the early stages of this contraction phase, with significant leverage in long-term assets, and more problems will arise after the collapse of Silicon Valley banks. According to his model, there will be:

• Forced asset sales at very low prices, reporting massive losses leading to further loan contractions
• Equity dilution, selling prices significantly below conservative estimates of their future cash flow present value
• Strong companies with synergies acquiring distressed companies due to extremely low acquisition prices
• Credit issues detrimental to the market and economy
• Since the problems pose a threat to the system, the Federal Reserve will eventually implement loose policies, with banking regulators providing money, credit, and guarantees

At this turning point into contraction, it is still too early for the Fed to loosen policies. However, as trade-offs become challenging, Dalio will closely monitor its actions. Looking ahead, problems may arise quickly, eventually leading to protective measures by the Federal Reserve and banking regulators. Therefore, Dalio believes we are approaching a turning point from the strong tightening phase into the short-term credit/debt cycle contraction phase.

Future Issues

When debt is denominated in a country's own currency, debt crises and the resulting debt spread can and will ultimately be controlled by central banks, creating enough money and credit to fill the funding gap. For example, the U.S. guaranteed all depositors against losses this time and indicated it would go beyond to protect others, not only providing more credit but also hinting at similar actions in other situations.

This creates a larger long-term problem where the U.S. central government holds a vast amount of outstanding debt, debt sold exceeds demand, and the central bank is monetizing debt. Controlling the funding problem comes from the central bank printing money and buying debt. With debt assets and liabilities so massive, it is challenging for lenders, i.e., creditors, to maintain sufficiently high real rates while not making them too high for borrowers, i.e., debtors.

When excessive printing fails to provide adequate real returns to creditors, the real big problem arises, forcing them to start selling their debt assets, significantly worsening the supply-demand balance. As the outstanding U.S. debt assets and liabilities are huge and will grow in the future, the supply of government debt is likely to far exceed demand, leading to excessively high real rates in the market and economy, creating more debt and economic pain, ultimately causing the Fed to shift from raising rates and selling debt (QT) to lowering rates and buying debt (QE).

Although the next rate cut and quantitative easing by the Fed are not currently being considered, investors should start taking it seriously as it could happen within a year, with significant implications. Dalio believes it is highly likely to result in a significant devaluation of currency values in the future. Therefore, the financial and economic outlook for the next one or two years may be challenging.

Master's Advice to Investors

While Dalio cannot make any guarantees about the future, he suggests maintaining diversified investment portfolios and tactical allocations. This way, the investment portfolio will not fluctuate with the ups and downs of the situation. This is exactly what Ray Dalio advocated in his previous book "Principles for Dealing with the Changing World Order," emphasizing diversified investment portfolios that can reduce risk without lowering expected returns, which is the current master's idea and recommendation.