Interesting comments from one of the world’s most influential investors, Ray Dalio of Bridgewater (via Zero Hedge):
Be Careful When Betting Against Human Nature
Alliances are shifting in a logical manner. The German-French alliance is breaking down in favor of contributor (higher rated credit) countries aligning against recipient (lower rated credit) countries. Similarly, the terminology to describe who is reasonable and who is unreasonable reflects these parties’ respective interests. Those who don’t have to contribute use terms like “inflexible” and “irresponsible” to describe the contributors’ reluctance to “do enough” to prevent collapse by lending more to recipients who can’t service their existing debts, while those who have to contribute use terms like “inflexible” and “irresponsible” to describe the recipients’ reluctance to “do enough” cutting of their spending and borrowing to service their debts. Students of human nature and deleveragings know that this is to be expected.
Similarly, talk of a fiscal union to resolve these problems has to be looked at in light of the question of whether it is in the interest of fiscally strong contributors to have a fiscal union with fiscally weak recipients in which the majority rules how the money is divided.
For this reason, we think the popular assumption that the Germans and the ECB (which requires agreement of the key factions within it) will come through with the money to make all these debts good should not be taken for granted. Said differently, we think 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 Plan B in place. This “fat tail” event must be considered a significant possibility.
Cullen Roche
Mr. Roche is the Founder of Orcam Financial Group, LLC. Orcam is a financial services firm offering research, private advisory, institutional consulting and educational services.
Follow Me:
Tom Brown on 
Cullen, what do you think of Ray’s statement that this scenario is a “significant possibility”? I mean do you agree or disagree with it? I assume you do not agree otherwise you will not be in equity accumulating mode, and lately you seem to be totting the line that Europe is starting to get it. So if that’s the case then this is the 180 degree opposite of that.
I personally don’t see a Lehman 2.0 as being a high probability event. The thing about Lehman is that it snuck up on everyone. But this “fat tail” event has to be the most forecast event ever in history. If it all comes unraveling it would be one of the most colossal policy blunders ever….
It seeems that policy blunders have already been made– why compound them even more?
But I don’t think it’s a fat tail if the european union splits–2 much end of the world scenarios hype
Business is still business no matter what currency the Europeans use–
??How can a “fat tail” event BE a “fat tail” event if it is the most widely forecast in history?? that seems oxymoronic……… And what is so “fat tail” about it, anyway?? just that we (collectively) don’t want to think about it happening?? Considering that this is a bimodal response, either eurozone unites fiscally, or dissolves………not much in between……….can fat-tail event even be applied?? I’m not a very good statistician, but I don’t think the fat-tail model can be applied to bimodal distribution..
“But this “fat tail” event has to be the most forecast event ever in history.”
If I heard that once I heard it a thousand times between 2005-08 in reference to the housing bubble popping. So I disagree. Perhaps it is the second most but I doubt that as well. I read a lot more commentary along the lines of your reasoning than I read along the lines of Dalio’s, a lot more.
“If it all comes unraveling it would be one of the most colossal policy blunders ever…”
The underlying presumption being that this is a matter within the purview of policy. I think those who share Dalio’s view would argue that this is a matter of terminally faulty construction, with any and all policy responses amounting to little more than rearranging deck chairs on the titanic.
Cullen,
I don’t agree with your assessment of Lehman. How exactly did Lehman sneak up on everyone? Einhorn talked for months (years?) about their balance sheet, and given the Bear Stearns blowup in March, 2008, people were onto the banks in general (with Lehman being a big subject, more so than other banks) for many months before the Lehman collapse in September, about 6 months later. So how again did this sneak up on everyone?
Bob Barker
Bob, love your work on the price is right. Probably my favorite show growing up. Not getting to spin that mega wheel will always be one of my life’s greatest regrets.
Lehman didn’t sneak up on everyone, but it did sneak up on most people.
The point about Lehman, surely, is not that the bank’s problems weren’t widely known or understood but that the overwhelming consensus was that Lehman WOULD NOT BE ALLOWED TO FAIL.
In my view, that is precisely the position, in terms of sentiment, that we are in in the European ‘echo’ crisis. This is self-evidently the case, otherwise the S&P would not be a piddling 6% off its highs.
The collective view, whether expressed or merely assumed, is: “Germany wouldn’t let a nation leave the euro / it’s not in their own interests to allow a break-up / they’ll have to say yes to eurobonds / before a catastrophe the ECB would certainly step in…etc.
Local variations of all these arguments were made in the run-up to Lehman. But Paulson and Bernanke had their own agenda – and it wasn’t to hold up the S&P500. Think Merkel is any more inclined than they were?
Dalio’s funds made a healthy profit in 2008. They did so because he was awake to the probability that, yes, the worst really could happen, and he positioned accordingly.
Germany’s plan is quite straight forward: they’re pushing South Europe towards better spending and balance policies in order to have a more stable and balanced environment for their exports and lending system, and this is also in the interest of the periphery: if you don’t live in Southern Europe you can’t realize the inefficiencies, mismanagement and huge waste of resources we’re into. Even though there’s a risk of EU breakout I think that odds are still good for a (bumpy) roadmap to EU integration.
The market rarely rewards that which makes people feel comfortable. Will Germany become the cynic or the seeker? According to Mr. Volcker, Bridgewater’s analytic tools & modeling are perhaps the best in the world, and Dalio’s comments about these forthcoming engagements in Europe must be weighed & counted all the more. His comments give us all an added edge of understanding.
He’s got a point moreover it is supported by the data we see before us in the way the relatiosnips have morphed in Europe. Germany won’t give the others what the others want and actually the Germans have been pretty consistent on this story.If markets permit the time there could be an incremental exchange of what they want (money) in favour of sovereign control.That’s what the Germans want and given the Germans have the keys to the vault then I wouldn’t bet against them. The issue is how long does such a process take and do the problem economies have enough time work through such a process and that is where Bridgewaters scenario comes into play because it might be the case they don’t.
+1
How is this a black swan or fat tail event. After 19 summits the only fat tail is that NIEN means yes. 9 means no or NIEN or no. Whatever.
It is not a fat tail. It is in the bell. Come Friday the answer will be 9 once again and wall st. better shift the fat tell into the bell where I have it.
Brave strategy to disregard every warning . To tell Germany check! If u don’t monetize our debts we made sure your going down also.
No matter how bad of a position you put yourself in after summit 20 and Bloomberg rumor 1 million no means nien.
I
How stupid is that? Germany is by far to small to bail out the rest of the eurozone banks and nations.
So would the so called ‘experts’ pls. finally stop to discuss if Germany bails out or not? It is not going to happen because it is not feasible.
Ah, and even if it would be feasible, it shouldn’t be done. There are no free lunches.
It’s not a matter of Germany bailing out the rest of Europe. It’s a matter of Europe *coming together*, and Germany is the biggest obstacle to that at present.
Soros, once again, has it dead to rights:
http://www.spiegel.de/international/europe/george-soros-says-germany-must-change-course-on-euro-crisis-a-841061.html#spRedirectedFrom=www
So all those commenting have agreed that Germany will refuse to bail out all the other eurozone banks and nations. So what options does that leave for an endgame? There are only two that I can see. 1) A large country like Spain or Italy will eventually default, or Spanish banks will be allowed to default in a technical restructing, similar to Greece. Or 2) the ECB will be permitted to buy up the sovereign debt of nations like Spain and Italy in vast amounts.
The 3rd possibility which appears unlikely at this point is a genuine move to fiscal union with budgetary autonomy taken away from each nation. Does anyone out there see any other options?
“So what options does that leave for an endgame?”
There will be so much can-kicking between now and the endgame that it is very difficult to predict exactly what that endgame will be. Ultimately, debt will be restructured all across Europe which will crush the current owners and bondholders of the banks (which is the primary reason this hasn’t been done already, the secondary reason being the fiscal union fantasies of the technocrats). Bank stockholders will be wiped out and bond holders will get their hairs’ cut. Banks will ultimately be recapitalized with new owners and we will be able to move on.
Whether that moving on includes the EUR as a functional currency or not (or depression or not; or war or not) depends on how long we run with the current can-kicking strategy.
“The 3rd possibility which appears unlikely at this point is a genuine move to fiscal union with budgetary autonomy taken away from each nation. Does anyone out there see any other options?”
This is obviously the preferred endgame of the nitwit technocrats in charge of the current can-kicking operation. Make things so miserable that Germany caves. Raise your hand if you think the current cabal of knuckle-headed nincompoops who designed this disaster are the ones best suited to orchestrate the complete fiscal amalgamation of the 23 sovereign states that currently share the EUR?
Yeah, that’s what I thought…
+1 Very well stated! Thanks!
well, you know Dalio must be right in assessing risk and then some, because there is a very long article in today’s NY Times arguing that Germany will eventually and inevitably cave–which almost certainly means it won’t. Not to submit to conspiracy theory, but it almost seems like the Times rushed that article out (poorly written and very poorly argued).
I remember that people talked about a lot Lehman fail before it actually happened. And the market did not crash because it did not really believe government will let it happen. So when it actually happened, it still shock people. The same thing now, although people talked a lot about EU break, but actually very few think government will let it happen. The evidence is the market itself, it would not be 1300+ as it is now if people really think EU break would happen.
I’ll add my plus-one to the collapse of the Euro not being a fat tail. It’s entirely predictable.
Even Lehman’s failure and the mortgage crisis was not a black swan type of event, according to the originator of the term (Taleb), in that it was predictable.
THe whole point of black swans or fat tails is that you *can’t* predict them, so you need to build robust structures that can handle the unexpected.
I hope when Monti and Hollande blame Germany for their Ills the people can remind them where the fault lies. The banks and the officials. When another leader in another country has to be relied on in a free economy you’ve done something wrong. This is not Russia moving to free “mafia” markets from communism. This is flat out malinvestments coming home to roost. This not Germany’s fault. Everyone knew the rules. The spend too much death cross was posted all over the cigarette box by the Bundesbank. And they should remind the other countries this weekend who’s problem it is. Lehman Moment. SO WHAT?! It’s not Bernakes, Geitners, or Montis job to tamper or interfer in the market proceedings verdict. Their job was to avoid us getting to this point. Now they must accept the verdict. If they did not want this to occur they should have not gone down this road man years ago.
Why do economies print? They print to paper over a serial strand of errors. Those errors should bear the fruit of the soil they planted. THE AMOUNT OF MONEY SPENT TO SUPPORT A FAILED SYSTEM IS DISGUSTING. FROM OUR BANKS TO THEIRS. THE AMOUNT OF TIME OUR GOVENMENTS AND THEIRS HAVE SPENT IN MEETINGS ON THIS ISSUE SINCE 2008 IS CRIMINAL. We did not elect them to spend all their time with Bankers on how to give money to bankers!!!!!!!!!!!!Imagine…like the the beetles a world where all this backstoping, all this money, and all the time spent which hasn’t helped was spent on education, growth iniatives, education, infrastructure, medical advancement, education technology, assisting citizens, education and ohh did I say edcuation?
Am I the only one who sees how wrong the path they went down is. I said this back in 2009.This is the mother of all moral hazards. Which from everything I read these days has twisted moral hazard around. It’s now a moral should Germany not bail out or Eurobond their neighbors?? Here we are 3 years later at the same place. Not one penny should be spent bailing out or supporting a broken model. The next QE or program should go directly to the citizens other wise I say break out the Guillotine app. One we can all download.
Why would I give more money to my cousin who’s squandered what I’ve given them. What makes them think because I will lose money they have me checked. The sooner I can take there assets or I can make sure I limit my losses today by stopping any further flows to them. I’ll take my cousin and his family being upset with me and the once I realize how cancerous that relationship is the sooner I end it the better my citizens will be.
Americas best qualities is helping others. This is not that. This is helping our banks. Let’s not twist the truth.
If this is poor brinkenmenship by Germany than what is it called by Spain, Greece and Italy to put Germany in this position? The problem is not in why doesn’t Germany bail out Europe. The problem is how we got to a point where everyone needs a bailout when your choices have lead you to insolvency.
Yes..I’m offically on Holiday as of NOW….and as you can tell…I really need a break! To that..I hardly get what I want but at least I got that out before I left. Now I can be free of the frustrations. I tried drugs, alcohal, Yoga, religion and self help books but god made me to care. And I care deeply about my country and the citizens of the world. For that..I always live with a fire that wants to protect people from debt burdens and lower living standards put on them by others. So…I needed to write this more than you needed to read this. It will be lost in the TPC archives in a week and the world will go on in a way that is not always how I want it. Yes, I’m aware of Adderall. I’ll consider that if we get to QE5
Cheers to the TPC readers..and especially Cullen- See you all mid July.
lol, great rant VII, and have a great break! i daresay the world will still be here in one form or another until you return (at least until Dec, 2012!)
rhp
@VII, ha, ha! Have a great European vacation, and let us know what you find out from talking with the European “man in the street”. Should be interesting.
@VII
To gen up on Europe’s DNA while over here, worth reading the last two comments re Napoleonic Wars in http://pragcap.com/a-few-brief-euro-thoughts/comment-page-1#comment-112757. Enjoy it while it lasts!
Europe has survived many brutal conflicts over the millenia. Each conflict saw a deep reduction in the wealth and stature of the ruling class.
I wonder if the last one is far enough behind the ruling class to allow them to think that they can win the next…
I would suggest that the next conflict will not be fought by killing people. But the violent wholesale transfer of assets will be just as severe and shocking.
Technocrats being installed as leaders could be just the warmup.
Just a thought.