Understanding and navigating the long-term debt cycle

Transcript

Jake Miller One thing people do in a portfolio is they assume static correlation between stocks and bonds. That works when growth is a dominant factor.

Joe Lonsdale The stocks go up, and the bonds are down, and vice versa.

Jake Miller But not in the world where we're dominated by inflation and Fed action because both of those assets are long-term in nature. And so they're going to be discounted by higher and higher rates driving today's price down. And this was the 1970s. In the 1970s stocks and bonds moved basically perfectly correlated. And so you have a moment where it's much more necessary if you're going to have a healthy portfolio to think about what can I add that is actually different.

Joe Lonsdale Where is this go? Do we just get into an emerging market-like debt spiral and interest rates go way up and there's massive inflation, they print lots of money and gold goes up? I mean, this is like the silly Gold Bug argument we've been hearing for 20 years. Is it finally going to happen or what? What's going on here?

Jake Miller Yeah, so this is a prototypical long-term debt cycle. We talk about this a lot at Bridgewater. There's a short-term cycle usually last three, five, seven years and there's a long-term cycle which lasts much longer as at the beginning of the cycle, debt levels are low and so it's easy to add interest to add debt, interest rates can climb, you can still want to add debt.

Joe Lonsdale So what's that longer-term cycle? Over the years you're talking about?

Jake Miller Takes about 30 or 40 years.

Joe Lonsdale So, from the early 1980s, we had very high rates.

Jake Miller And now we've been declining, and now we're at the bottom.

Joe Lonsdale 2020 was like the bottom, basically almost 0% for a long time.

Jake Miller Of yields, but we're still dealing with basically the the hangover effects of that. And so the government replaced private spending in 2020. That's in large part why the economy kept growing despite the contraction in consumer spending with COVID. The government kept spending. We're now getting to a place where, you know, as you correctly mentioned, that debt service becomes a huge part of the deficit, and the Fed can either raise rates and increase its own, increase the government's own spending on that each year, or cut rates and risk running inflation, which will drive that up even further. So it's pretty lose-lose, you know, ways of getting out of it would be a significant restructuring of how we spend. But as you noted, it seems unlikely with our political climate.

Joe Lonsdale We either need the political willpower to restructure how we spend or a crisis. Jake Miller Or a crisis.

Joe Lonsdale It feels like we're on this like path, and the path keeps getting narrower and narrower and narrower, and we've, like, slipped off towards the inflation side, and then we climb back on, but then we're going to slip off their side.

Jake Miller Yeah, I'm not a golfer, but I usually describe it as putting on a ridge. Which I hear is hard, right? You're trying to trying to walk, the Goldilocks path. And yet, speaking of American optimism, I think that's the only way you can describe a really positive path out of this, which I think we'll need budget cuts.

Joe Lonsdale Well, there's other ways you could do it, too. You know, AI could just solve everything, Jake. We can just pray to the AI gods and then put our heads in the sand. This is apparently what a lot of my tech friends are doing.

Jake Miller But unless AI spends money, it's not going to improve the deficit.

Joe Lonsdale You never know.

Jake Miller You never know. It could seem pretty. It could already be spending money.

Joe Lonsdale Some Pretty clever agents out there.

Jake Miller Yeah.

Joe Lonsdale So, but AI aside, you either need to restructure spending completely which actually I don't think it's that hard substantively. Yeah. I can make a plan for how we're going to only spend 3 trillion here and...

Jake Miller Deliver the same quality result.

Joe Lonsdale Deliver the same quality services by having competence and accountability. But assuming that these guys can't get their act together in D.C., then there's going to be a crisis instead. What does the crisis look like?

Jake Miller So my guess is, and this is just a guess, and he lives by the crystal ball will eat glass, but that it looks more like a slow bleedout than one sort of imminent moment. And, of course, there will be shocks. But I think what it looks like is for a protracted period, 12, 15 plus years, rates are higher than they would otherwise be because there's this big gap in demand for bonds and exogenous demands, similar to your example of that housing development is because the government is spending too much and not matching that to income streams for years and years, we have just elevated bond levels, exogenously, that's going to really hurt the real economy. Yeah, it might not happen all at once. It might, but I think it looks more like it’s just the higher costs...

Joe Lonsdale Almost 5% already on the ten year long run is already probably impacting things very negatively. Jake Miller I mean, no one has an incentive to refinance. It is very hard if you got a mortgage any time the last 15 years to think about moving right now. And housing activity is a major driver of economic growth. Joe Lonsdale I guess some people would tell me, well, Joe, these are normal rates. If you go back in time like, you know, you know, 20, 30, 50, 60 years, these are normal rates now. But I guess the question, do we blow through them and go to higher end? But you don't think there's long... You think there's near-term crises but you think this is a longer-term is a ten year thing? Jake Miller I think this is a longer-term thing. There will be bumps in the road for sure, and we'll probably have more, you know, bank issues that will be symptoms of the disease. But I think the disease is much more long-term in nature.