#writing - Unsustainable reliance on foreign capital - Unsustainable dependence on foreign manufacturing - These are artifacts of the post-WWII economic order where the US created trade arrangements that were in favor of foreign countries to keep those countries from aligning with Russia - Now that Russia is no longer a threat (confirmed with Ukraine) the US imperative changes - The dependence on foreign capital and goods puts the US in a weakened position that no longer serves its national interest (COVID, hollowing out of middle class, etc) --- **April 28, 2025** I usually sit down to write this letter on Saturday or Sunday and then edit and publish it on Monday morning. My aim is to make connections between current events which can be transitory and concepts, trends, and practices that are longer lasting. The markets provide plenty of raw material for current events and I usually have a few things that I have read, experienced, or talked to someone about during the week that I end up connected to what is happening in the markets. This week I was accidentally drawn to three different pieces of writing that come from people who all worked together at one point in time. I didn't realize this until Sunday afternoon, which prompted me to reflect on how blessed the average investor today. They enjoy a wealth of resources that was only available to professionals less than a decade ago. This week we are looking at the current views of Bridgewater, their founder, and former member of their Investment Committee. I remember a time when my firm invested in Bridgewater's Pure Alpha fund and one of the main attractions, besides the alpha, was access to their Daily Observations which proved to be priceless during the GFC. You don't have to be an LP to access some of the smartest brains in finance anymore, you can jump on X, LinkedIn, or Substack and hear their views firsthand. While this access is great, it requires careful work to derive value from it. Everyone has a different niche and style that takes time to get acquainted with and learn how to work with. It is the same challenge that any team faces when developing team dynamics. When reading the views of others you must avoid the trap of taking everything at face value, especially in the markets. We are all unique and have highly nuanced views of the same reality and by seeing the interconnectedness of these different views we can home in on what is really going on in the markets. We'll start with a Connecting the Dots email from Bridgewater: >To state the obvious: we are now facing a radically different economic and market environment that threatens the existing world order and monetary system. They don't mince words by presenting today's environment as a threat to the existing world order and they go on to describe three ways in which the world is changing. First, we have entered a new geopolitical and macroeconomic paradigm. This resonates with what we have said about [[CHG Issue 185 This is what the end of Keynesianism looks like|the end of Keynesianism]] and what George Friedman has said about the US's desire to decouple from an outdated global economic system that no longer serves its interests. The Bridgewater folks label this new environment as "mercantilist" which contrasts nicely with globalization but may overlook the social and political dynamics that are also at play. Globalization was the rule that grew out of WWII as the US invested in its allies either directly or through favorable trade arrangements to establish an economic front during the Cold War. These policies resulted in all sorts of social and economic imbalances that have become increasingly costly without offsetting benefits since the Cold War ended long ago and Russia is not the power it once was. These imbalances have created the current set of [[CHG Issue 186 Be Dumb|imperatives for China and the US]] which has [turned the US focus from Europe to Asia.](https://www.cfr.org/project/us-pivot-asia-and-american-grand-strategy) Luckily these imperatives align in a way that creates a path forward to manage this change in what Dalio calls a "Beautiful Rebalancing." Each country has its own domestic issues to consider and tools to manage them effectively but how those domestic actions impact the broader world is where things get more challenging. Dalio himself took to [LinkedIn last week](https://www.linkedin.com/pulse/us-china-beautiful-rebalancing-ray-dalio-bms2e) to describe the current dynamic as: 1. Americans and others buy inexpensive manufactured goods from China that are financed by the US borrowing from China 2. The US has lost its ability to manufacture effectively which has led to the plight of the bottom 60% and has created a dangerous dependence on Chinese manufactured goods 3. China and others have developed an unhealthy dependence on returns on their US assets He went on to explain how 1) the US needs to lower its deficit while China needs to lower its surplus, 2) the US needs to increase manufacturing while China needs to reduce manufacturing, and 3) the US needs to decrease consumption while China needs to increase it. These are nicely aligned and can be managed effectively however the alignment ends where both countries need to lower their debt burdens. Which leads us to Bob Elliott's [thread on X](https://x.com/BobEUnlimited/status/1914994473735438411) where he succinctly describes how the US has the luxury to prioritize domestic conditions because its debts are denominated in a currency that it can print. Downward pressure on the dollar will put upward pressure on the Yuan which may provide China room to lower its trade surplus, while boosting domestic consumption, and reducing manufacturing and debt. However, it could also put pressure on the Chinese economy by tightening financial conditions and increasing unemployment which is a risk Xi cannot afford to take. It is interesting to note the distance between Bob Elliott and the Bridgewater folks on the idea of the Fed's flexibility. The Bridgewater folks assume the Fed will be constrained in lowering rates because of inflation, whereas Bob says the Fed will ease because it does not need to worry about the dollar. Both can be true while operating at different wavelengths. We have seen the end of the secular bond bull market and embarked on a new secular trend higher, which underpins Bridgewater's view of the Fed's reduced ability to lower rates, but at the same time we are experiencing a Balance of Payments crisis of sorts in the short-term which is the framing Bob Elliott approached this problem from. He focused on the dollar as the most likely near-term release valve whereas the Bridgewater folks focused on inflation restraining the Fed in the long-term. ![[Pasted image 20250428082328.png]] This tension will naturally play out in the shape of the yield curve which has steepened recently but Bridgewater's concerns will only be realized when we discover the floor for Fed funds in the current easing cycle. The reluctance of the Fed to lower rates today stems from their concerns about the tariffs’ impact on inflation, but that will take time to fully realize. ![[Pasted image 20250428082930.png]] The second change that Bridgewater describes is the challenge to modern investment portfolios which are heavily weighted towards US assets. The paradigm that led to this asset allocation relied on strong growth, low inflation, and a central bank that could lower rates into problems and as we have already seen all of these are being called into question today. We have already covered this topic with a focus on the bond market in [[CHG Issue 163 Reframing the Bond Market|Issue #163]] where we showed a handy chart that overlaid the development of modern portfolio theory with long-term interest rates. Long-term interest rates peaked in the late 1980s as capital started flowing into the US which gave birth to modern portfolio construction orthodoxy and its bannerman the 60/40 portfolio.  Now that capital flows are reversing it calls into question everything that has underpinned how we have built portfolios since the 1990s. ![[Pasted image 20250428090030.png]] The question before the equity markets today is whether this is a change in trend or just another pullback in the long-term trend. Most seem to agree that it is the latter, and this would align with the change in secular trend that we have already seen in the bond market. Big secular changes like this typically occur across markets and given the magnitude and duration of the equity trend combined with the change already realized in bonds, equity investors should have been on high alert for a secular change. ![[Pasted image 20250428090729.png]] The dollar depreciated significantly heading into the 1990s when the capital flows into the US really took off and since that time has mostly remained within a well-balanced range. This stability was attractive and necessary for those flows and allowed imbalances to build; however, the imbalances themselves now present a threat to the nearly four decades of dollar stability. Over the past decade that range narrowed further and after the US exceptionalism narrative and higher rates pressured the dollar higher over the past four years the dollar has re-entered the prior decade's range and it now toying with the July 2023 low. If Bob Elliott and the Bridgewater team are correct the dollar will retest the 2018 low and potentially break out lower. This could occur amidst Dalio's "Beautiful Rebalancing" between China and the US. ![[Pasted image 20250428092459.png]] Shifting focus back to the present, the markets have just been awakened to the potential of this new reality and have initially repriced. The S&P traded down to the 2022 high and the DXY has traded down to the recent range low. After a precipitous drop the S&P came into a short-term balance and has broken out to the upside. The initial reflexive response of stocks down, gold up, dollar down has built up excess positions that need to be worked off and the easing of the US's position of tariffs provided the catalyst for that. It would not be surprising to see the dollar rally off support as well in the near term. ![[Pasted image 20250428093810.png]] The third change that the Bridgewater team identified fits nicely into the short-term market set up. Prior to this recent downturn the focus was on the generational technological disruption that AI represents. If we can sustain this upside breakout, we can easily re-attach to the AI narrative driving markets higher despite the significantly increased odds of secular change in trend. This makes for a great example of how difficult it can be for investors during times of change. There are multiple cross currents operating at different wavelengths which can disguise the primary movement. Like the internet boom of the late 1990s we could see 15 years of equity underperformance that would come along with a secular change in trend while we make exponential technological progress. AI is sure to have its largest impact on productivity, like the internet, but how that impact is felt in the markets is no clearer today than it was in 1998.