On January 21, the billionaire founder of the hedge fund “Bridgewater Associates” Ray Dalio, in an interview on the sidelines of the World Economic Forum in Davos, Switzerland said that in the current financial and economic environment cash is trash.
Ray Dalio is one of the greatest hedge fund managers of all time, born in 1949, he started his career in finance on the floor of the New York Stock Exchange as a commodity futures trader, immediately after completing his education. Then, in 1975 he founded the investment management firm “Bridgewater Associates” out of his apartment, it now manages about $160 billion. He appeared on the annual Time 100 list of the 100 most influential people in the world, and with an estimated net worth of $18.7 billion (Forbes 2019) is one of the richest men on earth.
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What is Cash?
When we talk about cash we refer mainly to currency or coins, and sometimes also to cash equivalents, meaning all those assets that can be easily converted into cash immediately, or near immediately, like for example U.S. Government Treasury bills, certificates of deposit, and other money market instruments.
However, Dalio in his interview refers mainly to currency, which has various characteristics and attributes that are changed in history, especially in the last 50 years. In fact, we are now in a Fiat currency environment, where the currency has not an intrinsic value and has been established as money by the government.
Fiat money has value only because the government of a certain country maintains it, or because parties that engage in exchange agree on its value.
In this kind of environment, a central bank can introduce new money into the economy by purchasing financial assets or by lending money to financial institutions, then the system of commercial banks redeploys this base money into the economy by credit creation.
In modern economies, the supply of new currency is composed for the smallest part by the supply of physical currency, it happens for the most part with digital currency.
However, this has not always been the case, in fact, before the Nixon shock of 1971, which determined the end of The Bretton Woods system, the value of the U.S. dollar was pegged to the value of gold, it was fixed at $35 to one troy ounce of gold. Then, other currencies were pegged to the U.S. dollar at fixed rates.
This system was based on the promise made by the U.S. to redeem dollars in gold to other central banks, while eventual trade imbalances were collected by gold reserve exchanges or by loans from the International Monetary Fund (IMF).
It all ended when the U.S. President Richard Nixon canceled the direct convertibility of the United States dollar to gold. This cancellation gave birth to the use of fiat money globally, with freely floating exchange rates between most currencies.
One major consequence of the adoption of fiat currency is the possibility of Central Banks to heavily influence the money supply, which has led, almost everywhere to huge increases in the supply of paper money, which causes inflation.
Inflation per se is not a negative phenomenon, in fact, economists believe that a certain degree of inflation can be beneficial to the economy, in fact in the European Monetary System, monetary institutions have set the goal to keep inflation around the 2% level.
A slowly increasing price level can help to sustain consumer demand and consumption.
However, it can become very negative when it turns into hyperinflation, which quickly erodes the real value of the local currency, and can be caused by excessive growth of the money supply.
The task of keeping a low rate of inflation and preventing it from going out of control is given to monetary authorities (usually Central Banks), that have the power to control monetary policy through various channels, like interest rates or open market operations.
Inflation with a fiat money system can become a problem, because the currency is not backed by some physical assets, and therefore monetary institutions could theoretically “print” infinite amounts of money.
The reason why Dalio says that “cash is trash” is mainly because this is what Central Banks are doing, they are increasing money supply as never before.
As you can see from the image above, which represents what $1 invested in 1802 in Gold, Treasury Bills, Bonds, Stocks, or Cash would have had become now, in real returns.
It is visible the point when the Nixon shock occurred, with the U.S. dollar and gold that separated, until then they were behaving almost in the same way, then the dollar started falling vertically, while gold kept going up. The annualized returns are pretty clear, in history cash has been the worst asset class ever, with an annualized loss of 1,4%.
Therefore, what he advises investors to do is to reduce their cash exposure, and therefore to be global and have a well-diversified portfolio that contains, in addition to Stocks, Bonds, and Treasuries, a certain quantity of Gold too. In fact, Gold is an asset that has intrinsic value and therefore should help to protect your portfolio when inflation sets in.
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