In recent years Ray Dalio, head of the Bridgewater hedge fund, has penned many high-minded, and hefty, reports on monetary policy, markets and macro economics.
This week, however, he swerved: Mr Dalio published a 61-page report about political populism on the Bridgewater website. While it marks a novel departure for the $100bn-odd fund, Mr Dalio clearly considers the shift in focus to be overdue.
“Over the next year . . . populism’s role in shaping economic conditions will probably be more powerful than classic monetary and fiscal policies,” he declared, warning that “ populism is not well understood because over the past several decades it has been infrequent in emerging countries, and virtually non-existent in developed countries.”
What should investors make of this admission? First, and most obviously, Mr Dalio’s note highlights a bigger trend: financiers of all stripes are belatedly (re) discovering that economic and quantitative analysis alone cannot explain the world.
This point has long been obvious to anyone with a liberal arts education. But a decade ago, say, most financiers considered “political risk” to be something that only infected the emerging markets world. So in the aftermath of the shocking results from last year’s popular votes in the US, UK and Italy, investment banks are scrambling to update their models. In recent weeks, for example, analysts at Citigroup have released a new framework for evaluating European equities with an explicit calculation for political risk.
Asset managers, for their part, now face pressure to show their clients that they can measure this political risk in a coherent manner - and trade it. Thus Bridgewater, the world’s largest hedge fund, has decided that modern populism has nine defining traits, such as “nationalism,” “militarism”, and “greater attempts to influence or control the media”.
Armed with this definition, it calculated the proportion of electoral votes captured by populist candidates in the developed world over the last century. This shows that populism garnered 35 per cent of developed world votes last year - the highest proportion since 1934 when it hit 40 per cent.
That highlights a second key point: as financiers create these charts on political risk, the echoes from the 1930s look increasingly striking. This is not a novel theme. After the 2008 crisis many economists devised charts showing the parallels between the modern era and interwar years, in terms of national debt levels, bank leverage, stock market bubbles and monetary policy.
One of my favourite of these is a graph created by the economists Ariell Reshef and Thomas Philippon that shows how the ratio of banker pay to non-banker pay last decade was an uncanny echo of that seen 90 years ago.
But the Dalio chart suggests the back-to-the-future parallels have moved from economics and finance to politics too. For what is really striking about the chart is not the fact that populism captured 35 per cent of votes last year, but that this surged from about 10 per cent of voting at the start of the decade - a speed of increase last seen in the charts around 1934.
This sounds alarming. However, there is a third key point - and caveat - to grasp: the subtle structural details of populism matter, too. This is not because populists hail from different parts of the “right” or “left” political spectrum. The more important issue to watch is how a country’s political ecosystem reacts to populism.
Mr Dalio’s analysis of history suggests that political systems can sometimes bend in the face of populism to accommodate and soften it, since on occasion “opposing forces can coexist to make progress”. This happened with President Franklin D Roosevelt in America. But in other cases, populism sparks all-out conflict, leading to an authoritarian and aggressive trajectory, such as that seen in 1930s Italy, Germany and Japan.
Bridgewater, for its part, refuses to make any hard prediction about what will happen to the developed world now. All it does is point out that today’s populism is less extreme than the 1930s variety.
But as investors try to make sense of the dramas unfolding in Washington around President Trump’s healthcare bill - never mind the coming elections in France and Germany - they should keep those three key points in mind. And fervently pray that we do not see any more replays of history.
Bridgewater’s historical calculations have a break in the chart starting in the mid-to-late 1930s because the electoral data series collapsed. Democracy was unravelling; war was about to intervene.
