Dalio interprets "When will the bubble burst": Stock market bubble + large wealth gap = huge danger

As U.S. stocks plummet, Ray Dalio discusses the bursting of bubbles again. Ray Dalio, founder of Bridgewater Associates, recently warned that U.S. stocks are currently in a bubble, and extreme wealth concentration is amplifying the market's fragility.

He stated that the bursting of a bubble is not triggered by high valuations, but rather by forced asset sales when investors suddenly need cash to pay off debts or deal with taxes. With the wealthiest 10% of Americans holding nearly 90% of stocks, the risk of such liquidity shocks is increasing.

In an interview with the media on Thursday, Dalio pointed out that while the current situation is not a complete replication of 1929 or 1999, the indicators he tracks show that the U.S. is rapidly approaching the critical point of a bubble. "There is indeed a bubble in the market," he said, "but we have not yet seen it burst. Moreover, the key is that there is still a lot of room for growth before the bubble bursts."

It is worth noting that Dalio is not focused on corporate fundamentals, but rather on the broader market's fragile structure. Under the current extreme wealth inequality, record margin debt, and potential policy shocks like wealth taxes, the dynamics of the bubble are becoming particularly dangerous.

The Trigger for Bubble Bursting is a Liquidity Crisis

In a lengthy post published on the X platform the same day, Dalio elaborated that bubbles do not burst merely because of high valuations. Historically, the real trigger for crashes has been liquidity crises—when investors suddenly need funds to repay debts, pay taxes, or meet other liquidity needs, they are forced to sell assets on a large scale.

He wrote:

Financial wealth is worthless unless converted into cash for spending. This forced selling, rather than poor earnings reports or shifts in sentiment, is the real reason that has driven market crashes throughout history.

The factors contributing to the current market's fragility are accumulating. Margin debt has reached a record $1.2 trillion. California is considering a one-time 5% wealth tax on billionaires, which could trigger large-scale asset liquidations. "Tightening monetary policy is a classic trigger," Dalio said, "but things like wealth taxes could also happen."

K-shaped Economy Amplifies Market Fragility

Dalio emphasized that the current concentration of wealth makes this fragility extremely pronounced. The wealthiest 10% of Americans currently hold nearly 90% of stocks and account for about half of consumer spending. This concentration obscures the deterioration of the lower half of the income ladder, forming what economists widely describe as a "K-shaped economy"—where high-income households soar while everyone else falls further behind.

Mark Zandi, chief economist at Moody's Analytics, recently found that the wealthiest families are driving nearly all consumption growth, while low-income Americans are cutting back under the pressures of tariffs, high borrowing costs, and rent inflation.

Lisa Shalett, chief investment officer at Morgan Stanley Wealth Management, described this inequality as "completely insane," noting that the spending growth rate of wealthy families is six to seven times that of the lowest income group. Even Federal Reserve Chairman Jerome Powell acknowledged this divergence, stating that corporate reports show "the economy is polarized," with high-income consumers continuing to spend while others downgrade their consumption

How to Deal with Bubble Risks?

Despite issuing warnings, Dalio has not advised investors to abandon this round of gains. He stated that bubbles can last much longer than skeptics expect and can bring significant returns before they burst. His advice is that investors need to understand the risks, diversify their investments, and hedge—he specifically mentioned gold, which has reached a historic high this year.

"I want to reiterate that there is still much room for growth before the bubble bursts," he said. But he warned in the article, "Historically, these situations have led to significant conflicts and massive transfers of wealth."

Dalio's warnings and NVIDIA's victories both acknowledge that the market is accelerating in ways that are difficult to explain with traditional models. The AI boom may continue to drive the stock market up, but the bubble mechanisms outlined by Dalio—loose credit, wealth concentration, and vulnerability to liquidity shocks—are also tightening simultaneously.

Here is the full text of Dalio's tweet:

While I remain an active investor and passionate about investing, at this stage of my life, I am also a teacher, striving to impart what I have learned about how reality works and the principles that help me navigate it to others. Having been involved in global macro investing for over 50 years and drawing many lessons from history, naturally, much of what I convey is related to this.

This article aims to explore:

• The important distinction between wealth and money,

• How this distinction drives bubbles and depressions, and

• How this dynamic, accompanied by significant wealth gaps, can potentially burst bubbles, leading to destructive depressions both financially and socially and politically.

Understanding the distinction and relationship between wealth and money is crucial, most importantly: 1) how bubbles form when the scale of financial wealth becomes very large relative to the amount of money; 2) how bubbles burst when the need for money leads people to sell wealth to obtain money.

This very basic and easy-to-understand concept about how things operate is not widely recognized, but it has greatly aided my investing.

Key principles to understand are:

• Financial wealth can be created very easily, but that does not represent its real value;

• Financial wealth is worthless unless it is converted into spendable money;

• Converting financial wealth into spendable money requires selling it (or collecting its returns), which often leads to the bursting of bubbles.

Regarding "financial wealth can be created very easily, but that does not represent its real value," for example, today if a founder of a startup sells shares of the company—assuming a value of $50 million—and values the company at $1 billion, then this seller becomes a billionaire. This is because the company is considered to be worth $1 billion, even though the real funds supporting that wealth figure are far less than $1 billion. Similarly, if a buyer of publicly traded stock purchases a small number of shares from a seller at a certain price, all shares will be valued at that price, thus by valuing all shares at that price, you can determine the total wealth of the company. Of course, the actual value of these companies may not be as high as these valuations suggest, as the value of assets lies only in the price they can be sold for Regarding "financial wealth is essentially worthless unless converted into currency," this is because wealth cannot be directly used for consumption, while currency can.

When the amount of wealth is large relative to the amount of currency, and the holder of the wealth needs to sell the wealth to obtain currency, the third principle applies: "Converting financial wealth into spendable currency requires selling it (or collecting its returns), which often transforms a bubble into a depression."

If you understand this, you will grasp how bubbles are formed and how they burst into depressions, which will help you predict and respond to bubbles and depressions.

It is also important to understand that while both currency and credit can be used to buy things, a) currency settles transactions, while credit creates debt, requiring future currency to settle transactions; b) credit is easily created, while currency can only be created by central banks. While people may think that currency is needed to buy things, this is not entirely correct, as people can buy things with credit, which generates debt that needs to be repaid. This is often a component of bubbles.

Now, let’s look at an example.

Although all bubbles and the mechanisms of their bursts throughout history are essentially the same, I will use the bubble of 1927-1929 and the burst of that bubble from 1929-1933 as an example. If you think about how the bubble of the late 1920s, the burst from 1929-1933, and the economic depression occurred from a mechanistic perspective, as well as the measures taken by President Roosevelt in March 1933 to mitigate the burst, you will understand how the principles I just described come into play.

What funds drove the stock market's surge, ultimately forming the bubble? And where did the formation of the bubble originate? Common sense tells us that if the money supply is limited and everything must be purchased with currency, then buying anything means reallocating funds from other things. Due to sell-offs, the prices of the reallocated goods may fall, while the prices of the purchased goods may rise. However, at that time (for example, in the late 1920s) and now, the surge in the stock market was driven not by currency, but by credit. Credit can be created without currency and is used to purchase stocks and other assets that constitute the bubble. The mechanism at that time (also the most classic mechanism) was: people created and borrowed credit to buy stocks, thereby generating debt that had to be repaid. When the funds needed to repay the debt exceeded the funds generated by the stocks, financial assets had to be sold off, leading to price declines. The process of bubble formation, in turn, led to the bubble's burst.

The general principles of these dynamic factors driving bubbles and their bursts are:

When the purchase of financial assets primarily relies on credit growth, leading to an increase in wealth relative to the amount of currency (i.e., wealth far exceeds currency), a bubble forms; and when wealth needs to be sold to obtain funds, a bubble burst occurs. For example, during the period from 1929 to 1933, stocks and other assets had to be sold to repay the debts incurred to purchase them, thus reversing the mechanism of the bubble. Naturally, the more borrowing and stock purchases there were, the better the stock performance, and the more people wanted to buy. These buyers could purchase stocks without selling anything, as they could buy with credit With the increase in credit purchases, credit tightening, and rising interest rates, this is due both to strong borrowing demand and the Federal Reserve allowing interest rates to rise (i.e., tightening monetary policy). When borrowing needs to be repaid, stocks must be sold to raise funds to pay off debts, leading to price declines, debt defaults, decreased collateral values, reduced credit supply, and a bubble transforming into a self-reinforcing depression, followed by the Great Depression.

To explore how this dynamic change, accompanied by a significant wealth gap, can burst the bubble and lead to a collapse that could cause severe damage in social, political, and financial realms, I analyzed the chart below. This chart shows the wealth/currency gap of the past and present, as well as the ratio of total stock value to total currency value.

The next two charts illustrate how this reading predicts nominal and real returns over the next 10 years. These charts speak for themselves.

When I hear people trying to assess whether a stock or stock market is in a bubble by judging whether a company will ultimately become profitable enough over time to provide sufficient returns for the current price, I think they do not understand the dynamics of bubbles. While how much an investment will ultimately earn is certainly important, it is not the main reason for a bubble's burst. A bubble does not burst because people wake up one morning and conclude that there will not be enough income and profits in the future to justify the price. After all, whether sufficient income and profits can be generated to support a good investment return often takes many years, even decades, to determine. The principle to keep in mind is:

A bubble bursts because the funds flowing into the asset begin to dry up, and holders of stocks and/or other wealth assets need to sell them for some purpose (most commonly to pay off debts) to obtain currency.

What usually happens next?

After a bubble bursts, when there is not enough currency and credit to meet the demands of financial asset holders, the market and economy will decline, and internal social and political turmoil will often intensify. This is especially true if there is a significant wealth gap, as the wealth gap exacerbates the divide and anger between the rich/right and the poor/left. In the case we are examining from 1927-33, this dynamic led to the Great Depression, which triggered significant internal conflict, particularly between the rich/right and the poor/left. This dynamic led to President Hoover being ousted and Roosevelt being elected president.

Naturally, when a bubble bursts and the market and economy decline, these situations lead to significant political changes, massive deficits, and substantial debt monetization. In the example from 1927-33, the market and economic decline occurred from 1929-32, with political changes happening in 1932, leading to a massive budget deficit for President Roosevelt's government in 1933 His central bank printed a large amount of money, leading to currency devaluation (for example, relative to gold). This method of currency devaluation alleviated the currency shortage and: a) helped those systemically important debtor countries that were under pressure to repay their debts; b) pushed up asset prices; c) stimulated the economy. Leaders who come to power during such times often implement many shocking fiscal reforms, which I cannot elaborate on here, but I can assure you that these periods often lead to significant conflicts and massive transfers of wealth. Take Roosevelt as an example; these circumstances led to a series of major fiscal policy reforms aimed at transferring wealth from the top to the bottom (for example, raising the top marginal income tax rate from 25% in the 1920s to 79%, significantly increasing estate and gift taxes, and greatly expanding social welfare programs and subsidies). This also resulted in significant conflicts both within and between nations.

This is the typical dynamic. Throughout history, countless leaders and central banks in too many countries over too many years have repeatedly made the same mistakes, and I simply cannot enumerate them all here. By the way, before 1913, the United States did not have a central bank, and the government did not have the power to print money, making bank defaults and deflationary economic depressions more common. In either case, bondholders would suffer losses, while gold holders would profit significantly.

While the example from 1927-33 illustrates the classic bubble-bust cycle well, it is one of the more extreme cases. You can see the same dynamics in the situations that led President Nixon and the Federal Reserve to do exactly the same thing in 1971, as well as in nearly all other bubbles and depressions (for example, Japan in 1989-90, the internet bubble in 2000, etc.). These bubbles and depressions also have many other typical characteristics (for example, the market is very welcoming to inexperienced investors who are attracted by the hype, buy on leverage, suffer heavy losses, and then feel angry).

This dynamic pattern has existed for thousands of years (i.e., the demand for money exceeds supply). People have to sell wealth to obtain currency, bubbles burst, followed by defaults, currency issuance, and poor economic, social, and political consequences. In other words, the imbalance between financial wealth and the amount of currency, as well as the act of converting financial wealth (especially debt assets) into currency, has always been the root cause of bank runs, whether in private banks or government-controlled central banks. These runs either lead to defaults (which mostly occurred before the establishment of the Federal Reserve) or prompt central banks to create money and credit to provide to those critical, too-big-to-fail institutions to ensure they can repay loans and avoid bankruptcy.

So, remember:

When the promises to pay currency (i.e., debt assets) far exceed the amount of currency in existence, and there is a demand to sell financial assets to obtain currency, be wary of a bubble burst and ensure you are protected (for example, do not have significant credit risk exposure and hold some gold). If this occurs in the presence of a significant wealth gap, be alert to major political and wealth changes, and be sure to take precautions Although rising interest rates and tightening credit have always been the most common reasons for selling assets to obtain the necessary currency, any reason that creates demand for currency—such as a wealth tax—and the sale of financial wealth to obtain that currency can trigger this dynamic.

When there is a significant wealth/currency gap alongside a substantial wealth gap, this should be viewed as a very dangerous situation.

From the 1920s to Today

(If you do not want to read a brief description of how we got from the 1920s to today, you can skip this part.)

While I mentioned how the bubble of the 1920s led to the depression and Great Depression of 1929-33, to give you a quick overview of the latest situation, that depression and the subsequent Great Depression led President Roosevelt to default on the U.S. government's promise to deliver hard currency (gold) at the promised price in 1933. The government printed a large amount of currency, and the price of gold rose by about 70%. I will skip over how the reflation from 1933-38 led to the tightening in 1938; how the "recession" of 1938-39 created the conditions for economic and leadership, combined with the geopolitical dynamics of the rise of Germany and Japan challenging the Anglo-American dominance, which led to World War II; and how the classic long-cycle dynamics took us from 1939 to 1945 (when the old monetary, political, and geopolitical order collapsed, and a new order was established).

I will not delve into the reasons, but it is worth noting that these factors led to the U.S. becoming very wealthy (at that time, the U.S. held two-thirds of the world's currency, all of which was gold) and powerful (the U.S. created half of the world's GDP and was the military hegemon at the time). Therefore, when the Bretton Woods system established a new monetary order, it was still based on gold, with the dollar pegged to gold (other countries could buy gold at $35 per ounce with the dollars they obtained), and other countries' currencies were also pegged to gold. Then, from 1944 to 1971, U.S. government spending far exceeded tax revenues, leading to massive borrowing, and these debts were sold, creating gold claims far exceeding the central bank's gold reserves. Seeing this situation, other countries began to exchange their paper currency for gold. This led to extreme monetary and credit tightening, prompting President Nixon in 1971 to follow Roosevelt's example from 1933, once again devaluing fiat currency relative to gold, causing gold prices to soar. Needless to say, since then, a) government debt and debt servicing costs have risen sharply relative to the tax revenues needed to repay government debt (especially during the 2008-2012 period following the global financial crisis and after the financial crisis triggered by the COVID-19 pandemic in 2020); b) income and value gaps have widened to the extent that they have caused irreconcilable political divisions; c) the stock market may be in a bubble, and the formation of this bubble is driven by speculation on new technologies supported by credit, debt, and innovation.

The chart below shows the income share of the top 10% relative to the bottom 90%—you can see that this gap is very large today

Where We Stand Now

The governments of the United States and all other heavily indebted democracies are now facing a dilemma: a) they cannot increase debt as they did before; b) they cannot significantly raise taxes; c) they cannot drastically cut spending to avoid deficits and rising debt, leaving them in a bind.

To explain in more detail:

• They cannot borrow enough money because there is not enough free market demand for their debt. (This is because they are already over-leveraged, and debt holders have too much of their debt.) Additionally, international holders of other countries' debt assets are concerned that conflicts similar to wars may prevent them from recovering their funds, thus diminishing their willingness to purchase bonds and shifting their debt assets towards gold.

• They cannot raise taxes sufficiently because if they tax the top 1-10% (who hold most of the wealth), a) these individuals will leave, taking their tax contributions with them, or b) politicians will lose the support of the top 1-10% (which is crucial for funding expensive campaigns), or c) they will burst the bubble.

• They cannot cut spending and welfare sufficiently because it is politically, and perhaps morally, unacceptable, especially since these cuts would disproportionately affect the bottom 60%...

...so they are stuck.

This is why all heavily indebted, wealthy, and ideologically diverse democratic governments are in a predicament.

Given these conditions, the way democratic political systems operate, and human nature, politicians promise quick fixes, fail to deliver satisfactory results, and are swiftly ousted, replaced by new politicians who also promise quick fixes, fail, and are replaced, and so on. This is why the UK and France (both of which have systems that allow for rapid leadership changes) have each replaced their prime ministers four times in the past five years.

In other words, what we are witnessing now is a classic pattern typical of this stage in the long cycle. Understanding this dynamic is crucial, and it should now be quite clear.

Meanwhile, the stock market and wealth prosperity are highly concentrated in the top AI-related stocks (such as the seven giants) and a handful of super-rich individuals, while AI is replacing human labor, exacerbating the wealth/money gap and the disparity between individuals. This dynamic has occurred multiple times in history, and I believe it is highly likely to provoke a strong political and social backlash, at the very least significantly altering the wealth distribution landscape, and in the worst-case scenario, potentially leading to severe social and political unrest.

Now let’s examine how this dynamic and the enormous wealth gap together pose problems for monetary policy and may lead to a wealth tax, thereby bursting the bubble and causing a depression.

Data Situation

I will now compare the top 10% of wealth and income with the bottom 60% of wealth and income. I chose the bottom 60% because they make up the majority of the population In short:

• The wealthiest (top 1-10%) possess far more wealth, income, and stock ownership than the majority (bottom 60%).

• Most of the wealth of the richest comes from the appreciation of their wealth, which is not taxed until it is sold (unlike income, which is taxed when earned).

• With the boom in artificial intelligence, these gaps are widening and may expand at an accelerated pace.

• If wealth is taxed, it will require the sale of assets to pay the taxes, which could burst the bubble.

More specifically:

• In the United States, the top 10% of households are well-educated and economically productive individuals who earn about 50% of total income, own about two-thirds of total wealth, hold about 90% of all stocks, and pay about two-thirds of federal income taxes, all of which numbers are steadily increasing. In other words, they are doing well and contributing significantly.

• In contrast, the bottom 60% are less educated (for example, 60% of Americans read below a sixth-grade level), have relatively low economic productivity, collectively earn only about 30% of total income, own 5% of total wealth, hold about 5% of all stocks, and pay less than 5% of federal taxes. Their wealth and economic prospects are relatively stagnant, leaving them feeling financially constrained.

Of course, there is immense pressure to tax wealth and money and redistribute wealth and money from the wealthiest 10% to the poorest 60%.

While we have never imposed a wealth tax, there is now significant pressure at both the state and federal levels to implement such a tax. Why was it not taxed before, and why is there a push for a wealth tax now? Because money is concentrated in wealth—meaning that the wealth growth of most top-tier individuals does not come from labor income but from their untaxed wealth growth.

There are three major issues with a wealth tax:

1. The wealthy can choose to relocate, and if they do, they take their talents, productivity, income, wealth, and tax contributions with them, reducing these factors in the places they leave and increasing them in the places they move to;

2. Wealth taxes are difficult to implement (the reasons you may know, and I don't want to digress, as this article is already too long);

3. Wealth taxes divert funds from investments that finance productivity-enhancing activities to the government, based on a less likely assumption that the government can manage these funds properly to make the bottom 60% productive and prosperous.

For these reasons, I would prefer to see a tolerable tax on unrealized capital gains (for example, a 5-10% tax). But that is another topic for discussion later.

P.S.: So how would a wealth tax work?

In future articles, I will discuss this issue more comprehensively. Just to note, the balance sheets of American households show about $150 trillion in total wealth, but less than $5 trillion of that is cash or deposits. Therefore, if a 1-2% annual wealth tax were imposed, the annual cash demand would exceed $1-2 trillion—and the liquid cash pool is not much larger than that Any similar practices will burst the bubble and lead to economic collapse. Of course, the wealth tax will not be levied on everyone, but only on the wealthy. This article is long enough, so I won't elaborate on the specific numbers. In short, the wealth tax will: 1) trigger forced sell-offs of private equity and publicly listed equity, depressing valuations; 2) increase credit demand, potentially raising borrowing costs for the wealthy and the entire market; 3) encourage the offshore transfer of wealth or relocation to regions more favorable to the government. If the government imposes a wealth tax on unrealized gains or illiquid assets (such as private equity, venture capital, or even concentrated holdings of publicly listed equity), these pressures will become particularly severe