By William Watts
That’s billionaire investor Ray Dalio, founder of hedge fund giant Bridgewater Associates, explaining in a Wednesday post on LinkedIn why the economy hasn’t slowed more convincingly since March of last year, despite an aggressive round of rate hikes by the Federal Reserve and other monetary tightening.
“As a result of this coordinated government maneuver, household balance sheets and income statements are in good shape while the government’s are in bad shape,” Dalio wrote.
Last week’s data showed the resilient US economy grew 2.4% annually in the second quarter, driven by resilient consumer spending and a rebound in business investment.
In the US and around the world, governments ran large budget deficits in 2020 and 2021, and still are, while central banks bought boatloads of bonds. Then, in 2022, as inflation soared and unemployment remained low, there was a move toward “less insanely easy fiscal policy,” Dalio said, as central banks move away from insanely easy monetary policies toward negative real ones led to bond returns.
When both stocks and bonds plummeted last year, “private sector net worth rose to high levels, the unemployment rate fell to low levels and wages rose sharply, leaving the private sector faring much better while central governments did much borrowed more.” And central banks and other government bondholders lost a lot of money on those bonds,” Dalio said.
Dalio argued that the historical record of similar episodes set off loud alarm bells.
In the short term, however, a period of “tolerably slow growth and reasonably high inflation” – or “slight stagflation” – is the most likely outcome, barring a large imbalance between the supply and demand for government debt.
But over the longer term, “central government budget deficits are all but certain to be large, and it is very likely that they will grow at an accelerating rate as rising debt servicing costs and rising other fiscal costs intensify and, if they rise, governments will have to sell more debt, leading to a self-reinforcing debt spiral leading to market-imposed debt limits, while central banks will be forced to print more money and buy more debt as they suffer worsening losses balance sheets,” he warned.
Dalio’s comments come a day after Fitch Ratings downgraded the US credit rating from AAA to AA+. U.S. stocks, which were on a strong uptrend, paused their rally, with the S&P 500 SPX falling around 1.3%, while the Dow Jones Industrial Average DJIA was down around 330 points, or 0.9%.
Watch: What Fitch’s US credit rating downgrade means for investors
-William Watts
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08-05-23 1233ET
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