Ray Dalio, co-chairman and co-chief investment officer of Bridgewater Associates, speaks during the Skybridge Capital SALT New York 2021 conference.
Brendan McDermid | Reuters
As the US Federal Reserve made its first interest rate cut since the start of the Covid pandemic, billionaire investor Ray Dalio pointed out that the US economy is still struggling with a “tremendous debt burden”.
The central bank's decision to cut the key interest rate by 50 basis points to a range of 4.75% to 5%. The interest rate not only determines the short-term borrowing costs for banks, but also affects various consumer products such as mortgages, car loans and credit cards.
“The challenge for the Federal Reserve is to keep interest rates high enough that they are good for the creditor, but at the same time not to keep them so high that they become problematic for the debtor,” the founder of Bridgewater Associates told CNBC's “Squawk Box Asia” on Thursday, pointing out the difficulty of this “balancing act.”
The U.S. Treasury Department recently reported that the government has spent more than $1 trillion on interest payments on its $35.3 trillion national debt this year. This increase in debt service costs also coincided with a sharp increase in the U.S. budget deficit in August, which is approaching the $2 trillion mark for the year.
On Wednesday, Dalio named debt, money and the business cycle as one of the five most important forces affecting the global economy. On Thursday, he expanded on his point, saying he was generally interested in “the enormous amount of debt created by governments and monetized by central banks. It's never been seen on such a scale in my lifetime.”
During the pandemic, governments around the world have taken on record levels of debt to finance stimulus packages and other economic measures to prevent collapse.
When asked about his forecast and whether he expected an impending credit event, Dalio replied that this was not the case.
“I see a big devaluation of this debt through a combination of artificially low real interest rates, so you don't get compensated,” he said.
Although the economy is “in relative equilibrium,” Dalio said, there is an “enormous” amount of debt that needs to be rolled over and sold – new debt created by the government.”
Dalio's concern is that neither former President Donald Trump nor Vice President Kamala Harris will make debt sustainability a priority, meaning these pressures are unlikely to ease regardless of who wins the upcoming presidential election.
“I think over time the path will increasingly be towards monetization of this debt, a path very similar to that of Japan,” Dalio postulated, referring to how the Asian country has kept interest rates artificially low, which Japanese Yen and lowered the value of Japanese bonds.
“The value of Japanese bonds has fallen by 90 percent, so artificially lowering the yield every year creates a huge burden,” he said.
For years, the Japanese central bank stuck to its negative interest rate regime and launched one of the most aggressive monetary easing measures in the world. It was only in March of this year that the country's central bank raised interest rates.
Additionally, if there are not enough buyers in the markets for the supply of debt, we could end up with a situation where interest rates have to rise or the Fed has to step in and buy bonds, which Dalio said would be the case.
“I would [the] Fed intervention as a very significant negative event,” said the billionaire. The oversupply of debt also raises the question of how it will be paid.
“If we were operating in hard currency, we would have a credit event. In fiat currency, on the other hand, central banks would buy up this debt and thus monetize the debt,” he said.
Dalio believes that in this scenario, the markets would also see a decline in all currencies, as they are all relative.
“So I think you're going to find an environment very similar to the 1970s or the 1930-1945 period,” he said.
As for his own portfolio, Dalio insists he doesn't like debt: “So if I were to try one thing, it would be to underweight debt like bonds,” he said.
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